The parallels between today’s Texas energy market and California’s energy market in the early 2000s are striking. Texas should learn from California’s bitter experience with deregulating energy markets and create competition in its market, lest monopoly power leads to disaster—again.

Twenty years ago, the California energy market was in shambles. Prices were high and eventually capped by the Federal Energy Regulatory Commission (“FERC”). FERC would follow those caps with caps for all the interconnected western states, as capacity shortages drove prices higher. Wildfires spiked prices even higher, causing Enron energy traders to say, “burn, baby, burn.”

It is now Texas’s turn to demonstrate the flaws in its electricity market, currently run by the Electric Reliability Council of Texas (ERCOT). First came last year’s freeze fiasco, where plants that were not weatherized for the cold forced power to go out, causing significant damage and deaths as prices spiked. FERC’s report on the freeze details the need for winterization, and reminders of past recommendations to winterize plants. The freeze cost the state 246 lives and $80-130 billion in direct and indirect economic losses.

Now that it’s a historically hot summer, the ERCOT grid demonstrates no signs of doing better than it did during the winter of 2021. Capacity shortages, unplanned outages of generation plants, record demand, and other factors caused ERCOT’s grid to teeter on the brink of calamity. ERCOT has begged consumers to cut back.

Many quickly assigned blame—and credit. Depending on which side of the political fence you were on, the reliance on wind and solar was either a savior or a major cause of the problems. Senator Ted Cruz (R-TX), for example, was quick to blame the “Green New Deal” for these events. Others hailed solar and wind as the saviors keeping the grid afloat. 

Texas is not yet out of the woods—and the next winter and summers are not expected to be any less rough. 

Santayana was right: Those who fail to learn the lessons of history are doomed to repeat them. And, despite the the 20-year gap, the parallels between the California energy market of the early 2000s and the Texas energy market now are striking. Sure, Enron stole the limelight of the California crisis, but there were many other factors that contributed to it—Texas should learn from that history and fix its electricity market. Those who are keen to deregulate markets, or create competition in markets where monopolies once existed, ought to pay attention to assure that monopoly power does not creep back into the market.

Some Basics for The Uninitiated

Electricity markets have unique features that limit the ability of regulators and market monitors to rely on many of the traditional aspects of competitive markets. Generation typically cannot be stored. This means that absent consumer demand responsiveness, the only market mechanism by which to discipline price is additional capacity available to generate at a particular time period. Second, for the grid to function without brownout or blackout, generation and demand must be balanced at all times. Thus, unlike with other commodities, energy generated in one hour of production is not fungible with energy generated in another hour.

In addition, due to the minute changes in demand that occur on a regular basis, excess capacity must be available to respond rapidly to changing demand conditions. This reserve generation is of varying qualities, making some reserves more expensive (and more reliable) than others. Once a generator is running, its power cannot be directed over a particular transmission line.

Electricity generation itself is not  homogeneous. Certain “baseload generators supply power on a continual basis, unable to “ramp up” or “ramp down” the power that these units supply to any great degree. Other generators supply power during peak and intermediate periods of demand. These generators are typically natural gas units that are able to ramp up or down fairly quickly.  Generators located in particular areas are more valuable than others. As stated above, a generator producing electricity may clog transmission lines and reduce the overall level of generation.

These basics help explain why the Texas approach embraces the same perils as California’s market during the Enron crisis.

Capacity Shortages—Planned and Unplanned

May 2022 was already hot in Texas. The state’s troubles increased with capacity shortages as six generation plants went offline. In one instance, ERCOT had asked a plant to stay online to meet demand instead of shutting down for scheduled maintenance. It went offline the next day. 

The problem with capacity in Texas would be familiar to anyone who knows you shouldn’t put all your eggs in one basket. Wind and solar generation have a place, but the wind does not always blow in west Texas. Delivering the power might be another issue. Thus, to assure grid stability, flexible generation capacity is located near cities. That simply hasn’t happened. No new combined-cycle gas-fired generation has been added to the fuel mix. And, as energy expert Ed Hirs has stated, some of that capacity is old and has not been maintained.

During the California crisis, capacity shortages arose from unplanned outages, too. Hot temperatures, high demand, and capacity shortages (whether manufactured or legitimate) led to Summer shortages in 2000. One component of those shortages was that hydroelectric power dried up. That fall saw more shortages, caused due to plants taken offline for maintenance and emissions reasons. Eventually, high wholesale prices also caused another problem: As Pacific Gas & Electric and Southern California Edison suddenly realized that their income was exceeded by their costs of supplying power, each company made public statements threatening to declare bankruptcy and claim insolvency. Gas suppliers, out-of-state generators, and marketers began to refuse to sell to these utilities because of concerns that the utilities might file for bankruptcy. 

