* Report calls for re-evaluation of needed reserve margin
* Advises progressive price cap increases when supply tight
* Sierra Club criticizes push for higher wholesale prices (Adds Brattle Group, NRG Energy, Panda comment)
HOUSTON, June 1 (Reuters) - The current design of the wholesale power market in Texas will not encourage needed investment in new power plants, the Brattle Group said in a report commissioned by the state electric grid operator.
Texas electric regulators and the grid agency that oversees the $34 billion deregulated wholesale market are working to encourage construction of new generation in the state, which has little ability to import power from its neighbors.
Unlike many areas of the United States, electric demand in Texas continues to grow because of the state's healthy economy.
"Electric reliability matters to all of us and we must remain focused on the central question of whether we are doing enough to guarantee an adequate power supply," said Craven Crowell, chairman of the Electric Reliability Council of Texas.
ERCOT, which oversees the grid for most of the state, has warned that the prospect for rolling blackouts in future years will increase as the power supply is unable to keep pace with growing demand.
Low wholesale prices and tight financial markets have stalled development of new generation in Texas even as more stringent environmental rules threaten to shut older coal- and gas-fired plants over the next few years.
"The cold hard fact is that new power plants will not be built unless power prices support that build," said Bill Nordlund, managing director of Panda Power Funds. Panda has two natural gas-fired plants primed for construction in Texas.
Last summer's protracted heat wave, which triggered record electricity demand and six emergency declarations from ERCOT, intensified the need to address the state's shrinking power reserve margin, the cushion needed to avoid blackouts.
The report by the Brattle Group, a power industry consultant, did not recommend a specific course of action to modify ERCOT's "energy-only" market, which pays generators only when they produce power, but outlined five options along with advantages and disadvantages of each.
Brattle principal Sam Newell said the energy-only market has worked well to attract generation investment in Texas, but low wholesale prices now will not encourage as many new megawatts as regulators believe are necessary to meet a 13.75 percent reserve margin in the summer when electric use soars.
Newell said Texans should reexamine that reserve target given the fact that power line problems are the cause of many more outages than supply shortages.
"You can plan on a very high level of reserves and almost never, ever have to shed load, but that would be more expensive than maintaining a lower reserve margin," Newell said on a call with reporters. "There's got to be a balance somewhere. We think it's worth re-evaluating those standards."
If the commission decides the state requires a higher reserve margin than the energy-only margin will provide, Brattle offered several potential solutions.
Options included keeping the energy-only design, but adding a market-based reserve margin; higher prices to support a target reserve margin; or a back-stop procurement process to maintain minimum acceptable reliability.
Other options included a mandatory resource adequacy requirement for companies that supply power to customers, or having a resource-adequacy requirement with a centralized forward capacity market.
While the Texas Public Utility Commission has resisted calls to create a capacity market similar to those used in other U.S. power markets, the Brattle report addressed a number of criticisms that capacity markets simply boost overall costs that benefit existing generation owners without attracting new power plants.
The PUC and ERCOT have already implemented a number of market changes, including raising the price cap on wholesale power when supplies are scarce, to encourage construction of new power plants.
"The Brattle Group's report confirms that we are moving in the right direction," said Donna Nelson, PUC chairman.
Unlike what the commission has proposed, however, the Brattle Group advised ERCOT to gradually increase the wholesale price cap to $9,000 per megawatt-hour from $3,000 MWh, reaching $9,000 only in extreme scarcity when power to customers is being curtailed. These prices would be paid by the suppliers who serve homes and businesses.
"We like scarcity prices to progress over a range instead of jumping to the cap (because) with a smoother price curve, you have better market behavior and it will work better with demand response," Newell said.
The report warned that simply increasing price caps will not attract more generation.
"Many market participants that were supportive of the commission's actions so far were wary of the prospect of raising caps much higher," the report said.
The Sierra Club criticized the report for its limited look at energy efficiency and conservation options where customers are paid to reduce power use when supplies are strained.
"Instead of using our money to build more coal and gas plants, the PUC should implement their rules proposed to raise energy efficiency goals," said Cyrus Reed, conservation director of the Lone Star Chapter of the Sierra Club.
The Brattle report said expanded demand-response programs will be needed, but that over the long-term the state will have to see new power plants built.
Reed also called on the state to increase use of renewable power, such as solar. Texas is already the No. 1 state for wind generation.
The Brattle Group noted that growth of wind power in Texas has depressed wholesale prices to the point that generators cannot justify investment in new gas-fired power plants.
John Ragan, president of NRG Energy's Gulf Coast region, complemented regulators and ERCOT for seeking "expert, external analysis of the different options Texas can implement to encourage greater resource adequacy while maintaining a strong commitment to competition and regulatory certainty."