Negative Power Prices Highlight Some Regulatory Problems

For anyone who needs more evidence that the world of power is changing rapidly, two recent cases have shown examples of companies actually receiving negative power prices. This essentially means the companies are paying others to take power from them. A power company, in a free market, paying another party for the right of the power company to generate electricity sounds very strange. Even if the marginal cost of production for the power company is zero after all, it is unclear why the power company would pay for the right to generate electricity - that is, why they would accept a negative electricity price.

Two recent cases illustrate how such a strange turn of events could unfold and why many of the assumptions investors hold about the business of power generation need to be rethought.

First in Texas, wholesale power prices recently turned negative overnight at one point. Texas functions as something of an island economy in the wholesale power markets and the grid there generates substantial amounts of power from wind energy. As wind energy is generated in the middle of the night, there is limited demand for that power. Yet power companies have very little means to store the power (this is where grid scale energy storage could play a big role in the future). As a result, the power companies are traditionally willing to sell the power for any price above their marginal cost of production. For conventional fossil fuels like oil and natural gas, the marginal cost of production - that is the cost of producing one more kilowatt of energy - is a small positive number. But for wind power, of which Texas has a lot, the marginal cost of production is very close to zero. Essentially the only cost is for extra overhead and machinery depreciation associated with generating electricity rather than keeping the turbines idle. Related: America's Top Shale Gas Basin in Decline

In this situation, wind power has a natural cost advantage over other forms of energy. Yet wind producers are actually willing to sell their power at a small negative price because they receive an incentive from the government for producing that power. In the Texas case, the price of energy became negative $8.32 per megawatt hour. Yet, the producers themselves get a Federal tax subsidy of 2.3 cent per kWh enabling them to turn a paper profit even at a negative wholesale price. Related: Saudi Arabia Continues to Ramp Up Oil Output in Face of Market Glut

The Texas case has some similarities to a JPMorgan case with FERC a couple of years ago. JPMorgan ultimately paid FERC a series of fines in the amount of $410 million because the bank allegedly manipulated power markets in California. In particular, the bank was accused of manipulating power prices by charging very low or even negative rates for power at certain hours one day and then jacking up the price to 80 times the market rate the next. The bank was able to exploit a series of loopholes that FERC created when that regulatory body wrote a very complex set of bidding rules and procedures that governed power price auctions. Related: OPEC Members In Jeopardy, How Long Can They Hold Out?

JP Morgan was able to take advantage of these rules consistently despite FERCs attempting to close the loopholes each time the bank exploited them. The cat and mouse game continued for months with FERC closing one loophole by rewriting the rules and then JPMorgan would find a new loophole to exploit.

The commonality between both cases is that power producers have been able to find ways to exploit rules written with the best of intentions. In any economic system there will always be ways to manipulate the rules or other market participants to earn extra profit. That's an unending challenge for regulators that cannot be solved.

Yet the flood of new power technologies from green energy to grid scale storage are going to create new ways for market participants to game the system to their own advantage. Regulators need to take new technologies more seriously and begin looking actively at ways to keep up or they risk economic inefficiency slowly creeping into the nation's electricity markets.

By Michael McDonald of Oilprice.com

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