The following is a contributed article by Peter Cramton, Professor of Economics at the University of Cologne and the University of Maryland (emeritus since 2018). He was vice chair and an independent director of the ERCOT board before resigning on February 24, 2021.
During four frigid days in mid-February, the Texas electricity market had more demand than supply. Out of necessity, the Electric Reliability Council of Texas (ERCOT), which operates the system, requested controlled outages for roughly 20% of the system. Electricity, unlike other products, requires that supply and demand balance every second so that frequency and voltage stay within tight tolerances. Absent this balance, generating units will trip off, causing a catastrophic blackout.
The controlled, multiple-day outages that avoided such a total blackout in Texas nonetheless inflicted a severe human cost. More than eighty lives were lost. Property damage totaled tens of billions of dollars. The event should not be repeated, not in Texas nor anywhere else.
The Texas crisis’s proximate causes were two unanticipated shocks induced from the sub-zero temperatures (‑2˚ F in Dallas): a failure of conventional (thermal) generating supply, mostly from lack of natural gas, and a surge in electricity demand.
Inadequate winterization caused freezing of the gas supply and many plants’ control instruments. In a system with a winter peak of 66 GW, about 30 GW of thermal plants were unavailable. In its worst-case extreme-winter analysis, ERCOT had expected a loss of 14 GW of thermal resources. The February storm caused more than double the anticipated thermal outages. Wind resources also experienced storm-related outages, but ERCOT anticipated these outages in its planning.
Simultaneously, electric heaters created a powerful surge in demand. About 61% of Texans rely on electric heat, mostly low-efficiency resistance heat, in poorly insulated homes — a seemingly sensible choice in a warm climate with cheap electricity, where home heating is often unnecessary. The demand surge caused by the cold came to about 20 GW or one-third of the winter peak. ERCOT based its worst-case analysis on a 2011 winter storm, the most severe cold-weather event in Texas in twenty years. The 2021 storm was much worse than that of 2011. It created an unexpected and unsupportable demand surge.
The combination of a sudden drop in supply and a surge in demand made it impossible to balance the system without initiating controlled outages. On Monday, February 15, at 1:20 am, ERCOT control room operators instructed distribution companies to shed load. Over the four days, the shortage averaged about 10 GW or 20% of demand. The deficit was so large that most distribution companies could not rotate their outages due to inadequate control systems. Millions of Texans were without power and water for days during freezing temperatures.
From a consumer perspective, there are few products as boring as electricity. It is there when you need it. You pay your monthly bill — always about the same and seemingly out of your control. You rarely worry about electricity, aside from brief local interruptions such as a tree branch downing a line or a squirrel causing a short circuit. Electricity is considered dependable. Even during Hurricane Harvey, the Category 4 storm that struck Texas in 2017, ERCOT did not need to order power outages.
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Behind the consumer’s easy access to electricity is one of the most sophisticated markets in our modern economy. Experts have carefully designed electricity markets to provide reliable electricity at the lowest possible cost. The market can and should be improved.
As policymakers grapple with the events of February 2021, it is vital that the victims of this crisis — the Texas public — understand what happened and what prudent steps are needed to avoid such tragedies in the future. The sooner we know the elements involved, the sooner regulators can direct resources to deal with them. Preventing similar catastrophes will require a dedicated effort.
It is also essential that policymakers rely on independent expert analysis rather than the moment’s talking points from interested parties. A market functions best when its rules evolve from basic principles. Such a market reduces risks to participants and therefore costs to consumers. Participants can manage market risks; political risks are unhedgeable.
As the world confronts climate change, our dependence on electricity must increase. Rapid innovation in the electricity sector brings challenges and opportunities for the electricity grid. At least for the next twenty years, as we rely more on renewable resources for our energy, we must rely even more on natural gas resources and price-responsive demand for our reliability and resilience.
The Texas crisis shows how critical infrastructures are vulnerable to failure when confronted with events that exceed the levels of stress for which they are designed.
Effective electricity market design is crucial as the market rapidly changes technologies in response to efforts to mitigate climate change. The task is challenging since it involves interdependent electricity and natural gas systems. Making effective adjustments is essential not only in Texas but worldwide.
I suggest five key improvements to the Texas market. Details and additional suggestions are here.
