Knowledge Problem

Michael Giberson

If you thought power prices in ERCOT’s West region were interesting in 2008, keep an eye on the prices in 2009. (For background see my earlier post on negative prices in ERCOT West for 2008. Note on updated data here.)

Late 2008 saw a few developments of note for the region:

• Almost 2000 MW of wind power capacity was added to ERCOT from September to December, most of it in ERCOT West.
• When ERCOT updated its zonal boundaries last Fall, a few dispatchable generators – coal and gas units – were moved from ERCOT West to the ERCOT North region.*
• Natural gas prices, which ranged above $10 per MMBTU last Summer, are now below $5 per MMBTU.
• The recession, and particularly the drop in oil and gas prices, will tend to reduce electric power demand throughout the state.

(*There are technical reasons justifying the change in zone boundaries, which wasn’t without controversy, but combined with the first bullet point the practical effect is that the West region prices will be even more reliant on intermittent wind power output.  ERCOT reviews zonal boundaries every year.)

How does this all shake out?  Safe to say that electric power prices in ERCOT generally, and ERCOT West especially, will be much lower this year. Peak prices will be kept down by lower demand and low natural gas prices.  Offpeak prices will be lower and more volatile because of the confluence of all four factors.

The key to producing negative power prices is subsidized wind power output in ERCOT West net of local load, compared to the transmission system’s capability to deliver the excess power out of the area.  Lower load combined with more wind power capacity indicates a more volatile price situation.

Will ERCOT West see more frequent negative prices this year?

Yes.  In fact they already have.

In January 2008, ERCOT West was faced with negative prices about 8.3 percent of the time; in January 2009 the region faced negative prices 12.5 percent of the time.  This increase in the number of negative priced periods resulted despite a drop in average wind speed in the area.  (At the Abilene Regional Airport, near the heart of the wind power in the area, the average wind speed in January 2008 was 12.1 mph, while in January 2009 it was 10.7 mph.)  Less wind, but more frequent negative power prices.  Not surprising given the substantial increase in wind power capacity, and not yet a comparable increase in transmission capacity.

So far, February 2009 has been a little windier than February 2008 at the Abilene Regional Airport.  While I haven’t examined February price data yet, I wouldn’t be at all suprised to see that February 2009 shows even more frequent negative prices than those of February 2008 (negative prices 18.8 percent of the time).

Michael Giberson

What is with all of the negative power prices in the West region of ERCOT?

In the first half of 2008, prices were below zero nearly 20 percent of the time. During March, when negative prices were most frequent, prices were below zero about 33 percent of the time. After mostly taking the summer off, negative power prices were back to near 10 percent in October.

[Chart at left shows the number of 15-minute intervals each day that had prices below zero from January through October, 2008.

UPDATE: Charts now revised to include all 2008 data. Contact author to receive full size chart.]

This seems a little crazy. During these negative price periods, suppliers are paying ERCOT to take their power. Consumers (at least at the wholesale level) are getting paid for using power, and the more power consumers use the more they get paid. These prices are a big anti-conservation incentive. You could, as a correspondent put it to me, build a giant toaster in West Texas and be paid by generators to operate it.

In fact most of the regional power markets that are integrated into systems operations (so-called RTOs and ISOs in the U.S.) will produce a negative power price now and then. On the margin, a power supplier should offer power into the market at approximately the net marginal cost of supply, at least in a competitive market. These offers are typically at positive prices and the market will produce a positive price.

Infrequently, a power plant might choose to bid below the short term marginal price in order to stay in the market and avoid shutting down. It can be economically rational for operators of less responsive generation units to offer negative prices in order for it to avoid the costs of shutting down for just a few hours and then start up again when load increases – think coal-fueled or natural gas steam turbine. When energy load is very low, near zero or negative prices can result.

This isn’t the cast in West Texas. Instead, the negative prices appear to be the result of the large installed capacity of wind generation. Wind generators face very small costs of shutting down and starting back up, but they do face another cost when shutting down: loss of the Production Tax Credit and state Renewable Energy Credit revenue which depend upon generator output. It is economically rational for wind power producers to operate as long as the subsidy exceeds their operating costs plus the negative price they have to pay the market. Even if the market value of the power is zero or negative, the subsidies encourage wind power producers to keep churning the megawatts out.

