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ERCOT Prices Spiked to Historic Levels – And It Can Happen Again

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Many Texas energy consumers were hit hard on Tuesday, August 13, 2019, when high electricity demand, low supply and depleted reserve margins caused power prices across the state to spike to the $9,000 per megawatt-hour price cap. As power prices were a mere $19 per megawatt-hour the morning of the increase, the nearly 500 percent price hike wreaked havoc on customers that pay a market-based, or index, rate. The afternoon spike nearly surpassed the Texas market’s new peak-demand record of 74,616 megawatts, which occurred just the day prior on Monday, August 12.

How did such a large price increase happen? And could it have been avoided?

If you’ve been following supply and demand in Texas, you already know the answer; because while the steep and sudden increase in price isn’t ideal, the market is, in fact, working as designed. Supply conditions have been tightening over the past several years as coal plants retire, leading experts to wonder when the other shoe would finally drop – and it was likely to happen on just such a very hot day in the middle of summer.

In fact, Texas power customers aren’t in the clear from future hot days creating unfavorable real-time market conditions again. To see the big picture, you need to understand the nuances of the Texas energy market.

How ERCOT’s Energy-Only Market Works

The Electric Reliability Council of Texas (ERCOT) differs from other regional markets, such as PJM, because it is an energy-only market without a forward capacity market. In a forward capacity market, electricity is procured in excess of what is needed to meet peak demand, thereby protecting consumers against unexpected shortages and keeping the grid reliable. Power customers cover this additional cost, labeled as capacity on energy bills.

When creating the Texas energy market, ERCOT chose a route more demonstrative of the economic principles of supply and demand. To minimize fees incurred by procuring an excess of energy, ERCOT runs on a capacity margin, also called a reserve margin, where the projected peak demand on the grid is subtracted from the total capacity generation available in the state. This surplus gap taken against available generation creates the reserve margin.

In addition to supply and demand market forces, electricity generation in Texas is changing. Texas has historically relied heavily on coal generation, much like the rest of the country. As cheaper natural gas and renewable options came into the market, many coal plants idled, only running during times of high demand. In October 2017, some plant owners cut their losses and retired, removing nearly five gigawatts of supply from the ERCOT grid. Because the reserve margin calculation relies on generation, shrinking supply resources leaves the market vulnerable to volatility during times when load is high and generation is low.

After the coal plant retirements in 2017, reserve margins fell to a historical low – around 8 percent in summer 2019. But the market doesn’t move one-to-one when generation disappears. ERCOT created a price adder curve that kicks in during times of high demand when operating reserves drop below a certain threshold. Serving two purposes, the adder both incentivizes consumers to curtail and developers to invest in generation resources. As the adder is included in the real-time settlement price, it increases the total cost consumers pay during times of high demand and low reserve.

Skeptics of the ERCOT market believed a day would come when its cost-saving design would backlash, and it did show signs of that under high demand in summer 2018. Fortunately, the grid and reserve margin held out under the excessive strain of a near-record heat wave with a record-setting electric demand.

What Caused the Price Spike

The price spike on August 13 was a perfect storm in the ERCOT market.

It was well over 100 degrees Fahrenheit in Houston and Dallas, meaning homes and businesses required more power to run operations and cool buildings. Essentially, power demand was very high. While the temperature was similarly high the previous day, there had been stronger wind production, significantly increasing the amount of supply. On August 13, a day already dangerously short on supply, ERCOT saw a decline in wind power generation of about 1,500-2,000 megawatt-hours day-over-day. Though wind production picked up in the afternoon, it wasn’t enough to prevent scarcity pricing from kicking in.

As a result, market-based prices skyrocketed. For residential and business consumers alike, those on index-based power rates finished the day with devastatingly high electric costs.

ERCOT Prices on Tuesday, August 13, 2019

ERCOT price cap graph

Texas power prices began rising around 1:00 pm CST, hitting the price cap of $9,000 near 4:00 pm, and falling back to normal prices near 7:00 p.m.

Those who follow the ERCOT market were likely not taken by surprise.

“There is always a chance that this will happen on a summer day in Texas,” said Ryan Neely, commodity trading analyst at Direct Energy Business. “And a similar event will be possible in the future as more plants are retired. The market is working as it was built to work, but there is a fear of generation shortage.”

How to Avoid ERCOT Price Volatility

While the chance of a price spike is always possible, planning for high demand and hot weather is the key to a successful electricity procurement strategy in the ERCOT market. While customers riding an index price were likely aware of the inherent risk involved, a layered energy procurement solution and curtailment strategy would have provided significant budget protection.

A layered procurement solution like PowerPortfolio allows organizations to purchase blocks of power over time while floating the remainder of their load on index prices. Using such a strategy, you can hedge more when market prices are high, creating budget certainty in an uncertain market. Collaborating with a team like Strategic Services from Direct Energy Business offers organizations insight into the best time to lock in to minimize total energy spending while still enjoying low market rates.

Organizations with smaller energy loads can look to suppliers like Direct Energy Business for a fixed rate power plan that keeps them insulated from market spikes altogether. It’s a simple set-it-and-forget-it option that can create security, certainty and savings.

For consumers looking for a demand-side approach, curtailment programs like Demand Response offer an ideal solution. By lowering or shifting energy usage during peak times to off-peak hours, organizations can save on high prices and even earn extra income.

“An event like Tuesday’s price spike in ERCOT really drives home the value of a layered fixed price,” remarked Paul DiNubila of Direct Energy Business Strategic Sales. “Our Texas customers using a layered approach, or those who curtailed their load via Demand Response were well protected. They weren’t surprised by what we saw because it’s something we’ve been preparing for over the last few years.”

There is still a risk of another heat wave that could cause ERCOT prices to skyrocket again. The best way to protect your organization – and bottom line – from uncertainty is to explore layered power procurement solutions and demand-side curtailment. Our energy experts are available to help you craft an energy management strategy that minimizes your risk.

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Posted: August 15, 2019

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