Electric Market Follies: Texas Style

Speaking of electricity, it looks like things are not all sunshine and roses in Texas.

Texas’ capacity to generate enough electricity could drop below healthy levels as soon as next year, thanks to companies’ market-driven decisions to shut down power plants across the state.

After a huge construction spurt at the start of the decade, Texas had a glut of power-generation capacity. But the recent mothballing and dismantling of older power plants could push supplies to the edge much sooner than expected.

There are some people in there who seem to understand the situation. The prices have to rise to induce more firms to make the rather substantial investment in new power plants. Not only that, but as prices increase, demand will also decrease. A higher bill even in hot summer months could induce a homeowner to set the thermostat to 78, 79 or even 80 degrees vs. 76. Do that over a large enough number of households and you can have a large drop in usage. Thus, the test of the market will be if the PUC and the policticians will have the intestinal fortitude to let prices fluctuate to solve the problem.

The problem is that some are starting to talk about going to the round similar to the one California went down.

State officials are considering changes to those bidding rules that restrict prices from rising.

Officials are also considering a tool known as capacity payments, in which generators are paid simply for being available in the market, even if they don’t produce energy. Critics say the system mimics a regulated market and moves risk back to consumers instead of the companies.

Preventing the price from rising is a big mistake. In California one of the contributing factors to the electricity crisis was the fixed retail rate. Customers always saw the same price no matter what the wholesale price was. In this case the utilities in California had to absorb huge losses due to the PUC’s reluctance to raise rates. Only when the utilities sued and were on the brink of winning the PUC relent and allow for price increases. It also helped that the FERC finally responded to the crisis and implemented price controls that set the wholesale price cap equal to the price of the least efficient generator necessary to clear the market (i.e., to set supply equal to demand).

If the price controls that the Texas officials are considering are like fixing the retail rate the effects could be disasterous. While it will protect the consumer it will place the utilities in serious financial risk that could lead to a crisis very much like California’s. During the height of the crisis, some of the utilities were no longer able to pay for the purchase of electricity so they simply stopped purchasing as per the rule of the market. This is what percipitated the entry of the Department of Water and Resources and Gray Davis’ ill advised long term contracts that has helped keep prices high.

If the price controls are more like what the FERC is contemplating, and I’m not sure the Texas PUC has that kind of authority, then it wouldn’t be as bad. Other options would be to let the utilities enter into long term contracts to hedge against higher prices. In any event, barring really stupid policies I don’t see how these things would put the rate payers are greater risk, and also, the rate payers should be at some risk of higher prices. That is part of the nature of markets. Sometimes the price goes up, and consumers have to pay those higher prices or reduce their consumption.

FILED UNDER: Economics and Business
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Steve,

    I’ve been out of the power industry for six years now, but, based on what I knew then, Texas has even more problems. Every time I heard about Texas during the deregulation of generation during the 90s, it was always followed with a comment about them not being hooked into the national grid. If still accurate, they have prevented themselves from benefiting from surplus capacity in other states. Extraordinarily dumb, not unlike California limiting their grid operators to the day ahead market and making long-term purchasing agreements illegal.

  2. Generation deregulation
    Steve Verdon has a good post on power supply problems in Texas. I added a few comments, taken from memory after being out of the power industry for several years. Take them for what they’re worth. The blog is free,…

  3. McGehee says:

    The grid isolation alone isn’t necessarily a problem, if a relatively free market for electricity exists in the state and leads to self-correcting supply. But if the regulators create a problem there the way they did in California, grid isolation will make the bad things worse.

  4. Recommended reading
    Excellent analysis of the economics behind the recent Texas power problems by Steve Verdon at Outside the Beltway….

  5. Walter E. Wallis says:

    Perhaps California should sent Texas all our regulators?

  6. Steve says:

    Walter,

    That is just simply mean. 😉

    Robert & Mcgehee,

    I agree with Robert for practical purposes while Mcgehee has a valid theoretical point. My guess is the bureaucrats and pols wont be able to resist “fixing the market” and hence will likely cause a problem where having an inter-connection with other states/regions would help. It sure helped in CA (and was also a problem at times) keep the lights on.