Streetwise Professor

February 18, 2021

Who Is To Blame for SWP’s (and Texas’s) Forced Outage?

Filed under: Climate Change,Economics,Energy,Politics,Regulation — cpirrong @ 12:44 pm

I am back following a forced outage, due to forced outages of Texas electricity generators caused by the cold snap–brutal by Texas standards, routine compared to what I experienced in my 40+ years up north–that is just relaxing its grip. Having some foresight, I had laid in some firewood, and that kept things from getting unbearable. Other than the power outage, water pressure was an issue: I thought my faucets needed a prostate check, but as of about 10AM the flow is back.

So, with fingers crossed, I have the opportunity to comment on what happened. As with so many things–everything?–today, the commentary has been highly partisan, and largely wrong. Blame wind power (or the lack thereof)! Uh-uh! Blame fossil fuel generation!

The facts are fairly straightforward. In the face of record demand (reflected in a crazy spike in heating degree days)

supply crashed. Supply from all sources. Wind, but also thermal (gas, nuclear, and coal). About 25GW of thermal capacity was offline, due to a variety of weather-related factors. These included most notably steep declines in natural gas production due to well freeze-offs and temperature-related outages of gas processing plants which combined to turn gas powered units into energy limited, rather than capacity limited, resources. They also included frozen instrumentation, water issues, and so on.

Wind was down too. Wind defenders have been saying that wind did great! because it sucked less than ERCOT (the Electricity Reliability Council of Texas) had forecast; that is, wind generation was somewhat higher than the low levels that ERCOT had predicted. The defenders were spinning, even if the turbines were not.

However, wind performance was objectively worse than thermal. In the weeks prior to the Big Freeze, wind was operating at ~50-65 percent of installed capacity, and supply ~40-60 percent of Texas load. When the freeze hit on Monday (and I was throwing another log on the fire), due to turbines freezing, capacity utilization fell to around ~10 percent to ~5 percent, and wind was generating ~3-10 percent of ERCOT load. Meaning that the relative performance of wind vs. thermal was worse during the cold wave, even as bad as thermal performance was. Further meaning that if wind had represented a larger fraction of Texas generating capacity, the situation would have been even grimmer.

The last few days wind defenders have been saying that the problem wasn’t with wind per se, but the failure to winterize adequately wind generators in Texas. After all, there are windmills in Antarctica! (Not to mention Sweden, etc.).

This brings to mind what Adam Smith wrote in the Wealth of Nations:

By means of glasses, hotbeds, and hotwalls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expense for which at least equally good can be brought from foreign countries.

That is, you need to consider cost. Yes, winterizing windmills to withstand the conditions observed in Texas this week is inside the production possibilities frontier, but winterizing is not free. It is a question of whether the benefits exceed the cost.

The same thing is true with regards to thermal generation (and natural gas production). After all, power plants in far colder climes (it was below zero in Missouri, for example) hummed along in even more frigid conditions. Similarly, gas continues to flow every year in winter conditions in Canada and Siberia. But achieving these results is not free. It is a question of cost vs. benefit.

The cost of not winterizing power plants that shut down due to temperature-related outages (rather than limitations on fuel supply) were certainly material. Power prices spiked to around $9,000/MWh, and were routinely over $1,000/MWh. For a 500MW plant, losing an hour at a $9000 price means $4.5 million in revenue forgone. Even at $1,000, that’s $500K up the flue. (That’s the gross loss. The net loss is harder to calculate, given that natural gas prices also spiked).

That’s a lot of money, but whether it would have been worthwhile to incur the cost to ensure operation under the conditions we observed also depends on the probability of the event. Given the extremes observed, the probability is pretty small. Meaning that it might have been rational for generators to forego the expense: zero failure rate is never optimal. This is in contrast to a generator in say Minnesota, for which such conditions are the norm.

I would imagine that there will be a pretty intense review of utilities’ decisions regarding winterizing their plants. The cost should be fairly easy to estimate. By applying market prices or the value of lost load (VOLL) it should be similarly straightforward to estimate the cost of such weather induced outages. The probability, however, will be much harder. It is inherently difficult to estimate the probability of extreme events, especially when they are seasonal in nature.

Similar considerations hold for gas processing plants and gas wells. The opportunity cost, and the cost of upgrades, are fairly straightforward to quantify. The probability that the upgrades will actually pay off (by avoiding shutdowns) is far more amorphous.

