Power Derivatives

A commodity that cannot be stored, priced by the hour

Electricity has to be produced at the instant it is consumed, which changes everything about how it is traded. A power contract specifies not just a price and a quantity but a shape — which hours, over which period — and a hedge that matches the total but not the shape leaves a residual bought and sold at whatever the spot market does. It is the purest case of delivery profile as a risk in its own right.

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What the lesson covers

1. What it is
2. Shape and profile risk
3. The spark spread
4. Why prices behave differently
5. Risks to watch

Key terms

• Baseload block — A constant delivery in every hour of the contract period — 1 MW for 31 days is 744 MWh.
• Peak block — Delivery only in defined weekday daytime hours, when demand and prices are typically highest.
• Shape risk — The residual left when a flat hedge covers the same total energy as a profile that is not flat.
• Heat rate — The gas needed per unit of electricity produced, the inverse of a plant’s efficiency.
• Spark spread — The power price less the fuel cost at a given heat rate — a gas generator’s gross margin.
• Volumetric risk — Exposure to how much is consumed, which moves with price rather than independently of it.

In practice

Utilities, industrial consumers and generators trade blocks for the bulk of the exposure and manage the residual shape with more granular products and with spot. The structural features here — no storage, hourly granularity, volume correlated with price — apply to any market where the product is consumed at the instant it is made.

Read next

• Crack Spread Swap — Hedge the margin between crude and its products
• Commodity Swap — Fixed price for floating market price
• Weather Swap — A payout driven by temperature, not price

In the app, Power Derivatives carries a five-step lesson, a worked example and a bank of twelve questions drawn differently every sitting.

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Educational content only. Nothing here is financial advice, an offer to trade, or a recommendation to buy or sell any instrument.