Then came some very tight spreads between supply and demand this summer, causing ERCOT to ask for consumers to up their thermostats and curtail load. In part, the plea came as the backbone of the ERCOT grid, wind and solar, had diminished capacity. The response was mixed: Consumers responded out of fear of outages, but there was hostility and frustration at the fragility of the grid. As energy expert Ed Hirs states, “This has got to be extremely frustrating for the consumer, because as we look out, we see prices really really high and ERCOT telling us to use much less at a time when we need it most.” Demand reached record highs.

California, too, pled for demand responsiveness. But it wasn’t until Californians felt the price increases in their pocketbooks that demand shrunk by 14 percent. Before that, California had guaranteed that its residents would receive a 10 percent reduction in their electricity bills

The promise that a deregulated market would lead to lower prices is full of assumptions. The first assumption is that the regulated price was inefficiently above cost. Thus, the price had nowhere to go but down. Second, it assumes a static market once the “rules of the game” of competition are instilled. However, those rules will change outcomes as incentives change. Third, it presumes market responses that may not be there: For example, capacity additions would be the natural result of price increases, not the quiet enjoyment of monopoly power.

“it is clear that Texas has some tough choices to make: It can continue to do nothing, to the detriment of its citizens and to the benefit of corporate profits—or it could stop creating perverse incentives to maintain the status quo.”

Help from Outside?

For ERCOT, there is no help. ERCOT outright refuses to be subject to Federal regulation, and therefore refuses any serious levels of interconnection with the rest of the US. There have been arguments that other markets nearby would be unable to help, even if they were interconnected.

California had help during its energy crisis, but that help quickly dried up. Historically, California had been a net importer from neighboring states. However, due to the increased electricity demand and decreased supply due to low rainfall in the Western Interconnect, neighboring states have had less energy to sell to energy-starved California. Thus, California was unable to obtain resources from outside the state and was unwilling to build resources inside the state. 

Sadly, it seems that if ERCOT has learned anything, it is merely how to repeat the mistakes of California. ERCOT refuses to import power to avoid Federal oversight. The only other options for Texas are increased generation within the state, reductions in demand, and to some degree, transmission to decrease congestion.

Here, ERCOT again follows California. Generators in California (many owned by Texas companies) learned that less capacity means higher prices. That means there is no incentive to build generation in Texas, or increase the reliability of existing plants. This incentive structure creates scarcity. As Californians can tell you, scarcity that creates unbridled market power leads to disaster.

Manipulating the Grid is Easy

Anyone who is good at markets knows quite well how to manipulate them, as Enron did skillfully in California. Energy prices are affected by bid prices of the generation capacity and availability. To the extent a greater than normal share of plants are offline, does ERCOT know the reason? Are the plants outside of their normal operation expectations?  Does ERCOT know when it’s being had?

Sure, ERCOT has a market power mitigation process–“the Texas two-step,” in which a determination is made whether the offer price exceeds a threshold amount, and then determination whether that price had an impact on the market.   But, market power has to be detected in order to be mitigated. Moreover, mere mitigation does not deter attempts to wield market power, without more. As California and Enron taught us, if the penalty is just giving the money back, crime pays. Mitigation without penalty is not deterrence.

Thus, it makes sense that ERCOT made calls in July for customers to reduce demand, as did California. California was able to reduce demand by 14 percent year over year in 2001. But that was due to exorbitant prices that Californians felt in their pocketbooks. It’s unclear whether Texans will comply with such requests to reduce demand or tolerate higher energy prices when they were promised lower ones and a reliable grid. 

Fixing the Problem

What’s to be done? There need to be strong incentives for generation owners to build new plants. That means killing hope for obtaining gains from wielding market power, and draconian penalties for generators who try or succeed in doing so. 

Perhaps the threat that will make generation construction blossom is to connect Texas’ grid to the rest of the United States—but such a threat must be credible. Residential solar and other distributed generation can help as well, but nothing beats larger generation capacity or, as a semi-substitute, transmission.

Demand that responds to price can help as well. But the jury is out as to what degree Texans are willing to sacrifice comfort in the midst of a heat wave. And climate change is only going to make those matters worse. Whatever happens, it is clear that Texas has some tough choices to make: It can continue to do nothing, to the detriment of its citizens and to the benefit of corporate profits—or it could stop creating perverse incentives to maintain the status quo. At the very least, it needs to keep a watchful eye on market manipulation, and ensure that manipulators face the consequences of their actions.

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