Musings on Economic Freedom from the Texas Public Policy Foundation’s
Center for Economic Freedom
Here’s how we wind up with more government involvement in our lives:
· someone in government or with a friend in government doesn’t like the outcome of voluntary exchanges between producers and consumers in the marketplace;
· the government then intervenes, i.e., regulates the market, to make future market outcomes fit the preferred outcome;
· the intervention not only fails to provide the preferred outcome, but its “unintended consequences” make even more people unhappy with the outcome of the now regulated market;
· the government further intervenes in the market, leading to even more distorted outcomes and broader dissatisfaction.
This scenario is essentially what we are experiencing in the Texas electricity market today.
Texas moved to a competitive electricity market over a period of about 12 years, from 1995 to 2007. The results for consumers have been amazing: billions of dollars of new investment in generation, lower prices, and a high level of reliability with robust reserves.
The industry experience has been a bit rockier. That, however, isn’t surprising. Consumers were in part paying higher prices to provide guaranteed returns for the industry. Without those returns, businesses are having to compete, and some are competing more successfully than others.
There is a fear, though, that consumers will soon experience more of the pitfalls of competition. Thus as private sector investment slows, we have calls for the government to step in and once again raise prices to provide the stability that the market is failing to achieve.
Except that it is the government, not the market, that is the source of the problems facing consumers today.
One reason that we are experiencing the lower investment and reserve margins today is because the market has become more efficient each year it has operated. This means that profits are harder to come by for market participants. And that intervention is having a bigger impact on profit margins than in the past.
When we take the regulations/subsidies that existed before full competition was ushered in in 2007 (the federal production tax credit, the state renewable portfolio standard, market power regulation, the state’s energy efficiency program, etc.) and add newer regulations to the mix (the wholesale price cap, PUC approval of mergers and acquisitions, federal environmental laws, PUC disgorgement authority, etc.), it is no surprise that the outcomes of this regulated market fail to satisfy.
The answer, as I pointed out in a commentary in Saturday’s Houston Chronicle (see below), is not to increase intervention, but to reduce it. In other words, let’s let Texas’ world class electricity market work as planned. In particular, we shouldn’t abandon Texas’ energy-only market, where investors rather than consumers bear the market risk. The problem facing consumers right now—unreliable service—is a regulatory creation. The answer to that is not more regulation.
There are real challenges facing Texas’ competitive electricity market. The question before us is whether a few policymakers and regulators in Austin can somehow make better decisions about how to deal with those challenges than the collective and cooperative decisions of millions of producers and consumers in the marketplace.
My take on it is that they can’t, and that Texas consumers will have greater access to a less expensive, more reliable supply of electricity if we let the market work.
Here’s the Chronicle commentary:
Texas' electricity market can power our future
By Bill Peacock
Updated 09:09 p.m., Friday, July 6, 2012
Opinion
Texas’ growing population and economy combined with high temperatures last week to produce new June records for peak demand on consecutive days. The 66,000-plus megawatt load strained the Texas electricity grid.
Two days later, the Public Utility Commission of Texas (PUC) increased wholesale price caps to address concerns that Texas may not have enough generation capacity in reserve to meet peak summer demand.
Investment in new generation has slowed as price signals, i.e., low prices, have caused companies to shy away from Texas. Critics blame the lack of new generation on the market. However, the market is not the problem.
Today’s low prices are the result of many factors, such as the low price of natural gas. But there are also many instances where prices are artificially lowered through government interference.
Renewable energy is one example.
Between the Texas renewable portfolio standard (RPS) and the federal production tax credit (PTC), wind generators receive more than $20 per megawatt in government subsidies, enabling generators to make a profit even if they give away their electricity for free.
This doesn’t make the electricity any cheaper for consumers, who pay for wind energy through higher taxes instead of their electricity bills.
The subsidies also distort the market by pushing overall electricity prices lower. This in turn reduces the revenues that generators need to make investments in new supply.
Wind-generated electricity also does little to make up for the reduction in conventional generation. Last week, wind provided barely 0.5 percent of the electricity used during peak demand.
Renewable energy subsidies help no one beyond investors and workers in that industry. The federal PTC is scheduled to end this year. Though the renewable energy industry is making a strong push to renew it, the PTC should end. Combining this with repeal of the Texas RPS next year would solve a significant part of Texas’ resource adequacy problem.
Another external source leading to reduced investment has been various forms of price regulation.
As Texas moved into full-scale competition, electricity prices were not directly regulated. But fear of consumer angst over high prices has led regulators to gradually increase regulation of wholesale prices.
This began with claims of market power abuse, based on the theory that there is something wrong with selling electricity at a profit. When this didn’t work as planned, a “shame cap” on wholesale prices was introduced, using publicity to shame companies into selling electricity at a loss. This didn’t work either, so it eventually morphed into the hard price cap we have today.
The problem with the cap is that it reduces prices at times of peak demand, when electricity is the most expensive to produce. If generators can’t sell electricity at a profit at times of peak demand, they won’t build generation plants that will supply electricity when we need it most.
The PUC last week took a good first step in raising the price cap, but should take the next step and eliminate it.
We must also reduce the ability of PUC to regulate prices through other means, such as spurious claims of market power abuse, its recently enacted power to disgorge revenues, and current proposals to increase its fines and issue emergency cease-and-desist orders.
These regulatory actions are all based on highly questionable theories about prices in perfect markets that don’t exist. Regulators apply them haphazardly in real life and introduce a high level of regulatory risk in Texas markets. It makes perfect sense that investors move billions of dollars in capital from Texas to other states where they can get more predictable returns because of less regulatory uncertainty.
About the turn of the century, California pretended to have a deregulated electricity market, but it was really a poorly-designed, government-controlled system that eventually collapsed under its own weight.
Texas’ economy is outperforming California’s and the rest of the country because we put fewer burdens on markets. This is why Texas has the most competitive and successful electricity market in the United States, if not the world.
Calls to “fix” Texas’ electricity market with more government and ending our “energy only,” i.e., free-market, approach to generating electricity won’t help—in fact, they will make electricity more expensive for consumers and make our market look more like California’s.
If we let it work, the world-class Texas electricity market will power Texas’ future.
Peacock is the vice president for research and director for the Center for Economic Freedom at the Texas Public Policy Foundation.
This update and all our previous Thinking Economically updates can been viewed under the Related Commentaries heading in the Thinking Economically section of the Foundation’s website. We will be adding automatic subscribe and unsubscribe functionality to this email. In the meantime, if you’d like to do either, please send an email to bpeacock@texaspolicy.com.
Bill
Bill Peacock
Vice President of Research
Director, Center for Economic Freedom
Texas Public Policy Foundation
o: (512) 472-2700
c: (512) 965-6476
bpeacock@texaspolicy.com
