Electric Power Deregulation in Texas: The History of a Bad Idea

When it costs $900 to fill up a Tesla, something is broke.

Garland, Tx. Feb. 15, 2021

MIT economists Paul Joskow and Richard Schmalensee recollect their surprise when they were approached by two economists of the then-new Reagan administration in 1981.

Joskow and Schmalensee shouldn’t have been all that surprised. Deregulation was is the air, and they were the experts. The Carter administration had applied the idea to the airlines, interstate trucking, railroads and long distance telephony. “They asked us,” Joskow recalled in 2019 interview, “‘Why can’t we do this for electric power?’”

Joskow and Schmalensee did a double-take. “We said, ‘What? Wait? Huh?’”

The Reagan advisors pressed on: Why Not?

The professors finally explained. “Dick and I said, ‘Because the electric power industry’s not like airlines.’”

Joskow and Schmalensee ended up writing the book on the subject: Markets for Power: An Analysis of Electric Utility Deregulation, published in 1983. In it, they concluded that was possible to put electrical power through a bid-ask type of market. These had actually emerged spontaneously among utilities in New England around 1970.

But there was a big fat caveat. What went missing in the system was any incentive for investment. “It was quite clear when you looked at it,” Joskow said in 2019, “It was a basically a short-run marginal cost market. and you couldn’t support investment in that market.”

T wenty years into Texas’s (and California’s) big experiment with deregulation, the wonkish warning of the two professors rings rather prescient.

The Invisible Hand that was guiding the Texas power grid allowed it run it off the rails.

Texas property damage lawyers will call the February 2021 ice storm an Act of God. Texas’ conservative politicians will see it as a test of faith. Belief in the omniscience — and ultimate benevolence — of the Invisible Hand is the cornerstone of Free Market theology.The prophet Adam Smith revealed how the Invisible Hand increases the greater good automatically, with no need for government intervention or rancorous human politics. To Believers, attempts by other mortals to interfere with the workings of The Hand are not only doomed to failure, they are a form of sin. Mandates that meddle with the market carry the sulphureous stench of blasphemy. The great sorting out of Winners and Losers — the Saved from the Damned — is a Power reserved unto The Market, and not to be arrogated by Man.

Only by getting inside this belief system can an anthropologist or a foreigner — meaning anyone outside of the state — understand such oddities as the Texas Public Utilities Commission’s docket order 51617 of February 15, 2021, asking grid market operator ERCOT (The Electric Reliability Council of Texas) to explain why electricity prices during the blackout got too low. The PUC noted “anomalous” sales at only $1,200 per kilowatt hour during the power failure — up from $50 before the storm. It demanded ERCOT explain itself. The price should have been $9,000 per kilowatt hour:

The Commission believes this outcome is inconsistent with the fundamental design of the ERCOT market.

In the fundamental design of the ERCOT market, price spikes are a feature, not a bug. As are the multi-thousand dollar electric bills for customers. Utility deregulation in Texas has proudly given retail customers what the state touts as “the power to choose.” Some were unfortunate enough to choose one of the real-time rate plans:

In the investigations that will undoubtedly come, one question certain to be asked is whether the power market in Texas got “gamed,” as that of California did in 2000.

It’s an interesting question and worth finding an answer to, but it misses a larger point: Texas’ entire deregulated electricity market was a game rigged from the start for natural gas to win.

How dare we say that? Isn’t the Market picking winners and losers?

This was written into The Texas Public Utility Regulatory Act:

It is the intent of the legislature that 50 percent of the megawatts of generating capacity installed in this state after January 1, 2000, use natural gas.

At least the same act gave Texans The Power To Choose. They can choose, for example, to buy their power under a Green Energy plan. Wait a minute… The law says retailers can

label the electricity generated using natural gas produced in this state as “green” electricity.

It turns out that writing the rules of the road for an Invisible Hand is a lot like writing the algorithm for an autonomous vehicle. Something you didn’t think of can send it over a cliff.

The response of the Faithful to such accidents will be to offer to patch the software. Again. Each patch, of course, risks introducing new bugs that may send the vehicle careening off in some other direction.

The infamous Texas price cap — or lack of one — was itself the result of such a patch. The California energy crisis of 2000, with its blackouts and bankruptcies, was closely watched in Texas. Enron traders chanted “burn, baby, burn” in 2000 when a fire on a transmission line in California helped out one of their trades.

The California debacle nearly derailed Texas deregulation. Texas Senate Bill 7 (SB7) had been signed into law by Gov. George W. Bush in June 1999, but had not yet gone into effect. After the California news, forty percent of Texans polled by Scripps-Howard thought deregulation should be put on hold. Another 13 percent said it should be scrapped altogether.

