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Texas, the biggest electricity consumer in the U.S., faces a shortage of power to fuel its growing economy that may force the most extensive overhaul of the state’s competitive market since deregulation in 2002.

Texas utility commissioners and grid operators are studying whether to allow the nation’s highest peak wholesale power prices to triple, part of a bid to encourage power-plant construction and avoid blackouts as early as 2014.

Falling natural-gas prices exposed a flaw in deregulated electricity markets for Texas and 12 other states that rely on the competitive model. Wholesale power prices, tied to the cost of gas, have fallen more than 30 percent since 2008, making generators reluctant to invest billions in new plants that would be subject to price swings and uncertain returns.

“This issue is what we call in the business the ‘missing money problem,’” said Shmuel Oren, an engineering professor at the University of California in Berkeley, who helped advise Texas on deregulating its market. “Prices of electricity are not high enough to pay for the fuel and also cover the investment in generation capacity. Business people are looking at this and they’re deciding it is not a profitable business.”

In regulated markets, state officials determine power prices, shielding consumers from rate spikes while ensuring utilities a certain level of profit for maintenance and construction projects. A deregulated market like Texas follows a competitive model, allowing supply and demand to set prices as producers and sellers vie for customers.

Not Profitable

A deregulated market requires companies to be more efficient to maximize profits while keeping prices competitive enough to win customers. It also makes it harder for generators to justify building new plants that may not be profitable for many years.

Deregulated markets New Jersey and Maryland have offered subsidies to power producers to jump-start new projects. PJM Interconnection LLC, the coordinator of wholesale electricity supplies in 13 states from Virginia to Illinois, holds capacity auctions to set prices for projected demand three years in advance to assure generators enough revenue to help finance building.

Texas so far is meeting growing demand with a market-driven approach that uses higher prices to force consumers to conserve and, in theory, spurs generators to finance new plants. Prices are raised during times of peak demand, such as hot summer days, so that generators can make more money to compensate for lower prices the rest of the year.

Bills Rising

Energy Future Holdings Corp., NRG Energy Inc. (NRG) and Calpine Corp. (CPN), the state’s largest power generators, would benefit from the higher prices. Critics say Texas is setting up consumers for skyrocketing power bills without any assurances that plants will actually be built.

In 2006, the Public Utility Commission of Texas raised its cap on wholesale power prices to $3,000 a megawatt hour. The Federal Energy Regulatory Commission, which doesn’t have oversight of the state’s grid operator, caps pricing in other parts of the country at $1,000 a megawatt hour.

Last year, power prices touched $3,000 a megawatt for a total of 28.5 hours, mostly amid extreme weather conditions in August and February, said Daniel Jones, vice president of Potomac Economics Ltd. in Austin, Texas, the company that serves as the state grid’s independent market monitor.

“It’s more than we had in prior years,” he said.

Tripling Prices

To attract new power plants, state regulators have proposed raising the maximum price Texas generators can charge during periods of heaviest demand to $4,500 a megawatt-hour as of Aug. 1 and to $9,000 a megawatt hour by 2015.

Power shortages have become a greater concern in Texas as the state’s economic growth outpaced the nation’s.

As soon as 2014, the amount of electricity available during hours when demand is highest, such as a hot midsummer afternoon when air conditioners are working hardest, may fall to a level that makes Texas more vulnerable to widespread power disruptions, according a May 22 report by the Electric Reliability Council of Texas, the state’s grid operator.

The state will need to add about 20,000 megawatts of power- plant capacity, the equivalent of 10 major coal or nuclear stations, to keep up with demand over the next decade, Samuel Brothwell, an analyst for Bloomberg Industries, said in an April 27 report. Texas only has one major power project under construction, a 1,000-megawatt coal plant, he said. Calpine is planning to add 520 megawatts of gas-fired capacity by 2014.

EPA Rule

Generators may be forced to close some plants that can’t meet new pollution limits from the U.S. Environmental Protection Agency, Warren Lasher, director of system planning at ERCOT, said on May 25.

The state has two choices: raise prices high enough that generators will determine it’s safe to build, or change to a model such as that used by PJM, which sets prices for needed power years in advance, said Oren, the Berkeley professor.

He expects Texas to hew to its model of paying for power only as its generated, which means the state will need to raise prices.

Brattle Group Inc., in a report commissioned by Ercot, said the state’s market structure was “only marginally riskier than energy-and-capacity markets,” such as PJM.

‘More Volatility’

Raising the price cap to $9,000 a megawatt-hour won’t be sufficient to end the threat of rolling blackouts, according to the report released today. Brattle Group said boosting the maximum price would give the state a reserve margin of 10 percent above peak demand, less than the 13.75 percent reserve margin federal regulators estimate ERCOT needs to avoid rolling blackouts during extreme weather.

“If they want an energy-only market, they’re going to have more volatility, understandably, and they may not get the reserve margins they want,” Paul Patterson, an analyst at Glenrock Associates LLC in New York, said in a phone interview today. “They may have more reliability issues.”

Texas will review the Brattle Group report before deciding on a course of action, including how high to raise prices, said Terry Hadley, a spokesman for the Public Utility Commission, said.

NRG Energy, the second largest generator owner in Texas, can’t attract financing to build in the state at current price levels, said John Ragan, president of the company’s Gulf Coast region.

‘Getting Close’

“The market signals we see do not support a return on an investment that makes sense,” Ragan said in a telephone interview. “We are getting close, but are not there right now.”

The state’s fourth-largest retail electricity provider, PNM Resources Inc. (PNM), based in Albuquerque, New Mexico, decided to jettison its competitive business in Texas after five years because of the “volatility, uncertainty of energy prices,” Charles Eldred, PNM’s chief financial officer, said in a May 23 interview at Bloomberg’s offices in New York.

Consumer advocates and lawmakers in Texas including State Representative Sylvester Turner worry that home electricity bills could soar, especially since the state hasn’t studied the repercussions of higher wholesale power prices on end users, said Turner, a Democrat.

“We need to be looking at all possibilities before we start throwing money at generators,” said Geoffrey Gay, an attorney who represents the Texas Coalition for Affordable Power, a group of more than 150 cities that buys power for government use.

To contact the reporters on this story: Mark Chediak in San Francisco at mchediak@bloomberg.net; Julie Johnsson in Chicago at jjohnsson@bloomberg.net

To contact the editor responsible for this story: Susan Warren at susanwarren@bloomberg.net

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Texas May Triple Power Prices To Keep Lights On Amid Shortages

Livestock graze near the Fayette Power Project coal-burning electricity generators near La Grange, Texas. Photo: F. Carter Smith/Bloomberg

Livestock graze near the Fayette Power Project coal-burning electricity generators near La Grange, Texas. Photo: F. Carter Smith/Bloomberg

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