The Public Utility Commission of Texas (PUC) is considering market reforms for the electricity market administered by the Electric Reliability Council of Texas (ERCOT). The suggested approaches will not fix the problem they hope to solve. Why? Because they have not addressed the root problem, that the regular ERCOT market does not allow generators to earn a competitive return on capital.

All electricity markets in the U.S. are government administered constructions. In Texas, ERCOT administers an “electricity only” market in which the generator companies are only paid when they generate electricity for the grid. Because an electron is an electron, and ERCOT first accepts the lowest cost electricity offered by generators, many older generating plants with higher cost operations are priced out each day. They do not earn revenues to offset their payrolls and maintenance expenditures. They do not pay their shareholders a return on capital.

Ed Hirs, University of Houston
(Source: LinkedIn)

“ERCOT and the PUC cannot persist in their unsubstantiated belief that short-term price spikes provide the “economic signals” that encourage the commitment of long-term capital.  This is not the way the Wall Street operates.” – Ed Hirs

In fact, for eight of the 10 years prior to 2021, the wholesale price in ERCOT was not enough to cover the cost of building new generation capacity or, especially with respect to 2021, reinvesting and maintaining the current generation fleet. In 2021, apart from the price gouging during the winter freeze, ERCOT’s Independent Market Monitor reports that the wholesale price was too low to support the construction of new natural gas generation, the least expensive option for generation that can be turned on when needed — the definition of reliably dispatchable electricity. 

Rather than addressing the primary problem, the PUC’s consultants have recommended that Texas add a “capacity” market on top of the electricity only market. A capacity market would make consumers pay idle generators to be ready. To support their recommendation, the consultants noted the capacity markets employed by other grids including those serving California, New York, New England and substantial portions of the Midwest and Atlantic coast.   However, they did not consider that these capacity markets really do not work very well.

Look at California’s historic grid failures. After the deadly 2020 grid fires California took action to address its failed electricity market design by acquiring 5,000 megawatts of new natural gas power plants and even hijacking some of Arizona’s electricity.

ERCOT’s troubled future

The immediate future for the ERCOT grid is not bright. Everyone knows wind and solar power plants have no fuel costs, few employees, and enjoy generous federal tax breaks, as do oil and gas producers. As ERCOT adds more  wind and solar, the 50-year-old coal and 30-year-old natural gas power plants that are already at the end of their operational lives will find fewer and fewer hours available for them to operate each year. But reliability requirements mean they cannot be replaced by wind and solar energy. Battery technologies and installations are years away from being able to backstop the grid for more than a few hours.   This is the major problem facing the Texas grid over the next several years. 

Not under consideration by the PUC is the solution provided by traditionally regulated electricity markets. In these markets, portfolios of wind, solar, coal, natural gas, and nuclear generation assets with obviously different operating costs combine to provide reliable electricity because the states and grid operators make sure power plant owners achieve a fair return on capital. ERCOT and the PUC cannot persist in their unsubstantiated belief that short-term price spikes provide the “economic signals” that encourage the commitment of long-term capital.  This is not the way the Wall Street operates.   

Shortly, just in order to get by, Texas will have to ransom the continued operation of the old higher cost power plants just like other states with failed grid markets in California, New York, Connecticut, Illinois, and Ohio.  For Texans, it will not matter if the bill falls to consumers or taxpayers, they are all the same voters.

Ed Hirs, is an energy fellow and lecturer in economics at the University of Houston.