With each passing day of summer, the deregulated electricity market looks more like the Titanic.
On Thursday, the Public Utility Commission rearranged the deck chairs while the iceberg – the prospect of a market failure – looms. As expected, the PUC voted to raise the price limits for wholesale electricity by 50 percent, just days after the state almost ran short of power.
The PUC’s actions will, as I wrote earlier, result in higher rates for consumers – we don’t know the full impact because the PUC never bothered to study the issue.
But in the arcane wholesale market that affects electricity prices and availability, a bleak scenario is emerging, one that some electricity traders fear could indicate the entire market is drying up.
The wholesale market is deregulation’s sausage factory, a complicated exchange that few outside the industry see or even know about, yet it’s vital in determining the price and availability of electricity across most of the state.
To understand what’s happening this summer, it helps to understand how the market normally works. Typically, generators agree to produce electricity under contracts that are sold days, weeks or months in advance. Retailers – which in turn sell the power to consumers and small businesses – buy enough to meet their forecasts of customer demand.
In times of unexpected high temperatures, though, demand increases, and retailers are faced with having to buy additional power at sharply rising prices. To protect against that expense, many retailers buy hedges – financial instruments that enable them to buy additional power at a set price. Hedges reduce the risk of price swings, enabling retailers to sell electricity under fixed-price contracts.
Last Tuesday, as temperatures surged across the state, hitting 105 degrees in Houston, electricity demand reached almost 66,600 megawatts, a record for June. That was uncomfortably close to the roughly 67,500 megawatts of total capacity online that afternoon, and prices hit the wholesale cap of $3,000 a megawatt-hour.
It doesn’t bode well for the next two months. The narrow margin between capacity and demand so early in the season is spooking the market. Contracts for electricity in July and August have become almost impossible to trade, traders told me.
Grim goings-on
The traders asked that I not name them because they fear generators would no longer trade with them if they were quoted, but they paint a grim picture of the behind-the-scenes workings for the state’s electricity markets.
Faced with the prospect of a tight market and sharply rising prices, generators have little incentive to sell power on a short-term basis, the traders said. Essentially, it’s as if they’re holding some generation in reserve. If one of their power plants experienced an outage, say, next week, they might have to buy power back at significantly higher prices to honor their contracts.
The PUC’s decision to raise the wholesale price caps to $4,500 a megawatt-hour only makes the problem worse by broadening the range of potential price swings. While the higher caps are supposed to encourage more generation, even the PUC acknowledges new plants won’t come online fast enough to meet demand this summer.
Many retailers can’t afford to hedge under these conditions. If they buy hedges to cover such a wide range volatility, they could be wiped out if the demand doesn’t materialize.
PUC spokesman Terry Hadley said concerns about market volatility haven’t been brought before the commission, although he said “we’re always looking at market activity.” A spokeswoman for the Electric Reliability Council of Texas, the grid operator for most of the state, referred questions to the independent market monitor, Dan Jones, who couldn’t be reached by my deadline.
Reduced choices?
This summer’s situation is reminiscent of 2008, when some retailers were driven out of business by volatile prices. This time, we’re likely to see more retailers consolidate or leave the market, reducing the customer choice that deregulation was supposed to bring.
Nor is the PUC’s decision to raise the price caps likely to spur new generation because banks aren’t willing to finance construction amid so much volatility.
Meanwhile, the PUC already is considering another hike in the wholesale cap, doubling the limit from $4,500 to $9,000 next year. At those prices, liquidity will essentially be gone, according to the traders I spoke with.
Just hours after the PUC’s vote on Thursday, the price of an August contract jumped by $20 a megawatt-hour. That prompted fears that prices could shoot even higher, essentially bringing the market to a halt, traders said.
And the hottest stretch of summer looms like an iceberg on the horizon.
Loren Steffy, loren.steffy@chron.com, is the Chronicle’s business columnist. His commentary appears Sundays, Wednesdays and Fridays. Follow him online at blog.chron.com/lorensteffy, www.facebook.com/LorenSteffypage and twitter.com/lsteffy.
