A Hearty Bowl of Texas Soup: How ERCOT Keeps the Lights On
ERCOT (or the Electricity Reliability Council of Texas, the independent system operator of that state’s stand-alone wholesale market) has confounded the doomsayers once again. Despite dire predictions that ERCOT lacked sufficient generation capacity, it came through the peak summer season of 2019 without any firm load curtailments, despite a hotter-than-normal summer and notching a new peak demand record. This happened despite the fact that ERCOT does not enforce a mandatory minimum reserve margin over peak demand, relying instead on its wholesale energy market construct to incentivize buyers and sellers to make their own decisions about how to manage their respective market risks.
Every year, it seems, those who stand to benefit the most from new mandates for government-backed contracts (principally the large generators) do their best to scare the bejesus out of everybody by shrieking that ERCOT will not be able to “keep the lights on.” These claims gain credibility by reference to target reserve margins published by the North American Electric Reliability Corporation (NERC). Environment & Energy News reported at the end of August that Jim Robb, NERC’s CEO, “told a regulatory conference that based on ERCOT’s percentage of power reserves, ‘there’s no way in hell they can keep the lights on.’ Then he added, ‘And yet they do,’ concluding ‘there’s something in the soup.’ ” So which is it? Is ERCOT playing with fire? Or are they onto something?
Robb’s choice of the soup metaphor proves to be apt, intentionally or not. In most other organized markets, resource adequacy is served as a simple meal consisting overwhelmingly of meat and more meat, in the form of mandatory amounts of generating capacity connected to the grid. How much is “enough” is expressed as a percent margin of firm capacity over the peak demand. These system operators, in concert with NERC, set target margins based in part on variations of a long-standing industry rule of thumb: “one [loss of load] event in ten years.” That rule, however, is maddeningly vague in application, and the end result is target reserve margins of 14% or more. Consumers in some markets are then compelled to underwrite investment in at least that much generation.
In contrast, ERCOT is held to the same reliability standards as these other markets but eschews mandatory minimum reserve margins. It relies instead on a hearty “soup” of market-driven short- and long-term decisions taken by Texas’s rich blend of wholesale generators, distributed generators, industrial and commercial consumers and, increasingly, residential consumers, on a base of robust and transparent energy market pricing, to ensure consumers enjoy the reliability they want and are happy to pay for. This has led to generation margins in ERCOT considerably lower than in other markets — 8.6% going into this summer’s peak season. (PJM’s official margin, for example, was 28.2% compared to a target of 16%.) This compares to NERC’s 13.75% target margin for ERCOT. And yet, as Robb notes, the lights remain on.
Why the disconnect? It turns out that the “one event in ten years” standard has its origins in technical papers from the 1940s, if not earlier, and has never been backed by an objective benefit-cost assessment. Texas utility regulators contracted a study by the Brattle Group in 2014 to assess, using information on customer experience and preferences, what an economically optimal reserve margin would be in ERCOT. The answer: about 10.2%. While this suggests 2019’s 8.6% margin was tight, it also suggests that it was much closer to what a reliable and economic ERCOT system needs than NERC’s target would seem to imply.
The extra cushion suggests that NERC and most system operators employ an extremely conservative interpretation of a conservative standard. System operators, regulators, and government appear to tacitly endorse a goal of never curtailing any firm load — an uneconomic and unachievable objective — by treating every instance of firm load curtailment, no matter how rare, as a failure not to be repeated in future. The result has been mandatory capacity margins leading to levels of capacity investment that, at the margin, cost their consumers $100,000 per MWh or more. If that strikes you as vastly more than consumers would knowingly pay to avoid briefly postponing or foregoing some of their more flexible electricity needs, that’s because it is. Many consumers, especially large industrial and commercial consumers, are happy to shift some of their more discretionary loads by a few hours for a tiny fraction of that cost. And simple economics tell you that, in extraordinary circumstances, it is in consumers’ best interests that system operators and regulators consider some level of directed firm load curtailment to be a feature, not a failure, of a prudently run power system.
NERC and the system operators have a difficult job to do, with nothing but downside risk, so a conservative bias is understandable. But consumers end up footing the bill. Some observers point to the few hours of very high prices that occurred in ERCOT this summer as a different kind of failure — “proof” that the market is failing. But rare instances of high prices are exactly what is to be expected — and desired — of the ERCOT market design. And at the maximum rate of $9,000 per MWh, they’re less than 10% of the $100,000 or more per marginal MWh that consumers elsewhere are paying for their all-meat diets. More to the point, weighted average wholesale electricity prices in ERCOT continue to be the lowest of any of the traded markets. ERCOT, with the support of the Texas commission and legislature, has chosen to trust in the wisdom of its consumers to recognize that this active dialogue between supply and demand is all part of why they enjoy reliable electric service at such low prices.
A final point to put this in perspective: Market ideology is not the issue here. The issue is how to position power systems to best serve consumers in the transition to a clean energy system. And here again ERCOT is at the bleeding edge, with the highest share of wind energy of any market in the country and rapidly growing solar production. Among experts it is well recognized that, as we travel farther down this road, it will be critical to tap into the inherent, low-cost flexibility of many end uses of electricity. It is difficult, verging on impossible, to imagine demand playing this essential role in the transition without having as a starting point the active, transparent dialogue between supply and demand that drives the ERCOT market model.
That dialogue begins with an adult conversation among system operators, regulators, consumer advocates and government — perhaps over a hearty pot of soup, or better yet, Texas chili — about what consumers really want when it comes to reliability and resource adequacy, and about the role that more transparent and robust wholesale energy pricing will have to play in delivering them cost-effectively.