Monday Study – The Path To Texas Power System Reliability

The Load-Serving Entity ~ Reliability Obligation A Market Design Reform to Ensure Electric Reliability in Texas

Beth Garza, Zach Ming, Arne Olson, Jack Moore, Nick Schlag, September 2021 (Energy Plus Environmental Economics and Exelon)

Executive Summary

In the aftermath of Winter Storm Uri, the Texas electricity market has been the subject of a series of discussions aimed at improving reliability. These efforts to reform the market operated by the Electric Reliability Council of Texas (El:tCOT) have been wide-ranging and have captured the attention of stakeholders and policymakers atthe highest levels. The cornerstone of these efforts was Senate Bill 3, a sweeping law passed bythe 87th Texas Legislaturedirectingthe Public Utility Commission of Texas (PUCT) to "establish requirements to meet the reliability needs of the power region."2 To inform these market reform discussions, the project sponsors retained the consulting firm Energy and Environmental Economics, Inc. (E3) and Beth Garza, senior fellow atthe non-profit R Street Institute.

As an energy-only market, ERCOT has no formal reliability standard nor any explicit mechanismto ensure there are sufficient resources to meet a specified reliability standard. Implied expectations of electricity scarcity in forward energy prices serve as the primary financial incentive for Load Serving Entities (LSEs) to procure supply and support investment. ERCOT does conduct technical studies of resource adequacy for its system, which have determined thata 13.75%3 reserve margin4 would be needed to meet the reliability standard most commonly used in other markets-one loss-of-load The LSE Reliability Obligation event in ten yea rs. However, ERCOT's actual reserve levels introducesaformal have fallen below that benchmark recently. reliability standard and a

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Many sta keholders have put forward proposals to improve mechanismto ensure that the reliability of the system, increase financial protection of there are sufficient resources consumers, or both. Most proposa Is continue to to meet this standard substantively rely on the existing energy-only market design, merely modifying the way in which the system operator derivesthe prices of energyor the quantities of real-time operating reserves inthe energy market.5 These are actions that may improve reliability but do not establish an explicit reliability standard. Minor modifications tothe current marketdesign are not only insufficient to ensure reliable electricitysupplies in ERCOT, but in some cases might inadvertently increase financial rewards for generators that do not consistently contribute to reliability. Instead, this whitepaper proposes a mechanism for directly addressing resource adequacy.

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The proposed LSE Reliability Obligation ldescribed more fully in Section 5 ) introduces a formal reliability standard and a mechanism to ensure that there are sufficient resources to meet this standard. LoadServing Entities, or LSEs, are responsible for procuring energy on behalf of customers in Texas (both competitive retail providers and municipal/co-operative utilities) and are the natural vehicle to procure additional resources for reliability, should they be needed. The proposal is designed to preserve the competitive and customer choice elements of the existing ERCOT energy market, while ensuring that there are sufficient resources with the right combination of attributes, namely their ability to perform during reliability events.6 Key elements of the proposal include:

+ Reliability Standard: the PUCT determinesa formalsystem reliability standard (e.g., 1-day-in10-years). ERCOT calculatesthe requiredseasonal reserve margintoachievethis standard.

+ Resource Accreditation: ERCOT will accredit the reliability value of each resource for each season. Resources with dispatch limitations - whether due to intermittency, energy output duration limitations, or fuel supply challenges - would be accredited according to their expected performance during reliability events.

+ System Assessment: ERCOT will project, on a 3-year forward basis, whether there are sufficient accredited resourcesto satisfythe seasonal reserve margin necessaryto meet the reliability standard.

+ Trigger: The PUCT will trigger the LSE Reliability Obligation on a 3-year forward basis when ERCOT systemassessment projects a likelihood of insufficient resourcesto meet the reliability standard.

+ LSE Requirement: Iftriggered, each LSE would be assigneda seasonal reliability requirement based on its projected firm load during critical system hours. LSEs serving interruptible loads would receive a reduction in their reliability requirement.

