Mothballing of SR Bertron Units Again Shows Subsidization of Certain Retail Providers Will Occur Under a Texas Capacity Market

NRG Texas Power LLC has filed a Notification of Suspension of Operations with ERCOT for several of the units at its SR Bertron facility, namely, units G1, G2 and GT2.

The decision to mothball the units at the conclusion of the peak season, as has been done in recent years, again shows that the benefits of the plants' availability -- whether such benefits be direct energy market revenues or benefits from serving Reliant, Green Mountain or Energy Plus load and the attendant reduction in collateral requirements -- are outweighed by the fixed costs of maintaining the units' availability.

However, if such units cleared a mandatory capacity market (as they are virtually certain to do in any "transitional" auction at market start-up if dire estimates of available capacity are to be believed), NRG could maintain the availability of the units with essentially zero out-of-pocket costs.

The fixed costs of the SR Bertron units would be paid for by the entire market -- meaning the majority of costs would be paid by competing retail suppliers and their customers.

However, while all customers would pay for the plants' capacity, the plants could be used to reduce the load following exposure and energy market collateral requirements of Reliant and other affiliated retail providers. All customers in the market would be subsidizing Reliant's costs. With such a cost advantage due to mandatory capacity payments, Reliant could artificially lower its pricing to win more customers, putting competing retail providers out of business, or could use the capital to buy up competitors and strengthen its market position.

Matters previously cited the SR Bertron units as the perfect example of the subsidization of select retail providers under the capacity market, due to the units' frequent mothballing and return to service.

Such subsidization threatens customer choice in ERCOT.

NRG has previously said that raising the ERCOT offer caps would be particularly challenging for retail providers, especially those without affiliated generation.

However, at least with a higher offer cap, individual retail suppliers can develop unique and innovative hedging strategies to minimize any additional costs brought into the market.

Although retail providers owning generation may still be at an advantage, there is no mandated payment to them, and independent retail providers still have a fighting chance if they are nimble and innovative enough to address the new market environment better than their competitors. Indeed, the mothballing of the SR Bertron units, even with a $4,500 price cap, shows that outside of superpeak times, owning certain generating units (particularly marginally economic units) does not provide so much of an advantage as to justify their fixed costs when the owner is solely responsible for such fixed costs.

However, with the mandated capacity payments inherent in a capacity market, there is no room for innovation by retail providers. They are forced to make payments to their competitors' affiliates, at a rate not regulated by the PUCT (unlike payments to TDUs affiliated with retail providers), and can't escape it.

Moreover, plants affiliated with a retail provider which were previously uneconomic, and mothballed, could now return to service with virtually no fixed costs paid by the affiliated retail provider who benefits from the plants.

This subsidization, alone, will kill the retail market, but if such forced capacity subsidization is implemented in tandem either with the current, or even worse, higher offer caps, the environment will be fatal for independent retail providers [to be clear, Matters believes offer caps of $9,000 or higher are appropriate in an energy-only design, and that independent REPs could be sustainable under such a cap, but not when capacity payments are also mandatory]

In a February 2012 earnings call, NRG CEO David Crane painted a bleak picture for independent retail providers from the contemplated wholesale market rules changes -- which, at that time, only seriously consisted of higher energy market offer caps, and not a mandated capacity market (an idea which did not gain traction until this summer).

Crane specifically said: "[T]he rules, as they're changing in Texas, are definitely favoring the wholesale. And if you look at -- in the scheme of things, that's probably not going to be positive for any retailer, but in the scheme of NRG, where the wholesale business is still bigger than the retail business, it's good for us."

"[T]hose rules are going to be a particular challenge that people that don't have the benefit of the wholesale supply to support their retail businesses," Crane said.

And that challenge is just from higher offer caps.

Now imagine what will happen if independent retail providers face the all of the following:

(1) offer caps of $4,500 to as high as $9,000, with cost impacts both from the cost of energy and collateral requirements;

(2) mandatory capacity payments subsidizing their competitors via generation owned by a competitor's affiliate;

(3) their competitors receiving capacity payments (through an affiliate) won't be exposed to the higher offer caps and collateral requirements, because they are affiliated with generation -- generation whose costs are being paid for by all retail providers in the market.

It doesn't take a PhD to see an untenable business model for independent retail providers under such a "market."