Economic Impact of Inadequate Generation in ERCOT – Comparison of Resource Adequacy Scenarios

August 27, 2013

In 2003, the electricity system of Texas experienced healthy reserve margins of over 20%, a result of significant investment in new generating capacity in support of a rapid economic expansion. Just a decade later, Texas is again in a period of relatively high economic and electricity demand growth, but the electric system’s reserve margin is barely satisfying the target level of 13.75%. Forecasts for the future show a drop well below the target without significant new investment. It is not clear that the needed investment will occur. Investors face headwinds in the current environment of low electricity prices driven by low gas prices, a generation fleet with many highly efficient gas plants at the margin and a large amount of wind energy, and uncertain investment returns in the Electric Reliability Council of Texas’ (ERCOT’s) energy-only market.

A low reserve margin is indicative of resource adequacy failures, which lead to higher frequencies of reliability events (such as power outages) and electricity price spikes. These resource adequacy issues have real economic costs that could dampen the growth prospects of the Texas economy if not addressed. As policymakers and market participants consider options for addressing the lack of capacity investment, it is important that the economic impact of resource inadequacy is top of mind. It is also important that any potential solutions be evaluated for their ability to restore adequate resources along with their costs relative to their benefits of improved reliability and more moderate electricity prices.

This study provides an economic comparison of two resource adequacy scenarios, one in which the current market rules are retained and one in which the reserve margin is made a requirement. The required reserve margin scenario is represented as implementation of a capacity market, which has been analyzed in some detail by others as the most efficient means to achieve a required reserve margin. The study is based on: 1) existing national-level studies of the economic costs of reliability events, 2) existing forecasts of resource adequacy and energy costs made by ERCOT and its consultant, The Brattle Group, and 3) customized economic modeling that applies the national sector-level cost estimates to the Texas economy.

We find that assuring the reserve margin with an efficient mechanism has a substantial net economic benefit compared to existing market rules. In a representative forecast of the next fifteen years, having a capacity market saves the state $14 billion in Gross State Product (GSP) losses. In extreme weather years similar to 2011, having a capacity market saves the state over 58,000 jobs. We recognize that higher levels of reliability are not free; the cited results net the cost of capacity payments to induce higher reserves against the saving in energy and outage costs. Moreover, consistent with sound market design, we assume that all capacity – old and new, demand-side and generation – is paid on an equivalent basis for its contribution to reliability. Our analysis likely underestimates the full value to the state economy of achieving resource adequacy as it does not quantify two key types of impacts: businesses locating elsewhere due to expectations of future reliability problems and the impacts of power quality (as distinct from actual outages) on quality-sensitive customers, such as high technology facilities.

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