The events of this week also bring to the fore longstanding debates regarding the appropriate generation mix in Texas. Yes, thermal experienced unprecedented outages, but as noted above, it performed both absolutely (measured by capacity utilization) and relatively (measured by decline in utilization) better than wind. Texas would have been better off with less wind and more thermal. Maybe not enough to avoid blackouts altogether, but enough to mitigate substantially their severity.

Texas has had longstanding concerns about reserve margins. The main drivers have been the retirement of substantial amounts of coal generating capacity, and relatively low rates of increase in natural gas generation (a measly 3.5 percent over the past 4 years) at the same time wind capacity has more than doubled and solar capacity has increased by 2000 percent.

The problems here are twofold. First, wind and solar availability and output are often negatively correlated with demand. (Solar wasn’t doing much at 10PM on Monday, now was it?) Second, and more insidiously, wind and solar generation depress prices–often to below zero–at other times, which undermines the economics of thermal generation. Hence, the low rate of investment in gas, and the actual disinvestment in coal.

As I said, this is a longstanding problem. I remember hosting a roundtable on this issue at UH in 2005 or 2006. Generators were already raising alarms that negative prices were a powerful disincentive to investment.

Things have only worsened since, and perverse policy is to blame. It is unarguable that wind and solar capacity have increased to extremely inefficient levels due to lavish subsidies, especially at the federal level. As a result, Texas has a grotesquely inefficient resource mix.

And with the new administration, the outlook is even worse. It has embraced increasing demand for electricity (electrify everything!–echoing the malign and evil Bill Gates) and subsidizing the production of electricity using unreliable renewables.

Texas’s travails raise questions about the viability of ERCOT’s “energy only” market design, in which generator revenues are solely from the sale of energy (or ancillary services). In this model, price spikes are intended to incentivize investment in generation (and upgrades to enhance availability rates). But price signals distorted by excessive renewables are a strong disincentive to investment.

The standard kludge in these circumstances is capacity requirements plus a capacity market. This was mooted in my roundtable so many years ago. If price signals are allowed to work, a capacity market is unnecessary and inefficient. But prices have been so distorted that it will receive serious attention going forward.

This is unfortunate, in the extreme, as the better approach would be to destroy the price distortions at their source–subsidies for renewables. Alas, in the current political environment it is likely that the nation will move strongly in the opposite direction, making the problem worse not better. Perhaps Texas could find ways of counteracting national policies–e.g., by imposing a state “reliability tax” on renewables–but this is likely to be politically impossible (although it would be a nice illustration of the theory of the second best!) Meaning that in the end, we will kludge our way to increasing reserve margins.

Not a cheery picture, but what is these days?

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  1. Craig, thanks for the typically lucid analysis. What do you make of ERCOT’s lack of contingency planning for such an extreme event? Inevitable because of the outlier nature of the event? Or another casualty of the complications caused by the governmental interference in the markets?

    Comment by Tom Kirkendall — February 18, 2021 @ 1:34 pm

  2. As usual it’s treat to read your article. I think you should also consider the fact that very existence of ERCOT is also to blame here.. If TX would have been connected to the national grid like say El Paso, we would not be facing this problem. It’s obvious that ERCOT was not able to solve this weather event generated energy reliability and availability problem but at least possibility of buying power from other states during emergencies like this would have been very helpful. Unfortunately no one even talks about this issue and no one raises a question that why TX gets it’s own grid?? Just so that they can thwart the Feds at the cost of common people?? I think this is a big question to ponder over.

    Comment by Sameer P. — February 18, 2021 @ 3:35 pm

  3. The market-design works 99.9% of the time 365 a year, and occasionally we have a high-severity event on one or two days each year…
    It’s highly redistributive to Texans (savings) even if you discounted these 2 or 3 events over the short-term.

    Wind, solar normally work as a back-up function for the nuke and the fossil generation mix and vice-versa.

    Wind blows, cheapening gas and making power absolutely affordable. Base CASE: ERCOT Electricity prices are within negative price territory to $25 mwh most of the time.

    Wind doesn’t blow => the market works the other way. Once in a while… prices go to infinity for a couple of minutes. Get over it people or know what you want

    Comment by ex-UH student — February 18, 2021 @ 4:12 pm

  4. Thanks for the insightful analysis.

    I wonder if another problem here is in the design of forward contracts and hedges. Are the generators really exposed to the highs and lows of the spot market? If a generator is contracted to sell it’s output at $30/MWH, and has a force majeure clause that relieves it of liability if it fails to deliver, then there is little incentive to winterize the generating plant (or the natural gas well) against a once in a decade contingency. I know crude oil contracts often have force majeure clauses, does anyone know about electricity & natural gas contracts?

