Texas Generators Shamelessly Seek Capacity Subsidies On Top of $7,000 Scarcity Prices

Despite an imminent increase in the ERCOT price cap to $4,500, and likely increase to at least $7,000 in 2014, several unregulated Texas asset owners continue to seek government subsidies in the form of capacity payments imposed on load.

Last week, AEP CEO Nicholas Akins claimed there was a need for supplemental forward price signals in ERCOT, claiming "short-term" signals were inadequate. Yesterday, Energy Future Holdings' CEO John Young floated some type of "market" (but assuredly compulsory, otherwise no one would purchase the product) mechanism to identify the reliability cost of maintaining adequate capacity (Young's comments are below).

At its core, capacity obligation proponents are asking that customers be compelled to pay (and let's assume a capacity rate of $200/MW-day to take an expected PJM number for 2015/16) for the privilege of later being sold power at $7,000/MWh.

That such an idea can even be suggested, let alone so openly and without shame, is an embarrassment to the competitive electric industry.

And, oh by the way, the capacity payments do not even assure capacity, as seen by the continued reliance on Reliability Must-Run agreements in PJM (see related story).

Matters will return to PURA Chapter 39, which established the restructured electric industry in Texas, which provides:

"The legislature finds that the production and sale of electricity is not a monopoly warranting regulation of rates, operations, and services and that the public interest in competitive electric markets requires that, except for transmission and distribution services and for the recovery of stranded costs, electric services and their prices should be determined by customer choices and the normal forces of competition."

A capacity obligation, load obligation, capacity market, or any other similar intervention would contravene at least four tenets of this finding -- regulation of rates, regulation of services, normal forces of competition, and most important, that customer choices, not regulators, should determine electric prices and services.

Although it should be obvious, because there is this notion that a capacity obligation is somehow a competitive or market mechanism; here are only a few of the ways a capacity obligation is inconsistent with these guiding principles of PURA:

1. A regulator, not the choices of customers, would determine the amount of the capacity to purchase through some administrative mechanism (e.g. demand curve or other resource needs study)

2. If implemented similar to capacity obligations elsewhere, a regulator, not market forces, would establish an administrative floor price for capacity

3. A regulator, not the market, would establish the inputs for such floor price (e.g. estimates of Cost of New Entry, etc.)

Although an auction or other "market" mechanism may be used, when an obligation is imposed on customers to purchase capacity, the auction mechanism is no more of a free market than a mandate to buy health insurance.

Of course, a mandatory capacity payment imposed on customers, through a charge on retail electric providers, would provide an unfair competitive advantage to retail electric providers whose affiliates own generating assets. Currently, these assets provide innumerable benefits to their affiliate REPs, from load following capability during super peaks, to a reduction in collateral requirements needed for market purchases, and the like. But under the current market structure, the REP, or some affiliate, must also bear costs to realize these benefits -- namely, the fixed costs of maintaining the assets' availability.

And the retail benefits from generation ownership do not always outweigh these fixed costs, which is why some units owned by parents of large REPs (such as NRG) remained mothballed, until very recently when they have come back online in response to expectations of higher energy prices.

Consider, however, what will happen when a capacity obligation is imposed on load. Assuming the units clear (which they will given ERCOT's current lack of excess supply), these REP-affiliated mothballed units will receive a socialized capacity payment from all REPs. Meanwhile, with the fixed costs covered by competitors, the units can now be operational and used to benefit the affiliate REP at only the marginal cost of the unit (rather than full cost), essentially letting the affiliate REP force its competitors to subsidize its affiliated plants, which the affiliate REP will then use to either lower its retail pricing, or earn more retail margin which can be used to acquire more customers (organically through more expensive channels or inorganically), all to the detriment of non-asset-owning REPs that are forced to pay a capacity obligation.

Young's specific comments were:

"The next evolution of this market is to try to identify specifically [and] quantify a reliability portion of price ... I don't want to get ahead of the Brattle Group study ... but my own view is that it will recognize that some market mechanism that identifies this reliability cost -- and it may be seasonal as opposed to year-round -- has to be added to the mix.

"You'll get into a debate after you recognize that there is a cost needed to maintain reliability, as to how you want to price that.

"The very nature of a short-term scarcity price approach, while on one hand adds a lot of good things, [is] it's harder to finance because of weather variability and a lot of other things, so there will be those that think in terms of a longer term price component, whether that may just be July, August and February, or spread on some basis throughout the year."