As the Lone Star State shivers in the dark, it’s worth considering how we got here.
As the Lone Star State shivers in the dark, it's worth considering how we got here.
A s practically every Texan and much of the rest of the country now knows, Texas’s electrical grid is managed by the comically misnamed Electric Reliability Council of Texas. To the extent that its reliability is the issue, what it is is reliably incompetent. As Texas shivers in the dark, there’s plenty for everybody to hate in this story. But it does present an opportunity to consider three concepts that can shape our public policy for better and for worse.
Hedging Risk
Hedge investments are investments meant to mitigate risk. The original idea behind hedge funds was that they would provide a place for big-money investors to park some of their assets and earn a decent rate of return while avoiding certain risks, such as stock-market downturns or inflation. Hedging can get complicated, but the idea is pretty simple: If you own an airline, for example, fluctuations in the price of jet fuel can wreak havoc on your profitability, and so you might invest in jet-fuel futures (or oil futures, or other instruments) to offset some of that risk: In the event of a price spike, your operating expenses will increase, but you’ll make some of the money back on your hedge investments. Airline stocks and oil prices are negatively correlated, meaning that news that boosts oil prices is bad news for airlines, and news that hurts oil prices is good news for airlines.
One of the principles of hedge-fund-portfolio management is the pursuit of such negatively correlated positions or simply non-correlated positions. If two assets are non-correlated, then market developments that influence the price of one will (in theory!) have no effect on the other. That’s the idea behind portfolio diversification: A failed clinical trial may be bad news for your pharmaceutical shares, but it probably will not change gold prices one way or the other.
What you don’t want in your portfolio is a lot of positively correlated assets, i.e. investments that are likely to rise and fall together, amplifying your overall risk rather than mitigating it. If you have half of your portfolio in GM shares, you probably don’t want to put the other half in Ford shares, because major changes in the automotive industry that are a risk for GM are also a risk for Ford.
As a way of thinking about risk, hedging and correlation are not limited to the schemes and shenanigans of Wall Street types. And while there is financial hedging at play here, what I am interested in is the management of risk that is not exclusively financial.
The fundamental reason for Texas’s blackouts is correlated grid risk: The kind of winter storm we currently are experiencing — unusual but hardly unprecedented — drives up demand for electricity while simultaneously driving down the available supply of the stuff. The system can withstand a spike in demand, and it can withstand a dip in supply, but it cannot withstand both at the same time. Hence the blackouts.
In addition to the usual troubles of downed power lines and the like, electricity plants are having a hard time getting fuel or using the fuel they have, including natural gas and coal. So-called renewables such as wind power and solar perform poorly, or do not perform at all, in such conditions, while natural-gas, coal, and nuclear facilities have been shut down or hampered by pipelines, instrumentation, and other equipment that is inadequate to the current conditions. Texas has more than enough natural gas to power itself through a storm such as this one, but it does not have sufficient capacity to get that fuel where it is needed or to use it in the current conditions. If you can’t get the gas where it’s needed, you may as well not have it at all.
Texas could have an infrastructure that is better prepared for this kind of thing, but the upgrades would be expensive. Nobody wanted to pay for them a week ago. Nobody will want to pay for them a week from now. But today, millions of Texans wish the money had been spent — preferably by someone else, of course.
One model for thinking about that infrastructure is a very common hedge used by millions of Americans: life insurance. Life insurance is a risk-management tool, a premium you pay in order to provide a financial hedge against the possibility that you die before you can make adequate financial provision for your survivors. There are two ways of looking at that proposition: Some people will live to 102 with plenty of money in the bank — was all that money spent on life insurance they never needed wasted? Depends on how you think about it.
Similarly, some people have responded to criticism of the situation in Texas with this line of argument: Why should cities such as Dallas and Houston, which rarely see snow, or the state of Texas as a whole, where most of the people live in metros that rarely see much snow, make costly preparations for rare events? Why should the utility companies serving these people make costly preparations for rare events, knowing that it is the very customers who would benefit during a blue norther in February who will in April and May most bitterly criticize any costs passed along to them?
That’s not a question that can be answered empirically, because it is a matter of disposition: Would you be more irritated by paying for something you end up not needing or by not having paid for something that you end up needing? One of the many shortcomings of democracy, including the regulation of industry by democratic institutions, is that people will change their minds about that depending on their own momentary situation.
This presents an ideological challenge for conservatives: Are we to be “conservative” in the sense of penny-pinching, or “conservative” in the sense of risk-averse? Both? Neither? There are legitimate, good-faith cases to be made for many different approaches. Money spent on improving Texas’s electricity infrastructure might prevent some loss of life and loss of economic activity, but the money thus spent cannot be spent on other needful things — road improvements, preventative health care, etc. — that also could prevent loss of life or of economic activity.
Don’t ever let anybody tell you that the choices are obvious. They aren’t.
Corporatism
So, is this a failure of Big Government or a failure of Big Business?
Yes!
In Texas, as in most of the country, utilities are run on classic corporatist models, meaning that formally private (in the case of ERCOT, nonprofit) corporations, heavily regulated in what’s alleged to be the public interest, serve consumers on a monopolistic or near-monopolistic basis. As in the case of the old telephone monopoly, this is only partly a matter of political preference — the situation is determined largely by the physical facts of running wires and pipes into houses and industrial facilities. There is no practical way to have 25 competing utility providers with 25 independent, privately owned sets of pipes and wires. The situation for Texans who have some notional choice of utility providers is more like the situation with parcel shipping: You can choose between FedEx and UPS, but the roads are the roads, and if the roads are unpassable, then one will be just as completely sidelined as the other.