    A contract that forces the generators to buy on the spot market to make up for what they failed to generate might help that. Alternately, those buying forward power could pay a premium to buy from a winterized generator to make sure they are not caught short. Either way, there has to be a premium paid to get that additional reliability. And after this week, I’m sure those contracts will be renegotiated when up for renewal.

    One other thought – the “independent grid” is not completely independent. It has DC ties to the east, west, and Mexico. I am sure increasing the capacity of those ties will be part of the discussion – there was a huge price incentive to import power, but the transmission wasn’t there. Tying into either the east or western US grids doesn’t solve the lack of transmission. And building transmission can include increasing those DC ties’ capacity.

    Comment by Jack — February 18, 2021 @ 8:51 pm

  5. Glad to hear that you made it through.

    Comment by Ex-Global Super-Regulator on Lunch Break — February 19, 2021 @ 1:46 am

  6. glad to hear you are okay. what about nuclear? I don’t hear anyone talking about nuclear. They are simply arguing the trade offs (without considering the opportunity costs) of “clean energy” vs fossil fuels. Of course, the ace in the hole for the clean energy folks is saving the planet. A cost that is impossible to quantify and since the science is settled, a point that cannot be debated.

    Comment by Jeffrey Carter — February 19, 2021 @ 9:30 am

  7. Thank you professor Pirrong for your analysis! I totally agree that winterization is not free, and current market and policy has little incentive for market participant to do so. However, the consequent of losing power in this scale and the stability of the grid is huge, both economically and socially. I don’t have the numbers, but I assume the cost of winterize equipment is not formidable as other states can do so without seriously burden the participants and consumers. For Texas, I think the regulators and market participants should work together to redesign the rules and policies to make it happen. Of course winterization is just one factor, there are many other lessons need to be learned from this disaster. What happened this week shouldn’t be this way, it’s a systematic failure of the energy industry.

    Comment by Chunxing Shen — February 19, 2021 @ 10:50 am

  8. Thanks, @Jack. You raise a lot of interesting issues. Probably best to handle them in a separate post. Essentially what you posit is a moral hazard problem.

    One quick comment. My work in the 2000s on electricity derivatives pricing, and work done by others at the time (e.g., Bessembinder and Lemon in the Journal of Finance) emphasized that one reason why generators might not want to hedge is that they gave up the opportunity to profit from price spikes by doing so. This would imply a big imbalance between long hedgers (who wanted protection against spikes) and short hedgers (those who wanted protection against price declines). In the early days of electricity markets, this lead to huge risk premia: forward prices were way above (sometimes as much as 100 percent) reasonable estimates of expected spot prices. Those premia have eroded over the years (I stopped following closely around 2008 or so). This was mainly due to financial players taking the other side of the long hedges, rather than generators doing so.

    Comment by cpirrong — February 19, 2021 @ 12:17 pm

  9. No such thing as a national grid and no one person is to blame.
    Government at many levels will always fail the public.

    Comment by Deserttrek — February 19, 2021 @ 12:42 pm

  10. You are correct, of course, about benefits vs. costs. But the real issue is not aggregate benefits vs. aggregate costs, it is who bears how much of each, and behind that the agent problem. That is fundamental to the whole idea of market failure and why natural monopolies are all owed to exist but regulated.

    My daughter, who lives in Austin, tells me that when the water supply started to fail, hospitals that depend on boilers for heat became unheated. That is scary, and beyond what the individual who may have 20 yrs of food and water and ammo in the shed, can deal with. It is also not possible to plan decades ahead and assess the people affected for the costs of mitigating infrastructure. You might say a hospital that didn’t take effective precautions can be sued and that would get them to act in an economically rational manner, but IRL that is ridiculous as a matter of policy, and would be little comfort to the dead whose survivors might have a cause of action. And the idea that price spikes will lead to more capacity is absurd in the real world where such investments take years, often decades, and even more in a world where large Black Swan events have such large impacts. I fully recognize how markets can be efficient, but at some level, collective action and regulation are necessary.

