James K. Galbraith blames the state's power outages and water shortages on a flawed free-market model for utility companies

James K. Galbraith blames the state's power outages and water shortages on a flawed free-market model for utility companies

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 stabilised 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 maximise 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 time. And, 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 weatherisation 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-weatherised 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, 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, and published here with permission.

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24 Comments

if socialism means entrusting life-and-death technical matters to engineers and others who know their stuff

Ah the American battle against socialism means literally leaving your life-and-death matters to bankers and claim assessors over a state-funded healthcare system.

- In a poll taken in July 2020, a-fourth reported not having enough tucked away to pay a $500 medical bill.
- US$45b of medical debt in the country is now owed to private debt collection agencies.
- Two-thirds of individuals who file for bankruptcy cite medical issues as a factor.

"The new system did work most of the time." Most being around 99.9%, my guess. 2011 t0 2021 is quite a few years with probably little or no interruption.
..." invented by economists, aided by a myth, that served the fossil fuel industry and the politicians it funds."
This is BS. It served the wind farmers no end. With Federal tax subsidies the wind Johnnies could install as much wind as they want and conveniently forget about de-icing equipment which surprise surprise requires electricty to de-ice and in Texas for the wind generators to stop while thr de-icing is carried out. What affected both coal, gas and i think nuclear was the freezing over of control valves. Compounding this is the requirement to supply gas to households first which then reduces gas supply to generators requiring gas.
So what we have here is a market that worked perfectly as mentioned by design and cheap electric for a long time. Whether this makes up for the financial losses during blackouts is a nice number crunching exercise. I await to see how its going to be resolved. There is already talk of more wind generation in Texas increasing the energy supplied by wind to over 25%.
A fix comes in increasing the available standby capacity which is not available by design currently as utilities are not compensated for additional standby capacity or for spending capital on winterising equipment. That additional standby capacity is least served by wind without massive over capitilsation and subsidies, whether Federal or State.

When my brother lived in a caravan in the Highlands of Scotland the control valve to his gas bottle would freeze on exceptionally cold days. His solution was to piss on it. Texan coal, gas and nuclear engineers could apply the same method.

I think urine to something there

A canny wee solution from Scotland.

Too bad if the standby generation wasn't weatherised...

It is yet another example of flawed economic theory about markets. We have been suffering that rubbish reasoning since 1984 here.

Anyone reading this should mouse over the source links for the writers assertions. This is a partisan article.
... All of this, Hogan accurately tells us, was according to design.
This is a gross misrepresentation of what Hogan actually said in the source.

https://wolfstreet.com/2021/02/18/whos-to-blame-for-the-texas-power-crisis/
Texas took the risks to avoid federal regulations and a freak event blew up in their faces (in hindsight they could have made a tougher worse case). If i had the option of paying wholesale power rates I would take the risk and assume it's never going to freeze (in the North Island) to the point our grid shuts down. The state will make changes in hindsight, I would think.

That wolfstreet article was pretty damming of the system - and confirmed the fossil fuel failure.

Yes in hindsight they should have had more stand by options but those coal piles and machinery may never have frozen before and may not freeze for another 120 years, this is a cost that everyone's going to to want to reduce. If the North Island here froze like that I bet we would do no better, unless we get lucky with hydro thermal mass keeping the plants warm or something.
The politics being played here is unhelpful for Texas actually fixing anything.

tim52 - ' may not freeze for another 120'? I can't remember, but are you a ' climate alteration isn't happening/isn't our doing' type?

These events are simply driven by there being more energy in the system (solar, not getting back out, mostly) and thus the weather events become either more frequent, or bigger, or both. This has been long foretold, and inf anything the foretelling has been on the conservative side of what is eventuating. Hurricane Sandy and this Texas thing are portents, not aberrations.

You do have the option of paying wholesale rates. Try Flick electric...

It's so binary the argument, either socialism or capitalism, without thinking there are better middle best of both models.

And the model for the future is to become more self-sufficient, especially for each individual home, which is becoming more feasible with solar and battery storage. But of course, it starts with being as Passively efficient as possible, so you need minimum external input.

This just sounds like another binary of Democrats having a crack at the Republicans.

Pretty weak-sauce. I've worked with utility companies who have a mandated rate of return on their assets, it absolutely leads to overinvestment. The culture of capitalising absolutely anything they can is pervasive in those organisations.

A proper analysis would look at the total costs of the Texas system and compare it with a similar sized socialised one like the author would prefer them to have. Over a timescale of a century or so (this was apparently a 1 in 120 year storm), the difference in cost between the two should allow for an interesting discussion about the worth of the ideas he is proposing. Instead this is just an opinionated hit piece.

See my comment above, re frequency.

1: 100 is not a measure when it happens twice in three years, say. What that tells you is that the base-line has changed.

Americans don't seem to mind having a "socialist" military.

Or a socialist banking sector. Or socialist airlines. Or socialist any big business.

America only opposes socialism when it might help poor people.

By all accounts Texas was let down by renewable energy sources such as wind turbines which aparently froze. Time and time again "renewable" equals unreliable.

That's simply not true...

"The Electric Reliability Council of Texas... predicted that this winter would see wind produce about 7,070 megawatts at peak load times. By the council's own daily figures, wind power in Texas has produced between 4,415 and 8,087 megawatts at peak times since the storm began. The state's "thermal fleet" — mostly natural gas, but also including coal and nuclear power — has been down significantly more, leading to a shortfall of 30,000 megawatts"

Perhaps try 600 MW? "Meanwhile, wind production weakened to 600 MW in this exact hour, slightly weaker than the 1.7 GW low wind planning case."
https://www.woodmac.com/news/editorial/breaking-down-the-texas-winter-bl...

This is a unenlightening analysis driven by politics. If you really want to know what happened, listen to this podcast.

And Galbraith's supposedly flawed free-market model looks a lot like the NZ market....

The flaw was in the ignorance that thought a 'free market' was free (it merely favours the already-rich) but more importantly, apparently thought it was sustainable.

It wasn't.

And yes, NZ is in a similar boat.