NCPA - National Center for Policy Analysis

Keep Capacity Markets Out of Texas Electricity

October 16, 2013

Competition has worked remarkably well in the Electricity Reliability Council of Texas (ERCOT) since its introduction about 15 years ago. Consumers can choose from over a hundred different plans from dozens of providers. Billions of dollars invested in generation have provided Texas with a reliable supply of affordably priced electricity. However, recent concerns about the adequacy of generation investment have led to the consideration of imposing a "capacity market" in ERCOT. Proposals would make ERCOT more like other U.S. power markets, which require that sellers of power to end-users must own or have contractual access to generation capacity sufficient to cover their loads, say Andrew N. Kleit, professor of energy and environment economist at Pennsylvania State University, and Robert J. Michaels, professor of economics at California State University, Fullerton.

In other words, in a capacity market the government rather than the market determines when supplies of electricity are adequate to meet long-term reliability needs. An examination of ERCOT's history and operation brings a conclusion that the costs of instituting capacity markets in its territory will almost surely exceed any benefits they might bring. Those costs have proven substantial in other regions.

  • In the Pennsylvania-New Jersey-Maryland Interconnection (PJM) capacity charges in 2010 added $140 per year to an average residential electric bill and $1,000 to that of a retail store.
  • From the capacity market's 2007 inception through 2011, PJM retail customers paid over $50 billion in capacity charges -- 93 percent of which went to owners of existing generation and only 1.8 percent to new and reactivated units.
  • Had they been spent directly on new capacity, the funds could have purchased 129 combined-cycle gas-fired generators, each with 400 megawatts (MW) of capacity.

Kleit and Michaels find little potential value of a capacity market in Texas.

  • They find the economic theory behind capacity markets to be deeply flawed, both in general and when applied to ERCOT.
  • Additionally, they find that investment in generation in ERCOT is likely to continue and, as it has in the past, provide sufficient reserves to maintain reliability.

Shifting to a capacity market is unnecessary, and would in reality be a source of inefficiency and a barrier to competition that would likely increase the cost of electricity for consumers.

Source: Andrew N. Kleit and Robert J. Michaels, "Does Competitive Electricity Require Capacity Markets? The Texas Experience: A Summary," Texas Public Policy Foundation, October 2013.


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