By Eileen O'Grady

HOUSTON (Reuters) - Forward power prices in Texas have moved up in response to efforts by state regulators to boost the wholesale market cap in its competitive electric market, industry sources said this week.

The Public Utility Commission of Texas proposed increasing the cap on wholesale price to $4,500 per megawatt-hour beginning in August, up from the current $3,000 price cap.

Raising the wholesale cap whenever supplies are tight is the latest in a series of market adjustments by the PUC and the Electric Reliability Council of Texas (ERCOT) to avoid problems seen in 2011 when a protracted heat wave strained electric supplies and threatened rolling blackouts.

"The market is watching the PUC very closely," said Sam Henry, president of IPR-GDF Suez North America, which is active in the Texas market.

Last summer's brutal heat wave and drought only heightened the need to address the state's already shrinking power reserve margin, the electric cushion needed to avoid blackouts.

Electric demand in Texas has kept growing due to the state's healthy economy, but low wholesale prices and tight financial markets have thwarted development of several new power plants even as stricter federal environmental regulation threaten to force the shutdown of some older coal and natural-gas fired plants over the next few years.

That has left ERCOT and regulators scrambling to increase the amount of generation that will be online this summer as well as addressing the longer-term need to encourage investment in new power plants.

Forward prices for the ERCOT North, the most actively traded hub, moved up 150 heat rate basis points for September and October delivery after last week's PUC meeting, according the GDF Suez.

Forward power for delivery in July and August 2013 and for the same summer months in 2014 rose by a similar amount.

Rising heat rate indicates power prices are moving up faster than natural gas prices.

"Progress has been made toward sending good market signals in the future and so the forwards have come up, particularly in calendar 2013 and 2014," Henry said.

ERCOT North power for this summer is trading around $66 per megawatt-hour. For summer 2013, the price is about $92 per MWh and summer 2014 is about $107 per MWh, according to GDF Suez.

That compares to 2011 when ERCOT North power averaged $78 per MWh in July, then jumped to an average of more than $225 per MWh in August when ERCOT was forced to declare emergencies on a half dozen days to avoid rolling power outages.

Real-time power prices hit the market cap of $3,000 per MWh on a number of hot afternoons when power supplies were strained. The average day-ahead energy price for the peak-hour was $970 per MWh, compared to $166 in July, according to an ERCOT report.

While forward prices have been heading higher since January, market trading has become less frequent.

"People are cautious," Henry said, and want to see the final PUC orders.

The three-member commission wants to raise the system-wide offer cap further in 2013, to $7,500 per MWh or higher.

Raising the price when power is scarce should encourage more companies to hedge their power needs rather remain exposed to a sudden real-time price spike.

Other ERCOT market rule changes have already coaxed some generation owners to bring aging units out of mothballs and one PUC commissioner expects to see more plants return.

"I think we still need to move up some more to get to new build economics, but this is a step in the right direction," Henry said.

Other market participants argue say higher price caps benefit existing generation owners and that only more dramatic changes, such as creation of a capacity market, will be needed to attract major investment in new power plants.

Mayo Shattuck, Exelon Corp's new chairman, said the same challenge is seen in all competitive markets across the country, in a recent speech at the Gulf Coast Power Association conference in Houston.

"At this time of low gas prices, anyone looking to build new generation in a competitive market can't ignore basic math," said Shattuck. "Without strong, sustained price signals, the problem of revenue adequacy will remain."

"Ultimately, it may require a combination of policy and prescription to achieve the goal and maintain the vigorous investment to address future energy needs," said Shattuck.

While utility commissioner Ken Anderson said the agency is working to eliminate price distortion and inefficiency, "We cannot eliminate all investment risk," he told the same power conference in Houston.

(Reporting By Eileen O'Grady in Houston; Editing by David Gregorio)