Spark Spread

Discussion in 'Commodity Futures' started by taxman, Mar 2, 2007.

  1. taxman


    I searched but couldn't find the information I was looking for...

    First, is there a pre-packaged spark spread product offered?

    Second, if I were to go long natural gas and short electricity (this would be considered a spark spread right?) would I be correct in assuming these positions ordinarily vary inversely?

    Third, for positions like this (that ordinarily vary inversely) would the aggregate margin requirements be lower than the sum of margin requirements for each of the positions when held seperately?



    Just stumbled across this and since no one else has responded I will take a crack at it. I do not trade the spark spread, but know of it and believe that any long/short combination of gas to power, coal to power, or heating oil to power would be a spark spread.

    I don't know if there is a spark spread product, but my guess is that there is not. If there is it would most likely be on ICE since that is where the bulk of power contracts trade (Clearport on NYMEX also offers them, but from what I understand it is an illiquid market).

    Whether they vary inversely I also don't know, but as far as weather conditions affecting them goes, I would think they would track each other closely, all other things equal. Excessive cold and excessive heat both increase the demand for both gas and power (admittedly heating oil is not typically affected by heat waves).

    Finally, on the cross margining issue, as long as you are trading both commodities on the same exchange, you should get some cross margining credit if you are long one and short the other. If you were trading natty on the NYMEX and power on ICE I wouldn't expect any cross margining to be done since they are competitors, but as long as both were done on the same exchange I would not expect that you would have to put up the full margin requirement for both positions.

    There's my best effort, and if this is all stuff you already knew, my apologies. Good luck with it and I'd be interested to hear what else you find out. Like I said hopefully now someone who knows more will offers their wisdom...
  3. I haven't traded power in a few years but last I knew there isn't a prepackaged spark spread because by simply looking at natty vs power you're leaving out a significant variable, the heat rate, which varies from plant to plant. Having said that you can get quotes from an OTC broker but they're not quoted regularly.

    What you're talking about doing is a "dirty" spark spread. To do this you determine the avg heat rate of power plants in a given region then based on the heat rate you put on a position using a power swaps vs gas swaps. For obvious regions you also need to determine what % of plants in the respective region are served by coal, heating oil, etc. As an example, if you have a view on power vs. natty in NYC, you would need to determine the avg heat rate of plants in NYISO Zone J and then run your numbers and take a position in NYISO Zone J vs. Transco Z6NY.

    I think there's a spark spread calculator on the NYMEX website.

    Taking a view on what happens ordinarily is what causes blow ups and many have lost their shirts being on the wrong side of a spark spread.

    Regarding margins, you should be able to find cross commodity margins on the NYMEX website but best bet is to call your clearing firm and ask them the margin requirements for a specific trade, that's the only way to get the correct answer.

    Last but not least remember that if you want to trade spark spreads that you're going up against elephants usually own assets/manage load and have deep pockets.
  4. contango


    The factors that go into the spark spread formula are power, natgas, conversion rate (heat rate) and plant efficiency. Each individual plant will therefore have it's own spark spread. In Europe you also need to factor in currency exchange rates and carbon prices i.e. if you're interested in the "clean spark spread". The "clean dark spread" is the generator's margin from burning coal, considering the carbon costs as well. If you're long the spark spread then you're long power and short gas i.e. the natural position for a generator.