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I tried a search with google but I can't find a clear definition of what a Heat Rate Option is. I would appreciate if someone could explain to me what this type of option is. My understanding is that it has to do with energy options but I am not sure on the underlying.

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up vote 5 down vote accepted

That's a complicated subject. Unless you're on the trading desk of a power/chemical/refinery company, you probably won't find much information. In addition, if your company doesn't have the "marginal" (best) equipment, such that you compete on efficiency/price, you'll only watch from the sidelines.

Here's a previous discussion:

http://www.wilmott.com/messageview.cfm?catid=3&threadid=54982

Keep in mind that some plants produce electricity by simply burning coal. Some by gas fired turbines with secondary heat recovery. Some by other means. And, some of those plants produce only power while others produce products (power is a sideline). The economics of each plant is different, and those numbers change rapidly. As a result, pricing a plant specific heat rate versus a market heat rate can be a real humbling experience.

I've watched that game from the sidelines long enough to know that I don't know anything about it.

Edit 1 ======================

Some additional links:

http://nodal.ercot.com/docs/tntarc/mo/CAHeatRates.pdf

http://www.potomaceconomics.com/uploads/ercot_reports/2010_02_ERCOT_IMM_Monthly_Report.pdf

http://www.owlnet.rice.edu/~inal/energy/ManualForEnergyEconStudent.pdf

http://www.ferc.gov/market-oversight/mkt-electric/texas.asp

http://math.stanford.edu/~valdo/papers/siam.pdf

http://www.capitolareaenergy.com/index.php/capitol/electricity

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bill_080 Thank you very much for the response. The documents you provided look promising on getting at least basic understanding of the issue. –  Financial Economist Aug 17 '11 at 14:01

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