Texas is an energy powerhouse. It dwarfs nearly every other state in total production on both a British thermal unit (BTU) and kilowatt-hour (kWh) basis. Yet the Energy Reliability Council of Texas (ERCOT) is reportedly facing a looming problem of shrinking capacity reserve margins thanks to peak electricity load growth outpacing new capacity additions. According to energy analysts, low energy prices and unfavorable future market conditions are not encouraging additional peaker generation capacity to be built.

To address the issue, the Public Utility Commission of Texas (PUCT) has enacted a number of rules which include raising the maximum amount the market will pay for power during scarcity pricing scenarios — known as the system-wide offer cap (SWOC). On August 1, 2012 the SWOC was raised for the second time this year and now sits at $4,500 per megawatt-hour (MWh). While some are concerned this could lead to market manipulation, the PUC's goals appear to be centered around improving "forward price signals" for new peaker generation investments. In fact, ERCOT published analysis on the effects of the rule changes on peaker net margins (PNMs) in 2011. As shown below PNMs would have improved 42% in 2011 with the new rule changes that just went into effect ($4,500/MWh SWOC).

Given the difficulty in predicting future spot-market pricing scenarios and market behavior, there is broad disagreement over both the rules' proposed levels and implications. Commissioner Anderson cautioned against increasing the SWOC again so soon after it was raised, whereas a recent report by the Brattle Group found ERCOT would still need "several thousand megawatts [of demand response] under a $9,000 price cap."

Although discussions of major market construct changes could discourage investment due to uncertainty, a major challenge facing ERCOT could be the construct of the market itself. The "energy-only" construct only pays resources for the energy and ancillary services they deliver, not installed capacity, making it difficult for investors to calculate the bankability of such infrequently called upon assets, according to Midwest ISO Discussion Paper on Resource Adequacy for the Midwest IS0 Energy Market.

Earlier comments filed with the PUCT by the multi-state energy company Exelon suggested, "there is no perfect adjustment to the energy-only market [because it] is inherently short term and volatile, and generation investment is inherently long term and capital intensive."

Former DOE assistant secretary Susan Tierney believes capacity markets make more sense. In a recent keynote address to the Gulf Coast Power Association, she noted, "A competitive capacity market allows for provision of capacity as efficiently as possible…and allows time for the winners of the capacity auction to bring their resources online." She also went on to say, "a capacity market can induce…distributed generation."

But what about "energy-only" markets such as ERCOT? Can they not also encourage distributed generation (DG)?

Energy-only markets clearly favor dispatchable power when spot prices skyrocket. But the uncertainty of these occurrences favors a more risk averse — and therefore more protracted — investment strategy which can include the development of smaller, more scalable, load-following solar generation. As evidenced by the lack of gas peaker development in ERCOT, market uncertainty is the antithesis of long-term, capital intensive projects.

Most importantly, the unintended market consequences of the PUCT’s new rules should not be ignored. Although the intent may be to improve peaker net margins, the rules could actually end up encouraging more demand-side curtailment instead.  Which means flexibility is key. Those who can most effectively predict or react fastest to the new rules will be the ones ensuring themselves a nice Texas-sized payday.

This article was originally published on NREL Renewable Energy Finance and was republished with permission.

Lead image: Texas flag via Shutterstock