    Comment by mhjhnsn — February 19, 2021 @ 1:01 pm

  11. ” It is unarguable that wind and solar capacity have increased to extremely inefficient levels due to lavish subsidies, especially at the federal level.”

    Only half the equation. There were and are the costs imposed on thermal (and delivery infrastructure, both for fuel and output) by government regulatory taxes.

    Comment by SDN — February 19, 2021 @ 1:06 pm

  12. Craig, Terrific post. How many standard deviations is this cold spell away from the expected? Keep up the good work.

    Comment by Lee Benham — February 19, 2021 @ 1:07 pm

  13. The “hunt for the guilty” will be a snipe hunt since the guilty parties are the lawmakers, regulators, lobbyists and donors who’ve all been feeding off of the taxpayer/ratepayer.

    You should note that power generation is a regulated utility. If the regulators are pushing wind and solar power, and those sources are receiving massive subsidies, then they will be funded to the exclusion of gas, coal, and nuclear power. In addition, only those expenditures approved by the regulatory agency are included in the utilities’ rate base. Which means the utility eats the costs that are not approved. If winterization were in the rate base then it would have been done, it wasn’t done so you can conclude it was not authorized by the regulatory agency.

    Of course, a good bit of blame also falls on ERCOT who boldly claimed that the ice storm of 2013 (or maybe 2014) was the “worst possible scenario” in their risk assessment. A known outcome is never the worst possible outcome in a risk analysis. The power usage during the storm of 2013 should have been, at most, assigned a probability of 80% given that the weather forecast called for much colder temperatures than seen in 2013. And that 80% is really too high given that the cold wasn’t limited to North Texas and Central Texas but extended down to Corpus Christi.

    The obvious outcome to the hearings will be more authority and more money for those who’ve repeatedly failed in their responsibilities. It’s the public sector way.

    Comment by ChrisS — February 19, 2021 @ 1:24 pm

  14. Modern Nuclear power plants deliver electrical power on demand regardless of climate conditions. Thorium reactors have the advantage of chewing up excess A-bombs nuclear material. Whats not to love. France is to be admired. Although I do recall a recent French Fry revolt. Alas not all is a perfect solution, yet nuclear thorium reactors are close to my heart and ought close to yours as well. Pls no carping or wahddabouts. thx

    Comment by jim walls — February 19, 2021 @ 1:34 pm

  15. This analysis is pretty much spot-on (I’m in the industry, sort of). The only thing I would add is that “winterizing” plants can mean that they run less efficiently in the summer, when Texas usually really needs the power. I suspect that the problem here is that lots of plan operators got pretty complacent: I can shut down, those other fellows will pick up the slack. When push came to shove, no one was left to pick up the slack. Now, as to why Austin Energy couldn’t *roll* the blackouts from customer to customer (which would have made a huge difference), I await an answer impatiently.

    I would like to see the answer in more distributed generation, such as neighborhood-sized nuclear reactors. It’s the only way to guarantee problems are limited to small areas.

    Comment by Rob — February 19, 2021 @ 2:15 pm

  16. I said finally something meaty – but am disappointed and frustrated.

    I am not seeing breakdown of energy capacity and demand supplied during “typical normal working day” by type of energy source [nuclear, wind, gas, coal]

    Analysis and comparison not possible to evaluate without that – a crucial defect of your report

    can you please add??!!

    Comment by narayanan — February 19, 2021 @ 2:24 pm

  17. The figures II saw were these: the system was said to have 83gW capacity, 30 from wind and the rest mostly from gas and nuclear. The system used wind roughly at its capacity because its cost to the system was negative, as a result of federal subsidies of 25 cents per kw hour which exceeded costs of production. The wind source produced then 42% of the power consumed.
    Two things happened. First, as a result of the cold, wind power usage fell to almost nothing; many wind turbines froze.
    This was made up by large increases in gas power usage, like 400% which even exceeded it nominal capacity
    The second event, which made itself felt several days later was even colder weather which caused gas heating usage to rise so that total power demand went well above 53gW which was the non-wind capacity. The system did not have the ability to meet that demand and had to ration power use, a disaster to those needing heat in subzero weather.
    What was to blame? The system did not have enough power available to meet these two events.
    The first event was expected because wind power is not always available. The second was also something that happens from time to time. That the same cold weather caused both should have been expected but was not.
    The problem was that as wind power grew coal plants were shut down. Had those coal plants been available, the system would have had the capacity to meet both events simultaneously.
    Those who blame gas failures for the problem start their calculations at the time after the wind power disappeared and gas was flowing at or above capacity, which eventually dropped by a few percent, because the cold weather eventually affected all outdoor activities including feeding gas into the pipelines. Gas at all times continued to flow at a rate more than three times what it done before these two events.

