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Scarcity Pricing: Near-Term Pain, Long-Term Gain

With summer on the horizon, it’s a good time to talk about scarcity pricing — a hot topic last year when real-time wholesale power prices in Texas hit a $9,000 per megawatt-hour (MWh) cap multiple times over a three-day stretch.

Generally, wholesale power prices are driven by supply and demand. Prices go up when limited power supplies are used to meet growing demand.

Picture a hot, humid day. The Electric Reliability Council of Texas (ERCOT), which operates the grid and power markets in nearly all of the state, must call on all available resources to meet soaring electricity demand on those days. Typically, ERCOT will need to ask less efficient and more expensive power plants to run, helping drive up prices in those periods.

ERCOT also uses an “operating reserve demand curve” mechanism, or ORDC, in its markets to help make sure Texas has enough power supplies to avoid blackouts. The ORDC gives an extra boost to prices when real-time electricity reserves grow short. The ORDC partly reflects an estimate of how much people would pay to avoid power outages.

Importantly, scarcity pricing provides an incentive for building new power plants and for existing generators to make sure their power plants are in shape to run when needed.

Before last summer, ERCOT’s $9,000/MWh price cap was hit only once since it was put in place in 2014. But in August, after a change in a key variable in the ORDC, the price cap was hit for four hours.