Electricity markets employ open access and non‐discrimination to foster competition, market entry, and innovation. The physical characteristics of the electricity system require explicit consideration of key elements in electricity market design. Pricing and settlement rules for the real‐time market must provide efficient incentives, both for short‐term operations and long‐run investment. The ERCOT energy‐only market design emphasizes the need to get the real‐time prices right. The recent innovation of the ERCOT Operating Reserve Demand Curve (ORDC) addressed the fundamental problem of inadequate region‐wide scarcity pricing that has plagued other organized markets, which have exhibited inadequate incentives both for reliable operations and efficient investment.
ERCOT employs an open wholesale electricity market as the basis for short‐term reliable electricity supply as well as for long‐term investments to maintain reliability in the future. A review of energy price formation in ERCOT leads to two important conclusions: (i) while the ORDC is performing consistently within its design, scarcity price formation is being adversely influenced by factors not contemplated by the ORDC; (ii) other aspects of the ERCOT market design must be improved to better maintain private market response to energy prices as the driver of resource investment, maintenance expenditure and retirement decisions.
The paper identifies three general issues that have affected ERCOT energy prices in recent years, and recommends policy and price formation improvements consistent with efficient market design. These recommendations cannot reverse the impact of broader economic trends, such as low natural gas prices, or national policies, such as subsidies for investments in renewable resources. However, the stress of these forces has exposed areas where there is a need for adjustments to pricing rules and policies within ERCOT.
System‐wide Price Formation
• Marginal Losses:The efficiency of region‐wide prices in ERCOT is distorted by the omission of the marginal cost of transmission losses from ERCOT’s energy market dispatch and pricing.
• ORDC Enhancements: The system‐wide ORDC calculation should be enhanced to address the reliability impacts of changes in the generation supply mix and the price impacts of reliability.
Locational Scarcity Pricing
• Out‐of‐Market Actions to Manage Transmission Constraints: Local scarcity pricing and mitigation rules require changes to properly set prices when there are reliability unit commitments or other ERCOT reliability actions to manage transmission constraints; these changes should not disable rules for local market power mitigation.
• Dispatch and Pricing for Local Reserve Scarcity: Introduction of local reserve requirements, implemented through co‐optimization of the energy dispatch and reserve schedules, would provide a market solution to properly set prices when there are constraints on reserve availability in a sub‐region.
Transmission Planning and Cost Recovery
• Transmission Planning: Market‐reflective policies for transmission investment should be considered as a replacement for Texas’ socialized transmission planning, which, by building new transmission in advance of scarcity developing, fails to provide the opportunity for markets to respond.
• Transmission Cost Recovery: Alternatives for transmission cost recovery to replace or reduce dependence on the summer peak demand‐based mechanism for the allocation of sunk transmission costs would reduce distortion of energy market pricing.
An Appendix provides further details on a formulation and computational approach for calculation of co‐optimized prices for energy and operating reserves with local reserve requirements.