ERCOT

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Energy Risk ReportMay 28, 2020

MAY 2020

Procurement recommendations for commercial, industrial and institutional electricity users

EBWAnalytics.com

Andrew D. Weissman, Editor in Chief

2 Energy Risk Report: ERCOT

ERC OTR E V I E W

ERCOT wholesale power futures are trading unevenly in May. Summer 2021 contracts at

ERCOT North have surged $11.77/MWh (12.7%) since late April, reflecting expectations for

record demand despite COVID-related headwinds. Later-dated deliveries have traded in the

opposite direction, however: the winter 2020-21 strip is down $1.04/MWh (-3.5%) and summer

2021 contracts have slipped $2.65/MWh (-4.1%) month-over-month.

Falling natural gas futures underscore the role of scarcity expectations in ERCOT power

pricing. Summer 2020 deliveries at benchmark Houston Ship Channel are down $0.20/MMBtu

(-9.9%) month-over-month, while the winter 2020-21 strip declined $0.14/MMBtu (-4.7%) and

summer 2021 contracts slipped $0.10/MMBtu (-3.8%) over the same period.

Gas futures have resumed their downward slide due to remarkably well-supplied market

conditions, relatively lackluster demand rebound expectations, and repeated inventory builds.

That summer 2020 electricity futures have surged despite declining anticipated marginal

generator fuel costs reflects the impact of perceived scarcity risks on power pricing.

ERCOT’s final Summer 2020 Seasonal Assessment of Resource Adequacy (SARA) projects

record demand and sufficient reserve capacity in the most-likely scenario. The final

SARA projects peak summer demand of 75.2 GW—marginally above the record set in 2019—

fueled by warmer-than-normal weather and population growth trend.

The grid operator reduced its summer peak demand outlook by 1.6 GW relative to the

preliminary outlook released in March due to COVID-driven demand reductions. In the most-

likely scenario, ERCOT could have about 7.0 GW of spare capacity—equating to a peak reserve

margin of 12.6%.

Despite considerable nameplate reserve capacity, end users could still be exposed to

significant upside price risk. ERCOT cautioned that hotter-than-anticipated normal,

higher-than-normal forced thermal outages or weaker-than-forecast wind output, could all

force the grid operator to declare Energy Emergency Alerts to keep the lights on—implying

ERCOT Anticipates Record Demand This Summer

Key Takeaways

ERCOT projects 12.6% reserve margin this summer.

ERCOT downgraded its final demand estimate due to COVID and does not anticipate reliability challenges in the most-likely scenario.

Extent of upside price risks mitigated, but not eliminated.

Hot weather and weaker-than-expected generator performance could send prices soaring, especially since the scarcity pricing threshold is lower.

Post-2020 summer outlook may loosen further.

A combination of new renewable capacity and likely demand headwinds may reduce summer price risks starting in 2021.

Time Period EBW* Recommendation

Price ($/MWh)

05/28/2020 Trend Past Month

Trend Over Past Year 12-Month Range Year-Ago Actual

Price

Jun-Sep 2020 Buy $78.11 -$2.90 -$5.13 $62.41-$96.78 $111.49

Oct 20-Mar 21 Buy $26.95 $2.73 $2.46 $23.82-$28.99 $25.90

Apr-Dec 2021 Portfolio $43.08 -$0.67 $2.68 $37.23-$47.69 —

Cal 2022 Portfolio $36.55 -$0.14 $2.18 $32.37-$38.51 —

* See Glossary on last page

OUR PROJECTIONS aND RECOMMENDaTIONS

Renewable additions could weaken summertime scarcity risks in the years ahead.

3 Energy Risk Report: ERCOT DO NOT DISTRIBUTE

ERC OTR E V I E W

significant scarcity pricing. The second bullish Operating

Reserve Demand Curve shift this past spring also lowers the

threshold for price spikes.

Nonetheless, the experience of the last several

summers suggests the most-likely outcome is less dire.

The anticipated summer 2020 reserve margin is wider than

the previous two years, which included some scarcity

pricing but generally did not threaten grid reliability.