    Comment by Daniel — February 19, 2021 @ 3:16 pm

  18. Thing is, though, that there was a smaller scale version of this in 2010, there were similar weather occurrences in the late 1980s, and a very near severity occurrence in the 1940s. It isn’t as though extreme weather events were unknown. There should have been a better effort at winterization. Building for a 30-year robustness standard should not be the common spec for such a general life-required quasi-government utility system: design it with the expectation that your system will crash during its design life does not seem to be a sound policy. The marginal costs for winterizing the equipment during construction / installation is a fraction of what it will take to retrofit everything…which will likely be an outcome to whatever investigation is conducted on all this.

    What were the financial incentives / financial impediments that resulted in compiling a utility that is promised to not survive even one generation’s life?

    Comment by Steve S — February 19, 2021 @ 3:27 pm

  19. So close to Mexico, perhaps Texas should connect to their reliable grid to forestall future problems.

    Comment by gnome — February 19, 2021 @ 5:18 pm

  20. Well the Federales have this racket: they collect taxes and then pass the money out. They have money to encourage and support wind power. Is it possible the incentives for wind power made it possible for that sector to grow at the expense of the other sectors? That might need to be considered.

    Comment by Milwaukee — February 20, 2021 @ 1:34 am

  21. I understand the weather in Mexico is quite agreeable ATM. Ted clearly isn’t as stupid as he looks.

    Comment by David Mercer — February 20, 2021 @ 6:20 am

  22. well, everyone is weighing in on this – and I do mean everyone. Yesterday, Feb 20, I tuned in for a second to NPR (National Propaganda Radio), who, among others, are not only circling the wagons but forming attack squads against anyone who dares to criticize “green energy,” or the wind turbine bird killers.

    And who did they have to carry on the defense/attack? An ANTHROPOLOGIST – who apparently is an American but teaches in Berlin. The radio propaganda host thanked the ANTHROPOLOGIST for her “expertise.”

    Anyway, here’a a bit more factual analysis – and as usual, SWP has done an excellent, informative job in his posts on this.

    The best explanation of Texas’s prolonged blackout was published by Mitch Rolling yesterday at Texas gets electricity from six sources: coal, nuclear, natural gas, solar, hydro and wind. How did those sources perform, and what contributed to the blackout?

    Comment by elmer — February 21, 2021 @ 10:20 am

  23. @Jack–upon consideration, hedging doesn’t really affect the analysis. A generator that sells output forward, and is unable to perform (because of an outage) must cover (by purchasing at the spot price) or pay liquidated damages (which are computed using the spot price). Either way, the opportunity cost of an outage to a hedged generator is the spot price, just as it is for an unhedged one.

    Indeed, it may be the case that the cost of covering is higher than the revenues that could have been earned by selling on the spot market. The market is likely illiquid in such extreme conditions and a generator scrambling to cover a short position might get held up. Further, the generator would need to come up with cash in a hurry, and that could be problematic.

    So all in all I don’t think the moral hazard is a real issue here. The opportunity cost of an outage is the spot price for both hedged and unhedged generators.

    Comment by cpirrong — February 22, 2021 @ 3:35 pm

  24. Wind people are defending wind because that was what politicians in Texas chose to criticize before all facts. Can you really blame them for playing offense now?

    And it’s about expectation. When you get a wind project, you know what you are getting for (is that called free market?). It can only produce when there is wind and not frozen. ERCOT would never just rely on wind to power the grid. As a matter of fact, ERCOT had done 2 worst case scenarios right before all the emergencies, one of which had a 2 GW wind forecast (don’t remember the exact number, but it’s a low number). Was ERCOT worried that wind production can be this low? No. Because it thought its gas/coal/nuke fleet would hold up just fine.

    To make it even more clear, if I were to hire 2 finance professors, one from University of Houston (wind) and another one from Harvard (fossil fuels) for a same project (grid reliability). When they both failed, would you criticize the professor from University of Houston first because he couldn’t get the word done? No. No one cares about the finance professor from U of Houston. It’s called expectation.

    Comment by Alex — February 25, 2021 @ 9:38 am

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