What’s the issue?
The University of Texas issued a report earlier this month on the blackouts that occurred this February in Texas during Winter Storm Uri and it noted some of the financial consequences of that event.
Why does it matter?
The report noted anecdotal evidence of some significant “wealth transfers” between electricity suppliers and retailers and between industries due to the ERCOT pricing mechanisms and in the natural gas markets. ERCOT has reported $3 billion in uncollected payments for electricity and CPS Energy has sued to avoid payment of over $400 million owed for natural gas it agreed to purchase.
What’s our view?
So far, these “wealth transfers” have primarily been on paper, as the losers fight the winners in court and some of the losers file for bankruptcy in an effort to shift the costs to the remaining market players. We probably won’t know for months, or even years, who the real-world winners and losers are, but it may lead to changes in the markets around the country, or at least it should.
The University of Texas issued a report earlier this month detailing the events that led to the blackouts that occurred this February in Texas during Winter Storm Uri. The report noted some of the financial consequences of that event, including some anecdotal evidence of significant “wealth transfers” between energy market participants in both the electric and natural gas markets. The report is authored by a committee of faculty and staff at The University of Texas at Austin, and was funded in part by the Public Utility Commission of Texas, but was not designed to provide recommendations. Instead, its purpose was to create a common basis of facts to inform the debate over policy changes under consideration as a response to the winter storm.
As we discuss more fully below, the report supports our earlier assessments of the factors leading to the blackouts, and the economic consequences discussed also suggest some market opportunities we previously suggested that could arise from the event. Finally, while the report suggests that there have been “wealth transfers” between players in the energy markets, as we discuss below, much of those transfers, to date, have been on paper only as the market participants are engaged in a number of lawsuits and bankruptcy filings which will take months if not years to be resolved. Until these cases work their way through the courts, it will not be possible to determine exactly who has benefited, and by how much, from the market events that accompanied the blackouts.
As we suggested in Texas: A Failure of Imagination, which we issued while ERCOT was recovering from the blackouts, and in ERCOT’s Reserve Margin and Renewable Forecasting - Problems Coming this Summer?, a key finding of the report was that ERCOT’s “worst-case” plan for the winter was not nearly as bad as what occurred just months after that worst-case plan was developed. Two key findings of the report are: (1) that “ERCOT’s most extreme winter scenario underestimated demand relative to what actually happened by about 9,600 MW, about 14%”; and (2) ERCOT failed to anticipate the extent of unplanned outages that would be caused by severe weather. According to the report, all “types of generation technologies failed. All types of power plants were impacted by the winter storm. Certain power plants within each category of technology (natural gas-fired power plants, coal power plants, nuclear reactors, wind generation, and solar generation facilities) failed to operate at their expected electricity generation output levels.”
In Will the Texas Outages Lead to Demands for Enhanced Services from Pipelines?, we expected one issue that would be reviewed is how reliable the gas supply was for the gas-fired power generators. The report highlights the “interdependence” of the electric and gas systems in Texas that arises when over 40% of all electricity is generated from natural gas. According to the report, dry gas production in Texas dropped 85% from early February to February 16, with up to two-thirds of processing plants in the Permian Basin experiencing an outage.
The failures in the natural gas supply system began prior to electrical outages. “Days before ERCOT called for blackouts, natural gas was already being curtailed to some natural gas consumers, including power plants.” According to the report, there were two main reasons for the sharp drop in gas supply. First, wellheads in Texas are generally not hardened for freezing conditions and this resulted in freeze-offs at unprotected wellheads. Second, the electric power interruption itself further exacerbated the problem. Remote processing plants typically used to have on-site power generation, but more modern processing plants are often grid-connected. The data in the report indicates that natural gas output started to decline rapidly, even before the electric outages, but the additional reduction in production during the outages could have been caused by the processing plants being on circuits that were shut down following ERCOT’s order to shed load on its system.
In one of the most charitable statements in the report, the authors note that “ERCOT is relatively unique in that it is an ‘energy-only market’ and thus does not operate a capacity market or impose resource adequacy targets in order to maintain a target reserve margin.” Instead, it relies on market forces to provide enough generation for resource adequacy. This has led ERCOT to substantially raise the cap on its market price for power “to relatively high levels in hopes of providing sufficient compensation to the generation sector to incentivize investment to meet peak electricity demand.” Over the past few years, ERCOT prices during normal operations have averaged in the low tens of dollars per MWh, but for the entire duration of the outages was essentially pegged at the market price cap of $9,000 per MWh.
