Report urges boosting Ercot price cap, restructuring Texas power market

A report commissioned by the Electric Reliability Council of Texas (Ercot) has recommended that the state increase its maximum peak power price in order to spur investment in new generation capacity and lower the risk of blackouts

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Texas, which has been at the forefront of US power-market deregulation, is facing a potential shortfall of generation capacity as low electricity prices have discouraged investment in new power plants in recent years. Following a major heat wave last summer, which severely stressed the state's power grid, Texas's independent system operator, the Electric Reliability Council of Texas (Ercot), commissioned a report on how to continue meeting its reliability targets.

The report, published last week by The Brattle Group consultancy, concluded that Ercot should triple its peak price cap from $3,000 to $9,000 per megawatt-hour (MWh) in order to spur the construction of new generation capacity. It emphasised, however, that the maximum $9,000 price should only be paid in situations of extreme scarcity when rolling blackouts are already under way. Moreover, The Brattle Group recommended instituting a price scarcity function that would gradually raise the price cap from $500/MWh to $9,000/MWh as the threat of shortages increased.

"This would be more reflective of system costs and will help demand response participate in efficient price formation, which will ultimately support a more stable investment environment and system reliability," Sam Newell, a principal at The Brattle Group and the lead author of the report, said in a statement.

Market participants have generally welcomed the report's pricing recommendations. "I think the idea of having a more gentle slope of pricing from $500 up to $9,000 is something that the stakeholders of Ercot can agree on and accomplish," says Bill Hellinghausen, director of regulatory affairs at EDF Trading North America, which trades power in Ercot from its office in Houston. "Today what we have is a $3,000 offer cap, and we see a very binary market where we run along the marginal cost of a generator, which is somewhere around $25 right now, and then when we start to run out of capacity, the price jumps up to $3,000. It tends to go from a very low level to a very high level very fast."

More controversially, The Brattle Group also laid out a number of potential ways that Ercot could restructure its market to better meet reliability targets. One of those options is the introduction of a centralised forward capacity market, in which Ercot would hold auctions to procure forward capacity three or four years before delivery. Other deregulated power markets, such as PJM in the eastern US, use such mechanisms to ensure that there is sufficient investment in capacity. But Ercot is unusual for the US in that it is an 'energy-only' market, rather than an 'energy-and-capacity' market.

Power-market experts are split on the value of adding a capacity market alongside Ercot's existing energy market. Those in favour of such a move say it would help bring new generation online, even though they admit it will cost time and resources to set up a brand new market.

"It will take some time, but I do think a long-term capacity market is the right market mechanism to put a signal in place," says David Shepheard, a principal at Houston-based consultancy The Structure Group. "Then you basically get people to lock up their capacity on a forward basis. If the price goes up, that creates an economic signal to invest in capacity. And I think the Texas market has enough supply margin today that they could introduce a capacity market and see the impact of that pretty quickly. I'm a big believer in free markets sending the right short-term, mid-term and long-term price signals, and I think a capacity market would do that."

Others disagree. "The upside of a capacity market is that you pay generators more to have capacity, and that typically means that, yes, they probably will build more capacity as a result," says Frank Wolak, an economics professor at Stanford University. "But the downside is that consumers have to pay for that capacity, and it's unclear whether that capacity is needed or whether lower-cost solutions are available to essentially keep the lights on."

The cheaper, more efficient way to ensure reliability would be to use price signals to lower demand at times of high power usage, says Wolak. He adds that Ercot is well positioned to let demand response play a greater role in price formation because it has invested heavily in smart-grid technology such as interval meters.

"The capacity market is sort of like a nineteenth-century concept for a twentieth-century world," says Wolak. "The reason that you have capacity markets is largely because of the regulatory history of the industry. The capacity market was probably not a bad idea in the power pool regime, but in a market regime, it usually just means the consumers get to pay more."

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