Trouble Is Brewing in Texas

 | Jan 18, 2013 | 6:00 PM EST  | Comments
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There isn't enough power to meet demand in Texas. While this is a problem for state policymakers, it certainly won't harm incumbent generating utilities.

The problem starts with Texas' largest grid, the Electric Reliability Council of Texas, or ERCOT. Besides its unusual name, it has a unique design and a challenging situation. Under present circumstances, it can hardly claim to be reliable. ERCOT serves more than 80% of the state's electric load. The state designed ERCOT to avoid federal oversight and regulation. The theory was that since all ERCOT's power is intrastate, Washington can't claim it is engaged in interstate commerce, therefore, the federal government would, theoretically, have no jurisdiction.

Isolating ERCOT created another problem. ERCOT could not rely on their neighboring grids to assist during peak periods. As such, ERCOT would have to go it alone should it lose generation or need additional resources to meet rising demand. And now, for a variety of reasons, ERCOT is losing generators and demand for power is growing. While it is technically possible to import energy into ERCOT, the transfer is inefficient, inadequate and limited. Worse, few investors are willing to jump into ERCOT, fill the gap and build major power generators.

The death shot was Texas' decision to deregulate utilities. The idea was that generators should compete in a market, and market forces would resolve supply imbalances. The problem is that politicians and free markets are a lot like oil and water; they don't mix. Texas regulators thought they had created a free market, but they hadn't. In designing ERCOT's "free market" system, the regulators imposed limits. One was to limit prices. Another was trying to get generating capacity delivered to the grid without paying for it. For suppliers, this doesn't represent a free market.

Nevertheless, the Texas deregulation scheme is still a work in progress. Rules are changing and policies are in flux. As a result, private investment is reluctant to take on additional risk. Few suppliers are willing to invest in new generating units until the dust settles.

In the middle of this chaos, the federal government entered the scene. The North American Electric Reliability Corporation (NERC), an independent arm of the Federal Energy Regulatory Commission, is concerned about ERCOT's ability to provide reliable sources of power. NERC's charter, and its congressionally mandated duty, is to be concerned about reliability. NERC cannot order construction of new generation or transmission. But NERC is accountable for assessing the reliability of the nation's bulk power systems and informing federal decision-makers. Those decision-makers would include federal regulators, who could make life difficult for state regulators and ERCOT.

In a Jan. 7 letter to ERCOT, NERC suggested that ERCOT might not be acting responsibly. NERC is requiring ERCOT to furnish plans that address resource adequacy and reliability.

A showdown is in the making. The time has come for ERCOT to address its challenges and assure reliability. In the meantime, generating utilities will likely see growing opportunities for profitable power production. But those changes will likely to take time. After all, we're dealing with state and federal governments.

One of winners is NRG Energy (NRG). Inside ERCOT, NRG owns more than 10,000 megawatts of generating assets. Approximately 47% of its capacity uses natural gas, 38% use coal, 11% use nuclear and the remaining 4% is wind. Its South Texas Project is a two-unit nuclear generating station. Because it is carbon-free and it operates reliably 24/7, South Texas will emerge as one of ERCOT's vital resources, not just another market-based generator.

Another long-term winner is Calpine (CPN), which owns 13 generating units totaling approximately 8,000 megawatts. In addition, Calpine is considering two expansion projects "under advanced development," which could potentially add another 520 megawatts in base load.

NextEra Energy (NEE) owns 14 wind farms, approximately 2,800 megawatts of gas turbines in Texas and owns Lone Star Transmission, a new, 300-mile-long transmission line running from West Texas to Dallas. It is expected bring renewable wind energy to Texas' major metro areas in the first quarter of this year. Policy changes will help NextEra's financial performance in Texas. Other potential winners include AES Corp. (AES), Edison International (EIX) the Public Service Enterprise Group (PEG) and a number of privately owned entities.

Be careful. This is a long-term issue. It could take months, even years, before all the issues are settled; however, expect news for generators in the upcoming quarters. If state policymakers become defiant, generators may have to wait. If ERCOT seeks aggressive solutions, investors could win.

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