Clean dark spread holds the key to the future of coal-fired power

The profitability of a power station depends on many factors, several of which can be volatile. The complex interactions between these variables complicate not just operational decisions — such as choosing whether and how a power station should run — but also risk management strategies, especially when it comes to hedging.

To cut through this complexity, the electricity industry has come up with a series of metrics – known as the dark spread – that provide an indication of how profitable a particular power station is likely to be at a given point in time. For generators who own a fleet of power stations, these metrics can assist in determining which of their power plants are likely to be more profitable to run than others.

Shedding light on the dark spread

A power plant fueled by coal uses the dark spread metric. It is calculated by taking the price of electricity­ and subtracting the cost of the coal needed to produce that electricity.

The electricity price will partly depend on the load profile of a power station; for example, whether it runs continuously in baseload mode, whether it only runs during periods of peak demand or some combination of the two.

The coal cost is made up of several components: the cost of the coal at the mine (in $/ton); the cost of transporting the coal to the power station (again, in $/ton); the heat content of the coal (in MMBtu/ton); and the heat rate (in MMBtu/MWh), meaning the amount of heat needed to generate a unit of electricity, a measure of efficiency.

Similar calculations can be made for other fuels. For a natural gas-fired station the metric is called the spark spread, for nuclear power the quark spread and for biomass the bark spread. The two most commonly used are the dark spread and the spark spread — partly because the system marginal price of electricity often is set by either coal or gas power stations, and partly because they are often in direct competition with each other in the merit order.

As useful as these two metrics are, they have their limitations. A generic calculation does not take into account operations and maintenance costs, finance charges and the fixed costs of owning a power plant, such as staff salaries. Coal stations tend to have higher fixed costs than natural gas power stations.

The dark spread also does not account for capacity payments, which are playing an increasingly important role in the economics of power generation in regions where capacity markets are established.

So generic calculations should be seen as indicators of general market trends rather than justifications for running or not running, or indeed investing in particular power plants.

Coal-to-gas switch

In the U.S., trends in dark spreads and spark spreads over the past decade have led to a steep fall in the use of coal for power generation because the shale gas revolution has made natural gas abundant and cheap. This has had two effects: It has pushed down the average wholesale price of electricity, and has made gas increasingly competitive with coal. This shift can be seen clearly in dark spread and spark spread curves.

According to the U.S. Energy Information Administration (EIA), “In 2017, coal consumption by the electric power sector reached its lowest level since 1982.” Meanwhile, gas consumption by the power sector reached a record high in 2016 and fell only slightly in 2017. This meant that in 2017, gas-fired plants generated more electricity (31 percent of the total) than coal plants (30 percent).

Accounting for carbon

In regions of the world where carbon pricing has taken a strong hold — the obvious example being the European Union — the dark spread as calculated above misses out one crucial cost, without which the results are meaningless. That is the cost of GHG emissions.

Therefore, the metric most commonly used in such regions is the clean dark spread. It is calculated by taking the original spread and subtracting from the margin the costs of buying carbon dioxide emission allowances and/or any carbon taxes that apply.

The impact of this can be seen most clearly in the United Kingdom, where, along with the price of emissions allowances under the EU Emissions Trading Scheme (ETS), the clean dark spread factors in a carbon tax called Carbon Price Support.

The result has been that, over the past three years, coal-fired generation in the U.K. has plummeted, as reported by The Guardian. This is mainly because gas-fired power stations emit much less carbon dioxide per unit of power produced than coal-fired stations. Coal is now finding it harder and harder to compete. One consequence is that carbon dioxide emissions in the U.K. have fallen to levels not seen since Victorian times.

So far, the coal-to-gas switch we have seen in the U.S. electric power sector has been mainly due to economic factors. Gas is so cheap and abundant that it is able to compete with coal even in the absence of carbon pricing.

But change is forthcoming. In a recent report, the EIA considers the impact of potential policies that would subject fossil fuel-fired power plants … to fees based on their carbon dioxide emissions.

Good times, bad times

The EIA considers two cases, $15/ton and $25/ton, starting in 2020 and rising in real terms by 5 percent per year. There would be a number of consequences, most marked in the $25/ton case.

Wholesale power prices would rise. Renewables such as wind and solar power would become more competitive. Nuclear power generation capacity would be much higher than in the Annual Energy Outlook Reference case. The impact on dark spreads and clean spark spreads would lead to an acceleration of the coal-to-gas switch in electric power. Over the coming two decades, this would be a positive development for the gas market — less so for coal.