Vantage Point Advisors’ Energy Blog March 2021

Texas Bankruptcies Triggered by February’s Severe Cold Snap

Brazos Electric Power Cooperative Inc., which supplies electricity to more than 660,000 consumers across the state of Texas, is one of dozens of providers facing enormous charges stemming from the severe cold snap last month.  The fallout threatens utilities and power marketers, which collectively face billions of dollars in blackout-related charges, executives said.  Unusually frigid temperatures knocked out nearly half of the state’s power plants in mid-February, leaving 4.3 million people without heat or light for days and bursting water pipes that damaged homes and businesses.  Brazos and others that committed to providing power to the grid – and could not – were required to buy replacement power at high rates and cover other firms’ unpaid fees.  The grid operator, the Electric Reliability Council of Texas (ERCOT), on Friday said that $2.1 billion in initial bills went unpaid, underscoring the financial stress on utilities and power marketers.[1]

Electric Reliability Council of Texas (ERCOT)[2]

ERCOT manages the flow of electric power to more than 26 million Texas customers, representing about 90 percent of the state’s electric load. As the independent system operator for the region, ERCOT schedules power on an electric grid that connects more than 46,500 miles of transmission lines and 680+ generation units.

ERCOT has four primary responsibilities:

  • Maintain system reliability.
  • Facilitate a competitive wholesale market.
  • Facilitate a competitive retail market.
  • Ensure open access to transmission.

ERCOT is a membership-based 501(c)(4) nonprofit corporation, governed by a board of directors and subject to oversight by the Public Utility Commission of Texas and the Texas Legislature.  Since the freeze, however, seven ERCOT Board members have resigned.

Texas Electricity Market Structure

So exactly what happened?  Dusting off my public utility history, these companies used to be run by engineers and reliability was king.  The only problem was that in order to have reliability, a system required excess capacity in the form of reserves.  These reserves cost money every month, whether needed or not.

So about twenty years ago, Texas began deregulating its power sector under then-Gov. George W. Bush (R), with support from both parties.  Today dozens of companies generate, buy, sell, and deliver electricity to customers.  In this market, providers of electricity put in a bid to provide one hour of electricity for a certain price. If your bid is at or below the highest bid for the power needed during that hour, you will receive the highest bid for all of the power produced.  In its defense, this system works well most of the time.

Last month, however, demand for electricity and natural gas spiked during the cold front that covered the entire state.  Many of the renewable sources like wind power stopped running given the frozen conditions.  Wind operators were criticized for not investing in more expensive temperature-resistant models, but why spend the extra money for a couple of days every few years?   It is easy to justify that from an investment value point of view; spending the extra money does not make sense.  Besides, an operator of wind turbines is not the one charged with keeping the grid up for the entire state.

This first announced bankruptcy may result in a change of market structure for Texas.  While an independent board from ERCOT certainly had the best intentions, perhaps giving some control back to the engineers (and their respective shareholders) will ensure that Texas does not find itself in this mess again.  Also of interest is that the chair of the Public Utility Commissioner of Texas, DeAnn Walker, resigned March 1 as pressure mounts from the state’s political leaders for more accountability.[3]

Litigation Heats Up

Texas retail electric supplier Griddy Energy LLC allegedly misled its nearly 30,000 customers, engaged in false advertising, and failed to disclose the risks associated with its business model, which resulted in skyrocketing electric bills as the Texas power system buckled under the weight of an Arctic blast in February, the state of Texas said Feb. 28 in a lawsuit against the California-based company and its corporate parent, Griddy Holdings LLC.[4]

Filed by Texas Attorney General Ken Paxton in a district court in Harris County, Texas, the suit alleges that Griddy acted in violation of the Texas Deceptive Trade Practices Act and seeks civil penalties, various injunctive relief and refunds for customers.  “Griddy misled Texans and signed them up for services which, in a time of crisis, resulted in individual Texans each losing thousands of dollars,” Paxton said in a March 1 statement. “As the first lawsuit filed by my office to confront the outrageous failure of power companies, I will hold Griddy accountable for their escalation of this winter storm disaster.”

WTI Strip Prices Increase

Over the past month, spot prices and near-term futures prices for the WTI contract increased by over $7.00 per barrel.  Although the futures prices are currently in backwardation, seeing an oil price starting with a “6” is a welcome sight for producers.

 

Oil Price Outlook

The price distribution below shows the crude oil spot price on March 3, 2021, as well as the predicted crude oil prices based on options and futures markets.  The blue lines are within one standard deviation (σ) of the mean, and the red lines are within two standard deviations.

Based on these current prices, the markets indicate that there is a 68% chance that oil prices will range from $49.00 and $72.50 per barrel in mid-June 2021.  Likewise, there is about a 95% chance that prices will be between $32.50 and $92.00.  By mid-August 2021, the one standard deviation (1σ) price range is $46.50 to $74.50 per barrel, and the two standard deviation (2σ) range is $28.50 to $99.00 per barrel.

Key Takeaways

Remember that option prices and models reflect expected probabilities, not certain outcomes, but that does not make them any less useful.  If someone asks you longingly if oil will be over $100 per barrel again soon, you now can respond with “the markets indicate there is a 97.5% probability that oil prices aren’t expected to get there by this August, so I wouldn’t count on it.”

 

For more information, contact:

Gregory E. Scheig, CPA/ABV, CFA, CMA
Vantage Point Advisors
Managing Director / Energy Practice Leader
Certified Mineral Appraiser
180 State St., Suite 225, Southlake, TX 76092

214.254.4801

gscheig@vpadvisors.com

[1] Reuters 3/1/21, https://www.reuters.com/article/us-bankruptcy-brazoselectric-texas-outag/texas-electricity-firm-files-for-bankruptcy-citing-18-billion-in-claims-from-grid-operator-idUSKCN2AT1FE

[2] http://www.ercot.com/about

[3] S&P Market Intellligence, 3/1/21, https://platform.marketintelligence.spglobal.com/web/client?auth=inherit#news/article?KeyProductLinkType=2&id=62938645

[4] S&Global Market Intelligence, 3/1/21, https://platform.marketintelligence.spglobal.com/web/client?auth=inherit#news/article?KeyProductLinkType=2&id=62934098