Capacity requirements don’t assure reliability when generators can’t get fuel.
Texas has gone through a terrible period, President Biden has declared a state of emergency and efforts are continuing to alleviate the suffering caused by a week of record cold, and massive problems with the Texas electric system. At the same time, fingers are pointing and the knives are out. Blame has been directed at everything from frozen wind turbines, to Texas’ semi-isolated grid, all the way to allowing non-Texans onto the board of the Electric Reliability Council of Texas (ERCOT). One criticism that I’ve followed closely is the role of Texas electricity deregulation in general, and its wholesale market design in particular. Yet, although virtually every story mentions it, few seem to consider the implications of the fact that many of the problems that hit the Texas electricity system stem directly from the failure of its natural gas system.
For those of you who don’t follow the energy industry that closely, natural gas is not electricity. The natural gas system in Texas isn’t regulated by ERCOT, wasn’t deregulated by George W. Bush, and to my knowledge doesn’t use wind turbines. Those pointing to the superiority of electricity market designs outside of Texas need to consider how those designs and regulations would fare if they ran out of natural gas.
One of the main criticisms of the Texas market is that it doesn’t have a capacity market, or capacity requirement. In the electric industry we are used to thinking about the supply shortages problem as one we combat by keeping extra generating capacity. What is overlooked in all this discussion about capacity is that every major supply shortfall event going back to California’s crisis in 2001 has resulted not from a lack of capacity but from a lack of electricity, or electrical energy. The problem is that capacity can’t keep the lights on or heat your house if it’s not operating.
In Texas, the failure of the more-than-adequate capacity to generate electricity was shared across all the technologies and fuel sources. But by far the biggest shortfalls came from the gas-fired power plants, and much of that shortfall was because those plants couldn’t get gas. This is not a new problem, but Texas was by far the most disastrous manifestation of the problem.
Different Markets, Different Standards
Obviously natural gas and electricity are very different energy commodities, and it is logical for them to have different regulatory and market structures. That said, the contrasts between the transparency and oversight of electricity markets and natural gas markets are glaring. Consider the following dimensions:
Regional Reliability Planning
Since 1968, in the wake of blackouts on the east coast, the federal government has required electric utilities and system operators to coordinate their resource planning and to file detailed analyses of their needs as participants of regional reliability councils that operate under the umbrella of the North American Electricity Reliability Corporation (NERC). The NERC develops standards and best practices for electricity balancing authorities to follow. To my knowledge, there is nothing close to an equivalent of NERC in the natural gas industry. If it did exist, an equivalent institution for gas might develop standards around storage, pipe insulation, and backup generation for compressors and pumps.
Wholesale Price Transparency
Electricity markets in areas with Independent System Operators (ISOs) function as centralized exchanges that handle almost all of the power flowing through their systems. As part of their role in balancing supply and demand, they determine and publish high frequency prices that set the value of electricity at a highly granular level of time and space. The natural gas market operates on a combination of non-transparent over-the-counter (OTC) trades and exchange-based standardized contracts in a handful of locations. And the gas markets that are transparent don’t do weekends.
The natural gas prices that are reported are derived either from surveys of OTC trades or from these standardized contracts. It’s not an ideal environment for price formation – remember the Bunny Slipper Lady? News articles that did focus on the natural gas market during the Texas freeze displayed pictures like this one. The problem with this picture (line graphs!) is that it glosses over the gaps in trading days. A more representative picture would look like this.
The absence of liquid transparent markets can be a problem when crises hit during, say, Presidents’ Day weekend. Everyone, including gas generators, are scrambling to get gas and it’s not clear exactly who to call and what to pay them. In that kind of chaotic market environment the gas that is available is not likely to flow to the uses where it would do the most good.
In that kind of situation, electricity generators can’t get gas, so load is curtailed, so gas wells lose power, so generators can’t get gas, …. You get the point. When the Governor bans exports by executive order, it’s a sign that something is seriously wrong in the market.
Retail Service Priorities
In most of the country we are used to thinking about electricity capacity problems as all about heatwaves. In heatwaves people need cooling, and air conditioners run on electricity. In cold snaps, people need heating, and many households rely on natural gas furnaces. This is still the case in Texas, even though electric heat has been growing. In most of the country therefore electricity demand peaks in the summer. Over the last two decades however, a majority of the generation capacity also needs natural gas. So, most of the supply shortage events outside of California have happened in the winter and have been driven by the competition for gas between heating and electricity generation.
We still lack the right mechanisms for allocating scarce gas between these competing demands. The lack of transparent prices is part of the problem. Another is the incentives of the natural gas distribution companies responsible for meeting the heating needs of their “core” residential and commercial customers. They would face holy hell if they curtailed their heating customers, but can lay low when the power is shut off to those customers instead. The kind of regulatory blowback they might face if they fell short far outweighs the benefits of selling off some gas to electricity generators, even when their own customers might benefit from such a sale. This kind of “skewed incentive” was at the root of this paper by Severin Borenstein, Meghan Busse, and Ryan Kellogg.
These skewed incentives, combined with illiquid markets and the absence of other coordination mechanisms can lead to the gas that is available being used in the wrong ways. The “right” answer would likely be to turn down thousands of furnaces, close some shops, and help keep the lights on. The current state of integration of our natural gas and electric systems does not operate at that level.
It’s quite possible that even if nothing went wrong with the gas system there would have been serious energy shortfalls in Texas. We will know more and more over time. Even outside of Texas though, one of the greatest threats to electricity reliability is the reliability of the natural gas system. The Trump administration’s answer to this threat was to subsidize some baseload coal and nuclear power plants (only the deregulated ones). Even ignoring the climate implications and the frozen coal piles, keeping billion-dollar plants operating beyond their economic lifetime to deal with a one-week in three-year problem can’t make sense. Gas storage, or even on-site dual-fuel gas/oil capability would probably make more sense.
But the first priority should be to make sure the gas that is available is being used in the way that creates the most benefits and minimizes the risk of another hell-freezes-over week in Texas again. A more reliable and transparent gas market would be a good place to start.
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Suggested citation: Bushnell, James. “To Fix the Power Market, First Fix the Natural Gas Market” Energy Institute Blog, UC Berkeley, March 1, 2021, https://energyathaas.wordpress.com/2021/03/01/to-fix-the-power-market-first-fix-the-natural-gas-market/
 It has been argued that electricity capacity requirements could also require plants to have contracted for sufficient fuel as well. This is easier said than done given the myriad types of possible contracts and the difficulty determining whose fault it may be if gas cannot be delivered. Ultimately the effectiveness of any such requirement depends upon the penalties for non-compliance. Electricity systems with capacity requirements rely upon performance penalties to provide the incentives for generation capacity to be available. Even the largest penalties are still smaller than the $9000/MWh incentives faced by electricity generators in Texas.
You could impose huge penalties on generators for not having enough gas, but then you could end up with the opposite skewed incentive problem, where the gas distributors can’t buy the gas they need from electricity generators afraid of paying those huge penalties.