ERCOT Summer Reset U.S. Power and Gas Weekly

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1 ? ERCOT Summer Reset U.S. Power and Gas Weekly Morningstar Commodities Research 18 July 2018 Dan Grunwald Associate, Power and Gas Data Sources Used in This Publication ERCOT NOAA EIA EOX Live To discover more about the data sources used, click here. Intro The ERCOT summer market has had a wild ride this year, with the promise of a hot summer and historically tight reserve margins. The August on-peak contract has traded in a sizable $160 per MWh range. From the start of the year, we saw a steady increase in the value for ERCOT summer on-peak contracts, which eventually hit their highs in May. Then the June contract collapsed to under $40 per MWh by the end of that month, after hitting nearly triple digits at the end of May. The July and August contracts suffered similar implosions until recovering this week. Now we may be seeing the real heat of summer after all, confirming that the high prices in May weren't just speculators' wishful thinking. Still Looking Hot The weather outlook has dimmed for the remainder of summer since our May note on ERCOT (see Excitement in ERCOT). The forecast back then showed cooling degree days, or CDDs, for July and August at 586 and 582, respectively, or 25 and 16 over historical norms. The most recent forecast shows July and August at 575 and 579, or 14 and 13 CDDs above normal. That doesn't mean the chances of a heat spike are any less likely this summer, as can be seen in Exhibit 1. In fact, the probability of above-normal temperatures pervades the next few months, and forecasts could continue to shift warmer. We saw record high loads for May and June and with industrial baseloads increasing off additional oil and gas sector drilling, the path to a blowup in July and August peak loads gets easier.

2 Page 2 U.S. Power and Gas Weekly 18 July 2018 Exhibit 1 NOAA July-August-September Probability Outlook Source: NOAA Heading for Summer Load Record In addition to elevated temperatures and dew points this summer, an increase in ERCOT's baseload helped drive record loads in May and June. The increasing baseload means it wouldn't be unwarranted to expect the same in July and August. A sizable increase in industrial demand over the past five years in the coast and western zones lies behind this higher baseload. The trend is most apparent in the Far West Zone, where average load has doubled in the last five years and is up 500 MW just since the start of Total average load in ERCOT so far this year is 1,500 MW higher than July has already beat last year's all-time peak (Exhibit 2), which typically occurs in August, leaving plenty of time for a new record this year. Exhibit 2 Historical Peak Loads by Month (MW) Year Month August June August August August August July July Peak 68,294 66,583 67,180 66,427 69,783 71,197 69,525 69,647 Source: ERCOT, Morningstar Natural Gas Picking Up the Slack In addition to coal capacity retirements earlier this year, ERCOT has seen a modest uptick in solar generation and a sizable increase in wind capacity. Yet, it is natural gas capacity that is filling a bulk of the void left by this year's coal retirements, as shown in Exhibit 3. This trend is affecting the region's natural gas storage picture, as south central's faster-cycling salt storage has experienced natural gas withdrawals since mid-june. While nonsalt storage has seen moderate injections, high power burn demand suppressed injection levels near to flat last week. While this is not uncommon in the southern

3 Page 3 U.S. Power and Gas Weekly 18 July 2018 regions during summer, it is leaving a heavy lift for the autumn injection season. We expect high summer demand to continue through the fall, suppressing storage levels come winter. Exhibit 3 ERCOT Net Generation Changes Net Generation (MWh) Coal Natural Gas Solar Wind Q ,830,816 25,944, ,469 8,767,571 Q ,389,140 36,625, ,056 10,416,777 Year over Year Delta -4,441,676 10,681, ,587 1,649,206 Source: EIA, ERCOT, Morningstar Discounted Wind Capacity While gas-fired plants are weakening the winter storage picture, increased wind capacity dispatch is weakening ERCOT power prices. Although the reserve margin in ERCOT's seasonal assessment looked tight, the capacity factor for wind was conservative, and the full stack capacity is considerably higher. The seasonal assessment only assumed 4,103 out 20,884 MW of wind capacity for its reserve margin. As can be seen in Exhibit 4, the actual average wind output is closer to 8,000 MW. However, ERCOT wind has been in the doldrums over the past five years during August, with an average 900 MW less generation than the rest of the year (Exhibit 5), but it remains to be seen if it drops to dangerous reliability levels this summer. Exhibit ERCOT Hourly Wind Profile Source: ERCOT, Morningstar

4 Page 4 U.S. Power and Gas Weekly 18 July 2018 Exhibit 5 ERCOT Average Net Generation by Month ( ) 4,000,000 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000, ,000 Average Net Generation 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: EIA, ERCOT, Morningstar Conclusion The ERCOT market has already had a wild ride this summer, and it's not yet over. The June price retreat should be seen as the eye of the storm. Continued above-average heat on top off a larger industrial baseload should drive the supply stack this summer. Unless a major shift toward cooler weather shows up, the remainder of July and the August contracts should trade at triple-digit premiums for the balance of summer. K

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