Texas Power Price Cap Intended to Spur Plant Construction

Jun 02, 2014 12:23 pm ET

(Updates with another pricing mechanism in the third paragraph under Market Hedging subheadline.)

June 2 (Bloomberg) -- An increase in Texas’s wholesale electricity price cap took effect yesterday, giving generators more incentive to build new plants while raising costs for consumers in the nation’s biggest power-consuming state.

The limit rose to $7,000 a megawatt-hour from $5,000 under a plan approved by state Public Utility Commission in 2012. The cap represents the highest price that power can be sold into the market during times of strong demand.

Prices reached the $5,000 price cap for the first time on Jan. 6, when frigid weather boosted heating needs while some power plants were offline, prompting the grid operator to warn of possible rolling blackouts. The Electric Reliability Council of Texas Inc., which manages the network, and state utility regulators have been debating policy changes to spur new plant investments after a drop in natural gas to a decade low in 2012 pulled down electricity prices, cutting generator returns.

“Assets are needed and they need to see a price that justifies development,” Teri Viswanath, director of commodities strategy at BNP Paribas SA in New York, said in a May 23 telephone interview. “There have definitely been moments in the last couple of years where grid reliability has been tested.”

A hot summer in Texas may boost prices toward the new cap. Air conditioning needs typically send electricity demand to an annual peak during the warm-weather months. The $5,000 cap has been reached twice this year, the second coming on March 3.

Price Impact

The new cap will have an impact on forward prices, or electricity prices set today for future delivery, and prices in the secondary markets, Kenneth Anderson, one of the three PUC commissioners, said in a May 23 e-mail from Austin, Texas.

“Retail customers should get better operational reliability from generators,” Anderson said. “With respect to generators, they will be further encouraged, with both positive and negative incentives, to maintain and enhance operation performance.”

The potential for wider margins “strongly encourage resource owners to maintain their units in top condition, which results in overall improvement in operational reliability,” he said.

Approval of the new cap wasn’t universal. Power plant operator Exelon Corp., in public comments submitted to the PUC in February 2012, advised against the plan, saying “it would subject both consumers and suppliers to greater price risk and likely would not be conducive to development of new generation capacity.” The cap would also increase the risk to small power retailers and add to “the burden on consumers who would face spiking power bills,” Exelon said.

Demand Outlook

Ercot forecasters expect about 68,000 megawatts of peak electric demand this summer, just below the all-time record set in August 2011. Rising demand can translate into higher wholesale prices and increase the risk that prices will surge to the new cap. Ercot said in a statement May 1 that it may need to ask consumers to reduce electricity use if Texas experiences extremely hot weather or widespread unit outages during the early summer months.

“For us, the big concern is balancing and just making sure we have our load forecast accurate and an appropriate amount of hedges to meet our load, so we don’t have exposure to the price cap should it get there,” Kate Trischitta, the director of trading at Consolidated Edison Inc.’s wholesale energy trading unit in Valhalla, New York, said in a May 28 telephone interview.

Trischitta said the higher price cap is being priced into rates offered to retail consumers, along with higher fuel costs from the rebound in natural gas.

Market Hedging

According to Anderson, proper hedging by retail electricity providers, municipally owned utilities and cooperatives might smooth out the prices end users see.

The cap is scheduled to increase to $9,000 a megawatt-hour next year. By comparison, the current wholesale price cap on the 13-state PJM Interconnection LLC network, which stretches from Washington to Chicago, is $1,000 a megawatt-hour.

Currently, wholesale prices in Texas could rise as high as $9,000 a megawatt-hour under a separate Ercot rule that also took effect yesterday, which adds a charge known as an Operating Reserve Demand Curve when declining power reserves increase the chances of rotating blackouts. A drop in reserves to 2,000 megawatts or less would automatically trigger a wholesale price of $9,000. The demand curve is not currently scheduled to be increased in 2015, Robbie Searcy, a spokeswoman for Ercot, said in an e-mail today.

Price Comparison

Viswanath said she doesn’t believe higher caps in Texas are too painful when put in perspective. As of May 29, the real-time average wholesale price across the Ercot network over the past 12 months was $36.25 a megawatt-hour, compared with $50.86 at PJM’s Western hub, $65.34 in New York City and $71.22 in Boston, according to grid data compiled by Bloomberg.

“When we think about what Texas consumers pay with the rest of the world, it’s not awful,” Viswanath said. “What Texas pays in comparison to other industrialized nations, it still appears to be a bargain.”