ERCOT Price Market Cap Changes Appear Politically Motivated

I’ve written before about the potential crisis in Texas due to the lack of new generation plants. Basically, not many new energy generation plants are being built, or even planned, at a time when Texas’s population continues to explode and our electricity needs along with it. The problem is that because of the deregulated electricity system, all new plants must be built by private investors instead of by taxing customers or raising electric rates. And right now the low cost of natural gas and the lack of guaranteed profits have investors leery of risking the construction of new plants in Texas.

A commonly referenced solution is to raise the market cap, which is the maximum cost a generator can charge for electricity per unit, from the existing three thousand dollars. And it looks as if Commissioner Donna Nelson of the Texas Public Utilities Commission is pushing to raise the market cap to four thousand five hundred dollars on July 1st of this year, followed by further increases over several years until the cap reaches seven thousand five hundred dollars.

In the past I haven’t been vocal against raising the market cap because, well, Texas needs the generation and there are only so many options to encourage investors to build new plants. Texas is adding the equivalent of the population of Corpus Christi every year so something needs to be done from a generation perspective.

But I haven’t been overly in favor of raising the cap either because it absolutely guarantees electricity rates will increase. Other options beyond raising the market cap would be to explore a capacity market or to improve the existing process of how the daily bid stack is ramped up, i.e. have some willing generation price points between the low 100’s and the absolute market cap. There should be a real debate about these options in the public eye, and to this point there hasn’t been. And now it looks like there won’t be one at all.

Results of Raising the Market Cap

Arguing about raising the market cap at this point is almost a religious argument in the sense that people believe in it or they don’t, oftentimes irrespective of actual facts. It is important to understand that this move is not a problem solving plan. Raising the market cap is an attempt to make the Texas market more attractive to investors that might build new power generation plants. But doing so in no way, shape, or form guarantees any new generation will take place. Texas needs new generation being built and coming online and raising the market cap is just a calculated roll of the dice the PUC hopes will land new investment in generation.

Raising the cap certainly does NOT benefit residential and commercial customers because higher price points will be passed onto the end consumer. Weeks to months before the market cap increases on July 1st, prices will go up for anyone who is signing a new electricity contract in the state of Texas.

Raising the cap also doesn’t benefit the retail electricity providers (REPs), who will immediately have to adjust to new purchasing models and pay substantially increased prices for electricity. REPs will also pay much higher amounts than they do currently if they’re forced to buy electricity on the spot market during power shortages like we experienced last summer when there were threats of rolling blackouts. Almost a half-dozen major REPs such as Reliant, TXU, Gexa, Dynowatt, and StarTex Power reported massive losses from the 2011 quarter that included August. Losses they have attributed directly to the Texas summer and the price spikes in the spot market when they were forced to purchase additional electricity to cover their customer’s needs. And none of those are small companies, they’re all part of major energy conglomerates.

Nor is it the energy generation companies and plants that benefit from the raising of the market cap, despite what some people, apparently including the commissioners, might think. No generation plant will enter the market under the assumption of maximum price potential in their forecast models. And while yes, the price they can charge will increase, so will the risk they assume. This is because power plants have to play the spot market as well. Power plants go offline unexpectedly regularly when something breaks or goes wrong, or if weather conditions force shutdowns. And when they do go down, generation assets have to participate in the spot market as well and purchase electricity just like an REP does to cover their own commitments to REPs. What this means is that when a plant goes down, they will be at the mercy of the increased market cap pricing of the spot market just like an REP, except they won’t have had the chance to hedge against this possibility like an REP. They’ll just be cutting massive checks. It is foreseeable in this situation that a power plant suffering an unexpected closure of just a couple days could cost them their profits for an entire quarter. It’s definitely risk versus reward. But does a tactic to raise the market cap when it comes with that kind of elevated risk really seem like a slam dunk to draw new investors in energy generation plants? There is no underlying data to support the theory being pushed by the PUC.

Who Does This Move Benefit?

My biggest issue with the PUC raising the market cap on July 1st is that it appears to be a 100% POLITICAL move for this summer. The only apparent benefactors from this decision are the commissioners themselves. Lets take a closer look.

First, why July 1st? Why raise these rates when the Texas summer is peaking and the market is the most active with customers switching providers and shopping prices? When the grid and energy generating plants are at their most taxed with meeting consumer demand? When the threat of rolling blackouts and inflated spot market prices are the most prevalent to both REPs and downed plants alike? What possible benefit is there in choosing this time to drop a massive change into the marketplace, a change that will immediately inflate the prices and risk for all parties involved? Wouldn’t it make more sense to pick the fall or winter, when generation needs are low, as a go launch date when everyone can easier adapt to the price changes and demands and plot forecasting models for the summer of 2013?

Perhaps because by picking July 1st any price spikes in the spot market under the new market cap might make the idea of investing more attractive to potential investors. If there is the threat of a rolling blackout and the spot market erupts to the new market cap, investors could look at that activity and see the potential for profit. They’ll also be able to view the price increases Texans will be forced to immediately pay, during the most expensive time of the year, and see the profit potential there as well.

The whole thing is a gambit, and consumers, generators and REPs are all on the hook. And the sad truth is that this effort will in no way ensure new investment in energy generation construction in Texas. It is implausible that the PUC commissioners don’t know this is the case. And down the line, if there is an energy shortage, they’ll be able to point to the July 1st initiative to raise the market cap to legislators and say they did SOMETHING try and avert the energy shortage. The problem is that everyone knows fully well that raising prices this summer does nothing to avert any potential energy shortage later. No new multi-billion dollar generation plants will be built in the next 4 months, that notion is absurd. That is why this feels like a politically motivated move by the PUC.

If no new generation comes online as the population continues to expand the commissioners can hold up their hands and say the shortage wasn’t their fault, they tried to do something. It isn’t their fault no investors took the bait. They’ll be covered politically. Meanwhile, by that time, the customers and REPs will have been paying out the nose for the PUC’s gamble for several years and Texas still won’t have enough electricity to meet the basic needs of the state.

It is a fact that the population of the state of Texas is rapidly expanding and needs energy desperately. The solution to the problem isn’t likely to come from politicians who don’t adequately understand how the market works in the first place. An encouraging sign that the commission somewhat understands this is that they have hired an outside consulting agency, the Brattle Group, to review the state of the ERCOT market. However, that doesn’t mean those politicians can’t tinker with the market to make sure they have their own political cover. Even if that tinkering forces the REPs and generators to adjust and guarantees Texas consumers will be paying substantially increased rates for electricity. And all of that for a strategy that still doesn’t guarantee any new investment in the electricity generation plants Texas needs.

The only thing a move on July 1st guarantees is that the days of low prices in the Texas deregulated electricity market will be behind us.