Power demand in Texas grows more slowly than forecasted

From StateImpact Texas, a joint effort of radio station KUT Austin and KUHF Houston, a report that consumption of electric power in Texas isn’t growing as fast as expected:

As the Texas Public Utility Commission (PUC) considers changing the electricity market so there’s more money to build new power plants, a mystery has popped up: why aren’t Texans using as much electricity as predicted?

“There’s something that’s been going on recently with the forecasts, which affects a lot of things,” said PUC commissioner Kenneth Anderson at the commission’s open meeting last week.

Who Turned the Lights Out?

Anderson said forecasts from the Electric Reliability Council of Texas (ERCOT) had predicted electricity demand would increase in 2013 by 2.1 percent.

In reality?

“It’s been barely one percent, if it’s even hit one percent,” Anderson said.

As the story highlights, this is kind of a big deal. The Texas PUC is contemplating fairly substantive changes to the ERCOT power market design based on projections that power generation capability won’t grow fast enough to meet forecasted future demand. If the forecasts are overstating the problem, maybe regulators need not be quite so nervous.

EIA shows higher wind power output cutting into baseload power generation

The Energy Information Administration’s “Today in Energy” series shows with a couple of charts how growing wind power output in the Southwest Power Pool region is cutting into the income of baseload power plants.

U.S. EIA chart based on Southwest Power Pool data.

The effect matters because baseload power plants tend to have the lowest operating costs. As baseload plants get pushed off the system, more of system capacity will shift to more flexible “load following” plants, which tend to have higher operating costs. Power prices in the Southwest Power Pool and other ISO power markets tend to reflect the operating costs of load following plants, so the effect will be to increase average wholesale power prices.

Wind power advocates sometimes want to claim credit for driving down power prices, and in the short run the addition of wind power can push prices down (especially, of course, if wind power plants have their output subsidized as with the Production Tax Credit). In the long run, as output of cheap-to-run baseload power plants is squeezed from the system, average prices will rise again.

The ERCOT market in Texas faces this same problem — in fact I suspect it is a little further down this path than the Southwest Power Pool — and the state has been struggling over projected resource adequacy concerns on the horizon. Of course, as Texas PUC commission Kenneth Anderson has pointed out, an efficient “energy-only” market with growing consumption should always see resource adequacy problems about four or five years ahead. If it doesn’t see shortages in the future, it implies the system is currently overbuilt. Still, incentives to invest in generation appear weak, wind power capacity additions in Texas are expected to continue, and resource adequacy analysts in ERCOT are nervous.

NRG seeks capacity market for Texas

Michael Giberson

Joe Ragan, a VP at Power generation company NRG, recently opined in the Houston Chronicle in favor of a capacity market for the ERCOT power grid in Texas. A capacity market provides what you might call “being there” payments to generators, whether the generator’s power turns out to be demanded in the market or not.

I was struck by two things while reading the op-ed: first, no mention of the role of wind power in shaping prices and economic conditions for generation in Texas even though ERCOT has the highest wind penetration market-wide in the United States; and second, the way “prices” get invoked.

As any economics student knows, prices are the product of the interaction of supply and demand. In the op-ed, however, prices seem to be something driven by and driving the supply side of the market only. The demand side of the market has “needs” driven by the weather, but apparently not linked to the prices that consumers have to pay.

Admittedly, this way of thinking has 100+ years of tradition behind it in the electric power industry–that’s how it was done under the old cost-of-service, monopoly territory, regulated rate system in the electric power industry.

Texas has been trying something different, with more commercial risk to drive efficiency on the supply side, and potentially high price spikes to motivate an active and engaged consumer side of the market. A capacity market would kill the experiment before it has a chance to pay off.

Al Roth, Matchmaker

Michael Giberson

Stanford’s alumni association magazine has a good article on recent economics Nobelist Al Roth. Several things about the article will trigger resistance among some free market readers, beginning with the title (“The Visible Hand”) and the subhead (A new breed of economist, Alvin Roth brings an engineering sensibility to fixing markets.). Deep into the article, this too: “Thanks to guys like Al Roth and powerful software … we were able to put all our incompatible pairs in there and just hit a button and the computer would spit out the answer.”