Both individual consumers and the electric providers in the state that were not properly protected from “floating” market prices were hit hard by this tremendous increase in prices for such an extended period, and a number of the electric providers have filed for bankruptcy protection to avoid paying the amounts owed. ERCOT has reported that it has not received payments totaling $3 billion from participants in the market. Under the normal process for distributing unpaid amounts to the remaining participants in the market, ERCOT reported that it will take 96 years to collect the amount outstanding from those who did not default.
The financial impacts on electricity retailers depend upon the degree to which their price risk was hedged and how service outages affected their obligations to provide energy during the event. While many of these companies are small and somewhat unsophisticated in understanding the risks they were taking, even NRG, the largest retailer in terms of market share in ERCOT, reported a negative impact of $500 million to $700 million according to the report. The report also notes that the state's four largest power producers – Vistra, Exelon Corp., NRG Energy Inc. and Calpine — collectively lost between $2.5 billion and $4 billion.
While the electric market rules are created and governed by ERCOT, the price of natural gas is unregulated and left to market forces. However, due to the tremendous reduction in supply noted above, those prices also experienced unprecedented volatility. The report notes that natural gas prices, normally much less than $10/MMBtu, spiked to over $400/MMBtu at Texas trading hubs. The most vocal entity impacted by this price volatility was the municipal gas utility for the city of San Antonio, which operates as CPS Energy. It has launched a series of lawsuits against the very companies that provided it with crucial supplies of natural gas during the emergency, and is attempting to avoid payment of over $400 million.
CPS is arguing that it should not be obligated to pay the price it agreed to pay for the gas it received because such prices constitute illegal price gouging. In each of the suits, it is proposing to pay the lesser of the agreed price or $38.83/Dth. This maximum price seems to be one that CPS invented for purposes of the lawsuits and on which it made the payments depicted above. But it has refused to pay any amount higher than that and is attempting to avoid paying the additional amounts reflected above. It claims in the various suits that the prices it has been charged by some of these companies went as high as $500/Dth. What is clear from the public statements made by CPS and the responses by the counterparties being sued is that CPS went into the crisis without sufficient supplies of natural gas and without adequate protection from the impact of spot price changes.
The litigation that CPS has initiated may take years to yield a final outcome. CPS has sought to bring all of these actions in the state court located in its home county, but given the weaknesses in its case, we expect that CPS will eventually be ordered to pay most if not all of the amounts in dispute. CPS has indicated that customers may be paying higher rates for as long as twenty-five years to recover the amounts due.
In addition to the numerous bankruptcies filed as a result of the price volatility and the CPS lawsuits, we have found a raft of other legal actions in Texas. These include suits by wind farms that may not have understood their own hedging strategy, class action lawsuits and yet another CPS lawsuit against ERCOT, and a whole host of suits seeking to use the force majeure clause in the form contracts issued by the International Swaps and Derivatives Association and the North American Energy Standards Board to avoid the financial consequences of the crisis. Until these lawsuits are all resolved, it will be hard to determine exactly who were the winners and losers and how much each counterparty will ultimately get to keep.
While ERCOT may be unique in its market design and overreliance on spot prices to drive long-term capacity creation, many of the issues that arose in this crisis could repeat in other areas of the country. One such issue is the use of retail gas or electric contracts that are fully floating rate. If sophisticated entities did not understand the risk they were taking by signing a floating rate contract, it is almost certain that retail customers do not. Should such contracts even be allowed in retail choice states? If one of the largest municipal utilities, CPS Energy, was not properly hedged against a sudden price increase, are other municipal utilities similarly exposed? For most utilities regulated by state public utility commissions, the cost of gas and cost of electric purchases are simply passed through to the retail consumers. Thus, even these customers, like the residents of San Antonio, are essentially on a floating rate plan and could be subjected to a similar price spike. Do all of the public utility commissions properly assess the hedging strategies of the utilities they regulate to assure that the retail customers are not exposed to this risk?
A crisis like this one often provides opportunities for everyone in the markets to adopt new strategies, which may include the need for new services. In Will the Texas Outages Lead to Demands for Enhanced Services from Pipelines?, we discussed some possible services that pipelines could offer at a premium rate to help their customers, like local distribution companies, physically hedge against such market risks. However, there also seems to be an opportunity for the energy marketers to provide a similar service that provides gas on a floating rate subject to a cap. If the CPS lawsuits are an example, the cap could be fairly high, as much as ten times the expected price of the gas, but then the local utilities, both municipal and privately-owned, would not be exposed to the extremes of the market. By calling attention to the risk, the crisis in Texas may create a more robust market for such services, especially if the state utility commissions recognize that the risk of price volatility is not limited to Texas.