How Texas And The Rest Of The US Regulate Electricity

By Theodore J. Kury (Director of Energy Studies, University of Florida)

Americans often take electricity for granted—until the lights go out. The recent cold wave and storm in Texas have placed considerable focus on the Electric Reliability Council of Texas, or ERCOT, the nonprofit corporation that manages the flow of electricity to more than 26 million Texans. Together, ERCOT and similar organizations manage about 60% of the US power supply.

From my research on the structure of the US electricity industry, I know that rules set by entities like ERCOT have major effects on Americans’ energy choices. The current power crunch in Texas and other affected states highlights the delicate balancing act that’s involved in providing safe, reliable electricity service at fair, reasonable rates. It also shows how arcane features of energy markets can have big effects at critical moments.

Let there be light

The electric age began in 1882 when the Edison Illuminating Company sent power over wires to 59 customers in lower Manhattan from its Pearl Street Generating Station. Edison was America’s first investor-owned electric utility—a company that generated electricity, moved it over transmission lines and delivered it to individual customers.

The scope and scale of electric utilities grew rapidly from those humble beginnings, but this underlying, vertically integrated structure remained intact for more than 100 years. Each utility had a monopoly on serving customers in its area and reported to a public utility commission, which told the company what rates it could charge.

Since the utilities knew more about their costs and abilities than anyone else, the burden was on regulators to decide whether the utility was operating efficiently. Regulators also determined whether the costs that utilities proposed to pass on to customers—such as building new generating plants—were just and reasonable.

The lines get tangled

Things grew complicated in 1996 when the Federal Energy Regulatory Commission issued Order 888, allowing states to restructure their electric power industries to promote more competition. Through the actions, or inaction, of individual state legislatures, the US electricity market fractured.

Some states, primarily in the Southeast and the West, maintained the vertically integrated structure. The rest of the nation moved to a market structure in which generators compete to sell their electricity.

Regions created new independent organizations—known as independent system operators or regional transmission organizations—to regulate the flow of power on the grid. In these regions, generators compete to sell their electricity, and organizations called market monitors make sure that generators follow the rules. This approach created power markets that prioritize generating electricity at the lowest possible price.

An imperative to keep prices low

What do these changes mean for electricity customers in regions with competitive power markets? The companies that deliver power over wires to homes and businesses still have to get their prices approved by regulators, but the system works differently for the businesses that generate that power.

Generators offer their electricity, typically at a particular price each hour, on exchanges run by market operators like ERCOT. Those operators figure out how much electricity is needed across the regions they serve and choose the lowest-cost bidders to supply it.

If a generating company is not selected, it loses the opportunity to sell its electricity during that hour. And selling power is how generators create revenue to pay for things like workers, power plants, and fuel. This means that generators have an incentive to bid as low as possible and sell as much electricity as possible.

Generators in Texas are facing criticism now that they weren’t prepared to operate in extremely cold temperatures. But consider the challenges facing two Texas generators that are identical in every way, except that one decides to invest in winterization. That company will have higher costs than its competitor and may be forced to submit higher-priced offers in the market, potentially losing out on opportunities to sell its electricity.

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