In fact just this morning I was just re-reading James Buchanan’s remarks about differences between economics as a science of allocation versus economics as a science of exchange – Buchanan was definitely in the exchange camp – and perhaps Buchanan would wonder whether or not these game-theoretic algorithms constituted a kind of applied economics or perhaps were something more akin to mere logistics tools. But in that article (“General Implications of Subjectivism in Economics”) Buchanan does suggest that game theory, in that it can frame situations from the point of view of economic agents, might constitute a valuable tool for understanding economics as a science of exchange.

But it is clear enough from the Stanford Magazine article that more than logistics is going on in Roth’s efforts. In all of the matching schemes Roth has helped develop, the incentives created for participants are a key constraint. It isn’t a mere matter of minimizing fuels costs for a delivery fleet, Roth is using economics to meddle with the rules of particular kinds of economic systems in order to bring about better arrangements as valued by the participants themselves. These efforts are not about imposing allocations, they are about enabling better exchanges in complex environments.

[HT to Daniel Cole, who draws attention to the dwarf-tossing issues raised at the end of the article.]


‘Demand Response’ in Electricity: Economists vs. FERC on (Over)Pricing

Michael Giberson

As noted here at KP in August, a group of electric power economists (including me) filed an amicus brief on FERC’s demand response pricing rule.

At the Master Resource blog, Travis Fisher examines the issue with some detail. Here is a bit:

In Order No. 745, FERC reasoned that, “when a demand response resource has the capability to balance supply and demand as an alternative to a generation resource,” the demand response resource should be paid the full LMP. Some commenters agreed – some not so much. As FERC stated:

In the face of these diverging opinions, the Commission observes that, as the courts have recognized, ‘issues of rate design are fairly technical and, insofar as they are not technical, involve policy judgments that lie at the core of the regulatory mission.’ We also observe that, in making such judgments, the Commission is not limited to textbook economic analysis of the markets subject to our jurisdiction, but also may account for the practical realities of how those markets operate. (Order No. 745 at P 46, emphasis added)

Then Order No. 745 wades beyond ignoring textbook economics into the murky waters of justifying full LMP with the infant industry argument (with market power thrown in for good measure). As FERC argues:

Removing barriers to demand response will lead to increased levels of investment  in and thereby participation of demand response resources (and help limit potential generator market power), moving prices closer to the levels that would result if all demand could respond to the marginal cost of energy. (Order No. 745, at 59)

I wonder out loud whether FERC commissioners actually had anyone (1) estimate price levels that would result if all demand could respond to the marginal cost of energy, then (2) estimate what will happen to the actual wholesale price of energy in a world in which officially-registered-demand-response resources are overpaid, and finally (3) determine whether result 2 is closer or further from result 1 than current wholesale energy prices.

My guess it that the majority simply assumed that it must be the case that subsidized demand response will behave like unsubsidized demand response would have behaved but for the restraints of state retail ratemaking practices.

Fisher’s conclusion quotes Bastiat to good effect:

The economists and the FERC minority make valid points – get incentives right, examine unseen or unintended consequences (regulatory rent-seeking, gaming, the stifling of new generation), and don’t provide any “free” lunches.

Sadly for the economists, the Administrative Procedure Act sets a low bar for “reasoned decision-making,” meaning the Court of Appeals would have to find FERC’s ruling “arbitrary and capricious,” etc., to order reconsideration. Further, the DC Circuit has a penchant for explicitly granting agencies like FERC Chevron deference, which means it substantially defers to agency interpretation, especially on nuanced or ambiguous issues.

It strikes me, though, that the FERC majority would do well to return to “textbook economic analysis” on this issue, and I would recommend Bastiat as one of the textbooks. As Bastiat said in 1848:

“[N]ot to know political economy is to allow oneself to be dazzled by the immediate effect of a phenomenon; to know political economy is to take into account the sum total of all effects, both immediate and future.”

Demand response is the next new thing. It may have very positive effects now and in the future, but in the case of the FERC Order Nos. 745 and 745-A, the agency let itself be dazzled by the immediate effects and pulled into a misguided policy.

I’ve left out quite a bit of Fisher’s analysis and cut out the useful links, so please do go read the whole thing.

