ERCOT IMM: Texas PUC Should Evaluate Drivers That Prompt Load To Voluntarily Shed Apart From Real-Time Prices (4CP, ERS), Due to Skewed Impact on Shortage Pricing

The Public Utility Commission of Texas should evaluate policies and programs that create incentives for loads to reduce consumption for reasons unrelated to real-time energy prices, including: (a) the need for and structure of Emergency Response Service (ERS) and (b) the allocation of transmission costs, the ERCOT Independent Market Monitor recommended in a 2015 State of the Market report

"A load that wishes to actively participate in the ERCOT market can participate in ERS, provide ancillary services, or simply choose to curtail in response to high prices. Participating in ERS greatly limits a load’s ability to provide ancillary services or curtail in response to high prices. Given the high budget allotted and the low risk of deployment, ERS is a very attractive program for loads. Because the ERS program is so lucrative, there is concern that it is limiting the motivation for loads to actively participate and contribute to price formation in the real-time energy market," the IMM said

"Transmission costs in ERCOT are allocated on the basis of load contribution in the highest 15-minute system demand during each of the four months from June through September. This allocation mechanism is routinely referred to as four coincident peak, or 4CP. Over the last three years, transmission costs have risen by more than 60 percent, significantly increasing an already substantial incentive to reduce load during probable peak intervals in the summer," the IMM said

"Both of these mechanisms provide strong incentives for load to act in ways that are not aligned with the most efficient electricity market outcomes which are to ensure that the price continually reflects both the cost to provide (supply) and the value to consume (demand). For example, loads’ preference for ERS may lead many to not provide ancillary services or not respond to high wholesale energy prices. High real-time prices are generally correlated with high loads, but they are more specifically correlated with low operating reserves. Loads that are focused on not consuming during an expectation of high load, and its associated contribution to transmission cost allocation, may be skewing shortage pricing outcomes in ERCOT’s real-time energy market," the IMM said

Other IMM recommendations included recitations from prior reports, including implementing real-time co-optimization of energy and ancillary services, modifying the real-time market software to better commit load and generation resources that can be online within 30 minutes, and pricing future ancillary services based on the shadow price of procuring the service.

The IMM report also contained a discussion of net revenue analysis and resource adequacy

"Based on estimates of investment costs for new units, the net revenue required to satisfy the annual fixed costs (including capital carrying costs) of a new gas turbine unit ranges from $80 to $95 per kW-year. These estimates reflect Texas-specific construction costs. The net revenue in 2015 for a new gas turbine was calculated to be approximately $23 to 29 per kW-year, depending on the zone location. These values are well below the estimated cost of new gas turbine generation," the IMM said

"These results are consistent with the current surplus capacity that exists over the minimum target level, which contributed to infrequent shortages in 2015. In an energy only market, shortages play a key role in delivering the net revenues an investor would need to recover its investment. Such shortages will tend to be clustered in years with unusually high load and/or poor generator availability. Hence, these results alone do not raise substantial concern regarding design or operation of ERCOT’s ORDC mechanism for pricing shortages," the IMM said

The IMM noted that the CDR shows that ERCOT will have a 16.5 percent reserve margin heading into the summer of 2016. Reserve margins are now expected to exceed the target level of 13.75 percent for the next several years. These projections are higher than those developed last year, which were higher than in 2013. These increases are due to more new generation capacity expected to be constructed in ERCOT. "The current outlook is very different than it was in 2013, when reserve margins were expected to be below the target level of 13.75 percent for the foreseeable future," the IMM said

"This current projection of reserve margins combined with relatively infrequent shortage pricing may raise doubts regarding the likelihood of all announced generation actually coming on line as currently planned. Given the projections of continued low prices, investors in some of the new generation included in the report on the Capacity, Demand, and Reserves in the ERCOT Region (CDR) may choose to delay or even cancel their project. Additionally, the profitability analysis of existing baseload resources casts doubt on whether all existing generation will continue to operate," the IMM said

"The generation-weighted price of all coal and lignite units in ERCOT during 2015 was $25.94 per MWh. Although specific unit costs may vary, index prices for Powder River Basin coal delivered to ERCOT were approximately $3 per MMBtu in 2015. With a typical heat rate of 10 MMBtu per MWh, the fuel-only operating costs for coal units in 2015 may be inferred to be approximately $30 per MWh. As with nuclear units, it appears that coal units were likely not profitable in ERCOT during 2015. This is significant because the retirement or suspended operation of some of these units could cause ERCOT’s capacity margin to fall below the minimum target more quickly than anticipated," the IMM said

"Given the very low energy prices during 2015 in non-shortage hours, the economic viability of existing coal and nuclear units was evaluated. The prices in these hours, which have been substantially affected by the prevailing natural gas prices, determine the vast majority of the net revenues received by these baseload units. The generation-weighted average price for the four nuclear units - approximately 5GW of capacity - was $24.56 per MWh in 2015. According to the Nuclear Energy Institute (NEI), total operating costs for all nuclear units across the U.S. averaged $27.53 per MWh in 2015.4 Assuming that operating costs in ERCOT are similar to the U.S. average, considering only fuel and operating and maintenance costs indicates that nuclear generation was not profitable in ERCOT during 2015. To the extent nuclear units in ERCOT had any associated capital costs, it is likely those costs were not recovered," the IMM said

Link to IMM report