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In Texas, reliability concerns pit manufacturers against generators

By: Nathanial Gronewold |

Texas is in the midst of a heated debate over electricity market reform that’s proving just as contentious as when sweeping changes to the system were instituted here more than a decade ago.

Stakeholders are in talks with the Public Utility Commission (PUC) in Austin over whether to make only minor adjustments to the state’s deregulated market, or to move in the opposite direction and introduce a new government mandate in the electricity marketplace. At least two of the three appointed commissioners at the PUC are seen as being in favor of the latter option, while one commissioner is joining the chorus of consumer and manufacturer advocacy groups in opposing any broad reforms.

At the center of this debate are calls to introduce to the Texas grid a “capacity market” model, a system common in the Northeast in which the government requires payments to energy generators not only for the amount of power that is consumed, but also for the volumes of generation that could be introduced into the market, regardless of whether it’s immediately needed. Capacity markets aim to ensure enough reserve generation can be tapped in emergency conditions, but they also raise prices for consumers.

Though it adds more government to a system now celebrated as a free-market model for the nation, energy generators largely favor the switch to a capacity market. But others, in particular the Texas Association of Manufacturers, are issuing strong warnings to the PUC and governor’s office that leaving deregulation for a capacity market will cost the state’s economy billions of dollars and will harm Texas’ image as a destination for manufacturing, including petrochemical industries.

Both sides agree that the change would translate to higher electricity prices, but they disagree on how high the bill would be. A recent report commissioned by NRG Energy Inc. put the costs at about $4.7 billion per year, but it argues that expenses will be even higher if the current system isn’t changed, due to future pinched power supplies. Others charge that fears over future power shortages in Texas are overblown and warn that the cost of a capacity market model could run as high as $14 billion annually.

Opponents of the capacity market system also complain that the PUC has resisted calls to conduct a thorough cost-benefit study to determine what the impact on electricity bills might look like. A PUC-commissioned assessment underway by economic consultancy the Brattle Group may shed some light on this question when it’s presented early next year.

Controversy over what to do about possible impending electricity supply shortages is pitting Texas’ powerful manufacturing coalitions against the lobbying clout of the state’s electricity generators.

“A capacity market would have an unmistakable chilling effect on economic growth in the state with a tremendous, long-term negative impact on Texas energy consumers,” Tony Bennett, president of the Texas Association of Manufacturers, warned in a letter presented during a state Senate hearing on the topic in late November. “The idea that a capacity market is the only way to address power reliability concerns is off-base and is fueled by generators who would benefit from a subsidized market.”

Opposition has proved so fierce that the PUC is proposing a more interim step: changing the rules to require a certain minimum “reserve margin,” or a percentage of excess electricity generating capacity that can be turned on in urgent situations, such as the unprecedented heat wave and drought in 2011. Currently, the Electric Reliability Council of Texas (ERCOT), which operates the grid that serves most of the state, oversees a reserve margin target of only 13.75 percent.

That proposal has not satisfied opponents of the capacity market model, either. Jake Dyer, a policy analyst for the Texas Coalition for Affordable Power (TCAP), says a mandated reserve margin is just the first step toward eventually introducing a capacity market. TCAP is a nonprofit that lobbies on behalf of Texas cities.

“You can’t mandate anything without some way to meet the mandate,” Dyer said. “So if we were going to determine that we have a mandatory reserve margin of whatever it will be, to the extent that we don’t meet that reserve margin there has to be some mechanism whereby we will meet it.”

Dyer argues it’s logical to assume that the method chosen to meet the reserve margin requirement will be some payment from retail electricity sellers to generators for them to keep extra generating capacity on hand. Those costs would then be passed on to consumers. “That is really a first step toward a capacity market,” he said.

Free-market model at stake

Texas officials previously liked to point to the state’s deregulated, competitive wholesale and retail electricity market as one that the nation could take lessons from. But Dyer and others say introducing a capacity market could be tantamount to acknowledging that the free-market model has failed to live up to its promise. That’s not the lesson supporters of deregulated power markets hoped to sell to other states.

The deregulated market in ERCOT covers more than 85 percent of the state’s population. Austin and San Antonio are the largest markets in Texas that are not under the new system.

Today, retail electricity consumers — households, businesses and governments — can choose to purchase power from a variety of retail electricity providers (REPs). These REPs market directly to consumers and compete with one another on price and service. The REPs buy their power at wholesale rates from a pool of generators.

When the change was made, Texans were promised that it would lead to lower electricity bills. The exact opposite happened. REPs have to cover their marketing expenses, causing them to charge more than what the city-owned utilities charge in San Antonio and Austin. High natural gas prices at the time also led to sharply higher electricity prices in this state, which draws a huge portion of its electricity needs from natural-gas-fired power plants.

For several years, electricity costs in Texas were higher than the national average. Today prices are slightly lower than the average thanks to the shale gas boom that has brought down prices. Businesses pay at rates that are quite low in comparison with other parts of the country. For households, it varies: Per-kilowatt-hour electricity price quotes by Houston REPs, for example, are about in line with rates charged in New Jersey.

Energy market analysts say that relatively low electricity prices (due to cheap Henry Hub gas price quotes) and an anticipation of weak pricing in the face of abundant gas supplies are causing investors to steer clear of putting money into building new generation.

That became a concern in Texas during the 2011 drought, when demand for power became so great that Texas’ grid came close to hitting the reserve margin. Forecasts by the PUC — believed to be overly pessimistic by TCAP — projected even tighter power availability in the near future as Texas’ population continues to grow quickly.

