Can Texas ERCOT Keep the Energy Flowing this Summer?

There has been much discussion by policymakers in Texas regarding reserve margins in ERCOT since the extreme weather of 2011 (extreme cold in February 2011 and extreme heat during summer of 2011) stressed the ERCOT grid. Why is there is so much discussion about ERCOT reserve margins? The quick answer is reliability. The public has an expectation that electricity will be available to power businesses in Texas’ growing economy, power air conditioners, power computers, etc.

One indicator as to whether or not ERCOT will have enough power to supply demand is the reserve margin forecast. The reserve margin forecast is a comparison of total forecasted supply in ERCOT to the forecasted power demand (forecasted supply – forecasted demand/forecasted demand = reserve margin). ERCOT’s current reliability target is ERCOT should only initiate rolling blackouts due to inadequate supply once every 10 years. This is referred to as a 1 in 10 year loss of load standard. Through study and analysis, ERCOT calculates the level of reserve margin that is needed to deliver the 1 in 10 year loss of load standard. The current reserve margin target to deliver the 1 in 10 year loss of load standard is 13.75%. Twice a year ERCOT releases a Report on Capacity, Demand, and Reserves (CDR Report) in its region that forecasts reserve margins for the next 10 years. The CDR Report issued in May 2013 forecasts a reserve margin of 13.8% in 2014 that declines in 2015 and beyond.

What are regulators doing about the declining reserve margins? It is believed that a combination of weak capital markets, environmental regulations and low energy prices driven by low gas prices create a challenging market for building generation and earning an adequate return on investment. Given that the Texas electric industry is largely deregulated, the Public Utility Commission of Texas (PUCT) can’t simply order utilities to build generation. The PUCT has been focused on whether or not the wholesale market design in state needs changes to better incentivize generation investment.

Since the summer of 2011, the PUCT has been focused on increasing energy price signals during times of scarcity. The theory is that a higher energy price signal during times of scarcity will increase the revenue opportunity for generators and fuel greater generation investment. The most significant decision by the PUCT regarding scarcity pricing was a decision in the fall of 2012 to significantly increase the price caps in ERCOT to $5,000/MWh as of June 1, 2013, $7,000/MWh as of June 1, 2014, and $9,000/MWh as of June 1, 2015. Under the current market design, the real-time energy price in ERCOT automatically increases to the price cap if ERCOT is relying on Responsive Reserves to meet system demand. In other words, if the system is under stress and relying on reserves to meet demand, then the real-time energy price will increase to the currently effective price cap.

The PUCT is expected to continue discussing resource adequacy intensely during the 2nd half of this year.  Generation investment appears to remain stagnant even with the PUCT decision to substantially increase the offer cap last year. ERCOT commissioned a report by the Brattle Group in 2012 that advised the Commission that it basically has two market design paths to consider for improving resource adequacy. The first path is to continue down the path of improving/increasing scarcity pricing in the current energy-only market design. The second path is to implement a centralized, forward capacity market similar to the Reliability Pricing Model capacity market in PJM. The PUCT seems committed to continuing down the energy-only market design path, but has not ruled out the implementation of centralized, forward capacity market. It is possible the PUCT will make a decision that will make it clear as to the PUCT’s long term solution to resource adequacy (energy-only vs. centralized, forward capacity market). One thing is certain: the industry, from generators to retail suppliers to end-use customers, will all be watching, because any ERCOT policy change is likely to have a direct impact on energy prices for everyone!

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