After prayerful reflection, the Texas politicians decided California’s faith in the Free Market had not been strong enough. Those Californians had been weak, thinking that retail price caps were necessary to protect consumers.

California’s algorithm 1.0 had failed to couple retail price caps with any in the wholesale market. As Enron could have told California — but didn’t — all it took was for someone to give those wholesale markets a little squeeze. California’s utilities, which could not legally deny service, were obliged to “buy high” and “sell low.” The bankruptcy of PG&E and near-bankruptcy of Southern California Edison followed, sure as God’s punishment.

Texas tweaked its algorithm. Getting rid of the price caps ought to do it. Its free market would be holier than thine, California.

After two decades of tweaks, the algorithm has gotten more than a little complicated. The acolytes hawked deregulation as a sweeping away of burdensome bureaucratic rules. The result has been anything but. The impenetrable thicket of rules guiding the Invisible Hand now make no sense to anyone outside a very select (and comfortable) priesthood.

Take something as basic as how prices are set. Say three companies bid to supply packets of power at $5, $10, and $15. Say all three packets are needed, and taken. All three bidders are paid the high price, $15.

That’s the easy one to explain. When something new pops up in an autonomous vehicle’s environment, it’s often at a loss to know how to deal with it.

Renewables have sorely tested a market mechanism built to run on gas. When the West Texas wind comes sweeping down the plain, wind farms will bid into the market at zero cents per kilowatt hour. Never mind that when the wind stops — or, with solar, when the sun goes down — the slack will need to be taken up quickly by rapid-response gas turbine. Whose owner may be thinking of getting out of the market, because payments have been too low. Renewable fans will not want to hear it, but their favorite technologies are presently doing what economists call “free riding.” It’s also an open secret that no one in their right mind would attempt to finance a renewable project “inside” the market. These must be financed “outside the market,” through subsidies, tax credits, and mandates.

FERC, the federal energy regulator, makes pious noises that electricity markets should be “technology neutral.” An electron is an electron, no matter how created. FERC misses the bigger point. The very structure of the “day of” and “day ahead” markets rewards short-termism and minimal investment in infrastructure. Technologies that have high capital costs, even zero-carbon ones like nuclear, don’t stand a chance. The Invisible Hand, in its wisdom, is driving out so-called “incumbent capacity” — along with the concept of fuel, of the sort stored at nuclear and coal-fired plants. Fuel is a handy thing to have around in the winter, when pipes can freeze.

After being taken for a ride by their errant autonomous vehicle, Texans might well wonder, “Can’t this car just have a driver?”

It had one, back in the day.

In Victorian times, it became been clear that public utilities were an odd — and potentially troubling — form of economic beast. It made no sense for a town to have two gas companies or multiple water works. Utilities were, in a term coined by J.S. Mill in 1848, “natural” monopolies.

Yet, like other monopolies, they were potentially dangerous. Their customers were captives. They had no choice. And the companies might crush competitors, grow fat and complacent, or stifle innovation.

It was Thomas Edison’s private secretary, Samuel Insull, who came up with the solution that took hold in the US. Faced with the prospect that Progressive Era voters might want utilities — which do, after all, provide public goods — to have public or municipal ownership, Insull invented the regulated monopoly.

Insull had built Chicago Edison during the 1890s. He had a low opinion of local politicians. Insull pushed for public utility commissions (PUCs) at the state level, modeled after the state railroad commissions of the day. Texas had a rather remarkable Railway Commission created in 1891, but that’s another story.

The system worked reasonably well throughout the 20th century. It’s still around in many states today. The large regional utilities did long-term planning and investment; after all, they owned the power plants and the grid. State public utility commissions set rates high enough not only to cover the utility’s short term costs, but to provide a “fair” rate of return on its invested capital. Regulated utilities were big, boring, and going to be around forever. Their stocks, which paid modest dividends like clockwork, were owned by pensioners and retirees.

The Long March toward deregulation began in the late 1970s. Deregulation was a paradigm shift, a change in the zeitgeist, whose causes are not easy to list in a few sentences. Important, however, was that it had an intimate connection with energy, especially natural gas. The two OPEC oil embargoes caused the price of natural gas to skyrocket, yet price controls contributed to shortages. In the Midwest, some schools and factories had to close.

The Feds, contrary to some narratives, never really wanted to regulate natural gas prices. The Federal Power Commission (FPC) found itself boxed in to doing it by an strange Supreme Court decision that had to do with pipelines being interstate commerce.

By 1990, natural gas was almost entirely deregulated and trading on markets like a commodity. Enron, originally Houston Natural Gas, a pipeline company, created its own financial exchange on which unregulated natural gas futures and derivatives could be traded.

