Texas takes pride in its spirit of self-reliance. That could make all the difference in the state's power market.
Texas is one of the few big electricity markets in the U.S. where demand is growing. It also happens to host the prolific Permian shale basin and a border with Mexico. For power producers, the interplay between these factors matters a great deal.
Despite decent demand, power prices in Texas have been weighed down by a confluence of things. Excess generating capacity -- including higher levels of wind power, which has no fuel cost and so runs cheap -- has been a big factor.
Another has been cheap natural gas. This isn't an issue confined to just Texas. For example, Rick Perry's, er, "reform" plan to boost coal-fired generators is a direct result of gas eating into their market share.
Gas generates about half the power produced in Texas, and so the fuel's price plays a big role in determining electricity's price. This chart from Greg Gordon, an analyst at Evercore ISI, compares the prices of both in north Texas. The relationship is pretty clear:
The other obvious thing from that chart is that gas prices were much more subdued after 2015. The discount at which local gas trades relative to Nymex futures has widened significantly:
This is all because of the Permian fracking boom. Higher oil production brings more gas to the surface, too:
Just as shale oil has contributed to a glut weighing on global oil prices, so this gas glut has depressed prices for that fuel and so weakened power prices.
An important safety valve is Mexico. Overall, pipeline exports of gas across the Texas-Mexico border have more than tripled since 2012:
It isn't enough.
In a recent report, analysts at Sanford C. Bernstein forecast that Permian gas production, net of liquids, would rise another 2.5 billion cubic feet a day by 2019 and keep rising from there. Moreover, while new pipelines have been built to take Permian gas south of the border, they are largely underutilized. Mexican demand hasn't kept pace either with the Permian's production levels or export capacity. Bernstein is also concerned that other proposed pipelines to take gas from the region may not show up on time over the next couple of years.
The upshot: If Mexican demand doesn't pull more Permian gas south, producers may find themselves having to flare or shut in gas as soon as next spring.
In this scenario, Bernstein estimates the spread between gas priced at Waha and Nymex futures could blow out to anywhere between $1 and $1.50 per million BTUs, versus today's discount of about 50 cents. Based on current futures prices, that would imply local gas prices of less than $2 by the middle of next year. It could be even less if we have another mild winter -- as is currently forecast -- and the surge of gas production in another prolific region, Appalachia, depresses prices in general.
Now look back at that scatter-chart above and guess what $2 gas would mean for Texas' generators, all else being equal (a clue: nothing good).
Luckily for them, all else isn't equal.
Vistra Energy Corp., the state's biggest generator, announced earlier this month it will shutter 4,200 megawatts of coal-fired plants, reducing Texas' buffer of spare capacity. As of May, the Electric Reliability Council of Texas projected this buffer to be north of 18 percent of peak summer demand through 2021. In general, 15 percent is viewed as adequate.
Removing Vistra's plants takes ERCOT's margin below 13 percent, based on current projections -- and the market reacted accordingly.
Even so, peak power prices remain relatively subdued given the big drop in the implied reserve margin -- and cheap gas may well be one factor capping optimism.
The net result is that Texas' power market definitely looks more attractive now, but still must contend with several wild cards. Besides gas, there is the potential for higher penetration of solar power and demand-response programs, both of which undermine the peak market where most of the generators' potential profits reside.
Those wild cards mean that Vistra, having helped to shift the dynamics in a more favorable direction, is also the best positioned to take advantage of it.
Vistra has been buying natural gas-fired plants, which should enjoy better profits as those competing coal-fired plants close. It also has a large retail electricity business, which provides a steadier stream of profits and acts as a crucial hedge if those wild cards in the generation market do end up holding back prices. And, of course, there's another lever Vistra might pull with regards to Dynegy Inc.
Simply relying on the energy market to swing your way stopped being a viable strategy in this sector a long time ago.
-- "Follow the Leader" graphic by Chloe Whiteaker
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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Mark Gongloff at email@example.com