Transmission Integration and the Market for Congestion Revenue Rights.

• Author: Doshi, Gaurav

1. INTRODUCTION

Texas electricity market is marked by a substantial wind energy penetration that accounted for about 17 percent of energy use in 2017, (1) up from 9 percent in 2011, whereas wind generation capacity in 2017 was 22 percent (ERCOT, 2018a). This is in part credited to the recent expansion of electricity transmission built as a part of Competitive Renewable Energy Zones (CREZ) that seek to harness the wind energy in predominantly western part of Texas and add to the existing electricity transmission, thereby relieving the growing demand for electricity across the state. CREZ was an ambitious project both in terms of scale and cost--3,600 miles of open access transmission lines with the cost of about $6.8 billion (Lasher, 2014). (2) The project completed in January 2014, ofers a unique setup to study the impact of transmission expansion on the Texas electricity market and explore the underlying heterogeneity.

In this paper, we focus on the market of Congestion Revenue Rights (CRR) that play a vital role in the Texas wholesale electricity market. CRRs are financial contracts that enable the holders (e.g., generating companies and retailers) to hedge the risk due to transmission congestion costs in the Day Ahead Market (DAM). CRRs also serve as a financial instrument used for speculative purposes by various market players such as financial traders. Our paper answers the question about how the addition of electricity transmission lines affects the prices of CRR? We also measure how this effect varies across different times of the day and spatial locations? Further, we discern various aspects of heterogeneity and provide justification for them.

We study the impact of transmission integration (3) as a part of CREZ on the monthly price of CRRs over December 2010-May 2018. We use final commissioning date of all CREZ related transmission infrastructure to be in-service as an exogenous change to the system. The construction of this transmission network began in 2010 and all the facilities started service by December 31, 2013. Hence, January 2014 serves as a credible exogenous change to the entire network and is used to analyze the effect of additional transmission on the market clearing price of CRR. Equipped with this quasi-experimental setup, we use a fixed effects model in order to disentangle various kinds of heterogeneity in the effect of transmission integration. We conduct a series of robustness checks to test for the presence of short run dynamics in firm behavior and the exogeneity of the January 2014 as the date of completion of CREZ.

The primary finding of this paper is that CREZ based transmission expansion led to a significant drop in prices of CRRs across all regions and Times of Use (ToUs) namely Peak Weekday, Peak Weekend, and Off Peak. However, there exists substantial spatial heterogeneity in the effects of transmission expansion on prices of contracts across West v.s. other load zones. We find decrease in prices to be most pronounced for CRRs associated with West than for CRRs across other zones in Texas. We find evidence of substantial heterogeneity with respect to the Time of Use aspect of the contracts as well, i.e. the effects of transmission expansion are stronger at Peak hours than Off Peak hours. The estimated effects are due to a combination of spatial and time varying generation profile of wind energy in the Texas electricity market.

The overall effect of this large scale policy is driven by decrease in market clearing prices for contracts at third and fourth quintile of the distribution. We also find evidence of differential effects across various firm types at different ToUs. Generating firms are found to have the strongest (most negative in magnitude) effect of CREZ based transmission expansion followed by retailers and traders. A policy relevant question is the reason behind the differential effect across firm types? To answer this question we examine the changes in CRR ownership between different locations at different price points by various market participants. We find that the observed heterogeneity is due to different incentives that various firms have in order to hold CRRs either to hedge congestion risks or use them for speculation. These incentives are driven by presence of physical assets like generation facilities for generators, residential and corporate customers in case of retailers, and speculative opportunities in case of financial trading firms.

We present cost estimates of changes in auction expenditures incurred by firms over January 2014 to May 2018 as a result of transmission integration. These estimates are perhaps the first ones in literature that isolate the empirical effect of transmission expansion on aggregate auction expenditures in an electricity market. We find that the drop in CRR prices translate to an aggregate decline in auction expenditure by approximately $261.1 million over January 2014 to May 2018. This amounts to almost 3.8 percent of the total cost (about $6.8 billion) of the CREZ project. The magnitude of these expenditure estimates highlights the close linkage between the transmission infrastructure and the CRR market.

