Texas PUC considers ERCOT wholesale market design options

E3 Report on ERCOT Market Design

On November 10, 2022, the PUCT’s Market Analysis Division filed the E3 report “Assessment of Market Reform Options to Enhance Reliability of the ERCOT System. Based on the analysis conducted in this study and E3’s broader experience in market design, E3 recommended that ERCOT implement a Forward Reliability Market (FRM) market design.” The report noted that “the LSERO and FRM market reforms – which both create a forward reliability product – differ mainly in the structure of the market: the LSERO requires individual LSEs to procure their share of total reliability credits through bilateral contracting, whereas the FRM relies upon a centrally cleared auction to procure the requisite quantity of reliability credits. Between these two structures, E3 finds the centrally cleared to be a better fit for Texas’ competitive market landscape.”

Staff Memo

Along with a copy of the E3 Report, PUCT staff (Staff) filed a memo recommending that the Commission issue a request for public comment and open a new project to receive comments. In addition to a list of suggested questions, Staff’s memo identified Senate Bill 3 (SB3) objectives and principles from the PUCT’s Blueprint for a load-side reliability mechanism.

In its memo, Staff noted that one design proposal that emerged is the Performance Credit Mechanism (PCM), a hybrid with elements similar to the Lord Serving Entity Reliability Obligation but with features that may be more consistent with ERCOT market principles, such as earned accreditation rather than an upfront administrative process. Staff stated that the PCM design fulfills the requirements of SB3 to meet the reliability needs of the ERCOT power region while also accomplishing the principles of a load-side reliability mechanism, as defined in Phase II of the Commission’s Blueprint. Staff noted that the Commission had not previously taken comment on the PCM design, therefore, Staff believed feedback from the public and market participants on this approach would be particularly instructive to the Commission deliberations.

Staff proposed that comments be filed by noon on December 15, 2022.

Open Meeting Discussion

Staff noted that, beginning in May 2021, E3 conducted numerous meetings with the commissioners and Staff to refine design concepts from the Commission work sessions and ensure each one was accurately represented and assessed and to establish uniform quantitative inputs that were modeled in the study and comprise a base case for 2026 projections over which market design proposals could be assessed. Toward that end, the Commission focused on developing designs that are reliable, market-based, procure power from resources at the lowest cost, and retain and incentivize dispatchable generation that is capable of performing in times of great reliability need throughout the year.

The base case incorporates the Phase I market design changes and each alternative is layered over that to provide a fair comparison. The model represents various combinations of weather, outages and other market variables, including high stress scenarios that are identified in SB3. Each scenario identifies both the costs and expected reliability outcomes.

Staff noted that the Load Serving Entity Reliability Obligation in the E3 study was refined from the one that was originally discussed in the PUCT work sessions. Other market alternatives identified include:

• Forward Reliability Market, which is centrally procured by ERCOT rather than by laterally prearranged;
• Backstop Reliability Service, additional generation resources procured by ERCOT up to a reliability standard;
• Dispatchable Energy Credits, which have also undergone technical changes since being introduced; and
• Performance Credit Mechanism, which draws on complementary elements from other proposals.

Chairman Lake noted that the model utilized in the study has been used in ERCOT for years and is well known to all market participants. He noted that this effort started 18 months ago, with landmark legislation after one of the most devastating tragedies in Texas history. He noted that the speed with which the legislature evaluated and enacted such substantial reform was remarkable and truly represented an “only in Texas” outcome.

Chairman Lake noted that this rigorous process included dozens of hours of public workshops during summer and fall of 2021 And many hours of deliberation among the commissioners, culminating in a Blueprint that was adopted by the Commission in January 2022.

Chairman Lake stated that, at the most fundamental level, the PCM requires anyone who sells power to a household or business in ERCOT to guarantee that they are buying that power from a reliable source. He stated that this represents a fundamental change in the underlying principles of ERCOT but will not interfere with existing market mechanisms, not disrupting the Day-Ahead market, the Real-Time market or existing bilateral contracts and arrangements.

Chairman Lake noted this proposed design is a market-based solution, using market solutions to drive better and more efficient technologies and reduce cost to consumers and is designed to be self-correcting.

Chairman Lake noted that one of the most fundamental concepts of the PCM is the separation of economic scarcity from physical scarcity, incentivizing resources without requiring the grid “to go to the brink, avoiding the old crisis-based business model.”

Chairman Lake suggested that the PCM is a combination of the best components from each of the concepts from the Blueprint, capturing the best features of each and discarding the flaws, which he believes the PCM does. The key features include paying for performance, avoiding arbitrarily assigning percentages to certain types of resources. In addition, there is no capacity payment for “sitting on the sideline.” The PCM only pays for what is needed when it is needed. When renewables are producing and there are plenty of reserves, ERCOT will continue to capture those low-cost resources. If generators do not perform they will be heavily penalized.

