Question

Suppose you are the CFO of a small Independent Power Producer in western PA (which is part of the PJM Electricity Grid (PA Jersey Maryland)). Your main business is to purchase natural gas and convert it to electricity for sale on the grid. You recently looked into PJM Western Hub futures contracts and natural gas futures that trade on the CMEGroup exchange.

Assumptions
Natural Gas Input	60,000,000	MMBtu's / Six Months
Megawatt Hours Generated	9,000,000	MWh / Six Months
Price of Power Futures (N9) Sold	$              19.00	$/MWh
Price of NG Futures Purchased	$                2.00	$/MMBtu

If the spot price of NG is also $2.00, what is the minimum spot rate for electricity at which the plant should generate electricity?

Ignoring the basis, how much profit can you "lock in" given current futures prices (in $/MWh)?

Answer 1

Solution:

Natural Gas Input	60,000,000	MMBtu's / Six Months
Megawatt Hours Generated	9,000,000	MWh / Six Months
Price of Power Futures (N9) Sold	$              19.00	$/MWh
Price of NG Futures Purchased	$                2.00	$/MMBtu

60,000,000  MMBtu's of Natural gas produces 9,00,000 MWh of electricity

So 1 unit of MMBtu's of Natural gas produces 9,00,000 /60,000,000 MWh of electricity = 0.15

So the prices should be based on these ratios

Price of NG future = 2, and spot price = 2

Since basis is zero so spot and future price is same

Price of Power spot rate = 2 / 0.15 = $13.33 / MWh

Since future price is more than the spot price

so we can short the Future at 19 and earn a profit of (19-13.33 ) = $5.67/ MWh