Texas Froze by Design

James K. Galbraith,

AUSTIN – Harvard Kennedy School’s William Hogan is credited with designing the Texas energy market. As Texans froze and their water pipes burst, he reportedly remarked that the state’s energy market has functioned as designed.

Hogan is right, which says a lot about how some economists think.

For years, electric utilities were a stable, dull business. To counter the effects of monopoly, utility commissions set and stabilized prices, and companies got a rate of return on their investment that was (in principle) enough to cover construction, maintenance, and a fair profit.

But economists complained: utilities had an incentive to over-invest. The bigger their operations and the higher their total costs, the more they could extract from the rate-setters.

Electricity is the ultimate standard product, every jolt exactly like every other. Texas had a self-enclosed energy grid, cut off from interstate commerce and thus exempt from federal regulations. What better place, what better product, to prove the virtues of a competitive, deregulated system?

So, economists proposed a free market: let generating companies compete to deliver power to consumers through the common electrical grid. Freely chosen contracts would govern the terms and the price. Competition would maximize efficiency, and prices would reflect fuel costs and the smallest possible profit margin.

The state’s role would be to manage the common power grid linking producers to consumers. In times of shortage, prices might rise, but those who did not wish to pay could flip their switches off.

In 2002, under Governor Rick Perry (later President Donald Trump’s secretary of energy), Texas deregulated its electricity system and established a free market, managed by a non-profit called the Electric Reliability Council of Texas (ERCOT), with roughly 70 providers.

While a few cities – including Austin – kept their old-fashioned public power, they, too, were tied to the state system.

The problem is that electricity demand is inelastic: it doesn’t respond much to price, but it does respond to weather. In times of extreme heat or cold, demand becomes even more inelastic.

And, unlike in an ordinary market, supply must equal demand every minute of every day. If it doesn’t, the entire system can fail.

The Texas system had three vulnerabilities. First, cut-throat competition to provide power in the cheapest possible way meant that machinery, wells, meters, pipes, and windmills were not insulated against extreme cold – rare but not unknown here.

Second, while wholesale prices were free to fluctuate, retail prices depended on whatever contract the consumer had signed. Third, prices would rise the most at moments when demand for power was greatest – and would not fall.

The new system did work most of the time. Prices rose and fell. Customers who didn’t sign long-term contracts faced some risk. One provider, called Griddy, had a special model: for a $9.99 monthly membership fee, you could get your power at the wholesale price. Most of the time, that was cheap.

But people don’t need electricity “most of the time”; they need it all the timeAnd, at least by 2011, when Texas experienced a short, severe freeze, the state’s leaders knew that the system was radically unstable in extreme weather. The system’s architects knew it as well, whatever they say now.

Yet Texas politicians did nothing. Texas energy providers, a rich source of campaign donations, didn’t want to be required to invest in weatherization that was not needed most of the time. In 2020, even voluntary inspections were suspended, owing to COVID-19.

Enter the deep freeze of 2021. Water vapor in the natural gas froze at the wells, in pipes, and at generating plants. Non-weatherized windmills went offline, but they were a small part of the story.

Because the Texas grid is disconnected from the rest of the country, no reserves could be imported; and, given the cold everywhere, none would have been available anyway.

In the small hours of February 15, demand so outstripped supply that the entire grid reportedly came within minutes of a meltdown.

As this happened, the price mechanism failed completely. Wholesale prices rose a hundred-fold – but retail prices, under contract, did not rise that much, except for customers of Griddy, who got socked with bills for thousands of dollars a day. Demand rose as supply collapsed.

ERCOT was forced to cut power, which might have been tolerable, had it happened on a rolling basis across neighborhoods throughout the state.

But this was impossible: you can’t cut power to hospitals, fire stations, and other critical facilities, or to high-rise apartments reliant on elevators. So, lights stayed on in some areas, and stayed off – for days – in others.

Freezing water was the next phase of the calamity. Pipes burst, and the water supply could not keep up with demand. Across Texas, water pressure fell or failed.

Hospitals could not generate steam, and therefore heat, and some had to be evacuated. All of this, Hogan accurately tells us, was according to design.

Power is now coming back in Texas; water supplies will take some extra days. Food is scarce, and damaged homes will take months to repair. Millions of Texans have suffered the effects of a design, invented by economists, aided by a myth, that served the fossil fuel industry and the politicians it funds.

One of these politicians, US Senator Ted Cruz, acted in perfect keeping with the system’s free-market logic by decamping to Cancún.

Perry says that we Texans are prepared to sacrifice ourselves to avoid the curse of socialism. But if socialism means entrusting life-and-death technical matters to engineers and others who know their stuff, and not to ideologues, hacks, and consultants, then many shivering Texans might prefer that curse to the one we’re living with right now.

James K. Galbraith, a former executive director of the Joint Economic Committee of the US Congress, is Professor of Government and Chair in Government/Business Relations at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin. He is the author of Inequality: What Everyone Needs to Know

Copyright: Project Syndicate, 2021.