Chairman Lake suggested that, most importantly, the PCM concept moves the financial and operational risk of generation in ERCOT out of the ERCOT control room and into where it belongs, the private businesses that make money by evaluating and managing risk. The PCM concept also includes the concept of a residual market, which provides flexibility and optionality to the market.

Chairman Lake noted that, at the end of the day, under the PCM concept, all Load Serving Entities in ERCOT, in aggregate, will purchase the performance credit equivalent of the net peak load so, when reliability is needed most, the ERCOT market will have it. Chairman Lake noted that this will give certainty to the generation and investment communities that there will be a dedicated pool of revenue for reliable resources to compete for.

Chairman Lake noted that, in response to Commissioner Cobos’ concerns about market manipulation and self-dealing, the PCM would be centrally cleared and all of the transactions would happen at ERCOT. ERCOT would be the central exchange, like the New York Stock Exchange, not buying or selling any performance credits but the central clearinghouse where market participants buy and sell credits at the prices and timing they see fit. This provides transparency and prevents self-dealing, requiring accountability for all market participants.

Chairman Lake asserted that the PCM would provide a 10 times improvement in reliability at a 2% to 3% increase in cost, “a tremendous deal.” Furthermore, he stated that, if reliability payments to intermittent resources are eliminated, the PCM would deliver the same improvement in reliability for less money than would be paid without the PCM.

In conclusion, Chairman Lake stated that “the PCM is the best mechanism to fulfill the PUCT’s obligation under SB3 and ensure long-term reliability in ERCOT but that the Commission needs to hear from the stakeholders and, most importantly, the general public.” The PUCT needs to hear from the experts that operate generators, run these companies, and have relationships with customers.

Chairman Lake noted that, if this process moves forward, the PUCT homepage will have a link for the general public and market participants to submit comments for a period of 35 days, making comments due by noon on December 15, 2022.

Commissioner McAdams stated that no model is perfect, that the foundation of the model concerning equilibrium is based on a view that E3’s model needs 11 GW of current thermal generation to retire over the next three years to make these numbers work out. While there is no immediate reliability problem, the PUCT’s job is to prevent a reliability problem as far in advance as possible.

Commissioner McAdams noted that the Southwest Power Pool (SPP) and MISO North capacity markets are currently in bidding wars for the same pool of finite dispatchable resources, resources that are declining every day despite forward capacity applications because of price pressure from low-cost renewable resources. The commissioner noted that every grid in the country is addressing the same problem.

Commissioner McAdams stated that he does not consider a forward capacity construct to be the right solution for Texas because of Texas’ volatile weather and large amount of intermittent renewable resources. He suggested that this challenge necessitates a Texas-based solution and believed that that the PCM appears to create a unique solution.

The PCM requires loads to purchase enough power to satisfy the needs, plus reserves, but does not do so on a forward basis, instead allowing both loads and generation to make their business decisions based on the best available information going into the operating day, including operating days that include unpredictable high-risk hours, which require both loads and generation to remain flexible to meet those conditions.

Commissioner McAdams suggested that, since the Commission is considering a firming requirement, this creates a fungible product that can be bought, sold or swapped, contributing to forward price formation, which the current market mechanisms do not send.

Commissioner McAdams stated that the PCM is a true hybrid of energy-only and capacity markets, adopting many of the best features of both, allowing us to cope with extreme variability in power supplies and an energy portfolio that is becoming more dominated by intermittent resources. But perhaps most importantly, he suggested it gives the opportunity to expedite implementation is to market design modifications in light of an enormous magnitude of renewable energy deployment within the market over the next two years.

Commissioner McAdams stated that the PUCT was “not deaf” to other information, including the ICF report, which identified criticisms of the way ERCOT computes the data that informs the resource adequacy goals and how well that holds up in high-risk scenarios, high net peak load days.

Commissioner Cobos suggested that what she believes the Commission is solving for is long-term reliability in a state with high economic and population growth coupled with a large amount of intermittent renewable generation. This effort is also focused on the need to attract new, flexible generation, while retaining existing flexible and baseload generation. She suggested that the Commission is evaluating an ever-changing, dynamic grid rather than trying to solve specific problems encountered during Winter Storm Uri, which the PUCT has addressed through other efforts, which have been successful.

Commissioner Cobos noted that the PCM is novel and has not been utilized in any other market in the world. She urged stakeholders and the public to read and analyze the E3 report, adding that comments on PCM will be very important.

Commissioner Cobos addressed near-term solutions, suggesting that all options should remain on the table. However, she noted that her proposed Backstop Reliability Service (BRS) provides reliability, is inexpensive, and is the fastest market reform to implement and, therefore, recommended keeping it under consideration.