The lesson of the utilities is a lot like the lesson of health care and mortgage lending: Having some kind of consumer choice and market competition may be helpful, but it works a lot better for some kinds of goods than others; regulation “in the public interest” does not ensure that the interests of the public are actually served; price controls can reduce investment and create artificial scarcity; there are practical physical limitations on the production and delivery of all goods, but these are expressed in an especially acute way in some sectors relative to others.
Conservatives generally prefer free markets and private enterprise to government-centered approaches, and generally prefer (at least in theory) deregulation to regulation, consumer choice to enforced standardization, etc. But the facts on the ground (and, in this case, the facts in the ground) are complex and not easily fitted into ideologically satisfying narratives.
It’s a great big world, with room enough for both public and private incompetence.
Tragedy of the Commons
When the Reliability Council goes wobbly, it immediately calls on consumers to reduce their own electricity usage, i.e. demands that they impose rationing on themselves in addition to the rationing that will be imposed on the state at large by rolling blackouts and other service interruptions.
But why should that be necessary? Why should we be experiencing a tragedy of the commons in a fee-for-service situation? Texans get utility bills. We pay for water, gas, and electricity — many will complain that we pay far too much for them. So why aren’t we naturally thrifty? Why, as some of our neighbors face danger and distress because of power cuts, do some Texans still have their Christmas lights on?
I live in a 100-year-old house in Texas that is not exactly airtight. The windows rattle a little bit loose in their frames, there’s no insulation in the walls, and none of the major mechanical systems is of the most efficient or economical kind. There are millions of people living in millions of old houses like mine, and millions who live and work in modern buildings that are no more energy-efficient — and in a surprising number of cases are less energy-efficient — than buildings put up a century ago. If economic incentives really work, why is that the case?
There’s an answer to that mystery: Energy is cheap.
Thank goodness for it. Cheap energy gives us a lot of choices about where we live, how and when we travel, what we eat, how we do business, how we entertain ourselves, etc. Having come to rely more and more on delivery services during the COVID-19 era, many Americans still do not really appreciate how much cheap fuel contributes to their standards of living. That $4.99 restaurant-delivery fee could be $20. Everything you consume via Amazon, and everything that moves on a truck, train, or ship — meaning, roughly, everything — could be 20 percent more expensive if energy cost more. It could be five times as expensive. Cheap energy is a critical ingredient in cheap everything.
Energy is cheap because of investment, entrepreneurship, and excellence in engineering, along with some reasonably good public policies that enable, in this area at least, prosperity to emerge. But environmentalist critics might charge that energy is cheap because we don’t really pay the full price for it — that negative externalities in the form of pollution or greenhouse-gas emissions are as a practical matter priced at $0.00. And they would have a fair point. That’s part of the case for a carbon tax.
The buying and selling of diesel and gasoline happens in much more of a real, consumer-driven free market, one with lots of sellers and buyers, than does the buying and selling of electricity at the consumer level. But electricity and gasoline are both, for the most part, cheap. And so neither the free market for automotive fuel nor the corporatist market for home and business electricity has led to a lot of economizing behavior on the part of consumers. As a friend of mine put it, “I don’t know what a gallon of gasoline costs — why would I? It’s not like I’m going to stop driving.” Of course, there is some point at which prices would influence consumer behavior, and we have seen preferences for more fuel-efficient cars wax and wane vis-à-vis trucks and SUVs as gasoline prices fluctuate. I’d probably drive a more fuel-efficient car if I were paying European gasoline prices. I’d probably have a more energy-efficient house if it meant savings that would improve my household budget in some meaningful way rather than in a one-venti-latte-a-month way.
So, energy is cheap. Is it too cheap?
Again, this is a question of disposition and priorities, not a question that can be answered empirically. If your priority is reducing greenhouse-gas emissions, then, yes, energy is too cheap — far from the price at which we might expect to see major changes in consumer behavior in the United States or around the world. If you want people in San Antonio to build more energy-efficient houses or for people in Dallas to live closer to their offices, then energy is too cheap. If you want impoverished people in India and China to cease closing the gap in their standards of living relative to the United States and Europe, then, yes, energy is too cheap.
But focus for now on the domestic context: If an extra $20 in your utility bill means $20 out of your grocery budget, then you probably don’t think energy is too cheap. If you are in the airline business or the trucking business, then you probably don’t think energy is too cheap. And most of us, with the exception of a few radical environmentalists whose convictions are metaphysical, probably don’t think that our standard of living is too high, that we would be better off paying more for the things we use and enjoy. That’s another way of saying that we don’t think energy is too cheap.
So we cannot agree about which energy-related risks ought to be hedged against and how, don’t have a lot of promising avenues for cultivating robust market competition and choice from wellhead to wall socket, face real limitations on physical infrastructure that would be very expensive to improve, and, to a considerable extent, disagree about what desirable outcomes would look like even if we enjoyed unlimited policy discretion and economic resources, which we don’t.
A few years ago, I was introduced to a very nice gentleman who told me that he was the head of strategic planning for the local utility company. “Is your strategic plan to keep being a monopoly?” I asked. “Because that would be my strategic plan.” It was a joke, of course, but the underlying dilemmas are real. They touch on a vital component of our prosperity and, occasionally, on urgent matters of life and death.