Contrary to fears, wind output has tended to overperform

during peak demand periods. Thermal generators have

also fine-tuned maintenance practices to ensure maximum

availability during the summer, although social distancing

may have impacted some of those preparations this spring.

History by no means guarantees future performance. Still,

it does at least suggest the most-likely result is several days

of scarcity pricing this summer even if grid reliability is less

threatened.

End users should still minimize exposure to summertime

price spikes—even if COVID demand reductions have

mitigated the extent of upside price risk.

The post-2020 summer outlook could loosen

further. ERCOT’s biennial Capacity, Demand and Reserves

(CDR) Report, also released this month, anticipates peak

summer reserve margins of 17.3% next year and 19.7% the

year after before declining to 14.1% by 2025. The actual

reserve margin may be even wider due to COVID-related

demand growth headwinds.

The latest CDR projections imply easing long-term

summertime scarcity risks. Reserve margin widening is

premised primarily on utility-scale renewables, however, so

a growing share of demand will be met with variable wind

and solar output.

End users should hedge their obligations through

winter 2020-21 and utilize a portfolio strategy for later-

dated deliveries. Ongoing natural gas price weakness has

extended an attractive end user procurement window.

Summer 2020 futures are well-priced now; end users should

hedge their exposure sooner rather than later to avoid

paying an even-larger premium as the market re-focuses on

scarcity risks.

A portfolio approach for post-winter 2020-21 reduces

end user exposure to re-inflated risk premiums driven by

scarcity pricing this summer while also maintaining the

flexibility to capitalize on further downside potential

driven by bearish factors such as a secondary COVID

outbreak, a particularly painful recession or the ongoing

surge of renewable capacity additions. ■

ERCOT North Day-Ahead Peak Futures, March-May 2020, 2H2020, Cal 2021, and Cal 2022

Source: EBW AnalyticsGroup, Bloomberg Source: EBW AnalyticsGroup, Bloomberg

Lost Daily Generation (GWh) from Nuclear Outages in ERCOT, 2020 vs 2019

4 Energy Risk Report: ERCOT DO NOT DISTRIBUTE

ERC OTR E V I E W

ERCOT North Day-Ahead Peak Electricity Prices, 2020 vs 2019 ($/MWh) ERCOT Daily Generation (GWh), 2020 vs 2019

ERCOT North Daily High and Scarcity Prices ($/MWh), Number of Days in June–August, 2016–2019 ERCOT Historical and Projected Reserve Margins, 2015–2020

Houston Ship Channel Natural Gas Hub Basis Differential, 2020 vs 2019 ($/MMBtu) ERCOT Natural Gas and Electricity Prices

Source: EBW AnalyticsGroup, Bloomberg Source: EBW AnalyticsGroup

Source: EBW AnalyticsGroup, Bloomberg Source: ERCOT, NERC

Source: EBW AnalyticsGroup, Bloomberg Source: EBW AnalyticsGroup, Bloomberg

2018

2019

ERCOT North Peak DA ElectricityHouston Ship

Channel NGHouston Ship Channel NGERCOT North Peak DA Electricity Price

Glossary: Our recommendations are made for a hypothetical commercial or industrial end user that consumes large amounts of electricity. With that in mind, end users must decide the timing to cover their electricity requirements.

“Wait” means that in our view prices are elevated and end users can get a better value by waiting for prices to fall.

“Buy” means that in our view prices are cheap relative to their true value, and end users are better served to buy now before prices rise.

“Portfolio” is more of a middle ground reflecting more balanced upside and downside risks. By taking a portfolio approach to procurement, end users cover a portion of requirements regularly to reduce upside risk exposure, but still retain downside potential should prices fall. In this light, a portfolio approach to procurement could be considered a cousin of dollar–cost averaging.

Terms and Conditions This publication is the property of Energy Business Network, LLC (“EBN”). The opinions and views expressed herein are those of the authors and not EBN and are subject to change based on market and other conditions. The articles and analysis are for informational purposes only and neither EBN nor the authors make any representations as to the completeness or accuracy of the information or conclusions stated.

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Eli Z. RubinSenior Energy Analyst

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