Good news and bad news from price-spike induced failure of retail power company in Texas

Michael Giberson

We know that several Texas generators were unprepared for the possibility of severe cold on February 2, and now comes word that at least one retail electric provider was similarly unprepared for the possibility of price increases. ERCOT real-time power prices jumped to about $3000/MWh for most of the emergency period that morning. Abacus Resources Energy has defaulted on its financial obligations to ERCOT, reportedly unable to cover costs due to the spot power price spike. More, from the Fort Worth Star-Telegram:

[Abacus Resources] General Manager Mark Angell said last week’s unprecedented spike in wholesale power costs, when numerous generating stations were out of action because of the weather, overwhelmed the company’s financial resources.

Buying power for its 7,700 customers, most of them residential, typically cost Abacus from $11,000 “on a good day” to $25,000 “on a bad day,” Angell said. “You take that to $300,000 a day, and it doesn’t compute.”

Abacus needed to come up with $750,000 to pay its energy bills and also meet cash collateral requirements required by ERCOT. That wiped out the company’s reserves.

“It was a once-in-20-years occurrence, and we got caught,” Angell said.

A couple of observations:

  • Any retailer that was severely bit by the price spike was a retailer that hadn’t secured enough power to meet its customers’ demand for that cold morning. Forward contract prices for the time period were likely in the $50/MWh range. In short: The cold was forecast, retailers have means to hedge themselves against financial exposure, retailers who were short that morning will pay.
  • And, by the way, generators who were contracted to deliver power and failed to deliver will also be covering their shortfall at the spot market price. The only generators that will be paid the seemingly exhorbitant $3000/MWh are those who had capacity not already under contract and were capable of delivering that uncommitted capacity to market.
  • Profit and loss is a great motivator, but only especially motivating when companies can actually go out of business.
  • Unlike the case in 2008, when a few companies went out of business and simply dumped their customers into the default “Provider of Last Resort” service, Abacus has arranged for its customers to transition to one of two other retailers that serve the same area. I don’t think that this transitioning is required of Abacus, but it is an improvement over last time.  It suggests that the retail provider industry can learn from past mistakes.

Who pays?

News items suggest that various consumer advocates are worried that, ultimately, consumers will have to pay for whatever losses retailers suffered last week through higher prices. One of the beautiful things about the relatively open and competitive retailer marketplace in the ERCOT region is that this isn’t true in any general sense. Prices on retail supply contracts should be forward looking, based on the expected cost of the supplier fulfilling that contract over the contract period. Since any future contract period won’t include February 2, 2011, future customers can’t be made to take that hit.

A local Starbucks had its roof cave in after heavy rains revealed a structural flaw. When the store re-opens, will they stick consumers with a surcharge to cover the cost of rebuilding? No, coffee consumers have alternatives, and because consumers have alternatives the coffee company will take the hit. Same for retail power consumers in ERCOT.

A few ways that last week’s power emergency can lead to higher prices for consumers: (1) if all companies become a more cautious, and contract-up extra power in advance or otherwise add to their hedges against rare power emergencies, then rates will creep up to cover the higher cost of operations.  But this only works if all companies become more cautious, including any new company that may want to join the market. Otherwise some company will have lower rates and take customers from the newly cautious; (2) if changes to Texas PUC or ERCOT regulations on retailers force them into excessive financial commitments, raising all retailers’ costs and so all retailers’ rates; or (3) if ERCOT decides to carry (or is forced into carrying by legislative or regulatory action) substantially higher amounts of reserves or to make other changes to operations to cover the possibility of rare power emergencies.

In case 1 the competitive market will yield higher prices to reflect the adjusted risk perceptions of participants in the market. In case 2 it is the residual monopoly transmission grid that will lock consumers into higher prices. By the way, when ERCOT’s retail market finally grows to its smart grid potential, events like the February 2nd power emergency will look a lot different. They might even look like non-events. Probably the subject of a future post.

In sum, a company has been driven from the market. Bad news for the company, the management, employees, and especially the owner. Not especially bad news for consumers in the short run, and ultimately good news.

Profit and loss can be a powerful motivator.