Brattle Economists Prepare Report that Addresses ERCOT Resource Adequacy Concerns and Provides Recommendations to Improve Long-Term Reliability Through Generation Investment

CAMBRIDGE, Mass., June 1, 2012 /PRNewswire/ -- Consultants at The Brattle Group released a report today analyzing resource adequacy concerns and identifying options for better aligning market design and reliability objectives in the Electric Reliability Council of Texas (ERCOT) electricity market.

ERCOT sponsored the study in response to concerns that investment has stalled and reserve margins are projected to fall below 10% by 2014 and lower thereafter, which is substantially less than ERCOT's current reserve margin target of 13.75%.  To inform ERCOT and the Public Utility Commission of Texas' (PUCT) ongoing efforts to maintain resource adequacy, the study: (1) characterizes the factors influencing generation investment decisions; (2) evaluates the market outlook for supporting investment and resource adequacy at the target level; and (3) lays out options to enhance long-term resource adequacy while maintaining market efficiency in ERCOT.

The authors of the study addressed these issues by interviewing a broad spectrum of stakeholders and conducting forward-looking analyses of prices, investment costs, and reliability.  Their primary findings include:

• ERCOT's energy-only market worked well for many years to support efficient operations and attract sufficient generation investment to maintain resource adequacy, but new investment is now impeded by low wholesale power prices due to low natural gas prices and an efficient existing generation fleet. 
• ERCOT's current energy-only market is not likely to support sufficient investment to meet the resource adequacy target.  Simulation results suggest that the "long-term economic equilibrium" reserve margin may be only 6% under current market conditions and rules.  Raising the cap to $9,000/MWh, as proposed by the PUCT, could bring the reserve margin up to 10%. 
• The projected reserve margin outcomes are highly uncertain due to unknown factors such as the likelihood of extreme weather, uncertainties about investors' beliefs and risk tolerances, and difficulties modeling scarcity market conditions accurately.  For example, sensitivity analyses suggest that long-term average reserve margins could be between 1 and 7% percentage points below the reliability target under a price cap of $9,000/MWh. 
• The analyses also show that reliability targets could be achieved with a significant increase in price-responsive demand that helps prevent load shedding but without eliminating high prices.  However, it would likely take several years before a sufficient level of demand response could be achieved.
• Given the large and uncertain gap between the equilibrium reserve margin and the target, the authors conclude that either the market design needs to be adjusted or the reliability objectives revised.

To resolve this mismatch between current market design and reliability objectives, the authors suggest that ERCOT and the PUCT first evaluate whether the current target is higher than necessary, given the much greater incidence of distribution-level outages and the ability to avoid shedding certain critical loads.  They point to other regions' different reliability criteria and recommend establishing the target based on an analysis of marginal benefits and costs.  They also recommend defining a lower "minimum acceptable" reliability level before any out-of-market backstop measures would be considered.

The report discusses the advantages and disadvantages of four options for attracting greater investment should policymakers demand a higher reserve margin than the current energy-only market can be expected to deliver:

• Energy-only market with price adders: requires only modest adjustments to the current market design, but is not a dependable way to meet the target. 
• Energy-only market with backstop procurement: requires only modest change, but can be inefficient and undermine market-based investment.  Backstop procurement should be used only rarely to maintain a minimum acceptable level of reliability, while otherwise letting the market determine investment.
• Resource adequacy requirements on load serving entities: would require significant adjustment to the current design, but presents a dependable way to achieve a target reserve margin; creates a specific "demand" for resource adequacy, which all types of resources can compete to meet.
• Resource adequacy supported by a centralized forward capacity market: the most significant change to market design, though likely the most efficient way to achieve a given reserve margin target; provides forward transparency and competition to efficiently meet supply challenges.

The authors also recommend various market design enhancements to better enable demand-side resources to participate in efficient price formation, as well as other measures to achieve efficient pricing during both scarcity and non-scarcity conditions.  They recommend increasing the offer cap to $9,000/MWh or a similar level corresponding to the value of lost load when shedding load, though scarcity prices should start at a much lower level, such as $500/MWh, when first depleting responsive reserves.  Scarcity prices would increase gradually as the severity of the event worsens, reaching $9,000 only when actually shedding load.  Dr. Sam Newell, the lead author of the report and a principal of The Brattle Group, commented, "This would be more reflective of system costs and will help demand response participate in efficient price formation, which will ultimately support a more stable investment environment and system reliability."      

The report was authored by Brattle principals Sam Newell, Johannes Pfeifenberger, and Bob Mudge, associate Kathleen Spees, and research analysts Mike DeLucia and Robert Carlton.  The authors have international experience in advising market participants and in helping system operators improve their market designs. The report is available for download at www.brattle.com.

The Brattle Group provides consulting services and expert testimony in economics and finance to corporations, law firms, and public agencies worldwide.  Areas of expertise include antitrust and competition, valuation and damages, utility regulatory policy and ratemaking, and regulation and planning in network industries.  For more information, please visit www.brattle.com.

SOURCE The Brattle Group