Improve communications. ERCOT, the PUC, the Governor’s office, and thousands of market participants knew of the terrible storm days in advance. As it grew closer, the magnitude of the crisis became apparent. By Friday, February 12, it appeared likely that load-shedding would be required. By Saturday, February 13, significant load shedding was expected. On Monday at 2 am CT, it was known that there would be load shedding on the order of 10 GW for many days. Effective communications are essential at three levels: from ERCOT to the market participants, the PUC, and the Governor’s office; from service providers to their retail customers; and from the Governor’s office to the public. The nice thing about improving communications is it can be done immediately at near-zero cost. Its benefit is considerable, especially regarding loss of life and property damage.
Reform the gas market to ensure a reliable supply. As we add more renewables, we must rely even more on natural gas to provide energy during shortages, at least until there is an economic alternative for long-duration storage. The gas market and the electricity market are interdependent. Regulators must recognize this relationship.
The electricity market is built from the ground up to handle supply and demand changes; balancing supply and demand every second is essential. By contrast, gas is storable and controllable in ways that allow a much simpler natural gas market. Yet, the Texas natural gas infrastructure is not up to the challenge of an extreme winter event. One cannot lose 45% of supply at a time of surging demand, as happened in February. For at least the next 20 years, electricity from natural gas will be the primary energy source during a sustained shortage. The electricity grid’s reliability can be no better than that of the natural gas market.
Promote energy-efficient homes. No one, absent information or standards, would pay more for an energy-efficient home. Better regulation is required. While standards can address new construction, grants targeted to those with less income are needed to subsidize energy-efficiency improvements in existing homes. All Texans benefit from these policies, especially during system demand peaks.
Encourage price responsive demand. The long-term solution for both reliability and resilience is price-responsive demand. The primary market failure in today’s electricity markets is the absence of demand response. Most consumers neither see nor feel the real-time price. The real-time price reflects the social cost of consuming electricity.
The best designs, such as the Texas model, mitigate this failure with a shortage price set by the Public Utility Commission. It is $9,000/MWh in Texas, roughly 300 times the typical electricity price. This high price motivates generators’ long- and short-term decisions to improve reliability by providing energy during shortages. Consumers who see and feel the real-time price, primarily industrial users, are motivated to take action to consume less. Retail rate design needs to encourage more consumers to see and feel the real-time price while simultaneously protecting them from price risk. With enough demand response, prices would never reach the shortage price, and the system would be fully reliable.
Facilitate efficient trade of forward energy. Forward markets are essential for market participants to manage risk. For example, the demand-side can purchase expected energy needs ahead of time to avoid volatile prices that emerge in real-time. Similarly, the supply side can sell energy forward to gain a steady income instead of depending on rare and unpredictable price spikes. The system operator can do more to support forward energy markets and improve the transparency of forward positions. Greater transparency reduces the potential for moral hazard—a bad actor imposing costs on others by hiding undesirable behavior.
The 2021 Texas electricity crisis is a wake-up call of global importance. Critical infrastructures are vulnerable as the impact of climate change grows. Infrastructures must be reinforced so that they are more reliable and resilient. Rapid innovation in how electricity is produced and consumed creates challenges and opportunities for resilience. Market designers need to find effective ways of inducing public and business behavior to improve reliability.
With additional resilience comes additional expense. For example, improved winterization of homes with caulking and insulation is expensive, but it brings considerable benefits. Such homes’ improved energy efficiency reduces demand during the winter and summer peaks, lessening the need for more power plants. It also reduces the risk of frozen pipes and the ensuing damage to homes. Legislatures and regulators need to establish the broad principles and policies that guide these processes on the desired path.
The conclusion from the crisis is not “markets don’t work.” Instead, it is “markets need to work better.” Continuing the constant improvement of the market rules is the best path forward.
A resilient electricity grid requires complementary improvements in related infrastructures. Regulators must reform the natural gas market to perform well in a cold snap. Governments must encourage energy efficiency for new and existing houses based on standards and targeted grants.
Electricity is key to addressing climate change. Reliable electricity is also crucial. When it fails, we quickly learn how essential electricity is to modern life. A system blackout can tear the fabric of society.
We can build a reliable electricity market as we transition from fossil fuels. Such a system will hasten essential electrification in transportation and other sectors and bring on the energy future.