+ LSE Showings: Iftriggered, LSEs would be required to show sufficient resources (based on ERCOT's resource accreditation) to meet their seasonal LSE requirement on a year-ahead forward basis. Any showing deficiency would be assessed a penalty that would be used by ERCOTto procure accredited resources and correctthe deficiency.

+ Performance Assessment: Resourcesthat are accredited with a reliabilityvalue and obligated as part of an LSE Showing would be required tooffer intothe energymarket during designated reliability events, with penalties assessed fornon-performance.

Many core components of the LSE Reliability Obligation build significa ntlyon experience and policies in other jurisdictions around the worldi or prior reform proposalstothe ERCOT market.8 Theend result is a balanced and comprehensive solution to help ensure electric system reliability for a healthy and prosperous twenty-first century Texas.

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Introduction and Background

The restructuring of the Texas electricity system in the late 1990s introduced many reforms, notably generation competition and retail choice. It also redefined the role of the Electric Reliability Council of Texas (ERCOT) as the state's independent system operator (ISO).9 For more than twenty years, competition and retail choice have served Texas electricity consumers well, allowing for some of the lowest-priced electricity in the nationlo and a rich selection of retail electricity supply products that fit individual customer needs and preferences.Ill

The cornerstone of Texas' restructuring wasthe creation of an offer-based "energy-only" market design, whereinthe lowest priced generatorsclearthe marketand receive a clearing price equaltothe marginal generator required to serve customer demand. In this system, there is no explicit mechanism to ensure there are sufficient resources to meet a formal reliability standard. Instead, hourly energy prices are allowed to rise to very high levels (much higher than other electricity markets) with the implied expectationthat electricityscarcity assumptions influencing forward energy prices will serve as a financial incentive for Load Serving Entities (LSEs)to procure supply and support investment.

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While this market structure has promoted competition within Texas' deregulated environment, concerns that it may not be sufficient to maintain reliability are not new. A study commissioned by the PUCT in 2012 found that "involuntarycurtailment in an energy-only market mayoccurmore oftenthancustomers, regulators, and policymakers find acceptable" and further that "regulators and policymakers must be committed to tolerating price spikes. "12 Around the world, In the current ERCOT similar market structures are only seen in Alberta and Australia; system, there is no explicit however, these markets have also been the subject of market design reform discussions and legislation intended to ensure mechanismtoensure resource adequacy. there are sufficient

In February 2021, Winter Storm Uri crippled the ERCOT electricity resources to meeta system, knocking out power to over a third of the state's formal reliability standard customers, resulting in significant damages and loss of life. The event resulted in the resignation of all sitting commissioners on the Public Utility Council of Texas (PUCT),13 several ERCOT board members, and the ERCOT CEO. 14 While many of the physical causes of those events may be beyond the reach of electricity market design (e.g., challenges with naturalgasdelivery), Winter Storm Uri nevertheless drew attention to ERCOT's electricity market design …

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Conclusion

Electric system reliability is critical to modern society, both from an economic and a health and safety perspective. The importance of reliability is only likely to increase as more aspects of life become dependent on electricity, including transportationand heating. The current ERCOT 'energy-only' market design provides financial signals for investment in resources but does not ensure there are sufficient resources or resources with the right capabilities to meet a specified reliability target. Recent historical events such as Winter Storm Uri and concerns an impending increase in intermittent (wind, solar) and energy-limited (storage) have made thesechallengeseven more acute.

The LSE Reliability Obligation provides a market reform proposal for ERCOTthat retainsthe best elements of the existing design while providing a mechanism to ensure thatthere are sufficient resources to meet a specified reliability standard. The proposal retains a competitive, restructured retail electricity market and provides the opportunity for the energy-only framework to deliver sufficient reliability before imposing additional obligations on LSEs. The proposal is directly responsive tothe directive of Senate Bill 3 to "procure... reliability services on a competitive basis,"delivering fair and low-cost reliability in a way that is responsiveto the diverse set of unique Texas stakeholderinterests. The LSE Reliability Obligation represents an important step forward in the evolution of the Texas electricity market and is an important component of comprehensive energy-sector reform.

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