Understanding Negative Prices in the Texas Electricity Market
Negative prices are in fact a periodic—if relatively uncommon—feature of the Texas electric markets for reasons that are often misunderstood. Prices in the Texas wholesale electric market are set by auction. Generators offer bids to the state’s grid operator, the Electric Reliability Council of Texas (ERCOT), about what prices they would be willing to accept, and the lowest bids are accepted until there is enough generation to meet demand. When demand is low, such as at night, there can be much more available supply than there is need for demand, which tends to drive prices down close to zero. In some cases, prices go below zero, with generators actually offering to pay others to consume their electricity.
While uncommon, negative prices can actually be a rational market response to underlying supply-demand fundamentals. The economics literature describes this as socially optimal in cases where the cost of production is lower than the cost of not producing. For example, some production processes are inflexible in the short term and can render the supplier willing to pay another to dispose of excess stock. This surplus inventory occurs most often in markets with limited storage capacity.
Electricity is an unusual combination of inflexible types of supply, limited price-responsive demand and very little system-wide storage capacity. This renders power market prices notoriously volatile, and occasionally makes them negative. For some types of generators, it can be more expensive to not produce electricity than to produce it. A nuclear power plant, for example, has to run at more or less a constant level at all times. Shutting down and restarting a plant takes days and is expensive, so nuclear plants must find buyers regardless of price in the short term. Something similar can happen with certain types of industrial facilities that generate electricity as a byproduct of their industrial process. Considering the non-electric revenue stream, it can be more economical for the facility to accept occasional negative electricity revenues rather than shutting down the entire factory.
A bigger cause of negative pricing in the Texas electric market involves subsidies to certain types of electric generation. Under the federal Production Tax Credit (PTC), wind generators can receive a tax credit of as much as 2.5 cents for each kilowatt hour of electricity generated. As such, these generators could make a profit from generating even if the market price for electricity is less than zero.
Even with these factors at play, negative prices are not common in the Texas electric market. Systemwide electricity prices in ERCOT were at or below zero for 40 hours in 2019 and 53 hours in 2020—less than 1 percent of the time. Nevertheless, while there are cases where it can be rational for generators to offer a negative price, the situation is somewhat awkward for those generators—who after all are in business to make money.
Price controls are not a good way to deal with negative prices
Some opponents of wind energy have suggested instituting price controls on electricity prices, either prohibiting negative bids or even setting a minimum above zero. These proposals misunderstand the function of the ERCOT market. It is important for grid reliability and economic purposes for regulators to let prices go negative, provided they are consistent with market fundamentals. We usually worry about grid reliability when there is insufficient supply to meet demand, but the inverse is also true. Reliability authorities note overgeneration as a material threat. This makes it imperative for market rules to let prices rise during periods of shortfalls and fall during periods of excess. Prices provide short-term signals for the most economical and reliable power production and consumption behavior. They also signal investors to pursue generation that is more flexible; motivate more price-responsive demand; and foster development of storage technologies that arbitrage prices.
Prices are a means to allocate resources, and the ERCOT auctions exist to make the amount of electricity generated match demand from consumers. A mandatory price floor would result in more offers from suppliers at the minimum price than was needed to meet demand. ERCOT would need to use some alternate way to select from among these offers, which would not only be inefficient but would involve picking winners and losers in the market—something that runs contrary to the spirit of freedom undergirding the Texas electric model.
Negative prices are a concern when they do not reflect supply and demand. Sometimes this can result from the exercise of market power, which has various remedies. Policies that shift market fundamentals artificially also pose a problem. For example, subsidies can make an otherwise positive or zero cost resource effectively negative cost. One simple way to reduce negative pricing in the electricity market would be to end the PTC, thus removing part of the incentive for wind to bid negative. But simple is not the same as easy. The PTC has almost been shut down several times, but has been brought back.
Using demand response to reduce negative pricing
Aside from ending subsidies, the market itself can actually mitigate negative prices. Prices are a key way to convey information about the state of a market. And when electricity prices turn negative, people should consume more energy, suppliers should reduce output and storage owners should buy low to sell high later. While much of electric demand is time and place dependent, not all of it is, and negative prices could provide a variety of profitable business opportunities and be a factor in operations such as Bitcoin mining or battery charging. As these opportunities are exploited, this would tend to reduce the number of hours in which demand is low enough for prices to go negative.
Texas is currently in the process of fundamentally rethinking many aspects of its electrical system. This can be an opportunity for some much-needed improvements to the system—or it could be something much worse. In order to make sure that attempts to deal with negative prices don’t end up being themselves a net negative, we need to understand the rationale behind current market dynamics.