Table of Contents

Spark Spread: What It Is and How It's Used

By

The Investopedia Team

Updated July 11, 2024

Reviewed by Charles Potters

Fact checked by

Yarilet Perez

Close-Up Of Hand Using Mobile Phone — Chuanchai Pundej / EyeEm / Getty Images

What Is the Spark Spread?

The spark spread is the difference between the wholesale market price of electricity and its cost of production using natural gas. The spark spread can be negative or positive. When negative, the utility company posts a loss, but if it is positive, it posts a gain. This measure helps utility companies determine their bottom lines.

Key Takeaways

The spark spread is a method to determine how profitable natural gas-fired electric generators are.
The spread is the difference between the wholesale market price of electricity and the cost of production using natural gas.
When the spread is negative, the utility company takes a loss, but when the spread is positive, the company sees a profit.

Understanding the Spark Spread

The spark spread is a means of estimating the profitability of a natural gas-fired electric generator. It is the difference between the input fuel costs and the wholesale power price. The spark spread is calculated using daily spot prices for natural gas and power at various regional trading points.

The spark spread can be calculated as:

Spark Spread = Power Price ($/MWh) – [Natural Gas Price ($/mmBtu) * Heat Rate (mmBtu/MWh)]; MWh represents megawatt-hours and MMBtu is a Million British thermal units.

Spark spreads are volatile because of the volatility of wholesale electric power prices, which are volatile because of changes in demand and availability of electricity. Additionally, spark spreads vary by region. New York has high average spark spreads, while the Pacific Northwest has low average spark spreads, for example.

Low average spark spreads in the Pacific Northwest are a result of an ample supply of low-cost hydropower.

Evaluating Spark Spreads

A vital component of the spark spread equation is the heat rate of an electric generating unit. The heat rate is the efficiency of the generator. The heat rate of a generator is measured against a benchmark, which can be seen via the Energy Information Administration's daily price tables for various energy products.

The relationship between natural gas prices and wholesale electricity prices is demonstrated through the spark spread. The higher the spark spread, the more profitable a natural gas-fired plant. In New York City, spark spreads waver due to the volatility of wholesale electricity and natural gas prices.

Example of the Spark Spread

In 2022 (latest information), NYC spark spreads were occasionally negative as fuel prices outstripped the cost of electricity, making running a natural gas-fired plant unprofitable during periods of low wholesale electricity prices and high natural gas prices.

Federal Energy Regulatory Commission - NYC Spark Spread 2020-2022 — Source: Federal Energy Regulatory Commission - Derived from S&P Global Platts data. Uses Transco Z6 NYC gas prices with Zone J Day-ahead electricity prices. Uses a heat rate of 7,000 Btu/kWh.

Source: Federal Energy Regulatory Commission

Limitations of the Spark Spread

The primary limitation of the spark spread is that it does not take into account other costs related to electricity generation. Other costs could include pipeline costs, fuel-related finance charges, maintenance costs, operational costs, and taxes. For this reason, the spark spread is better viewed as a gauge of market conditions rather than a strict measure of the profitability of a power generator.

How Do Investors Use Spark Spreads?

"Spark spread" is also the name of a trading strategy based on differences in the price of electricity and its cost of production. Investors attempt to profit from changes in the spark spread through over-the-counter trading in electricity contracts. Energy derivatives allow investors to hedge against or speculate on changes in electricity prices.

What Is a Dark Spread?

When measuring the electric power generation fueled by natural gas, the difference in cost is the spark spread. When analyzing coal, the difference is called the dark spread.

What Do Spreads Indicate for Electricity Consumers?

Changes in spark spreads in an electricity power market indicate the operational competitiveness of natural gas-fired electric generators in meeting electricity demand.

What Is the Spark Spread Margin?

The spark spread represents a theoretical profit margin for a power plant. A positive spark spread indicates that the price of power is higher than the cost of fuel, which would mean there is a positive spark spread margin. Conversely, if the price of power is below the cost of fuel, then there is a negative spark spread margin.

The Bottom Line

The spark spread represents the difference between the wholesale market price of electricity and the cost of production using natural gas. Investors can attempt to profit from changes in the spark spread through over-the-counter trading in electricity contracts.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.

U.S. Energy Information. "An Introduction to Spark Spreads."
Federal Energy Regulatory Commission. "State of the Market," Pages 12-13.

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