Trying to fix FERC’s demand response pricing mistake

Michael Giberson

Last year the Federal Energy Regulatory Commission ruled that RTO and ISO markets should pay retail consumers an amount equal to the market’s real-time marginal price when consumers reduce consumption at peak periods. Economically speaking, it is the wrong price.

Parties opposed to FERC’s action have taken the issue to court. A group of “leading economists and educators” have filed an amicus brief in the case (and somehow I got invited to be part of this group). Here is the introduction:

Amici curiae (listed in Addendum A) are leading economists and educators who have designed, studied, taught, and written about the electricity markets affected by the Federal Energy Regulatory Commission Final Rule under review here, Demand Response Compensation in Organized Wholesale Energy Markets, Order No. 745, 76 Fed. Reg. 16,658 (Mar. 24, 2011), FERC Stats. & Regs. ¶31,322 (2011), reh’g denied, Order No. 745-A, 137 FERC ¶61,215 (Dec. 15, 2011). That Rule establishes the rate wholesale market participants must pay retail customers for reducing purchases of electric energy during peak-demand periods. In particular, FERC now requires market participants to pay the full “locational marginal price” (“LMP”) for electricity that is not consumed, treating non-consumption of energy as the equivalent of costlessly producing energy. See Pet. Br. 45-61.

Although the views of amici may diverge on market-design issues in other contexts, they all agree that FERC’s Rule creates a counterproductive demand response mechanism that produces economically undesirable behavior and wasteful outcomes that will injure consumers and society in the long run. Although FERC invokes economics to justify its course, the Final Rule is economically irrational. Retail customers that reduce their consumption should not be paid as if they generated the electricity they merely declined to buy. Instead, retail customers should be compensated as if they had entered into a long-term contract to purchase electricity at their retail rate but instead, during a peak demand period, resold the electricity to others at the market rate (LMP). In other words, they should be paid “LMP-minus-G,” where G is the rate at which the retail customer would have purchased the electricity. Simply put, the customer must be treated as if it had first purchased the power it wishes to resell to the market.

FERC never adequately explains its decision to adopt its contrary approach. Nor could it. By overcompensating reductions in retail purchases, the Final Rule encourages retail customers to reduce demand even when society would be better off if they continued purchasing electricity needed to engage in productive activity. It encourages inefficient self-supply of electricity. And it leaves market participants paying for the delivered electricity more than once—first to the generator that created it and then to the user who provided the demand reduction. That overpayment harms both suppliers and non-demand-response consumers, to whom the cost of the subsidy ultimately will be passed on.

So far as I can tell, the case Electric Power Supply Association v. Federal Energy Regulatory Commission hasn’t been heard yet at the U.S. District Court of Appeals. The full name of the brief is: “Brief of Robert L. Borlick, Joseph Bowring, James Bushnell, and 18 other leading economists as Amici Curiae in support of petitioners.”

Does EPSA support capacity markets? For power markets, yes; for gas pipeline markets…

Michael Giberson

The Electric Power Supply Association, “the national trade association representing competitive power suppliers,” supports the use of electric power capacity markets to ensure sufficient generation capacity is available to reliably serve peak consumer load. See, for example, EPSA’s policy paper on the topic:

Well-functioning forward capacity markets are a critical component of organized wholesale competitive electricity markets in many parts of the country. These markets provide the capacity needed for the continued reliable operation of the grid through the commitment of existing supply, investment in new generation when needed and participation by consumers to manage their demand (demand response).

So you might expect that when the issue is securing sufficient natural gas pipeline capacity to ensure continued reliable operation of gas delivery at peak times, EPSA would favor a capacity market-style solution.

If you expected that, you would be wrong.

In EnergyWire Peter Behr reports industry viewpoints on coordination between natural gas and electric power markets. From the gas pipeline side of the business:

Generally, across the board, the electricity market is not stepping up … to contract for the reliability that they seek from the gas-fired generators,” said Richard Kruse, vice president of regulatory affairs for Spectra Energy Corp., which operates 19,000 miles of natural gas pipelines….

“We hear all the time from gas-fired generation in New England, ‘We cannot afford pipeline capacity if we don’t get paid to hold that capacity,’” Kruse told reporters at a press briefing Friday sponsored by the Interstate Natural Gas Association of America (INGAA).

“When people step up and say they want to sign up for contracts, that’s when we’ll start working on the infrastructure that they need,” Kruse said.

