Why federal regulation is not the answer

Federal regulation may seem like the solution to the recent electricity shortages in Texas. It isn’t for a couple of reasons.

Understanding why it may be best to leave the job to Texas policymakers requires understanding some of the unsexy details of constitutional law. The federal government regulates interstate commerce, whereas states are responsible for regulating commerce within their boundaries. For electricity this means that wholesale markets are the domain of the Federal Energy Regulatory Commission (FERC) and state public utilities commissions (PUCs) regulate retail markets.

In all continental states except Texas, energy policies must satisfy the regulatory mandates of two masters: FERC and the relevant state PUC. It is an uneasy conflict-ridden relationship. There are many examples where these conflicts led to costly and ineffective regulatory responses. For example, it would be extremely difficult to find a California policymaker involved in the state’s electricity sector during the crisis of 2000 to 2001 that would say FERC helped avert it. In fact, a common refrain among the state policymakers at the time was that California had been FERCed by federal regulators.

There is no reason to expect that the problem of conflicting goals between FERC and state regulators would not arise in Texas. The relationship would likely be fractious.

Whatever its failings now, the PUC of Texas does have a record of successfully—for the past 20 years no less—regulating wholesale and retail markets in the state. Up until the events of the past few weeks, many industry observers considered the Texas market as quite possibly the best performing electricity market in the United States.

This was due in part to the fact that Texas policymakers did not have to satisfy the competing mandates of a state regulator and FERC. The PUC of Texas could set wholesale market policies that were best suited to its retail market policies and vice versa. These policies were well designed for a wholesale market where the supply of electricity was at least equal to the demand for electricity at a wholesale electricity price less than or equal to $9,000 per megawatt-hour, the maximum price a supplier can offer to sell energy to the Texas market.

Average wholesale electricity prices in Texas in 2019 were less than $50 per megawatt-hour. However, there was a low, but not zero, probability that the demand for electricity could be so high that there could be insufficient supply available at a price of $9,000 per megawatt-hour to meet it. The extreme weather event of mid-February trigged such a demand as well as a reduced supply, which led to rolling blackouts to reduce the amount of this demand to the available supply.

In short, the implicit assumption in the design of the Texas market that the supply of electricity at an offer price of $9,000 would always be sufficient to meet demand turned out to be false. That implicit assumption needs to be changed and there are good reasons for letting Texas itself figure out how to do just that.

All other wholesale markets in the United States have a mechanism aimed at ensuring that there will always be enough energy supplied at the highest allowable price in the market to meet all possible future demand realizations. Designing these mechanisms is extremely tricky for all wholesale markets, and especially so in regions with a large amount of intermittent wind and solar resources like Texas. No region has the right answer—there are only imperfect answers that depend on local conditions. When the answer depends on local conditions, the best course of action is to leave it to local policymakers.

The human cost of the power system's failures is clearly unacceptable, but there are ways for Texas policymakers to prevent it from ever happening again that do not involve abandoning a market design that leads the nation in the deployment of wind and solar generation capacity and the innovativeness of its retail sector. 

Wolak is a professor in the Department of Economics at Stanford University, where he is director of the Program on Energy and Sustainable Development and co-director of the Stanford Natural Gas Initiative.

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