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Study: Texas Capacity Market to Cost $4.7 Billion Annually

August 28, 2013

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Copyright 2010-13
Reporting by Paul Ring •

A Texas capacity market would cost $4.7 billion annually, according to a study by Charles Rivers Associates commissioned by NRG Energy, Inc. which was filed with the Public Utility Commission of Texas.

Of course, being filed by a capacity market supporter, the study draws the conclusion that these costs would be offset by reduced losses in gross state product. Specifically, the study claims that over 15 years (by 2028), the capacity market will save Texas $14 billion in gross state product losses ($17.1 billion in outage cost savings less $3.1 billion in additional electricity costs [representing capacity costs net of claimed energy market savings]).

Notably, these benefits of the capacity market only exist compared to the strawman energy-only market scenario which is used as a reference case. They are not net benefits to the state, but rather, smaller losses versus the claimed losses occurring under the energy-only market, as the market is designed in the study

Of note, in calculating outage costs under the energy-only market, the study provides: "We assume the Energy Only market reaches the Brattle-estimated long run equilibrium reserve margin of about 8-9% after several years." (emphasis added)

There is no apparent independent justification for use of these reserve margin levels for the energy-only market. After a decade (a long time) of relying on the energy-only market, ERCOT has not reached this "long run equilibrium reserve margin," and instead, once the delivery year arrives, ERCOT generally hovers around the target reserve margin.

Therefore, the CRA study is basically a portrait of what would happen if energy-only market reserve margins reached an equilibrium level which the market has never seen, and for which there is no apparent support. While a fun exercise of what the world may look like in an 8% reserve margin market, it amounts to a strawman assumption. The "savings" purported under the study are not justified as having any real-world applicability if the 8% reserve margin for energy-only is only "assume[d]."

What is notable is the enormous gross cost of the capacity market, net of any claimed offsetting benefits.

CRA pegs the capacity market costs at $4.7 billion per year.

This is even higher than back-of-the-envelope calculations (using PJM pricing) that had put the cost of a Texas capacity market at $3.6 billion.

Putting aside for a second arguments about the need for a mandated reserve margin, the question must be asked, if a mandated reserve margin is essential to the Texas economy, is spending $4.7 billion annually to meet an installed reserve margin via a capacity market (which as noted in related stories today may not equal capacity supplier performance during emergency grid conditions) really the most economic way to assure Texans that there are no rolling outages?

Indeed, CRA concedes, "Implementing a capacity market and consequently increasing the assumed reserve margin does not completely eliminate reliability events."

Also of note is how CRA adjusted loss of load event forecasts. Certain values were "estimated or calculated based on CRA assumptions." (emphasis added)

"For example, the size of event in an average year (1,500 MW) was estimated as the average event size in the ERCOT LOL Study. The size of event in the extreme weather year (2,500 MW) was estimated based event sizes in the ERCOT LOL Study for low reserve margins, adjusted for the size of an actual February 2011 event that reached 4,000 MW."

Having only had since yesterday afternoon (when it was publicly filed) to review the study, Matters concedes that it does not understand completely, at this point, the use of the 4,000 MW from the February 2011 event, and what it is driving in the CRA study.

However, the use of the value concerns us, particularly if it used for the energy-only loss of load values, but not for the capacity market loss of load values (we concede we cannot determine after our initial readings if CRA is using this number in both studies or not, so our concern may be moot).

The February 2011 rolling outages were not the result of a lack of installed capacity. They resulted from forced outages, and to a lesser extent gas supply and transportation issues. Depending on capacity market design, both forced outages and gas supply issues would have excused capacity suppliers from meeting their capacity supply obligation, with no penalty or loss of capacity payment. In other words, the capacity market would have provided no additional incentive (such as through a penalty that generators would have taken measures to avoid) for being available during the February 2011 cold snap, and therefore, the capacity market would have produced the same forced outages and gas supply issues, and the same interruption of load.

The CRA study also raises the specter of, "potential loss of new business in the state, and loss of business expansion, driven by concerns about reduced power supply reliability in ERCOT on quality-sensitive customers, such as high technology facilities." The report specifically cites data centers as key businesses impacted by reliability.

However, as noted by our related story today (click here), and countless recent stories about the continued attractiveness of Texas' business climate, these concerns are not shared by real-world businesses which are considering locating in Texas. Aside from being ranked No. 1 in total business climate, Texas was ranked second in the data center metric, strongly rebuking any claim that the energy-only market is not viewed favorably by data centers.

Some two years after the 2011 extreme summer, and two years of incessant scare-mongering by capacity owners, businesses still see the Texas energy-only market as attractive, and superior to alternatives.

Finally one last note. The CRA study observes, "One increasing concern for ERCOT is the age and condition of the portion of its generation fleet that will be relied upon more frequently as the reserve margin decreases [without a capacity market]. New generation assets generally displace older units that are often more susceptible to outages. Low levels of new construction not only reduce the reserve margin, they further reduce reliability because old units are not retired. This is especially true when the 'new' generation brought online is really vintage units brought out of mothball status as has occurred recently in ERCOT. A third of the operating on-grid fleet in Texas is over 30 years old."

However, despite this concern with the age of generation, capacity markets tend to prolong the life of these "older units that are often more susceptible to outages." It is unquestionable that the eastern capacity markets extended the lives of what were old units that were at the end of their useful lives, and have increased reliance on 40, 50, and 60-year old units. This is not surprising because these units have an unfair competitive advantage in meeting the artificial, government-designed capacity product, which is defined to only procure resources with the lowest going-forward fixed costs, regardless of how expensive the units are when all of their costs to consumers are taken into account.

These old units clear the capacity market regardless of how expensive their energy is, or how well they can flexibly follow load and be dispatched, because of their low going forward fixed costs due to age and depreciation. Very little new construction occurred in PJM until federal-government regulation forced coal retirements for environmental reasons, meaning all those years when PJM was meeting its newly instituted reserve margin when RPM first began, it was relying on the very units PJM said needed to be replaced and which compelled the need for RPM to build new units (see full discussion here).

CRA's study was filed by NRG in Project 40000

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