The Great Texas Power Pricing Fiasco

I put up this post two days ago, which described the first of two primary causes that I see for the Texas power grid problems last week (I will address the second primary cause next week). This first cause was economic: to quote the author of that post, “Texas trusted the markets too much and went way too far in deregulation.”

The next morning, I got a long email from my friend Kevin Perry, which provided a lot of context on the markets problem. Kevin is in a position to know this, since he was for a number of years a member of the IT leadership team at Southwest Power Pool, the Regional Transmission Organization based in Little Rock which now, according to their web site, “oversees the bulk electric grid and wholesale power market in the central United States on behalf of a diverse group of utilities and transmission companies in 17 states.” Kevin was also the Chief CIP Auditor for ten years for SPP Regional Entity, the NERC Regional Entity that covered what was at the time the SPP footprint.

Of course, SPP is next door to Texas, where the grid is run by ERCOT. ERCOT just oversees the Texas market, since most of Texas is on a separate grid from the rest of the country (more about that when I discuss the second primary cause of the outage). So he knows a lot about power markets, both in ERCOT and SPP. Kevin described to me two important reasons why the power market broke down so badly in Texas last week. I’ll describe one of the problems in this post, and the other in (hopefully) my next post.

Kevin pointed out that Texas is a retail choice state, meaning consumers have a choice of who they can buy their power from. In other retail choice states (including Illinois, where I live), consumers can buy from their local utility, which also delivers the power (and charges a set fee for that, set by the regulators), or they can buy their power from one of the 220 or so retail choice providers (it's still delivered by their local utility). Those providers enter into contracts with power generators to meet their normal demand, but in cases of market turmoil those providers have to go on the spot market and pay the going rate. In some cases, they simply pass these prices on to their consumers (although some retail choice providers sell their power to consumers at fixed rates).

However, in Texas 60% of consumers didn't have a choice whether or not to buy power from their local utility; their only choice was which retail choice provider they wanted. According to this WSJ article, since 2004, customers of the retail choice providers have paid $28 billion more for power than have customers of traditional utilities. 

And there was plenty of turmoil last week. As everyone knows, power supply was severely constrained because so many natural gas plants couldn’t produce at all, and also because natural gas pipelines couldn’t transmit gas to the plants that burn it (about 40% of Texas generation) because of freeze-ups in the pipelines and at gas wellheads; both coal plants and wind/solar farms also had a lot of outages due to the cold. When you add to that the fact that most Texas homes are heated by electricity, the soaring demand combined with plummeting supply led to…high prices.

But that wasn’t the whole story. The normal settlement price on the spot market is under $50 per megawatt-hour (MWH); when Kevin emailed me yesterday morning it was $18. But for a couple of days last week, it was $9,000 per MWH. Was this price a result of pure supply and demand? Kevin had heard the settlement price was $1200 at the worst of the crisis, but then it suddenly jumped to $9,000. Why did that happen? Kevin wasn’t sure.

I found out why it happened this morning when I read this article in the Wall Street Journal. It provided a great picture of what happened, and points the finger at the Texas Public Utility Commission: 

Hours into widespread blackouts in Texas last week, the state’s power regulator took an unusual step: It stopped relying on the deregulated market to set electricity prices and did so itself.

The Texas Public Utility Commission said it raised prices to a market cap of $9,000 per megawatt hour during a six-minute emergency meeting Feb. 15, up from recent prices as low as $1,200 a megawatt hour, because the computer that was supposed to help match supply and demand on the power grid wasn’t working properly, and it needed to intervene to relieve a growing crisis.

But the higher prices didn’t result in additional power production, because many generators were dealing with frozen equipment or fuel shortages, and were unable to deliver more megawatts, no matter the price. Some electric-market participants now say the commission’s action turned an energy crisis into a financial catastrophe for many electricity buyers, who were left paying billions of dollars more for the same limited supply of electricity as before.

The role of the PUC, a three-member panel appointed by Texas Gov. Greg Abbott, in last week’s power fiasco is poised to garner more attention as state lawmakers review what went wrong. Up to now, most attention has focused on the Electric Reliability Council of Texas, or Ercot, the state’s nonprofit grid operator, but the PUC is the state’s chief electric regulator, and took key actions during the crisis.

State hearings examining the causes of the power collapse began Thursday.

PUC officials told The Wall Street Journal that, while Ercot had begun ordering blackouts as power supplies fell short last week, its computer that ran the market was apparently confused by what was happening. Ercot was trying to stabilize the grid by building up reserves of available generation. The computer was “misinterpreting those reserves as abundance and turning off the more expensive natural gas plants,” exacerbating power supply problems, said PUC spokesman Andrew Barlow.

Ercot spokeswoman Leslie Sopko disputed that the computer was turning off gas plants.

At the time, the situation left the PUC members dumbfounded. Chairman DeAnn Walker described herself during the Feb. 15 meeting as surprised by the market’s prices, which were hovering around $1,200 a megawatt hour at the time. Commissioner Arthur D’Andrea added: “We are not calculating prices correctly.”

The commission moved to set prices at the $9,000 cap, concluding that the prices at that time were “inconsistent with the fundamental design of the Ercot market. Energy prices should reflect scarcity of the supply.” That was intended to encourage power generation to come back online and allow Ercot to end the blackouts, which had plunged millions of homes into the dark in subfreezing temperatures, triggering a humanitarian crisis in the nation’s second-largest state.

But the Monday order didn’t immediately have the intended effect. At the time of the order, there was about 50,000 megawatts offline—out of 107,500 megawatts. This would remain the case through midday last Wednesday, according to a presentation by Ercot this week.

While the Ercot computer glitch may have turned off some plants, many more were shut down because of freezing conditions, fluctuations on the power grid and natural gas shortages.

Let’s be clear about this:

·        The settlement price was $1,200 per MWH at the worst of the crisis.

·        However, the PUC decided that this price didn’t reflect the real scarcity (which was possible), so they decided to assist the market a little in finding the right price. They pushed it up to the maximum allowed, or $9,000.

·        Why did they do this? Just to make sure the generators made a real killing - which is in fact what happened? No, they had a noble goal: They knew – because their Economics 101 class had taught them that – that high prices induce big supply increases.

·        Unfortunately, they never reached Economics 201, where they would have learned that supply never increases instantaneously, but takes some time to ramp up.

·        And if they’d taken Common Sense 101, they would have realized that, given that plants and pipelines were shutting down because of cold weather, only a return to warmer weather was going to allow them to increase output, no matter how high they raised the price.

·        And it seems the PUC learns slowly. After making sure that the price consumers had to pay was more than seven times what it would have been without their intervention, they kept prices high for the rest of the week, thinking…hmm, what were they thinking, if they were thinking at all?

All of this isn’t a story of a few people getting gouged. Billions of dollars were transferred from residential, commercial and industrial customers, municipal utilities and Retail Choice Providers (some of which, like NRG, sell their power at fixed prices, so they had to eat any overage) to generators and gas pipeline operators – more specifically, to the ones that were able to keep operating last week. There will be hell to pay for this, and we haven't seen the end of it.

The big problem in this case is that some people put way too much faith in their theories and way too little in common sense. This includes the PUC members and Prof. Hogan of Harvard (discussed in my last post) – who designed this wonderful system and reassured Texans last week that his handiwork had performed exactly as it was intended to perform. I’m sure that was very comforting to those Texans, especially the parents of the 11-year-old boy who froze to death in his bed.

Any opinions expressed in this blog post are strictly mine and are not necessarily shared by any of the clients of Tom Alrich LLC. If you would like to comment on what you have read here, I would love to hear from you. Please email me at tom@tomalrich.com.