Texas electricity officials are considering a switch to a “capacity market” as a way to solve the state’s pending supply and demand imbalance. Under a capacity market, producers of electricity are paid just to build power plants and make the supply available to the grid.
This would be a change from the current system where electricity producers are paid only when they sell the electricity they generate. The price the producers receive for their electricity is mostly a function of the available supply and demand for electricity in the real-time marketplace.
When electricity becomes scarce relative to the current demand, prices spike to many times higher than normal. It is the prices paid during these brief moments of scarcity that make up most of the profit realized by electricity producers.
In other words, the current system creates an environment where producers are most profitable when the grid is running right on the edge of having enough power to meet demand.
The state likes to have excess capacity (called reserve margin) as a safety cushion in case demand jumps or supply is unexpectedly lost. The problem with this is that building power plants requires a lot of money. Power producers don’t like to invest large sums of money to build power plants that might set idle and not generate revenue.
Under the capacity market plan the retail electric companies would pay a fee to the Electric Reliability Council of Texas (ERCOT) which would use the money collected to pay generators for building new plants that would add to the reserve margin. Though on paper the extra fees are paid by the retail electric providers, the money would ultimately come from end users who would pay higher electricity bills to fund the scheme.
Not surprisingly, the idea of a capacity market is backed wholeheartedly by Texas’ two largest producers of electricity; NRG and Luminant. The politics of the situation are made sticker by the fact that the largest generators of electricity in Texas are part of corporate families that also include the largest electricity retailers in the state. Luminant for example, is owned by the same company that also owns TXU. Critics contend that this would give such companies an unfair advantage in a capacity market structure.
Pro & Cons of a Capacity Market in Texas
Pro: Capacity – If the scheme works as proposed it would help alleviate the capacity concerns in Texas. That is, in fact, exactly what it is designed to do. It would seek to anticipate future demand for electricity and essentially prefund the future construction of power plants to meet the need.
Pro: Higher electricity rates – While to the consumer higher rates in a con not a pro, the desired outcome for planners is higher rates. Like the recent increase in the wholesale electricity rate cap, a capacity market would be another way of moving money from consumers to electricity producers. Many people believe this is necessary in order to incentivize new investment in power plants and ensure enough capacity in the future. Once you buy this premise, everything else is just a matter of finding the least painful and politically viable way to move money from the consumer to the producer.
Con: Less Competition – Retail electric providers are still feeling the sting of the recent move to increase the cap on wholesale electric rates. It’s reasonable for them to fear that a move to a capacity market would squeeze them further, increase volatility in the market and increase their costs of hedging in the financial markets. There is also the concern that it would impart an unfair advantage to the large retail providers who are affiliated with power producers. All of this could result in fewer electric companies in the market place and less choice to Texas consumers.
Con: Higher Rates – While planners may feel the need for Texans to pay more for their electricity in one form or another, consumers are, understandably, not happy with that notion. A report by one consulting group predicted that the base rates of electricity could fall in a capacity market. However, the fixed fees paid to fund the capacity market would more than offset the decrease in base rate. This would result in a slightly increased total cost of electricity for consumers.