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Centrica Exec's Comments Highlight How Capacity Market Would Put Independent Texas REPs Out of Business Centrica's Chief Executive Sam Laidlaw demonstrated in an earnings presentation this week how introduction of a capacity market in Texas, which compels retail electric providers to provide payments to capacity owners, would destroy the Texas retail market, and leave only a handful of generation asset-owning competitors in the retail market.
We stress that this was not Laidlaw's or Centrica's own conclusion; but rather, this conclusion is the natural extension of a point Laidlaw raised in discussing generation ownership in Texas. Interestingly, Direct Energy is one of the stronger capacity market supporters in Texas, likely due to the challenges faced in owning generation that isn't subsidized by its competitors in the retail market.
Specifically, as discussed more fully in our related story today (click here), Laidlaw said that Direct Energy now sees market products, along with its existing Texas generation ownership, as the preferred method of managing the pricing and load following risk of super-peaks in ERCOT, rather than owning additional generation assets.
Why?
Because relying on power generation to manage super-peaks means, "having to own [generating] assets that have relatively low utilization and high capital intensity and low returns on capital employed."
Implicit in this explanation is that the costs incurred to maintain the availability of this generation (fixed costs) outweigh any peak-management benefits (both from actually avoiding scarcity prices and also reducing credit requirements). Right now, it's cheaper to use market products to obtain the same benefit of managing the super-peak risk.
Put another way, without the capacity market, Direct has to bear alone the costs of using generation to manage its super-peaks (just as all other REPs must do, whether they use generation or risk management products in the market), and Direct must reflect these costs in its retail pricing, or accept lower profits.
However, if Texas instituted a capacity market, and Direct Energy owned units which cleared the market, its fixed costs of owning the power generation would be subsidized by all retail electric providers in the market. All retail electric providers would have to pay the costs of Direct's cleared capacity resources, but the benefits of those power plants would flow to only a single entity -- Direct Energy. Direct Energy would essentially get to manage its super-peak risk on the backs of its competitors having to only fork out the variable costs of running the plants.
Other REPs would receive no benefit from the Direct Energy power plants they'd be paying for -- no entitlement to power, and no sharing of inframarginal revenues which would normally occur with free-market investors (REPs who are covering the fixed costs of power plants through conscripted capacity payments may as well be considered investors, or underwriters, of that generation).
No, instead, Direct Energy could now use its subsidized power plants to manage its super-peak risks instead of relying on market purchases -- an option not available to REPs which do not own subsidized capacity. This would drastically lower Direct Energy's cost to serve retail customers. Direct Energy could use this cost advantage -- which stems solely from the government-created capacity market and not any competitive advantage -- to underprice competitors and put them out of business, or to amass capital to then deploy in buying up competitors. Either way, a reduction in retail electric choices for Texans is inevitable with the capacity market, which will lead to a further increase in retail pricing (on top of higher prices due to capacity payments).
And this pattern would repeat with all REPs which happen to have affiliates owning generation -- like NRG Energy and its various retail companies. NRG continues to operate certain plants on a seasonal basis only (such as SR Bertron), taking them out of mothball status just for the summer peaks, because that is the only time when the benefits of plant ownership (whether it be through managing the retail book's peak exposure or just maintaining an open position to receive scarcity prices) outweigh the costs of maintaining those units' availability to be dispatched.
Indeed, though Matters stresses this is solely our own analysis, Matters sees Direct Energy's advocacy of a capacity market as indicative of its continued desire to own power generation, in line with Centrica's oft-stated desire for further integration. However, Direct Energy doesn't want to take on the risks of plant ownership itself. It doesn't want to have to, "own assets that have relatively low utilization and high capital intensity and low returns on capital employed," just to manage its super-peaks. Centrica essentially said so itself when in 2011 Laidlaw said that its vertical integration strategy was challenged by weaker near term returns for generation in regions without capacity payments.
Instead, Direct Energy wants to socialize all these costs to all other retail electric providers and customers in the market.
If it can get someone else -- and not only someone else, but its direct competitors -- to pick up the tab for those costs, then Direct can enjoy the competitive advantages and benefits of vertical integration, without taking on any of the costs or risks. You can't blame them for trying, but it shouldn't be the Texas government's position to force independent businesses to reduce risks for an international conglomerate with about $20 billion in revenues for the first six months of the year.
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August 2, 2013
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Copyright 2010-13 EnergyChoiceMatters.com
Reporting by Paul Ring • ring@energychoicematters.com
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