Unbelievable: Desperate Texas Capacity Market Supporters Claim Rational Investors Won't Build on Potential Future Energy Market Revenues; But Apparently Are Investing Based on Speculation, Hope of "Reform"

Desperate to maintain their narrative of a Texas capacity crisis, supporters of a mandatory capacity market in Texas have said that new generation being built in ERCOT, which has resulted in a 2014 reserve margin above the target, should be ignored, but if not, such investment should be seen as investors speculatively betting that Texas will adopt some form of a capacity market -- contradicting the claim that investors only invest based on certain, known, and measurable revenues (the key criticism of the energy-only market)

Specifically, EquiPower Resources Corp., on behalf of Odessa-Ector Power Partners, LP, said that it is, "very concerned that new generation projects currently under construction are being viewed as validation that the current market is working and a reason to slow down the urgency for market reform and the level to which reforms are implemented to achieve Resource Adequacy."

"In our view this is a misread of the market and risks confidence and further investment in ERCOT. We believe that the current development activity is due to investor confidence that the Commission will make the necessary changes to assure Resource Adequacy in ERCOT, not that the existing design is adequate," EquiPower Resources said (emphasis added).

EquiPower Resources, which filed the comments in Project 40000, said that the "most effective" solution to resource adequacy is a capacity market.

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EquiPower Resources continued:

"Investors are expecting that those entrusted to ensure the proper functioning of ERCOT will act in the market's best interest and implement a market design that leads to Resource Adequacy - not just a partial solution ... Again, we recognize that some generation is being developed in the current EOM [energy-only market], but the amount of new generation falls short of the amount needed to ensure Resource Adequacy and to a great extent is based on an expectation that the future market design will properly focus on Resource Adequacy and a properly functioning market."

Matters will note that with respect to 2014, which is the only year that should carry any weight of finality under an energy-only market design, the amount of new generation does NOT fall short of the amount needed to ensure resource adequacy, contrary to EquiPower's broader assertion quoted above. While out-years in the CDR report do show a reserve margin declining below target, as has been repeatedly stated (and shown in practice), this is expected, and indeed beneficial, under the energy-only market design, which incents resources to come online when needed, not years before.

EquiPower Resources continued:

"We believe it is ill advised to look at the current new generation development and construction in ERCOT and believe it is validation of the ERCOT market as currently designed or a reason to make minimal incremental tweaks to the current market."

In other words, the actions actually undertaken and dollars spent by investors in the only assured market design, the energy-only market, should be ignored. Instead of examining real-world experience, the PUCT should apparently speculate on investor motives.

EquiPower Resources continued:

"Rather, we believe that the current development activities are based on the belief that this Commission will take prudent, bold action to modify the markets to provide for Resource Adequacy in ERCOT."

Matters does not necessarily disagree that this may, in fact, be a bet that some investors are making. However, it should be viewed as only that, a bet -- a risk, which investors are taking, and a risk they appropriately should bear alone (as correctly occurs under the energy-only market).

However, EquiPower Resources said that reforms are needed to essentially bail out these investors, who are undertaking millions if not billions of dollars in investment in an actual market-design they (according to EquiPower Resources) know is flawed and does not guarantee compensatory revenues, on the speculation that market design changes to increase their revenues will be undertaken.

"Missing the mark [on market design changes] could have disastrous effects possibly leading to financial distress for investors and dampen future investment in ERCOT as investors lose trust in the market and those entrusted to ensure its proper function," EquiPower Resources said.

Stop. So in Texas we have:

(1) A Commission which has proceeded very deliberately on resource adequacy market design changes,

(2) At least one Commissioner vocally opposed to centralized/eastern-style capacity markets,

(3) Key legislators offering anti-capacity market bills during session (which admittedly did not pass), and

(4) Extensive end-user opposition to capacity markets,

...and yet investors are claimed to be confident enough in this environment to bet that reforms which produce compensatory revenues (with a capacity market claimed to be the most effective solution for this) will be implemented?

Oh, and if investors are wrong, that is, they take a risk that future, uncertain, market design changes would be favorable to them and such changes are not implemented, apparently, it's not their own fault -- its Texas policymakers' fault, and policymakers must undertake the market reforms bet on by investors to restore investor "confidence." This reasoning, quite frankly, is what's wrong with America today, and represents the worst of corporate welfare/crony capitalism, and not free enterprise, the latter of which has created the "Texas miracle."

Nevertheless, some investors, those with a large risk appetite, may in fact be making a bet on future market reforms akin to a capacity market. The beauty of free enterprise is that different investors can look at current market conditions and allocate capital according to their read and belief of market conditions, and appetite that their analysis and instincts may be wrong.

However, what we find untenable is the position that investors are going to pour billions of dollars into building new Texas capacity on the bet that a capacity market will be implemented, but that these same investors won't undertake similar investment on the bet that future weather or market conditions support enough scarcity pricing under the 20-year life of a plant to justify investment in the plant under an energy-only market design.

It simply defies logic that investors will make one bet, but not the other.

EquiPower Resources also lists challenges facing generation investment:

"There are numerous challenges with financing new generation in the current market. The lack of liquidity, lack of long-term hedging, and earnings volatility have led to limited financing opportunities. Commercial lenders are not willing to loan money to finance new generation, and public markets do not look favorably on companies that use their equity to finance new generation when the construction costs are significantly higher than would be recovered in the current forward markets. This has led companies to turn to institutional lenders as one of the only ways to finance new generation. While this has led to some newly announced generation, the cost of using this approach is very high and not widely available to most market participants."

Matters does not dispute any of these challenges, but questions how any of the following are solved by a capacity market: "liquidity, lack of long-term hedging, and earnings volatility"

The longest existing capacity market obligation is three years forward, which does not provide liquidity over the life of an asset, or long-term hedging. As seen in several of the eastern capacity markets, particularly PJM, capacity market revenues are also quite volatile. As has been stated by numerous developers seeking ratepayer-backed long-term contracts with loads in capacity market states, the short-term nature of capacity markets do not provide needed assurances for investment in a long-life asset, essentially making the same claims that are made regarding the energy-only market, despite a three-year forward capacity obligation imposed on load.