From the February 01, 2012 issue of Futures Magazine • Subscribe!

Trading power to spark profits

The spark spread represents the theoretical margin of electric power producers. Its understanding can reveal several speculative opportunities that traders can use to expand their market activity.

There are several fundamental methods of transforming various energy forms into electrical energy. These include static electricity, electromagnetic induction, electrochemical effect, photoelectric effect, thermoelectric effect, piezoelectric effect and nuclear transformation. The electromagnetic induction method has the widest commercial application today.

In electromagnetic induction, an electromagnetic generator transforms kinetic electric energy (energy of motion) into electricity. This process involves conversion of energy generated by rotating turbine blades that usually are driven by heat engines. Heat engines, by burning different fuels, heat water and transform it into a vaporized state, thereby producing steam that puts turbine blades into motion. Fuels used in heat engines include coal, natural gas, oil and biomass. Even nuclear power plants make use of nuclear decay energy to transform water into steam, which drives turbine blades.

Apart from heat engines, turbines also are powered by the energy of falling water (hydroelectric power plant) and wind (wind turbines). Recently, an electricity generation method using photovoltaics, in which solar energy is directly converted into electric power by special silicon cells, has become increasingly common.

Electric market makeup

The electric power market is quite diversified, featuring a host of independent companies, both privately and state owned. This market has two components: Wholesale and retail.

In the wholesale market, companies generating electric power sell it to retail resellers. End consumers, as a rule, do not participate in this market, although recently, on the back of an ongoing liberalization of the market, some major users, such as aluminum smelters, have started buying electricity directly from power generating companies. Retail market players resell electric power directly to end consumers, such as businesses and private individuals.

Alongside generating companies and retailers are independent operators of transmission systems, which control electric power distribution across the entire system. Recently, several countries have set up electricity exchanges that serve as trading floors where electric power suppliers and consumers can sell and buy power and hedge their risks. Apart from electricity exchanges, there are also futures contracts traded on CME Group’s New York Mercantile Exchange (Nymex), the IntercontinentalExchange and others. Furthermore, there is a highly developed over-the-counter (OTC) market that allows its participants to efficiently handle these tasks.

All these options stir up competition, eventually reducing electricity prices for end consumers. However, because population represents the primary electric energy consumer, the government monitors pricing in this market and interferes in it, where necessary, by putting caps on prices or, vice versa, taking measures to support producers.

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