Everyone has seen the ERCOT notices to conserve electricity recently. They seem like there have been daily alerts and calls to action for people to regulate their electricity intake for the sake of conservation. I’m sure a lot of people dismiss this stuff out of hand, but the concern is valid. And I’m going to take the time here to explain what is going on behind the scenes that make this a crisis, because I believe there is an extremely high probability that this record drought and heat wave is going to end up driving a number of Retail Electricity Providers (REPs) out of business and change the deregulated electricity market forever.
Ok, I think the first step in understanding the dangers facing our Texas electricity market is to understand the grid and electricity demand, and how it effects an REP’s expenses. So, starting there, lets state that the Texas Electricity Grid has a capacity to generate 73,000 megawats, or Megs. But the actually every day capacity is more around 68-69k megs because ERCOT wants to be able to maintain their reserves. And lets also keep in mind that almost every day last week, ERCOT was calling for electricity conservation. 3 times last week, the Texas grid had demand higher than 68k megs…so basically, the entire grid red-lined for 3 straight days. That’s an important fact, so keep that in mind, while we take a look at the trading aspects.
The REPs who bill you every month have to buy electricity, just like we have to buy our electricity. Every month, an REP has to estimate how much electricity they’re going to need to purchase to cover their customer base. So your average REP does some math, estimates what their monthly need will be, and places their order for Megs. They’ll lock in a certain amount at a pre-set price from a trader, and then they’ll go about their business. If they guess close, they’re doing good. If they were too conservative and bought more than they needed, they left some money on the table. If they guess short, then they have to buy spot amounts of electricity from traders at a much higher premium to cover their needs.
Two important factors to consider: 1.) A key part of an REP estimating their monthly purchase of Megs is taking into account how weather will potentially effect usage. Hotter weather means they need more electricity for their customers to meet their demands. 2.) Last week there were several articles talking about how the demand for electricity was so high during this heat wave that prices were shooting up to 3k dollars per unit during certain hours of the day as to what is normally anywhere from 20-400. Of course, it’s normally anywhere from 20-400 during summers that don’t have record heat and aren’t going through the greatest drought and lack of rain in most of our lifetimes.
And make no mistake. There’s been almost no rain in Texas in many months and there doesn’t appear to be any end to the record breaking heat in sight.
The Dangerous Landscape
Ok, now that I’ve laid out some of the pieces, lets take a closer look at the weather. I already mentioned that the weather plays a role in how REPs forecast their monthly energy purchases. I’ve also mentioned that this is the hottest summer Texas has seen in decades. So now lets take a look at exactly what that means when those two things combine. Unless an REP specifically forecast an August that had no rain and more than two straight weeks of 110 degree temperatures in Dallas and 103 degree temperatures in Houston, then odds are they underestimated how much electricity they had to buy for August. I’m speculating here, but I feel extremely confident when I say that almost no REP in the market predicted this kind of heat, consecutively, this long without rain. Which means that almost no REP bought enough electricity in advance to meet this kind of demand. I’m betting that almost everyone is short.
So what happens when everyone is short? Well, the short answer is that REPs have to spot buy energy to cover the needs and demand of their customers. And when REPs have to buy short, they have to pay a premium. But what happens when the grid is operating at maximum capacity…for consecutive days and even weeks? How does an REP buy electricity when there’s almost no electricity to purchase? The answer to that question is that the cost of buying this electricity goes way up. At the height of a day’s heat, back in July, the highest consistent prices we saw were 300 per unit. And mostly it was anywhere between 30 and 100. The same numbers here, for about 3 hours a day each day for the past two weeks have been 3000. So the cost of buying spot power is 100 times more expensive if a company has shorted their demand. And above I’ve made the assumption that almost everyone has to have shorted their demand. So instead of an electricity company maybe having to cut some checks for 5k if they need to spot buy some power, now being short will cost them 500k. And that’s just an estimate for smaller or medium sized companies. What happens for guys like Reliant or TXU with millions of customers? They could be having to cut checks to ERCOT for energy in the 5-10 million rage. And that is PER DAY. And we’ve been having record heat and a maxed out grid for the past 10 business days, and there’s no relief in site for the hot weather.
More on the Financials
So if you’re a bigger electricity provider with near a million customers or more, such as Reliant, TXU, or Direct Energy, could you end up having to write a check to ERCOT for 50 million or more in excess energy purchases because of this heat? Quite possibly, but lets not pretend that the big guys have a slush fund where they can write a check for that kind of money without feeling any pain, because they cannot. That will hurt a LOT, but they’ll probably survive. They also have energy generation resources that likely give them quite a few advantages in terms of trading and energy purchases because of the amount they buy, as well as connections they likely have with their own traders from back when Texas was regulated. But what about companies like Stream and Ambit, who have hundreds of thousands of customers between them, and no access to any trading benefits in Texas? Or larger companies like First Choice Power or Cirro? Can these companies afford to write a check for 15-20 million dollars for the month of August just to cover power? Even big companies rarely operate with that much cash on hand, particularly in an industry where margins are so small. And what about smaller companies, with less than 20k customers? Do we really think those companies have the kind of cash reserves that they can afford to burn hundreds of thousands of dollars a day in spot energy purchases to meet their customer’s demands?
And there’s one more financial consideration to consider: Ancillary Charges. Now, I’m not going to lie, I don’t completely understand Ancillary Charges and everything that goes into them. I do know that they’re basically fees paid to ERCOT by the REPs as a percentage of an REPs total “load” on the marketplace. Basically, it’s a check that has to be cut to ERCOT based on how many customers an REP has on the market, or their percentage of the electricity on the grid. In other words, the bigger a company, the bigger the bill for Ancillary charges. Talking to some of the people in the market place, because of the increased amount of energy on the grid, smaller and medium sized companies might be paying an additional 50-100k dollars a DAY in Ancillary Charges, and this is entirely on top of their spot energy purchases. And all of this is on top of whatever operational costs they have as a company, like employee salaries and insurance, etc. I can assure everyone, this is a complete nightmare for the Texas electricity market.
One thing I think is important to consider here is that this really is a fluke circumstance. It’s not like any of these businesses have likely done anything wrong, it is simply that this weather is so far outside the realm of any expectation that no one could reasonably expect temperatures this high, this many days in a row. And there’s no relief in sight from the weather, with temperatures projected in the high 100’s in Dallas all week, and the low 100’s in Houston. Electricity Companies are absolutely bleeding cash and writing huge checks unless they forecast weeks of 100 degree weather and zero precipitation across the entire state and purchased their energy accordingly back in July. And even if they did, they’re still cutting ERCOT huge checks every day because of the massive amount of electricity being used by a grid that is running at 100% maximum capacity for the past week and, again, likely to be running near 100% capacity all through August.
Let me try and sum this up as easily as possible. Back in February, we had a couple of cold snaps that maxed out the electricity grid for a couple days, caused electricity outages, and generally really stuck it to the electricity providers. As a result, two companies went out of business because they couldn’t come up with the money to pay ERCOT for their energy purchases and Ancillary Charges. Compared with this record drought weather, that cold snap is starting to look like a walk in the park for REPs. I would not be surprised to see anywhere from 10 or even 20 electricity providers having to fold up shop or getting purchased by the larger entities for a song. It will be interesting to see, but I bet by September the landscape of deregulated Texas electricity doesn’t look anything at all the way it does today. The only question is how many guys will go out of business, and how the market will permanently change as a result if a mass exodus of competitive electricity providers takes place.
If a massive change does take place, I’ll examine what it means for consumers in the marketplace in regards to electric choice. But right now, it’s simply important that customers understand what is happening behind the scenes at their electricity providers.