Last time I described the crack spread, which reflects the relationship between the price of crude oil and the prices of its refined products, but many more spreads are being used in the energy markets.
Cross trading can be achieved by trading spreads like the WTI crude versus Brent crude, whereby traders buy one and sell the other. The setting up of such positions aims at buying undervalued products and selling overpriced products.
After the initial trade, the trader waits for the prices to develop in the way he anticipated and then he liquidates the position. What is left, in the case of a positive scenario, is a positive cash balance.
With spreads, like WTI versus Brent, traders don't need to pay the full amount of margin. In fact, margins are mainly offset. How much will be offset and what is left to deposit (cross margin) depends on the allocated correlation between two products.
As from May 1st you may consider using Oman-backed futures. These instruments (including some cross spreads) will be listed on DME when it begins these activities after April 2007.
Besides crack spreads, there are also many more spreads, crush spreads being just one of them. Crush spreads are also price comparisons between crude products and refined products. However, we talk about crush spreads when the crude products are soybeans and the derived products are soy meal and soy oil.
Obviously, the price of the derived products greatly depends on the basic product, although sometimes the correlation varies. Traders can profit these variations by, for instance, going long soy beans and short soy meal and/or soy oil.
Soy oil can be used for energy purposes (bio-energy). There are many more energy products, ranging from oil and gas, to coal, uranium and electricity.
Electricity is produced in power plants. These plants use various forms of energy; most use coal because the coal price is relatively low. Gas, however, is used in countries that own a lot of gas fields (like the Netherlands).
Since the rise in the oil price, and because of environmental issues like climate change due to emissions of pollution gasses, nuclear power is gaining support. Uranium prices have gone sky high, and mergers and acquisitions in this sector seem to be very popular these days.
Again, the variety of spreads in the energy markets is huge. The spark spread is another example.
It is the theoretical net income of a gas-fired power plant from the selling of a unit of electricity, after having bought the fuel required to produce that unit of electricity. All other costs, including operation, maintenance and capital costs must be covered from the spark spread.
In formula: Spark spread = (Electricity price - Gas price) / Power plant efficiency
The dark spread is comparable to the spark spread, the difference being that this time the power plant is fired with coal instead of gas.
Countries that have ratified the Kyoto protocol are faced with the situation that their power plants also have to consider the costs of carbon dioxide emissions allowances which will be under a cap and trade regime. Trading emission allowances began in the European Union in 2005.
Clean spreads reflect the net revenues. A clean spark spread represents the net revenue a generator makes from selling power, after having bought gas and the required number of carbon allowances.
Whereas part of the carbon allowances is provided to the power plants operators for free, any production of electricity will require the purchase of carbon allowances. Similarly, a clean dark spread is an indicator that refers to the coal-fired generation of electricity.