EPSA’s John Shelk offers the power generators viewpoint, stating they don’t need firm capacity rights on gas pipelines all of the time, just those times the power plant will be dispatched in the power market. He adds that a power generator that pays for firm capacity it can’t use will not be competitive in the power market.

I can see his point, which mirrors in a way, how many power consumers feel about electric power capacity markets. Power consumers don’t want to pay for a lot of extra generation all of the time since they only actually need those extra bits of generating capacity for, typically, just a few hours out of a year.

NOTE: In August the Federal Energy Regulatory Commission will be holding five regional technical conference to explore interactions between natural gas markets and electric power markets.

NYC Brownouts? But why?? I thought they had electric power capacity markets

Michael Giberson

From Reuters: Amid NYC heat wave, Con Edison lowers power voltage

New York energy company Consolidated Edison Inc reduced the power voltage in some Manhattan neighborhoods on Wednesday, in an action known as a brownout, as a brutal heat wave stressed the city’s electric system for a third day.

This was the second voltage reduction during this week’s heat wave, aimed at easing the load on the power grid and allowing workers to fix heat-stressed equipment in the affected neighborhoods. The company had also turned down the voltage in a few Manhattan neighborhoods for several hours on Monday.

MORE ABOUT CAPACITY MARKETS: Capacity markets are economic rules by which consumers collectively pay electric power supply resources to be available to help meet consumer demand, particularly if and when consumer demand is especially high.

See the New York ISO capacity market rules for the details, though the document is not exactly easy to read. Part of the problem is that capacity markets have been difficult to design well, so there has been constant tinkering with the rules. (Notice, for example, that the NYISO capacity market rules document begins with an 18-page “Revision History,” see pages vii-xxiv.)

The NYISO’s “2011 State of the Market Report,” which is more readable than the NYISO capacity market manual, describes the markets as follows (p. 35):

The capacity market is designed to ensure that sufficient capacity is available to reliably meet New York’s planning reserve margins. This market provides economic signals that supplement the signals provided by the NYISO’s energy and operating reserves markets. Currently, the capacity auctions determine clearing prices for three distinct locations: New York City, Long Island, and NYCA. By setting a distinct clearing price in each location, the capacity market facilitates investment in areas where it is most needed.

What reliably “meeting New York’s planning reserve margins” means is that suppliers get paid extra, that is in addition to being paid for supplying electric power and providing transmission support services, they get additional pay for ‘being there’ in order to help assure that consumers can get all of the power they want AND the system still has sufficient extra resources available in case of an emergency. The use of brownouts indicates either that the ISO didn’t plan for enough resources or that some of the resources paid for were unable to deliver when needed.

As mentioned here and here before, currently regulators in Texas are considering whether they should stick with ERCOT’s so-called “energy-only market design” (where generators can get paid through the ERCOT market for supplying electric power and providing reserves and other transmission support services, but nothing more**) or switch to a capacity market, as was recommended by a Brattle Group report.

Mostly the point of my post here is that even with capacity markets, sometimes there isn’t enough power to go around. Part of the problem, as everyone knows, is that no amount of market design or contracts or financial assurance can actually guarantee physical resource adequacy. In plainer English: No matter how much you pay or promise to pay, you can not guarantee there will always be enough power to go around.

Makes you wonder what consumers are paying for in capacity markets.

**Most generators make most of their revenue through contracts with retailers, which could include a payment for capacity in addition to energy supplied. However, ERCOT rules do not require consumers to buy “capacity.”

LATE AMENDMENT: A correspondent points out that the Manhattan brownouts were most likely a distribution system problem, not a resource adequacy problem. NYISO capacity reports indicate adequate reserve margins on July 18 and 19, the days of the brownout. A more careful reading of the article itself supports the distribution system view; notice that the article mentions the brownouts were “aimed at easing the load on the power grid and allowing workers to fix heat-stressed equipment in the affected neighborhoods.” (emphasis added).


Hayek’s knowledge problem as an issue in electric power market design

Michael Giberson

Recently the Brattle Group submitted a study of resource adequacy issues within the ERCOT power system and the policy options available to ERCOT and the PUC of Texas, the regulatory authority overseeing the ERCOT system. As the Brattle report points out, ERCOT has so far stuck with a so-called “energy-only” market design while the other RTO markets have implemented some form of capacity markets to help assure the market will be adequately supplied with generating resources.