This study contributes to the contemporary literature in several ways. First, this paper presents a detailed empirical analysis of heterogeneity in the effect of transmission integration on the market of CRR. We also estimate spatial, distributional, and firm type (i.e. generators, retailers, and traders) heterogeneity in 'treatment effect' of CREZ. Economists have long been interested in studying the effects of geographical expansion in electricity markets. However, these studies have largely been either theoretical modeling or simulations (Cardell et al., 1997; Borenstein et al., 2000; Joskow and Tirole, 2000), whereas empirical analyses in this regard have been limited. Recent empirical papers have looked at efficiency effects and competitiveness of wholesale electricity markets as a result of changes in transmission policy and infrastructure (Wolak, 2015; Davis and Hausman, 2016; Ryan, 2017; LaRiviere and Lu, 2017; Du and Rubin, 2018).

Second, we add to the burgeoning literature on the efficiency of electricity markets due to transmission expansion. We define efficiency as gradual convergence of CRR prices across different locations for various ToUs. Narrowing of price differentials across different locations induced by transmission expansion indicates improvement of production efficiency and cost savings while low cost generators are more likely to be dispatched before high cost ones with less frequent and severe transmission congestion. This is associated with significant welfare improvements (Joskow and Tirole, 2005). LaRiviere and Lu (2017) provide empirical evidence by estimating transmission congestion loss due to transmission constraints in the Texas electricity market. We address the gap in the literature on the convergence of CRR prices as a result transmission expansion.

Third, our results on price convergence and heterogeneity in the effects of transmission integration are also informative about the efficiency of wholesale electricity market. Convergence of CRR prices across different locations limit the ability of market participants to accrue profits from speculative behavior in the CRR market. This aspect has been analyzed in the economics literature and is a concern amongst policy makers as well (Adamson et al., 2010; Mount and Ju, 2014; Leslie, 2018; Bushnell et al., 2018). Inefficiency due to quantity constraints has also been found to create arbitrage opportunities that the market participants may exploit in order to profit from the CRR auction (Mount and Ju, 2014; Leslie, 2018). Another strand of literature looks at the incidence of market power in the generation side and the resulting inefficient allocation and pricing of CRRs (Ito and Reguant, 2016; Bushnell, 1999; Joskow and Tirole, 2000; Borenstein et al., 2002, 2008).

The rest of this paper is organized as follows. Section 2 describes the institutional details the Texas electricity market and CREZ transmission expansion. Section 3 describes the data followed by the empirical strategy in Section 4. Results of the baseline specification along with heterogeneity analysis are presented in Section 5. We discuss efficiency of the market in terms of convergence of prices in Section 6. Section 7 reports estimates of auction expenditure and Section 8 concludes.

2. INSTITUTIONAL DETAILS

2.1 Texas electricity market and the CREZ project

The Texas electricity market is one of the largest deregulated electricity markets in the US. As of December 2019, Texas has the largest installed wind capacity of any state in the US. However, the major source for electricity generation is natural gas which represents about 52.8 percent of the total generating capacity, followed by wind and coal at 23.3 percent and 14.5 percent respectively (ERCOT, 2020). From the consumption side, the residential sector represents the largest share of electricity consumption followed by the commercial sector, and then by the industrial sector (EIA, 2019).

A distinctive feature of the Texas electricity market is that it is the only state with a standalone grid. The Independent System Operator (ISO) for the electricity market in Texas is the Electric Reliability Council of Texas (ERCOT) and is overseen by Public Utility Commission of Texas (PUCT). With over 600 generating units and 46,500 miles of transmission lines, ERCOT is primarily responsible for maintaining the system reliability and managing the competitive wholesale and retail market.

In 2005, Texas legislature passed the Texas Senate Bill 20 which mandated PUCT to identify 'Competitive Renewable Energy Zones' in consultation with ERCOT. In 2007, PUCT identified five scenarios based on preliminary transmission analysis and wind generation potential (Bills, 2017). After several rounds of analysis by ERCOT, PUCT in...