Heat Rate
Executive Summary
Key Takeaways
- ✓ Heat rate expresses the amount of fuel energy input required to generate one unit of electricity output, the standard efficiency metric for thermal and other fuel-based generation.
- ✓ A lower heat rate indicates a more fuel-efficient plant, since less fuel input is required per unit of electricity produced.
- ✓ Heat rate directly determines a plant's marginal cost of generation, which in turn determines its position in a merchant electricity market's merit-order dispatch.
- ✓ Heat rate should be modelled with reference to the specific unit's actual tested or manufacturer-specified performance, not a generic technology-class average, since actual performance can vary materially between units of the same nominal technology.
- ✓ Heat rate typically degrades slightly over an asset's operating life and, where material, should be reflected as an explicit assumption rather than held constant across the full modelled life.
Definition¶
Heat rate expresses the amount of fuel energy input required to generate one unit of electricity output, the standard efficiency metric for thermal and other fuel-based generation, typically expressed in units of fuel energy (such as BTU or kJ) per kilowatt-hour of electricity generated.
Why It Matters for Marginal Cost¶
Heat rate, combined with the applicable fuel price, determines a plant's marginal cost of generation — the incremental cost of producing one additional unit of electricity. A lower heat rate means less fuel is required per unit of output, giving the plant a lower marginal cost at any given fuel price.
Relationship to Merit-Order Dispatch¶
In a merchant electricity market, generation is dispatched in order of increasing marginal cost until forecast demand is met — the merit order. A plant's heat rate is therefore a direct input into where it sits in this order, affecting both how frequently it is dispatched and, since the market clearing price is typically set by the marginal dispatched unit, the price it realizes. See Electricity Market Fundamentals for how merit-order dispatch should be represented in a model.
Unit-Specific, Not Technology-Class Average¶
Heat rate should be modelled with reference to the specific unit's actual tested or manufacturer-specified performance, not a generic technology-class average. Actual heat rate performance can vary materially between individual units of the same nominal technology and vintage, due to design differences, operating conditions, and maintenance history, and a technology-class average can materially misstate a specific plant's actual marginal cost position.
Degradation Over the Asset's Life¶
Heat rate typically degrades slightly as equipment ages. Where this degradation is material to the plant's economics or its position in the merit order over the model's full projection period, it should be reflected as an explicit assumption rather than held constant throughout the asset's modelled life.
Audit Considerations¶
- Confirm heat rate is sourced from the specific unit's tested or manufacturer-specified performance, not a generic technology-class average.
- Confirm heat rate and applicable fuel price are combined explicitly to derive marginal cost, feeding the merit-order dispatch assumption where relevant.
- Confirm any heat rate degradation over the asset's life is modelled explicitly where material, rather than assumed constant.
Common Errors¶
| Error | Description | Risk |
|---|---|---|
| Generic technology average used | A class-average heat rate applied instead of the specific unit's actual performance | Misstates the plant's actual marginal cost and dispatch position |
| Heat rate degradation ignored | Heat rate held constant across the full asset life despite material expected degradation | Understates long-term fuel cost and marginal cost |
| Disconnected from dispatch modelling | Heat rate calculated but not linked to the merit-order or dispatch assumption | Marginal cost calculated but not used to inform realized dispatch and price |
Continue Reading¶
Prerequisites¶
- Merchant Power Models — the parent guide
- Energy Financial Modelling
Related Technical Guides¶
Related Glossary¶
How OXXON tests thisRun a free structural check with FMAE
Frequently Asked Questions
What is heat rate?
The amount of fuel energy input required to generate one unit of electricity output, the standard efficiency metric for thermal and other fuel-based generation — typically expressed in units of fuel energy (such as BTU or kJ) per kilowatt-hour of electricity generated.
Why does a lower heat rate matter?
A lower heat rate means less fuel input is required to produce the same unit of electricity, indicating a more fuel-efficient plant with a lower marginal fuel cost per unit of output.
How does heat rate relate to merit-order dispatch?
A plant's heat rate, combined with its fuel price, determines its marginal cost of generation, which is the basis on which merchant electricity markets order dispatch — lower-marginal-cost (typically lower heat rate) plants are dispatched before higher-marginal-cost plants, directly affecting both dispatch frequency and realized price — see Electricity Market Fundamentals.
Should heat rate be modelled as a technology-class average or a unit-specific figure?
Unit-specific, referencing the actual tested or manufacturer-specified performance of the specific plant being modelled, since actual heat rate performance can vary materially between individual units of the same nominal technology and vintage.
Does heat rate change over an asset's operating life?
Typically it degrades slightly as equipment ages, and where this degradation is material to the plant's economics or dispatch position over its modelled life, it should be reflected as an explicit assumption rather than held constant throughout.
Related Articles
Merchant Power Models
Merchant power revenue is sold at prevailing market price rather than under a fixed-price contract, carrying genuine, undetermined price risk that a static assumption understates. This guide covers how to build merchant exposure into a power project model: constructing a forward price curve, testing an explicit sensitivity range around it, representing any hedging arrangement, and modelling the merchant tail that follows PPA or contract expiry.
Electricity Market Fundamentals
Electricity markets are structured as regulated (tariff-set), merchant (wholesale-price), or hybrid arrangements, and the specific market a power project sells into determines how its revenue and dispatch are actually set. This guide covers the market-structure fundamentals a power project financial model needs to represent: tariff-setting and cost-of-service regulation, wholesale market and merit-order dispatch, and the hybrid structures — capacity markets, contracts for difference — that combine elements of both.
Levelized Cost of Energy
Levelized cost of energy (LCOE) expresses the average discounted cost of generating one unit of electricity over an asset's operating life, combining capital cost, operating cost, and expected output into a single comparable figure. It is the standard metric for comparing generation cost across technologies and projects on a like-for-like basis, independent of each project's specific financing or contract structure.