By Eileen O'Grady
AUSTIN (Reuters) - The summer heat wave that pushed Texas' power grid to the brink of blackouts has faded, but the debate over how to keep the lights on next summer is just warming up.
State regulators and utilities are weighing a myriad of short-term and long-term strategies to encourage companies to build new power plants at a time when long-term wholesale power prices are barely half the level needed to justify new investment.
Texas's hottest summer on record pushed power consumption to records on three consecutive August days, reaching a new peak of 68,379 megawatts on August 3, a whopping 2,600 MW above the previous summer, according to the grid operator, the Electric Reliability Council of Texas (ERCOT).
Power plant operators took extraordinary measures to keep plants running while ERCOT grid operators urged conservation as demand soared and the state's fleet of wind turbines provided the critical margin to avoid blackouts on at least one day.
Regulators point out that the system worked to avoid widespread power problems, but market critics say the inability of the market to maintain robust power reserves is a sign that electric deregulation has failed. Views from all sides were aired this week at a conference of the Gulf Coast Power Association.
Texas moved to loosen the reins on its monopoly power industry in 2002 as other states backed away from deregulation in the wake of Enron Corp's collapse and California's costly energy crisis.
Now, the $34 billion market faces its biggest challenge. Cheap natural gas, tight financial markets and more stringent federal environmental standards could choke new investment needed to prevent the state from running out of power.
"I'm saying there is a problem now that didn't exist in the past that we cannot avoid," Brad Jones, vice president of Luminant, the state's largest generator, said at the conference on Wednesday. "We must look it straight in the eye and fix it."
The topic of future ERCOT supply dominated discussions at the conference, which drew officials from Luminant, NRG Energy and Calpine Corp, transmission companies like American Electric Power and financial players like Goldman Sachs, Deutsche Bank and JP Morgan.
Even though most power plants were running full throttle, ERCOT was forced to declare six power emergencies in August as the power supply dropped below a margin needed to avoid a widespread blackout. On two days, it avoided rolling outages only by curtailing power to willing industrial customers.
After a boom in power-plant construction in the early 2000s, ERCOT has warned that under normal summer weather, available power generation to serve Houston, San Antonio and Dallas will slide below a 13.75 percent reliability target by 2015.
According to ERCOT, too few new megawatts are being added to meet growing demand and to replace inefficient and dirty power plants that may be forced to shut under the latest federal air pollution mandate which Texas has challenged in federal court.
"The EPA regulations only increase the criticality of what is a fundamentally serious problem," said Marianne Carroll, a partner at Brown McCarroll who represents power producers.
Even a willing developer would be hard-pressed to build new power plants in the time frame needed to counter low reserve margins.
The ERCOT forward power price for 2012 is about $45 per megawatt-hour, "well below the $70-plus you would need -- not in one year but consistently for many years" -- to support investment in a new gas-fired plant, said Kamir Barbir, senior vice president of strategy and risk at IPR-GDF Suez NA.
"It is a weak price signal despite the fact that the reserve margin is tightening," Barbir said. "The time to act is now, not next winter or summer."
Most conference officials agreed power prices don't justify new investment in ERCOT, but that's where the agreement ends.
The debate centers on "energy-only" market rules under which Texas power plants are paid only when they produce power. ERCOT lacks a "capacity" market used in PJM in the eastern United States and elsewhere, which pays generators to be available in future years even if they do not run.
When the current system was formed, the Texas Public Utility Commission shunned creation of a capacity market. Conference panelists were divided on whether capacity payments would be sufficient to encourage new power-plant construction or just add a layer of costs for all electric consumers.
Some market players said the summer of 2011 exposed serious flaws in ERCOT's market design, but others warned that regulators should not overreact to extreme temperatures that may not be repeated for years.
"The sky may not be falling," said Phillip Oldham, an Andrews Kurth attorney who represents large industrial power users. "We believe in this market. We believe it will deliver resources. It has in the past and will again."
Others said investors might put more money into Texas if the $3,000 market cap for real-time power is doubled. They also called for changes in pricing for ancillary power in times of short supply and more incentives for large companies to cut power use during shortages.
Former PUC chairman Barry Smitherman remains a staunch advocate of the energy-only market design, but added that some other rule changes are inevitable.
"You never put a market on auto-pilot and let it run," Smitherman said.
Donna Nelson, appointed chairman of the PUC to succeed Smitherman just as the protracted heat wave worsened, described the market challenge as significant, but not insurmountable.
"We have changed cowboys a few times; we've tightened the saddle; we've even fallen off the horse a few times," Nelson said. "But we've gotten up, gotten back on the saddle, adjusted things and moved on."
(Editing by Chris Baltimore and David Gregorio)