In a key strategic decision — known in company lore as the “Come To Jesus” meeting — Enron executives decided to pursue trading in any unregulated market it could find. If they could trade it, Enron figured, they could make money out of it. They were, after all, the smartest guys in the room.

The electric power market was a very big cookie jar, about $400 billion per year. But, of course, it was regulated. The last federal obstacle to state deregulation disappeared in 1993. About that time, Enron began lobbying politicians in both California and Texas, pushing utility deregulation. In 1997, Enron graciously authored on behalf of Texas lawmakers the “Texas Consumer Power Act.”

The only problem with the scheme was that most Texans didn’t want it. The state already had electricity rates below the U.S. average. Polls showed that a large majority of Texans were satisfied with the regulated system. An East Texas lawmaker quoted at the time had a typical opinion. “I don’t see the great public necessity for what we’re doing,” he said. “Texas has some of the lowest rates in the nation. We have some of the best reliability in the nation. And obviously, we don’t know what this [deregulation] thing will do.”

Enron Chairman Ken Lay took to the Op-Ed pages of the Dallas Morning News on March 16, 1997, informing that paper’s readers that “Competition in power industry will aid consumers.” A steady drumbeat in favor of deregulation began to sound, although it was not entirely clear who was banging the tom-tom. “I think it’s the industry people who are pushing it,” Consumers Union analyst Janee Briesemeister speculated in 1999. “They’re trying to create this kind of frenzy so that legislators feel like they have to act…. [They are] putting ads on television, telling people they want it, even though people don’t know they want it.”

The Texas legislature knew what it wanted. Which just happened to be the same thing Enron wanted.

As for the worried public, the message was: trust us on this. Your electricity rates will go down. Deregulation worked for long distance, didn’t it?

When Gov. Bush signed SB7 in 1999, he made the usual assurances: “Competition in the electric industry will benefit Texans by reducing rates.” Waco State Senator David Sibley, who had introduced SB7, put himself more squarely on the line. “If we don’t get consumers lower rates, then we have been a failure — I’ll be the first to say it.”

Consumers didn’t get lower rates:

  • In the 10 years prior to deregulation, Texans paid average residential prices 6.4 percent below the national average. In the 10 years after deregulation, Texans paid prices 8.5 percent above the national average.
  • Texans living in deregulated areas would have saved nearly $25 billion dollars in lower residential electricity bills from 2002 through 2014, had they paid the same average prices during that period as Texans living in areas with traditional regulation. That’s than $5,100 per household.

It’s probably time to take Sibley’s 1999 comment seriously, and call Texas’ deregulation a failure.

Where Texas goes from here, is anybody’s guess. ERCOT, which has been so much in the news people think it is a utility, is just a nonprofit consortium that has no ability to invest in generation or infrastructure. But its board members are likely candidates for human sacrifice. The Market God will have its blood.

The autonomous vehicle algorithm will probably be patched, yet again. “Capacity” payments — they would require a book to explain — are one idea for a Band-Aid that will make everything all better. The Rube Goldberg machine will rattle on, along until the next emergency.

Time scales in the utility industry are very difficult for people to get their heads around. The regulated utility of Georgia, Southern Company, is building a nuclear power plant that is to be sure very expensive, but will be generating (carbon free) electricity into the next century — 80 years.

Likewise, it takes time for infrastructure to crumble. Nothing happens very fast in the utility industry. It’s not Silicon Valley. On the rare occasions when actions are taken quickly (Germany’s Energiewende comes to mind), it’s often in reaction to a media panic, and the unintended consequences can decades to become apparent.

It’s fine for competition make power generation more efficient. And market signals are useful for informed decision-making. The thing about decision-making, however, is that it usually assumes somebody is around to make a decision. Texas needs some entity with some legal teeth to do what is called “integrated resource planning.” For example, every day some 390 million cubic feet of natural gas is flared off — burned in the air — by oil companies in

the Permian Basin. That’s a lot of gas going to waste, not to mention contributing to greenhouse warming. Somebody ought to run a pipe out there and get it that gas before the next cold spell. But it turns out in Texas natural gas pipelines are regulated by the Railroad Commission, not the Public Utilities Commission.

You get the idea. Texas needs to put some body in charge — preferably a body that is humane, responsible, compassionate and smart. The Invisible Hand had it’s shot, and blew it. Planning by humans will be messy. People don’t all want the same thing. They’ll bicker and fight. But that’s what poor sinners do.

Will Bates is a Texan and very much in favor of keeping Austin weird. You can follow him on Twitter: @will_bates_sci

Will Bates writes about science, technology, and business. His journalism has appeared in the New York Times, the Wall Street Journal, and numerous magazines.

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