Evidence from market data suggests that wind power producers will accept prices down to about negative $35 MWh before they shut down, since marginal operating costs are very low for wind power we can conclude that the subsidies are worth about $35 – $40 for each MWh of wind output. [UPDATE: Chart now includes data through December 2008.]

Subsidies do this sort of thing – distort the market and lead to waste – and of course to some degree distorting the market is just what is intended when policymakers offer a subsidy. Only usually it isn’t so easy to see the evidence of the waste created by the subsidies. Wind turbines that operate more hours require more maintenance, so these hours spent producing negative-value electric power do consume real resources. At the same time, the conventionally-fueled generation that is forced offline temporarily will also face additional “wear-and-tear” and require additional maintenance because of the effects of shutting down and then restarting the machines. This extra wear-and-tear and extra maintenance also represents wasteful use of resources due to PTC- and REC-subsidized power production.

The subsidy for renewable power may be defended as compensation for avoiding the environmental costs associated with power produced by conventional means, but in this case the link between the payments and the possible reduced emissions effect is tenuous. In Texas the PTC is probably offsetting natural gas generation most of the time, perhaps a relatively efficient combined-cycle gas unit, but maybe an inefficient old steam generator. Sometimes the PTC will displace coal-fired generation. The environmental benefits will vary dramatically depending upon just which kind of unit is displaced by the subsidy, but the cost of the policy is the same. Surely there are more targeted and effective ways of achieving environmental goals.

A second possible defense for the renewable power PTC is that it will spur enough growth in the industry to allow progress in research and development and economies of scale to reduce costs in the future. I think these learning and economies of scale arguments are much abused in renewable policy discussions – treated as if they are somehow automatic if we only spend enough resources now. If learning by doing and economies of scale were automatic, the U.S. auto industry would now be a paragon of efficiency. (A paper on “Learning Curves For Energy Technology and Policy Analysis“, by Tooraj Jamasb and Jonathan Kőhler is on my “to read” list, but I haven’t read it yet.) In the wind energy case, the industry is led by huge international corporations like General Electric, Siemens, and Gamesa. These companies and many others have been in the business for years, and in some cases decades. This is hardly a case of an “infant industry” that needs a handout to grow to maturity.

Maybe there is a public good argument buried in this line of thinking, but like the externality argument my sense here is that some alternative approach would more effectively achieve the desired public policy goals.

I don’t see any easy approaches for Texas. The federal PTC is the main subsidy, and localized evidence of waste due to the PTC in part of Texas in unlikely to derail U.S. Congressional support. Even if more detailed examples of widespread waste could be produced, I’m not sure it would overcome the coming Congress’s warm fuzzy feelings for renewable power. Possibly Texas could take-away the Renewable Energy Credit for wind power generated at negative prices, and that would slightly reduce the waste. But the boom in wind power construction in Texas has already greatly reduced the value associated with a REC in Texas, so taking it away altogether wouldn’t do much. And really, the negative prices in ERCOT’s energy markets are only an especially visible indicator of the waste created by PTC-based distortions, any excessive investment in renewable power or production from existing wind power units at below-cost prices is wasteful.

To be clear, I’m not arguing that wind power or other renewable power projects are inherently wasteful. The policy design is at fault, not the technology. It is the policy that needs repair. Also, I don’t have an estimate of how significant this problem is. Maybe the waste is in the hundreds of thousands of dollars, but could be higher or lower. There may be more significant problems to work on. But the PTC is a key element of renewable power policy, and it is troubling that it causes waste.

Economics provides some guides for fixing the policy: if an externality is the problem, then tax the externality and compensate the harmed parties; if the goal is additional learning, don’t tie the payment to per unit output, tie the payment to progress toward the learning goal.

Renewable power industries are pushing for further expansion of the PTC. Before Congress agrees, it ought to try to find less wasteful ways to achieve intended public policy goals.