California and Texas Fail the Power Test Together

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Are Texas and California really so different? They certainly look different from the rest of the country in one respect.

California and Texas Fail the Power Test Together

For all their contrasts, Texas and California are currently united in asking their respective populations to unplug appliances and forgo the air conditioning. Both have experienced blackouts of some form in the past year, and both have issued warnings about potential power shortages this week amid unusually hot weather. Given that it’s only June, both may yet suffer more as summer rolls on.

The proximate cause of their problems is very hot weather raising power demand to levels that may outstrip supply. The latter is constrained by various things, with California’s drought curbing hydropower and Texas facing an unusually large amount of generator outages.

Behind these lie similar structural issues, however, revolving around reconfiguring a 20th-century grid for 21st-century changes.

Weather on steroids is one of them. Episodes of extreme heat — and in Texas’ case, cold too — test the historical norms used by grid planners. Climate change is likely to make those tests more frequent.

Another is the expansion of renewable energy meant to mitigate those climate risks. Solar and wind power are different from conventional generation because they depend on weather and timing to operate and have minimal running costs (as they don’t burn fuel). This makes them an odd fit for power markets designed around the concept of switching power plants on and off as demand rises and falls, with the most expensive plants switching on last and off first.

California presents the most extreme example of this. Booming solar capacity — roughly a third of it on rooftops — has crushed demand for grid power in the middle of the day.

California and Texas Fail the Power Test Together

This squeezes the generators that typically switch on quickest when demand surges: natural-gas plants. California’s gas plants ran the least of any regional power market in 2020, at less than 40% utilization, on average; down from almost 50% just five years before . With fewer hours in the day to make money, they rely on peak pricing after sundown to make the business work.

California and Texas Fail the Power Test Together

Texas faces a similar issue, albeit less pronounced today and for different reasons. High wind-power penetration has squeezed gas-fired plants there (see this). Yet solar power is expected to also proliferate under those sunny Texan skies, taking market share during peak air-conditioning hours in the afternoon.

Two states with different systems and politics. But both have high and rising renewable power capacity that, for now, relies on gas-fired plants for backup even as it eats their lunch.

This isn’t an argument against renewable power. If the market structure struggles to accommodate it, then the answer lies in changing the market structure, not forgoing cheaper, zero-emissions energy.

What both states grapple with in their own ways is how to reward reliability; that a power plant will be available when needed, in other words. In old-style, vertically integrated power markets, this is done by building spare plants and embedding the carrying cost in utility bills. Deregulation kicked off multiple experiments in other approaches.

In California, it’s done via a hybrid of price signals and regulatory mandates, such as forcing utilities to contract for extra supply and via the grid operator signing contracts with certain plants deemed critical to keep open. In Texas, it’s done purely by price signal.

Other markets use mechanisms such as capacity auctions, where plants are paid something simply to be available, on top of the money they make for the electricity actually produced. This is one important reason why California’s and Texas’ wholesale power prices are multiples of those elsewhere, as they contain that “capacity” element priced separately in other markets. They also tend to run with less of a buffer.

California and Texas Fail the Power Test Together

The debate over which system is best has raged for years and is given added impetus by events such as February’s Texas freeze. Think of it like home insurance. You pay all those premiums over the years for a catastrophe that in all likelihood will never happen. You do sleep easier, though. Conversely, you could forgo the premiums but may end up facing an enormous bill if your house burns down.

For example, BloombergNEF calculates the “notoriously expensive” capacity market run by PJM Interconnection LLC — which runs the grid across large parts of the Midwest and Mid-Atlantic states — costs about $8 billion a year. Meanwhile, the power bill for just one week of horrendous weather in Texas in February came to $50 billion. Texas would need a freeze like that to be just a 1-in-17 years event for the cost to match that of PJM’s capacity auction, around $140 per megawatt per day, according to Bloomberg NEF calculations .

The real bugbear with California and Texas, however, is less the price spike and more that, even with those prices, the danger of blackouts remains. It’s difficult to persuade generators to invest in new capacity that lasts decades with price signals that swing wildly from minute to minute and season to season. Oil producers do something like that, but they have liquid long-dated futures to hedge their exposure.

For power producers, the risk is compounded by those 21st century changes that upend the traditional trading day, shift the mix of generation and raise the probability of freak events. Regulators also haven’t kept up. In California, wildfire risks were allowed to build around the grid for years. The push for renewable energy, while necessary, is outpacing the capability to back it up, resulting in Californians paying extra to keep old, higher-emissions gas plants open.

In Texas, the energy-only market isn’t delivering enough reliability, especially given a lack of penalties for plants that don’t run when called upon. Beyond this, the touted reliability of gas-fired electricity clearly isn’t ironclad, especially as the state government remains reluctant, even now, to enforce stringent weatherization on that part of the energy system. And don’t get me started on Texas’ abhorrence of hooking its grid up to neighboring ones.

Perhaps the most glaring failure of both states concerns this week’s calls for citizens to conserve power. This is a powerful tool that almost certainly prevented more blackouts in California last summer. Yet in 2021, why is this still mostly being done as tweeted pleas for voluntary action rather than as an explicit market mechanism where households get paid to do it?

California and Texas may feel they have nothing to learn from one another. Yet they’re engaged in the same thing: groping for the right insurance premium to pay for their grids even as they’re transformed.

These are simple averages, rather than weighted by capacity, for combined-cycle gas plants. California's average capacity utilization in 2020 was 38% compared with a national average of 46%. California's average in 2015 was 47%, comapred with 45% nationally. For Texas, the figures are 47% and 46% for 2020 and 2015, respectively. Source: BloombergNEF's U.S. Merit Order Maker.

Plus, of course, the $50 billion doesn't reflect the added costs of disruptioncaused by the blackouts in Texas.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.

©2021 Bloomberg L.P.

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