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.

Every key term, A to Z

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.