The Brattle report is available from the ERCOT website. The PUCT is taking comments on the report in Project No. 40480, “Commission Proceeding Regarding Policy Options on Resource Adequacy.” A workshop will be held to discuss the Brattle recommendations on July 27, 2012 at the PUCT offices in Austin.

BP Energy Company finds Hayek’s knowledge problem as a key issue in electric power market design. After quoting a segment from “The Use of Knowledge in Society,” BP Energy Company writes:

Hayek’s “Knowledge Problem” and its optimal solution – decentralized commercial markets – provide the best lens for regulators to see the fundamental issue in electricity market design in response to rapid technological change and increasingly diverse groups of willingly innovative buyers and sellers. As the procurement and use of electricity cross a complexity threshold, as a few customer classes are transformed into a multitude of individual market participants, electricity market design needs to move away from centralized planning to a decentralized procurement of resources, to be both sustainable and efficient in meeting the resource adequacy objectives for the bulk power system and society at large.

The unwieldy process of centralized procurement of resources in the organized markets within the Eastern Interconnection is not proving to be a healthy evolution for electricity markets; instead, these interventions have greatly interfered with the natural development of networks among market participants that can lead to a healthier market ecosystem. Utility economist Kenneth Rose, in a recent working paper that highlights the continuing problems of centralized procurement in the capacity mechanisms in the Eastern Interconnect, reprises the “Knowledge Problem” in the following analysis:

“…. They (RTOs and regulators) are attempting to create a final product market for something that is merely one input of many that are needed to generate electricity.

This may explain why the capacity construct that the RTOs are using has become so complex. Every aspect of the capacity market design has to be redesigned and readjusted to fit changing conditions, rather than allowing the market participants to adjust to market information over time, as happens generally in competitive markets…..

The complex mechanism of capacity markets is not self-sustaining since the RTOs and regulators will need to continuously update and fix the apparatus as conditions change…. A truly competitive market, in contrast, changes as circumstances change, without the stakeholders having to agree on changes and without the regulator having to insert its judgment by choosing and approving what it thinks will work. “

The result is that to date, regulators, not market participants, procure virtually all of new resources. Some of those resources, especially “demand resources,” are poorly designed and have questionable value. Incumbent technologies and business practices are favored over innovative ones, to the ultimate detriment of consumers and local businesses.

As might be obvious by the name of this blog, we at KP find Hayek’s identification of the knowledge problem a key discovery in the long history of the study of markets. It is no surprise that efforts to manage the growth of markets run up against knowledge problem issues, and regulators and other market designers would be wise to consider its significance.

NOTES: Hayek’s article, “The Use of Knowledge in Society,” was published in the American Economic Review (September 1945) (ungated here and here). Rose’s report is “An Examination of RTO Capacity Markets,” IPU Working Paper No. 2011-4, Michigan State University (September 2011). I mentioned the Brattle report on ERCOT resource adequacy issues in this earlier post, see also this earlier post on capacity market issues.

Solar subsidies in Italy

Michael Giberson

Carlo Stagnaro, writing in the European Energy Review, finds that Italy’s generous feed-in tariffs for solar power are creating challenges for both the Italian budget and the Italian energy market.

In terms of investments, Italy’s experience with solar power is definitely a success… Only Germany has more PV capacity. Indeed, Italy has more solar capacity than Japan, the US and China together.

[Image] Congested nodes in the high-voltage power grid in Italy. (Source: Terna)

But the success of Italian solar power came at a cost. It is built on Italy’s very generous incentive scheme, based on an extremely high feed-in tariff that is awarded to PV-installations (at least, to installations that were built before the end of June 2011). In addition, distributors are required to accept and dispatch “green” energy with top priority, regardless of the volumes offered. The combination of a guaranteed high price and virtually unlimited supply created the grounds for the boom.

Not only has government support for solar power led to high costs (€3.9 billion in subsidies in 2011 alone), it has also had another unforeseen effect: it has undermined the very market design that, until recently, had worked remarkably well, and had made Italy one of the most competitive electricity markets in Europe.

Stagnaro works for the Istituto Bruno Leoni, based in Milan.