The delicate balance between supply and demand is a critical factor in estimating future energy prices. This blog post will take a look at how these variables impact energy prices, and how you can use this information to estimate prices moving forward.
Power Plants are Privately-Owned, For-Profit Enterprises.
In 2002 the Texas Electricity market deregulated. Privately-owned power generators were automatically enrolled into deregulation, while municipally-owned utilities and electric cooperatives were given the choice to opt-in or remain regulated. Power plants producing your energy are privately-owned; they are for-profit enterprises, not owned by the state. In ERCOT, energy prices control profitability, and profitability encourages generators to supply energy.
Types of Deregulated Markets
Energy Market: Pays generators ONLY when they provide power day-to-day; Texas is an Energy Market.
Capacity Market: Ensures Reliability by paying generators to commit generation for delivery years into the future. These payments are a price floor as they are guaranteed and independent of energy cost.
Energy prices are driven by a few key variables.
By understanding the correlation of each variable, you’ll be able to make proactive decisions to best manage energy costs and reduce price risk.
Demand Determines Wholesale Price of Power
In the Real-Time Market, generation resources bid price offers every 15 minutes to contribute their generation to meet demand. Generation resources clear the market in order of lowest to highest cost until demand is met. When supply matches demand, the price of the last generation resource to offer becomes the wholesale price of power. With natural gas being the primary fuel source in ERCOT, thermal generation (natural gas) typically clears the market last. During peak summer months, less efficient generation units are needed to satisfy demand at a higher wholesale price.
Wholesale Price Determines Profitability
The last dispatched generation unit determines the wholesale price of power. With gas fired plants making up the majority of available resources, the settlement price typically falls below the break-even point of profitability for coal plants. Coal plants are forced to operate less or retire operations.
Profitability Determines Operational Supply
If a generation unit is profitable, it'll operate at a high frequency. Less efficient generation units are used when supply is low or during emergency events. With excess supply, less efficient units are forced to retire operations due unprofitable power prices. High efficient gas and renewable units have replaced many high cost units driving settlement prices to historical lows.
Forward Price Determines Future Supply
A forward price is the cost today of your future energy supply. This is important as it helps investors determine the ROI of constructing new plants, which takes 24 months from start to finish. If pricing is too low, scheduled builds will be delayed or canceled until forward prices increases.
Real-Time Volatility and Scarcity Pricing
Reserve margin is the cushion of available generation capacity during peak demand. ERCOT's current target reserve margin is 13.75%.
Sources: Constellation, ERCOT.
What happens when reserve margins are too high?
High reserve margins produce low energy prices. Low prices discourage new resources builds, and cause inefficient resources to operate less or shut down. Reserve margins over 13.75% are unsustainable without paying capacity fees for the excess generation. Without capacity fees prices are too low to payback investment costs on inefficient or new assets.
Source: The Brattle Group.
What happens when reserve margins are too low?
Low reserve margins increase shortage events, prices, system-wide operating costs, and generation profitability. Scarcity Prices are when demand pushes reserves below 6,000 MW, and a real-time price adder is triggered. The price adder is based off of The Operating Reserve Demand Curve (ORDC). The ODRC Adder is the added cost of less efficient resources needed to satisfy demand. If reserves fall below 2,000 MW, a price cap of $9,000/MWh ($9/kWh) is triggered to fund higher cost generation and emergency resources. Power plants are dependant on revenues earned during shortage years to recover investment costs. Low reserve margins increase forward power prices. High future prices entice investors to build new plants.
The energy market in Texas is designed to maximize efficiency and minimize prices. When the market operates as expected, high prices are balanced with added generation capacity, while low profitability encourages power plants to find more efficient ways to generate electricity. Analyzing reserve capacity and tracking power plant profitability can help you predict movements in the price of energy. Texas Energy Exchange uses these factors, along with countless other data points, to help our clients access the lowest energy rates on the market.