[co-author: Christian Rice]

Potomac Economics, the Independent Market Monitor (IMM) for the ERCOT market, released its “2017 State of the Market Report for the ERCOT Electricity Markets,” which contains several important insights for market participants and offered seven recommendations for market improvements.

Prices and Demand Move Higher in 2017

First, the IMM found that energy prices increased 14.7% over 2016, to $28.25 per MWh. This price is still significantly less than 2011’s average annual price of $52.23 per MWh and even 2014’s average annual price of $40.64 per MWh. The 2017 price increase correlates with a 22% increase in the cost of natural gas, the most widely-used fuel in ERCOT, as fuel costs represent the majority of most suppliers’ marginal production costs.  The IMM also found price convergence to be very good in 2017, with the day-ahead and real-time prices both averaging $26 per MWh.  However, the absolute difference between day-ahead and real-time prices still increased from $7.44 per MWh in 2016 to $8.60 per MWh in 2017.

Average demand also increased, rising 1.9% from 2016, with demand in the West Zone seeing the largest average load increase at 8.3% (possibly due to oil and natural gas production activity in that zone). Despite this increase in average demand, peak demand in ERCOT reached 69,512 MW on July 28, 2017, which is lower than the ERCOT-wide coincident peak hourly demand record of 71,100 MW, set on August 11, 2016.  Even with general price and demand increases, market conditions were rarely tight as real-time prices didn’t exceed $3,000 per MWh and exceeded $1,000 per MWh for just 3.5 hours in all of 2017.

Congestion Costs Skyrocket

Surprisingly, the IMM found congestion in the ERCOT real-time market increased considerably, contributing significantly to price increases in 2017 with total congestion costs equaling $967 million – a 95% increase from 2016.  The IMM stated that this increase is due to three main factors: (1) limitations on export capacity from the Panhandle; (2) planned outages associated with the construction of the Houston Import Project; and (3) the aftermath of Hurricane Harvey.

While congestion was more frequent in 2017 than in 2016, congestion on the North to Houston constraint declined after June due to the completion of a new 1,200 MW combined cycle generator located in Houston. The completion of the Houston Import Project in 2018 should reduce congestion in this area even further.

Generation Updates

The IMM also found that approximately 3.6 GW of new generation resource came online in 2017, 2.2 GW of which are due to two new combined cycle natural gas units.  In addition, 160 MW of solar came online as well as 1.1 GW of wind.  While a significant amount of new generation came online in 2017, 14 units, totaling 1,222 MW were retired, mostly due to aging natural gas infrastructure.

The Report also, quite expectedly, showed that generation from wind has increased annually since at least 2011, to where wind now totals approximately 17% of the annual generation requirement in 2017.  Though overall generation from coal has decreased since 2014, the share of coal has actually increased in the last two years and is now 32% of annual generation requirement.  Natural gas, on the other hand, has been declining as a percentage of annual generation requirements and now is approximately 39%, down from its 2015 high of 48%.

Recommendations for ERCOT

The IMM ended the Report by including seven recommendations for ERCOT that are “intended to improve the operation of the ERCOT markets,” and “improve ERCOT’s prices and performance incentives.”  Six of these recommendations have been recommended in prior years and one is new.  The following are the IMM’s recommendations:

1. Implement real-time co-optimization of energy and ancillary services.
2. Evaluate policies and programs that create incentives for loads to reduce consumption for reasons unrelated to real-time energy prices, including: (a) the Emergency Response Services program and (b) the allocation of transmission costs.
3. Modify the real-time market software to better commit load and generation resources that can be online within 30 minutes.
4. Price congestion at all generator locations that affect a transmission constraint. (This is the only new recommendation).
5. Consider including marginal losses in ERCOT locational marginal prices.
6. Price future ancillary services based on the shadow price of procuring the service.
7. Evaluate the need for a local reserve product.

ERCOT is currently in the process of modeling recommendations one and five and is expected to provide the Public Utility Commission (PUC) with the results in June 2018.

What Does This Mean for Texas Energy Markets?

The IMM Report was not unexpected given the current state of the market and the fact a majority of these recommendations were made by the IMM and other market participants late in 2017 in PUC Docket 47199, Project to Assess Price-Formation Rules in ERCOT’s Energy-Only Market.  The IMM was expected to continue to make these recommendations in this Report, so now the question is whether the PUC will take action on any of these recommendations.  As the summer temperatures increase, so will demand.  With added congestion and fewer reserves, the ERCOT market will expect to see higher pricing than in previous summers.  These higher prices, coupled with the 2019 Legislative Session, may cause the new Commissioners to refocus on market rule change recommendations parties, including the IMM, submitted in PUC Docket 47199.  While ERCOT will be submitting modeling recommendations associated with real-time co-optimization and marginal losses later this month, the Commission is not expected to act on any of these recommendations until sufficient time has passed to see how the market reacts this summer, and until the Commission can assess whether the market has sufficient resources to successfully function.  While the Commission expects the increased demand and lower reserves to spark new generation investment, the fear is that this investment will not happen quickly enough to mitigate against price pressures and scarcity events, or will not be efficiently located.