15 years after deregulation, should Texas revamp its power markets?
This is the time of year when power generators make their money. Much like retailers that depend on a short holiday season to keep them in the black, power generators in Texas rely on the hottest days of summer, when air conditioners run flat out, electricity supplies grow short and prices in wholesale markets spike hundreds of times above their normal levels.
But those spikes are fewer and farther between as new sources of electricity, particularly wind, enter the market, shaving peak prices and squeezing profits of power companies. As result, companies say, they are cutting investments in maintaining and modernizing Texas plants and starting to plan shutdowns – developments that have analysts, regulators and the state’s grid manager, the Electric Reliability Council of Texas, concerned about future shortages that could affect the power system’s reliability.
“Nobody saw this coming,” said Ed Hirs, an energy economist and professor at the University of Houston. “What ERCOT is concerned about is … not having enough electricity for when you need it, for whatever reason.”
The threat has become serious enough that the Public Utility Commission this week will launch a workshop on what changes the state may need to make to protect the reliability of the power grid – that is, ensuring the lights go on when people flip the switch. The issue is the design of the state’s wholesale electricity market, adopted 15 years ago, hasn’t kept up with changes in the power industry, which relies more on intermittent renewable sources, particularly wind and increasingly solar, and less on traditional generation.
The state still needs coal, natural gas and nuclear plants to meet electricity demand, but the problem for power companies is they only make money when their plants are running, not while waiting for the wind to stop blowing and the sun to stop shining. In the past, earnings from summer price spikes more than covered the costs of maintaining plants that operated at less than full capacity and kept companies profitable.
But that’s no longer the case as spikes come less frequently, reducing the incentives for companies to keep plants operating or ready to operate. ERCOT has already had to invoke its emergency authority to postpone the shutdown of power plant – a rare move – and negotiated an agreement with NRG last year to keep operating its Greens Bayou plant east of Houston to protect the integrity of the system.”
“There is a lot of uncertainty,” said Robbie Searcy, ERCOT’s spokesperson. “We do expect that some plants will retire. We don’t know which ones or when.”
Reliability is not only becoming an issue in Texas, but also in Washington where the Trump administration, pledged to revive the fading fortunes of coal, has ordered studies on the impact renewable energy has on reliability of the power grid. All this reflects one of the challenges of deregulating electricity: finding market mechanisms that not only increase choice and lower prices, but also keep the system reliable.
In regulated systems, the costs of keeping plants on the sidelines until needed are built into rates set by utility commissions. Deregulated markets, however, have to find other incentives to ensure that enough generation is available if demand spikes
The most common method is a capacity market, in which companies get paid, based on competitive bidding, for keeping idle generation ready to run. Think of it like a professional sports team, in which players get paid for sitting on the bench.
Texas, however, has the only competitive electricity market in North America without a capacity market. Since 2002, when the state deregulated electricity, Texas has relied on price spikes, euphemistically called “scarcity pricing,” to make it worthwhile for power companies to keep extra generating capacity at the ready.
On the hottest days of summer, soaring demand can create temporary shortages in wholesale markets, driving prices from an average of $25 a megawatt hour into the thousands of dollars, leading to a lucrative payoff for generators able to quickly supply the market. While consumers are often insulated from these price spikes, the higher costs eventually filter down to their bills.
This system has shown cracks over the years, leading the Public Utility Commission to lift a cap on wholesale prices three times – from $3,000 in 2013 to $9,000 in 2015 – to provide incentives to power generators to invest in their plants and maintain back-up generation. In 2014, the PUC approved an additional surcharge to be paid to power companies when supplies are scarce.
“ERCOT’S market only works if the price is right,” said William Hogan, director of the Harvard Electricity Policy Group, which studies competitive electricity markets.
But power companies, struggling to remain profitable in an era of low electricity prices, say even the higher cap and surcharge are proving inadequate, in large part because scarcity pricing kicks in less often as wind and solar, as well as new transmission, brings more supply into the market. While this can be good for consumers’ electric bills, the danger comes if power companies don’t make enough money to justify the costs of operating their plants.
Power executives say they are approaching that point.
NRG lost $891 milllion in 2016, following a $6.4 billion loss in 2015, which the company blamed in part on its significant operations in Texas. Calpine’s profit fell more than 60 to about $90 million.
Chris Moser, NRG’s senior vice president of operations, said he expected far more plant closures in coming years than projected by ERCOT, which estimates companies will shut down plants with a total capacity of 840 megawatts, enough to power about 17,000 Texas homes. ERCOT, he noted, forecast that companies would retire 354 megawatts between 2009 and 2016, but power companies shut down more than 10,800 megawatts.
It’s difficult to make such a forecast because in Texas, plants only need to give 90 days notice before shutting down.
“The market was literally built for a different world than we have today,” said Moser. “We are trying to figure out how can we adapt to this new world. We’ve got a big stake in Texas.”
ERCOT disputes NRG’s figures, but would not provide its own.