Texas Passes SB 2627 and HB 1500 to Strengthen the Electric Grid and Energy Market

The two bills, Senate Bill (“SB”) 2627, and House Bill (“HB”) 1500, comprise the second major attempt by the Texas Legislature to shore up the state’s power sector in the wake of the rolling blackouts that occurred during Winter Storm Uri in February 2021. That effort began with the passage of SB 3 shortly after the winter storm, which, among other reforms, required the Public Utility Commission of Texas (“PUCT”) to implement stringent weatherization requirements for power plants and utilities, and bolstered communications between the state’s natural gas and electric systems.

Since the passage of SB 3, the PUCT and the Electric Reliability Council of Texas (“ERCOT”) have debated a series of additional reforms to the energy market intended to improve grid reliability by providing more stable revenue streams to gas generation and increasing the amount of operating reserves available to ERCOT during emergency conditions. To that end, in January 2023, the PUCT proposed a novel “Performance Credit Mechanism” or “PCM.” The PCM construct would provide an additional revenue stream to generators that commit in advance to being available to provide power during hours of highest reliability risk. If implemented, the PCM would constitute a dramatic change in the underlying structure of the ERCOT market, which has historically compensated generators only for the power that is actually consumed by end-users. This controversial proposal generated significant legislative feedback that in part led to the adoption of HB 1500 and SB 2627. Some of the most significant aspects of these new laws are summarized below.

SB 2627

Grant and Loan Program for “Dispatchable” Generation Within ERCOT

SB 2627 would establish an up to $7.2 billion low-interest loan and grant program for “dispatchable” generation, which refers to power sources primarily under human control (e.g., natural gas, coal, and nuclear) as opposed to variable resources that depend on natural forces (e.g., wind and solar), that are located within the ERCOT power region.

The loans, which must have a term of 20 years with an interest rate of 3%, may be used to either (1) finance upgrades to existing dispatchable generation facilities that would result in a net increase of at least 100 megawatts (“MW”) of capacity, or (2) finance the construction of new dispatchable generation with at least 100 MW capacity. New dispatchable generation projects are also eligible to receive a completion bonus grant of up to $120,000 per MW of capacity if they are interconnected by June 1, 2026, and up to $80,000 per MW of capacity if interconnected before June 1, 2029. The loans and grants, considered together, may finance no more than 10,000 MW of added generation capacity.

Significantly, energy storage facilities are not eligible for loans or grants under the aforementioned programs.

Grant Program for Facilities Outside of ERCOT

SB 2627 would also allocate up to $1 billion of state funds to finance grants to transmission and distribution infrastructure and electric generation facilities located within Texas, but outside of the ERCOT power region. These grants may be used for (1) facility modernization, (2) facility weatherization, (3) reliability and resiliency facility enhancement, or (4) vegetation management. These grants are not limited to dispatchable generation.

Grant and Loan Program for Micro-Grids

SB 2627 would provide up to $1.8 billion of state funds for grants or loans for the operation of stand-alone, “behind-the-meter” multiday backup power sources that can be used to isolate a small portion of the electric grid from the rest of the system during emergency conditions (referred to in the bill as “Texas backup power packages”). Loans to Texas backup power packages may be used for procurement and operating costs, while grants (which are not limited to procurement or operating costs) are capped at $500 per kilowatt of capacity.

SB 2627 also directs the Texas Commission on Environmental Quality (“TCEQ”) and PUCT to provide, respectively, expedited Clean Air Act and utility interconnection processes for backup power packages that are awarded grants or loans.

Implementation Pending

While SB 2627 was passed by both legislative chambers and signed by the governor, the law depends on a state constitutional amendment that must be approved by Texas voters at an election to be held on November 7, 2023.

HB 1500

PCM Guardrails

HB 1500 places a variety of restrictions on the PUCT’s potential adoption and implementation of the PCM. After voicing substantial concerns regarding the costs and efficacy of the PCM, the legislature decided to place a number of “guardrails” on any PCM-type construct that might be adopted by the PUCT. Most notably, HB 1500 provides that the net cost of the PCM to the market cannot exceed $1 billion annually.

As of the date of this article, the PUCT has yet to decide whether or not it will seek to implement a PCM construct with the guardrails imposed by HB 1500.

Generation Reliability Requirements

Another significant aspect of HB 1500 is its requirement that ERCOT generators (other than battery storage) that execute a generation interconnection agreement on or after January 1, 2027, must annually meet certain performance standards, or else pay a fine. In essence, these generators will need to demonstrate their ability to produce power when called upon by ERCOT a certain percentage of the time. The basic idea behind the new performance standards is to allocate some of these costs directly to intermittent resources (though non-variable generators like gas plants would also be subject to penalties in the event that they are unable to perform).

While this provision could negatively impact the economics of some renewable projects, it may also prove to be a boon to battery storage technologies, which will have the opportunity to earn additional revenue by providing firming services to resources that are unable to independently meet the new performance requirements. However, the economic impacts of HB 1500 will remain uncertain until the PUCT sets the applicable performance standard for each resource type and establishes the scale of financial penalties for noncompliance.

Interconnection Cost Cap

HB 1500 also seeks to address concerns regarding high costs of building transmission infrastructure to connect certain types of generation to the grid. Historically, the costs of all transmission facilities used for generation interconnections have been socialized among all ERCOT ratepayers. HB 1500 will dial back that practice to a certain extent by only allowing ERCOT ratepayers to pay for a standard allowance for certain future interconnections, based on potential consumer cost savings, historical interconnection costs, and other factors. Interconnection costs in excess of that standard allowance must be paid by the generator seeking interconnection. This provision has the practical effect of incentivizing generators to locate their facilities as close as possible to interconnecting transmission lines, and may have a disparate impact on wind and solar resources that sometimes locate in more remote regions of the state to take advantage of cheap land and optimal weather conditions. As with the generation performance standards, the economic impact of the cost cap will be difficult to ascertain until the PUCT establishes the applicable parameters.

Dispatchable Reliability Reserve Service (“DRRS”)

HB 1500 directs ERCOT to implement DRRS, a new ancillary service to compensate generators for being available to produce power during relatively brief periods of low supply, by December 1, 2024. Participation in DRRS is limited to generators that can (1) produce power within two hours of being dispatched, (2) provide such power for at least four hours at a time (or longer if required by ERCOT), and (3) have other (as yet undefined) attributes to address inter-hour operation challenges. The term “dispatchable” is left undefined in this provision, which appears to signify that participation in DRRS may be technology-neutral — i.e., new technologies such as utility-scale batteries may be able to participate so long as they meet the requisite operational requirements.

The economic impact of the new DRRS program is difficult to determine given the substantial amount of discretion afforded to ERCOT and the PUCT regarding implementation. For example, the bill leaves it to ERCOT to determine the quantity of DRRS to be procured, as well as the minimum run-time requirement. As with many of the provisions included in HB 1500, the devil will be in the details.

Conclusion

SB 2627 and HB 1500 contain a number of provisions that will likely have significant impacts on the Texas energy sector. Nevertheless, the true impacts of SB 2627 and HB 1500 will depend greatly on how the PUCT and ERCOT ultimately choose to interpret and implement SB 2627 and HB 1500 over the coming months and years. As such, stakeholders should actively monitor decisions coming out of the PUCT and ERCOT in order to stay updated on the status of SB 2627 and HB 1500.