By: Peter Kelly-Detwiler |
Electric power traders have a saying that “weather drives prices,” and last week’s ‘polar vortex’ event provided a compelling example of how energy markets respond to weather. The cold spell also highlighted troublesome issues related to regional natural gas supplies and the power grid’s current vulnerabilities.
ICF International – a respected consulting firm – just released a summary of last week’s events that does a very good job of framing the whole situation. I spoke with several authors of the report, Judah Rose (Managing Director), Frank Brock (Senior Energy Market Specialist) and John Karp (Senior Associate) to get some further perspectives and insights.
They noted that the extreme weather event from the first week of January was a boon to generators in the eastern and southern regions of the U.S. Wholesale spot prices reached extraordinary levels in a number of markets, driven by influences including limited natural gas supplies, generator outages, high demand, and various market structures.
During the period from January 3-7, daily natural gas and electricity prices were highly volatile, with gas selling from $4 to $40 per MMBtu, while spot electricity daily prices ranged from $40 per megawatt-hour (MWh) to nearly $800/MWh. Although ICF reported no major gas supply disruptions, prices in eastern New York and New England spiked as a consequence of limited pipeline delivery capabilities.
Brock commented on the mismatch between availability of gas pipeline capacity and power generation.
Many of the generators don’t have contracts for firm gas pipeline capacity, and during cold snaps like this there is little interruptible capacity available. And this isn’t the first time we have had winter issues on the power system. We tend to focus on summer planning and that has to be revisited.
Brock also observed that pipeline constraints drove price spikes. “Prices in the Northeast soared to record levels, while just a few hundred miles upstream in the Marcellus play, we saw $3/MMBtu gas.”
Since gas is the underlying fuel for 52% of power generation in New England (a figure that will only increase with the pending retirements of the Vermont Yankee nuclear and Brayton Point coal plants), power prices surged on gas price volatilities.
At the same time, the weather event highlighted electricity system vulnerabilities from Texas through the Northeast. ICF commented that they expect weather patterns to accelerate the number and size of these ‘opportunities for investors’ in the future, and that such patterns highlight potential reliability risks to the grid.
ICF’s Rose pointed to several factors that merit review, among them: the incentive structures in various markets, the protocols for planned generator outages and the planning parameters being used. For example, in ERCOT (Texas), 13,000 MW of capacity were offline owing to planned outages.
On a system of 70,000 MW, we had 3,700 of forced outages, a number that’s not too bad. But there was a large number of planned outages. We recommend that this should be looked at. Some outages may be seasonal where plants decide they don’t want to operate during a certain period of the year. That raises the question as to whether or not there is adequate incentive to keep plants operating during the winter periods.
In addition to ERCOT’s 3,700 MW of forced outages, the mid-Atlantic PJM power pool saw 36,600 MW of idled power plants. And this underscores a major problem with the U.S. power grid today. It’s not built to withstand the increasingly frequent stress tests of our new weather normal. Periods of extreme heat or cold drive extraordinary levels of consumption, at exactly the same time they put enormous physical demands on the power grid. In the summer, equipment fails. Overheated power lines sag, and generation is stressed. In the winter, power plants fail for other reasons, or simply don’t start at all. Those issues create reliability concerns and they also drive power prices.
The award for the highest spot electricity price was garnered by ERCOT, where adequate generation supply has been a source of concern for the past five years, but little to no new generating capacity has been built. In contrast with other markets such as New England, New York, and PJM, ERCOT does not pay power generators a fixed capacity price for the physical capability to generate power (in addition to paying for the actual electrons generated). Instead of instituting capacity prices, ERCOT has opted to raise energy price caps and let the allure of higher megawatt-hour prices incentivize new power plant construction. Price caps are currently set at $5,000 per megawatt-hour ($5.00 per kilowatt-hour), and they were touched briefly during the cold snap. These caps will move to $7,000 and then $9,000/MWh over the next two years.
It remains to be seen whether this will be enough to spur new power plant construction. Regardless, it will certainly mean that if electricity consumers or traders are caught ‘naked’ and unhedged when caps are hit (some consumers have a portion of their electricity contracts structured to take spot market prices), the economic carnage could be mighty painful indeed.
With respect to the bigger picture, ICF and other observers have called for a detailed forensic review of the performance of markets and resources to evaluate whether potentially compromised grid reliability and extremely high prices might be avoided in the future.
Rose commented that some forensic reviews are already underway. From his perspective, the investigation must be comprehensive.
It has to address a pretty broad range of issues – are there enough incentives for generators to be online? Are the reliability pricing mechanisms sending the right pricing signals? Are the right planning parameters being used? It was cold last week, but I don’t know it was outside the parameter of a design day. It’s worth looking at power plant planning parameters and assumptions more closely in light of what just happened. We also need to look at other parameters such as forced outage assumptions.
Without any major blackouts this time, we got lucky. As Rose dryly observed, “One view of this is that the system avoided disaster, but do we really need to skate so close to the edge?” If we fail to make the necessary changes, Polar Vortex Redux could leave some – or many – of us freezing and cold in the dark.