For the almost two decades of its existence as an independent system operator, only electricity wonks, neo-liberal economists and systems engineers talked about ERCOT (the Electric Reliability Council of Texas). Then the lights went out last week, and then the water, and then a radically imperfect market design caused electric bills throughout the state to skyrocket. Not surprisingly a raft of investigations has begun. In the 1990s deregulatory fervor first took hold in California where electricity prices were already high compared with the rest of the US. This however was not the case in Texas, which, as an energy producing state rich in natural, fossil resources, enjoyed electricity prices below the national average. Nevertheless the ideological commitment to free markets held sway and Texas decided to deregulate. After all, the professional consensus among neo-liberal economists was that utility deregulation, embracing free market principles, would lead to efficiencies that would reduce prices drastically in an already low cost electric system.
So, let’s start with a fact: electricity prices in deregulated states—places where we were told to expect lower power prices— did not decline relative to price levels in the nation as a whole, after deregulation. Why? Our two best guesses are that 1) the savings from deregulation were not actually meaningful or the competitive power market simply transferred wealth internally without delivering any cost savings to consumers. This is probably what occurred in Texas. (See Figure 1.)
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Figure 1. ERCOT prices vs national prices and vs price of natural gas
Before full implementation of electricity deregulation in ERCOT (1995 and 2000 on the figure) power prices in Texas were modestly below the national average. They rose above the national average during the 2000-2010 period when natural gas prices escalated dramatically. This is probably because natural gas fired power generation has increasingly displaced coal and lignite as well as the bidding system that determines price itself hinges on natural gas prices. When natural gas prices fell, Texas electricity prices fell back to moderately below the national average. Related: India's Largest Refiner To Invest $4.5 Billion To Boost Capacity
In other words, whatever happened to Texas power prices may be due more to fluctuations in commodity natural gas prices than from whatever actions ERCOT may have taken to enhance the state’s energy market. Also retail prices lag the fuel price changes, both up and down. That makes sense because electricity suppliers (at least to the extent they’re not using any form of real time pricing) can only change retail prices periodically. This means that if commodity gas prices rise quickly, electricity suppliers absorb the gas price increase until they can raise retail prices. This also works to the electricity suppliers economic benefit when commodity prices decline faster than the changes in tariffs.
ERCOT’s electricity market (into which the generation is sold) has a peculiar feature which underscores the organization’s adherence to pure market economics, that is the belief that the market is omniscient and that all of this supposedly reflected in the power price at any given moment. Other market organizations have come to the conclusion that not many investors will build power stations whose profitability is contingent on rare, unpredictable but wildly remunerative events.
But every grid to varying degrees needs electric generating resources that sit idle for most of the year but remain ready to be called upon in emergencies. So the power markets in other parts of the US set up separate economic arrangements for those generators to assure their availability when needed. Not so in Texas where all incentives for generators are rolled into daily power prices. Most of the time the state of Texas has managed to maintain enough available electric generating capacity. However when capacity runs short, price rockets upwards and customers suffer egregiously. All of which surprisingly ERCOT’s backers say is supposed to happen.
Which brings up another question. What does the high power price accomplish especially knowing that 1) consumer demand is inelastic and 2) home heating customers in Texas were consuming electricity prodigiously simply to stay alive in cold weather. High power prices according to the theory should dampen demand and increase supply. However, the customer does not reduce demand because he or she does not see the price until afterward. Generators cannot suddenly increase supply if they don’t have any to offer (unless they have been withholding supply to get a high price). Of course, maybe some public spirited venture will be inspired to build new electric power generation in advance of the next capacity shortfall.
Does the Texas electricity market really raise capital more cheaply and maintain lower prices than the regulated utility network that existed before? Theoretically the answer should be the free market does it better or more cheaply. Competition, even in this weirdly regulated and formerly monopolistic system, supposedly lowers costs and prices. But after a quarter century of operation, we still haven’t seen the evidence.
By Leonard Hyman and William Tilles for Oilprice.com
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Leonard Hyman & William Tilles
Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…
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