The PUC has responded to availability concerns by raising the price cap on wholesale electricity. The price will increase from $4,000 per megawatt-hour this year to $7,000 next year and ultimately to $9,000 in 2015, by far the highest wholesale electricity price cap in the nation.

PUC commissioners also indicated they intend to introduce a minimum reserve margin in a contentious 2-1 vote during a meeting in October. Commissioners defended that move during a hearing at the state Senate Committee on Natural Resources convened just before the Thanksgiving holiday.

“It’s our responsibility to establish rules such that Texans have reliable electricity at reasonable rates,” PUC Chairwoman Donna Nelson said while under intense questioning by Senate committee Chairman Troy Fraser. “The core question really is, are we comfortable with the market going down to a more narrow reserve margin, and so the decision that we made is should we have a required reserve margin? Honestly, this question has been around since almost right after the market was structured.”

Nelson acknowledged during questioning that ERCOT has never fallen below the reserve margin level since deregulation occurred, even during the 2011 drought. She also acknowledged that the PUC’s electricity load forecasts have been repeatedly incorrect — TCAP and others point out that the PUC tends to overestimate future demand growth and simultaneously underestimate the volumes of new generating capacity being added.

The PUC plans to revisit its decision on a mandatory reserve margin at a hearing in late January. Though Fraser recalled that the PUC chairwoman opposed an earlier attempt at legislation that would have required a cost-benefit analysis, Nelson promised during the hearing that the PUC would move in that direction as new information comes in.

“Whatever we do, we will do it only if it makes sense from a cost-benefit standpoint,” she said. “I am absolutely in favor of doing a cost-benefit analysis. I am doubtful that what we are talking about would cause an increase of $4 billion.”

Searching for certainty

Those opposed to both a capacity market switch and mandatory reserve margin say the PUC should give the new higher price caps time to work. But Everett Wheeler, a senior market analyst at SNL Energy, says the higher price caps will still not be the signal investors will need to direct more money at new capital spending projects.

“The price only rises up to that cap when there’s a shortage of generation in real time,” Wheeler said. “So the issue that a lot of investors would have with that model is that it doesn’t provide certainty about what forward prices are going to be.”

At the same time, Wheeler said, simply switching to a capacity market in Texas may not be in the answer, either. He points out that forward price signals are failing to entice new generation builds even in existing capacity markets elsewhere in the United States.

The Texas Association of Manufacturers and TCAP also argue that introducing a capacity market to ERCOT will not guarantee that energy generators spend the windfall on new generation. They worry that much of the money could be spent instead on existing plants, or simply end up getting passed on in the form of executive compensation or dividends to shareholders.

Another point of contention in this debate is whether the summer of 2011 will become a new normal for Texas or whether it was an aberration. The state climatologist warns that such intensely hot, dry summers in Texas may be more common in the future.

Don Clevenger, senior vice president for strategic planning at the north Texas utility Oncor Electric Delivery Co., says the debate is difficult to resolve because both points of view have merit.

“Whether the free market can keep up with demand … there’s a legitimate argument there because electricity is unlike any other commodity,” Clevenger said. “The other side is if you built enough generation for the 100-year summer, you’ve built too much. It’s inefficient. You won’t ever need that much except once in 100 years.”

Clevenger said his company is neutral in this debate. Oncor owns and operates portions of the grid in Texas, controlling the power lines but not the power than runs along them. His firm’s only concern is that the electricity keeps flowing, even on the hottest days of the year, he said.

While he says he supports the PUC’s decision to raise the wholesale price cap, Clevenger would not predict what impact it could have over the next couple of years.

“Raising the price cap seemed to be the right thing to do,” he said. “Will it completely solve the problem? I just really don’t have the ability to say.”

Waiting for answers

The debate is far from over, and the two sides are waiting for new insights to come in that both hope will support their arguments for or against the capacity market.

The next Brattle Group report on Texas’ future power needs could be made public as early as January, possibly in time for the next PUC public meeting in Austin. The PUC itself is also changing the methodology it uses to forecast future power needs. A newer forecast with the revised calculating method applied could show what many are beginning to suspect — that electricity demand in Texas isn’t growing as fast as earlier forecasts had suggested.

Also, construction on massive new high-capacity power lines for the state’s Competitive Renewable Energy Zones (CREZs) is expected to wrap up by the end of this year or early 2014. The new lines connect growing wind energy hubs in central Texas and the Panhandle region to major demand centers. Completion of CREZs will likely spark new fervor to build more popular wind power projects in the state. Texas leads the nation in wind power capacity, with about 12,000 megawatts of installed capacity in place, and huge new sources of wind power have changed the calculation for the state’s growing power needs.

Supply might be an issue, but transmission is not. Clevenger said his company is investing about $1 billion a year for the next five years to improve its part of the grid. “When you have a growing populace and you can replace things and fit it in, you’re selling more so you can replace more, and those go hand in hand really well,” he said.

To Dyer at TCAP, defeating the proposed capacity market is necessary to prevent electricity bills from spiking, but it’s also about giving time for deregulation to work. Winning on this issue would also send a message to the electricity generators that they can’t keep seeking to tweak the rules every few years to benefit their industry alone.

“When rates were really high, the refrain from the industry was, ‘Well, this is how the market is supposed to work, let’s not mess with the market,'” Dyer said. “What’s frustrating is now that we’ve seen some lower prices in the last couple years, we now see folks in the generation industry coming forward with their hands out wanting subsidies.

“This really leads to a heads they win, tails we lose version of electric competition,” he added. “That is another concern for us, and it should be a concern for anybody that pays an electric bill.”