Recently there was an article in the Wall Street Journal about the unprecedented high prices in the ERCOT wholesale power market encompassing Texas. This has raised new questions about the reliance on deregulated locational marginal price (LMP) markets as a mechanism for competition to set prices and promote economic efficiency for electric power generation. Prices during peak periods have been exceeding $2000 per MWh and the previous cap of $1500 per MWh was recently raised to $2200. The variable costs of the nuclear generation in ERCOT are even lower than the average variable generation cost for coal-fired power plants.
The pure “energy-only” LMP market used for ERCOT is not only used to provide economic signals for efficient use of existing generation. It’s also intended to provide economic incentives to add new generation capacity as the total market demand for electricity grows. Several other LMP markets – including PJM, New England ISO, and NY ISO – have tried to address this problem by adding a capacity payment to the energy-based LMP price signal. Their intent is to reduce volatility in energy (LMP) prices and provide a clear signal to incentize upkeep of existing generation capacity needed during times of high demand, as well as the capital investments required to add new capacity when needed.
There’s not enough experience with capacity payments to draw definitive conclusions. But growth in electric power demand and permitting constraints and financial risks associated with new generation point to this refinement of market design having merit, and it could be useful for ERCOT as well.
Not Another California
Some commentators are drawing parallels to California’s failed deregulation experiment, where market design flaws and manipulation resulted in extremely high prices, electricity shortages and a popular belief that deregulated electricity markets were not in the public interest.
My view is that we should not be so quick to blame deregulation itself for the recent issues in ERCOT. Drawing parallels between ERCOT and the disastrous California experience is potentially dangerous given all the progress that’s been made during the last decade with well-designed organized wholesale power markets. There were many problems with the design of the California market, but the most fundamental was the de facto decoupling of price signals affecting supply on one hand, and demand on the other.
As part of a complicated political negotiation, generators were able to bid into the wholesale market based on their costs and any profit market conditions would support (i.e. the difference between the market-clearing, congestion-adjusted price and the actual cost of generation). Retail electricity providers such as PG&E and SCE, on the other hand had agreed to a multi-year price cap.
The market’s design gave rise to a “perfect storm” that ultimately led to a calamitous market failure: natural gas prices led to substantial generation cost increases, which led to higher wholesale power prices. Retail electricity providers were unable to cover the costs of meeting aggregate customer demand. Because the retail providers were unable to pass on the higher wholesale power costs to consumers, they were pushed to the brink of bankruptcy. A study by Charles River Associates (now CRA International) showed that the California power shortages during the time of this crisis would have been avoided entirely if even a relatively small proportion of the wholesale price increases were reflected in retail power prices, due to what is referred to as the price elasticity of demand, i.e. that consumers would have found ways to use less electricity of make more efficient use of it if they had seen even part of the run-up in wholesale power prices.
Adding insult to injury, the market manipulation resulted in greater gaps between the prices retail electricity providers paid for power and the price for which they could sell it. Reforms undertaken at the federal, regional and state-level since the California crisis and Enron melt-down make market manipulation much more difficult, and there haven’t been any findings of such manipulation since then.
Have we learned from mistakes?
Competition is a very good thing for consumers, our power generation infrastructure, and the US economy. Designing competitive markets for something as complex as power generation; there have been mistakes made and lessons learned. The recent ERCOT experience in Texas may offer additional lessons, and results from some of the market modifications recently implemented in the other organized LMP markets need to be carefully monitored and analyzed. But let us not “throw away the baby with the bathwater” and hastily conclude that competitive markets are not a viable mechanism for enhancing the efficiency of power generation when there has been so much learned and so much more to discover.
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Check out www.fairelectricrates.net for more stories from consumers who seem to be having trouble finding the benefits of competition.
Did I understand you to say there might be a method to T. Boone's madness?