Putting the Severe August Heat-Wave in Perspective

by Peter Kelly-Detwiler - Storyteller in Residence

With a thin reserve margin of 8.6% coming into the summer, ERCOT market watchers had been wincing, watching and waiting for that brutal midsummer heat-storm that would drive up air conditioning demand and potentially push the grid to the brink.

 
ERCOT (August 14th Twitter):  a sunny outlook for generators

ERCOT (August 14th Twitter): a sunny outlook for generators

 
ERCOT (August 15th Twitter):  Please barbecue outside, under the shade of your clothesline

ERCOT (August 15th Twitter): Please barbecue outside, under the shade of your clothesline

In the middle of August, that heat finally came and ERCOT did step pretty close to that brink, with record levels of demand and precious little room for error. In fact, ERCOT issued its first emergency alerts – on August 13th and 15th - since 2014, requesting customers to cut consumption where possible. The system hit its all-time peak demand level, and the pressure stayed on for a few sweltering days.

http://www.ercot.com  Going Up!  The afternoon of the 16th was tight as well, but no emergency

http://www.ercot.com Going Up! The afternoon of the 16th was tight as well, but no emergency

A LONG-AWAITED WINDFALL FOR GENERATION

As a consequence, operating reserves (available generation on the margin) fell to as little as a couple thousand megawatts, and prices soared, pegging out briefly at the $9,000 per megawatthour (MWh) cap on several occasions. BloombergNEF estimates the state’s generators reaped $1.5 billion in just two days last, equivalent to over 10% of total ERCOT market revenues in 2018. But markets are a zero sum game: for every winner, there is a loser. And for those on the short side of the equation, it was a painful and costly month. And it seemed that (to use a technical term) everybody “freaked out.”

However, as exciting as it was, a few charts may help to put all of this into some badly needed perspective and cool things off just a bit. 

A FEATURE, NOT A BUG

A critical thing to understand is that for generators (“especially conventional dispatchable gas-fired plants),” August provided exactly the type of incentive that may be necessary to lure them into building new generation in future years. In other words, it was a case of classic Econ 101 Supply and Demand. Demand was high, supply was tight, and prices did what prices are supposed to do – they went up.

After all, ERCOT lifted its price caps for exactly that reason. While other U.S. wholesale markets (regulated by the feds) have price caps at $1,000 per MWh, combined with capacity auctions that pay actors for the ability to generate (or reduce consumption) when needed, Texas has opted to go a different route. ERCOT instead saw fit to create a capacity-free ‘energy only’ market, and raise the energy price caps over a number of years, to today’s current $9,000 level. The intent of this market architecture was precisely to create the market conditions we saw last month. Or, as respected analyst Joshua Rhodes from the University of Texas at Austin aptly put it in a recent Axios article “the recent high electricity prices are a feature of the system, not a bug.”

In recent years, prices haven’t gotten remotely close to those that would bring rational investors to invest in new Texas generation. In fact, many coal plants shut down in that brutal low-priced environment. The only new plants built were highly efficient wind and solar renewables that also benefit from federal tax credits, but are not dispatchable (they generate when the ‘fuel’- wind or sunshine shows up - and thus cannot ‘follow load’). Retirements combined with minimal investments in facilities led to declines in the reserve margins.

https://www.potomaceconomics.com/wp-content/uploads/2019/06/2018-State-of-the-Market-Report.pdf   Generator’s pain = consumers’ gain (just don’t expect healthy reserve margins)

https://www.potomaceconomics.com/wp-content/uploads/2019/06/2018-State-of-the-Market-Report.pdf Generator’s pain = consumers’ gain (just don’t expect healthy reserve margins)

THE ‘MISSING MONEY’ MAY HAVE FINALLY SHOWN UP

The table below from the ERCOT Market Monitor’s 2018 State of the Market Report indicates just how much of a shortfall exists from an investor’s perspective. The light blue line “Estimated Cost of New Entry” suggests that one would need to see revenues in the $80 to $95 per kilowatt-year of installed capacity for a new combustion turbine. As one can see, we haven’t gotten remotely close to such prices – a windfall for consumers, but at the cost of luring new generation.

Economists refer to this issue as the ‘Missing Money’ problem. An ERCO training slide indicates just how low one probably would need to see reserve margins fall (somewhere around 8%) before average prices would create a sustainable market for generation. Note how many years prices have been really low. Not much for consumers to complain about since 2011.

http://www.ercot.com/content/wcm/training  _courses/109606/ordc_workshop.pdf   Looks like we might have found the missing money in August

http://www.ercot.com/content/wcm/training
_courses/109606/ordc_workshop.pdf
Looks like we might have found the missing money in August

PUTTING PRICES IN PERSPECTIVE

For those screaming Chicken Little last week, an additional 2018 State of the Market chart puts the Texas market in some perspective. It turns out just everybody else pays more for power than we do here in Texas. This chart shows how ERCOT compares with other U.S. wholesale markets. Note New York and PJM with high capacity revenues in green (and New England, not shown, is right up there as well).

At the end of the day, we have enjoyed very low prices here in Texas for the past six years, as a result of a combination of renewables and low-priced gas. That has led us to the current situation with low reserve margins, where markets get tight occasionally. One of two things is probably going to happen: either sufficient quantities of generation (and demand response) will be built and integrated into the system (holding prices down again) and the design will remain unchanged. Or it won’t and the system will become occasionally stressed with some high-priced intervals.

Only failure, such as a blackout, is likely to bring about some type of change, such as capacity markets. Otherwise, nail-biting and scarcity pricing are probably a feature of the electricity markets we live with for some time to come. That is, after all, what supply and demand is all about…