Keeping the Lights On in Texas

In June 2012, I wrote an article for NBIZ Magazine where I described Texas’ “Energy-only” power market structure, quoted industry officials explaining their business model, and warned of failures like those we experienced in February. An excerpt from that article appears below:

[[ Low natural-gas prices create a disincentive for power producers to maintain or retrofit old plants at a time when not many new plants are under construction. This situation is complicating matters for the Electric Reliability Council of Texas (ERCOT), which controls 85 percent of the electricity generated in Texas, and whose main concern at the moment is meeting the projected demand for electricity this summer. Texas experienced rolling blackouts in 2011 during the extremes of cold and heat.

Texas deregulated its power industry in 2002. Some benefits and increases in efficiency in Texas have resulted from deregulation. For instance, some believe that Texas would not have adopted smart grid technology as quickly in a regulated environment. But deregulation has been a mixed blessing for Texas ratepayers. Electric-power rates in Texas are tied to natural-gas prices. In May 2008, high natural-gas prices were cited as the reason for high electricity rates—at a time when natural gas prices were up substantially from the previous year. Now, Texans are asking why electricity rates are still high while natural gas prices are low. And residential consumers are being urged to lock in their rates now, while prices are still “low.”

Texans are also worried about a replay of the events from last August, when “hourly day-ahead” wholesale power rates in Texas climbed to $2,500 per megawatt hour (an average price is around $40 per MW/h). This occurred after a similar wholesale price spike during a cold snap in February 2011. For the rest of the country, whole-sale electricity prices were down, on average, in 2011.

Another issue plaguing ERCOT is Texas’ low reserve-power generating capacity. Rolling blackouts can begin when reserve capacity falls below 12 percent. ERCOT projects that it will have a 14.3 percent reserve capacity in the summer of 2013. Since deregulation, insufficient new generation has been brought online to cope with the increased demand. Power companies have to time the completion of new generation projects carefully. They have a financial incentive to wait until new generation is really needed before bringing it online.

To address this issue, the Texas PUC has tentatively approved raising the cap on wholesale power prices from $3,000 to $4,500 per megawatt hour. This is supposed to create an additional incentive for investors to bring more generation out of mothballs and back online. Explaining this situation at CERAWeek, PUC Commissioner Kenneth Anderson said, “But I think that generation has to have the opportunity, and it really only happens in the summer months … to earn a return on their investment.” Anderson continued, “It’s in the summer months that you’re going to get your return if you’re going to get it at all.”

Investors also recoup faster the more times they hit the PUC-controlled price cap. As Dan Lonergan, Senior Managing Director of Tenaska Capital Management, explained at CERAWeek, “Certainly as we look back on last summer, the market prices that you were able to achieve… on average because of hitting the cap as often as we did made 2011 a very attractive year.” Chris Weston, president and CEO of Direct Energy, also spoke to this point. “Ensuring that we get the right market structure that continues to be successful and to incent the new build of generation is very important.”

The Texas power market is based on an “energy only” structure, meaning that no rules exist requiring generators to maintain an excess capacity. Maintaining sufficient capacity is now a function of the market. “Energy only” is a feature of ERCOT’s “Texas Nodal” program.

Some markets, like those in the Northeast, employ a separate capacity market, to ensure that the grid doesn’t run out of power. Under their rules, each individual retail supplier bears part of the burden of ensuring enough reserve generating capacity to prevent power shortages. Retail suppliers can then trade this generating capacity, in the form of “entitlements,” in lo-cal spot markets. Still, maintaining this capacity represents a cost to the individual companies. It’s one that power generators in Texas are eager to avoid.

Texas’ “energy only” structure makes separate capacity markets unnecessary because, theoretically, consumers’ response to market signals is enough to ensure that no critical supply shortages occur during periods of peak demand. One mitigating step ERCOT took after a major problem they experienced in April 2006 was to start a Voluntary Load Response program in which large power consumers can voluntarily opt to reduce their power consumption during supply emergencies. These businesses are in turn paid for their inconvenience. When a customer voluntarily cuts power under this program, they must wait until ERCOT gives them the green light to resume normal operations. A PUC program allows businesses with sizable diesel generators to supply additional electricity to the grid during peak demand.

The steps already taken, together with optimistic weather forecasts and the addition of more wind power in the last year, have led ERCOT to predict that we will be able to avert any critical shortages during the summer, if only barely. ]]