Commissioner Cobos recommended taking Non-Spinning Reserve Service (NSRS) off the table because the ERCOT Independent Market Monitor (IMM) has expressed some concerns about non-competitive bidding in the non-spin market. Therefore, she believed additional non-spin should not be procured as a potential near-term solution until those issues have been resolved.

Commissioner Cobos asserted that near-term solutions, such as BRS, could start enhancing reliability and sending market signals for new investment now while waiting for a broader solution.

Commissioner Cobos recommended adding a question concerning the impact of the PCM on consumer costs, adding that consumer cost is a very important consideration for Phase II. She wanted comments from market participants and the public to evaluate E3’s analysis of the cost of PCM.

Chairman Lake replied that these cost and reliability results are the product of tremendous amounts of analysis, discussion and deliberation and did not want anyone in the public to think this analysis was “slapped together with duct tape.”

Due to her interest in the potential of short-term solutions, Commissioner Cobos recommended modifying Staff’s Question No. 9.

Chairman Lake stated that Staff’s questions were well-thought-out and would not be changed but she could add a new question. To address Commissioner Cobos’ concerns, the Chairman suggested asking “if a short-term bridge product or service is determined to be needed, what is the fastest, most efficient way to implement the service?”

Commissioner Cobos accepted the Chairman’s proposal for an additional question.

Commissioner Jackson recommended “future proofing” the grid, adding that “just-in-time supply” is no longer an option. She recommended moving to a performance-based approach, to incentivize performance and provide more certainty so that reliable power producers will invest in Texas, creating more dispatchable generation and enhancing reliability for the grid. She supported the PCM as meeting the PUCT’s objectives, fulfilling the requirements of SB3, and being aligned with the principles from the market design Blueprint. She believed that the PCM incorporates the best elements of the BRS and DECs.

Commissioner Jackson suggested that another critical tool in the tool box to support grid resiliency is energy conservation, adding that demand response is automatically integrated into the PCM approach, providing the perfect mechanism to support energy conservation. She stated that built-in demand response empowers consumers and provides a direct correlation between reducing their demand and reducing their cost. She suggested that relying on market-based mechanisms, companies in ERCOT will be empowered to develop innovative and creative strategies to incentivize customers to reduce demand when conservation is needed most.

Chairman Lake agreed that built-in demand conservation is a key feature that everyone has kept in mind throughout this process, adding that it is not just about building more steel in the ground but about leveraging both sides of the equation, reducing demand and increasing reliable supply.

Commissioner Glotfelty reiterated his belief that Winter Storm Uri was not a market failure, that a lot of different issues went into that failure, but that doesn’t mean the PUCT can’t act. He noted that challenges are being faced that have never been faced before. He suggested that wind, solar and nuclear all have tax incentives but natural gas does not. He suggested that finding a mechanism to allow natural gas-fired power plants to get built in Texas would be hugely valuable.

Commissioner Glotfelty stated that he preferred a Backstop Reliability Service combined with a Dispatchable Energy Credit program. He asked the public to comment on how a DEC program could be expanded to get different desirable service attributes. Specifically, he asked how reducing the hours or increasing the heat rate might affect the amount of megawatts you get for different attributes of the DEC. He also believed small modular reactors should be added to the eligibility for DECs because it would send a signal across the country that Texas is open for those when they are approved and ready for the market. He was interested in how modifying the DEC eligibility requirement and/or expanding the quantity of DECs would affect the market.

Acknowledging that the PUCT will not resolve this issue today and that every other market is going through it, Commissioner Glotfelty addressed whether the 1-in-10 Loss of Load Expectation (LOLE) standard is the appropriate reliability standard. He noted that a North American Electric Reliability Corporation (NERC) Senior Vice President had recently stated that he agreed with the need to move beyond the 1-in-10 construct because that construct is solely based on equipment failures and not weather. The NERC executive stated that weather is not random, sometimes it’s a bit predictable and we need start bookending that, maybe through climate change models and all that to develop different scenarios. He concluded that it used to be that capacity was king but the king has no clothes, it’s energy and essential grid services.

Commissioner Glotfelty suggested that moving away from something that is totally capacity based will help move the debate forward and emphasized the importance of getting stakeholder input on that issue.

Finally, Commissioner Glotfelty stated that any changes to the market are hard. He committed to moving away from BRS and DEC if industry comments come back saying the PCM is the right design. He urged the other commissioners to be open-minded when considering public and stakeholder comments.

Commissioner McAdams expressed confidence that the public and the industry will tell the Commission where they are wrong.

Chairman Lake concluded by stating that there is a lot to digest in this report and from these last 18 months of work. He noted that the PUCT has been directed to make the grid reliable, to take action, adding that the Commission has moved along that pathway in a measured, thoughtful way. He suggested that they are on track with the timeline that has been laid out.

The Commission voted to open a new project for the E3 Report and issue a request for comment on Staff’s memo, as modified by the Commission’s discussion to include the additional questions.