Pokalsky, Borlick, Kiesling: Capacity Markets Now Essential in Texas (central planning rethink)

By Robert Bradley Jr. -- August 5, 2021

“Arranging deck chairs on the Titanic if no capacity market.” (Joe Pokalsky, here)

“I have stated earlier that the ERCOT market’s reliance on scarcity pricing did not foresee an environment with high penetration of zero-marginal cost resources. Back in 2005 I generically simulated an energy-only market to demonstrate how scarcity pricing would work. I never anticipated the mass introduction of renewables at that time.” ( – Robert Borlick, below)

“(oops!) There is now a need to revise the scarcity pricing framework in the light of recent events, and to reflect ever-changing market conditions.” (Lynne Kiesling, June 30, 2021)

There is a Texas-sized rethink going on with the PUCT/ERCOT model for electricity. The experts/planners presiding over the Great Texas Blackout of February 2021 are in the redesign mode, with some breaking away to advocate a major new pricing system.

But don’t believe for a second that this has anything to do with a true free market in electricity, one based on private property rights and voluntary exchange.

The Texas experts/planners/regulators thought they had it right between giving consumers the right price and incentivizing reliability. Don’t worry about reliable capacity (gas-fired, coal-fired, nuclear), they believed. Why? Because even if wind and solar idled such capacity, and reduced margins otherwise, the reliables would be well compensated at peak demand when wind and solar went missing.

Sound risky, even bizarre? Only central planners (“the fatal conceit’) could cook up such a recipe for 26 million Texas ratepayers under ERCOT’s thumb. Yet this was all part of a grand “free market” approach for electricity, defined as ‘flexibility’ to market conditions. In the words of Lynne Kiesling and Andrew Kleit (Electric Restructuring: The Texas Story. AEI: 1999, p. 3):

By facilitating decentralized coordination instead of imposing specific outcomes, the institutions designed in Texas became the most market-oriented in the country, and the most likely to be resilient and adaptive in the face of unknown and charging economic, technological, and environmental conditions.

But Texas’s unsinkable ship hit an iceberg that had a lot of do with incentives and design. Specifically, a decade or more of low or negative margins–created in large part from low-to-negative pricing for wind and solar that had no fuel costs but a lot of tax credit for every kWh generated–did its corrosive work, a story told elsewhere.

Now, the Texas legislature has ordered big changes, and PUCT/ERCOT is ratcheting up its command-and-control, a quest of new intervention attempting to address the problems of prior. Deregulation is not on the table.

Will the reforms get it right? Without a major shift to reward reliable capacity to be at-the-ready, with capacity payments rather than energy-only payments, it might not work. ISO/RTO expert Joe Pokalsky worries:

… a capacity and operating reserve market providing financial incentives along with obligations for availability would incentivise weatherization, maintenance, and fuel security. The inductive process by ERCOT to introduce yet another, hopefully this time successful, mainly energy price driven market design is going to ruin Texas.

Borlick Rethink

Pokalsky’s view is one that another power planning expert, Robert Borlick, has reluctantly come to. Borlick first denied that wind and solar had compromised the capacity market:

The blackout was not caused by renewables; it was caused by a lack of weatherization of fossil generator and natural gas assets. It is well known that renewables are intermittent and have to be backed up by firm capacity. They were – except that those backup generators couldn’t perform when needed. It is not that they didn’t exist.

But after some polite exchange with the present author, Borlick added:

You may be right. I have stated earlier that the ERCOT market’s reliance on scarcity pricing did not foresee an environment with high penetration of zero-marginal cost resources. Back in 2005 I generically simulated an energy-only market to demonstrate how scarcity pricing would work. I never anticipated the mass introduction of renewables at that time.

Pokalsky and Borlick are cracks in the establishment view that the Texas model had it right and still does. Some, like ERCOT architect Eric Schubert, remain opposed to a capacity market.

But this retreat from Planning Scheme 1 to Planning Scheme 2 (in process) in marry “a respect for decentralized coordination and competition as a discovery process with a pragmatic recognition of the reality of institutional design in a complex world” (Kiesling) is notable.

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Appendix: Shelby Webb Insights (Houston Chronicle)

An article by Shelby Webb, “Expect more conservation notices as ERCOT, PUC announce plans to overhaul Texas electricity market” (July 22, 2021) aptly summarized the PUCT/ERCOT struggle to get prices right. (Webb’s previous article, Insight: Why Houston’s energy transition is unlikely to be smooth, was profiled at MasterResource here.)

Her article describes a wounded grid limping along and in the throes of a fundamental legislative-directive restructuring.

The leaders of the Public Utility Commission and the Electric Reliability Council of Texas said Thursday that they will redesign how Texas’ electricity market provides incentives to power generators to produce a more stable flow of electricity to the state’s troubled electric grid.

But, they said, ERCOT will continue to ask Texans to conserve energy at times, especially as the state heads into the hottest part of summer.

In a joint press conference, PUC Chairman Peter Lake and ERCOT’s interim CEO Brad Jones said they don’t yet know how the redesigned market will work, but that it will move away from the current crisis model that pays generators much more when grid conditions are tight.

“By no fault of their own, private companies can only generate revenue as Texas gets closer and closer to the edge. That’s not a good way to run a reliable grid,” Lake said. “The market needs and will receive a major overhaul.”

Texas’s current energy market model was created in the 1990s and uses prices alone to encourage power generation, said Oliver Kerr, USA lead for Aurora Energy Research. It built scarcity into the system by design, he said. “In this market, you need those times when the lights almost go out to incentivize new generation or old generation to stick around,” Kerr said. “Right now, the market is functioning exactly as designed.”

To bolster reliability, ERCOT adds a “bonus” to power prices when the capacity margin — the amount of generation in excess of demand — is getting low. This so-called scarcity pricing means prices for power can soar to as much as $9,000 a megawatt hour in Texas when grid conditions are tight or that they can tumble into negative territory when there’s too much.

Kerr said the PUC or ERCOT could use the scarcity pricing mechanism to raise power prices before grid conditions get as tight as they were during the February freeze and in June, when about 15 percent of the grid’s capacity went offline unexpectedly during heat wave. The agencies could also pay generators for their existing capacity to entice them to stay online and to do more maintenance.

A third option could be to move to a capacity market, which pays companies to keep backup generation available, whether or not its brought into service. Lake on Thursday dismissed that method, which requires more regulation, saying it was not discussed or approved by the Texas Legislature during its 2021 session.

While the agency begins tinkering with the power market, Jones said, ERCOT has already lined up more reserve power to help the state get through summer, when demand peaks. This month, ERCOT has bought 4.4 million megawatts of power compared with the 3.2 million it bought in July 2020. 

The additional reserves could be tested as soon as next week, when temperatures are forecast to top 100 degrees in some parts of the state.

Jones said the heat will lead to record demand of around 74,000 megawatts. One megawatt is enough to power about 200 homes on a hot summer day. While ERCOT has procured more back-up power generation, both Jones and Lake said conservation notices could be among the tools ERCOT will have to use to keep the lights on.

“Please don’t panic,” Lake said. “It’s the opposite of panic — it’s a few things for a few hours here and there. It’s no different than changing your lawn watering schedule in a hot summer.”