In some U.S.
markets, efficient combined-cycle natural gas fired power plants are
showing signs of improved profitability while, in others, earning
power has remained weak. The primary driver of this improvement is
rising gas prices, not strengthening market fundamentals. Although
the effect on the bottom line is the same, improvement that is not
driven by the fundamental market structure is less comforting to
long-term credit ratings because gas prices are very volatile.
The concept that high natural gas prices improve profitability
for natural gas-fired units is counterintuitive. For a typical
business, margins improve as the price of its primary input
decreases, but the opposite is true of gas-fired power plants. For a
power plant operating in a competitive electricity market, its
variable cost of generation is the key determinant of whether it
will be dispatched and be profitable. Natural gas fired plants will
only be dispatched when all available baseload units are operating
and there remains additional demand for electricity. When this
occurs, it is said that natural gas is the "marginal fuel" or is "on
the margin".
Typically, the least efficient plant to be dispatched will set
the price of electricity. A power plant's efficiency is defined by
its heat rate, a measure of the amount of fuel necessary to produce
a kilowatt-hour (kWh) of electricity. When natural gas is on the
margin, the implied market heat rate can be calculated by dividing
the price of electricity by the price of natural gas. As demand
increases, implied market heat rate increases (if no new generating
units are added), and a plant's profitability will improve.
Operating margin or net revenue is simply price minus variable
cost. Ignoring differences in variable operations and maintenance
(O&M) across natural gas-fired units, which would have a negligible
effect on relative profitability, the following relationships emerge
(see below).
