frozen electrical tower

Texas Power Crisis Revealed Flaws in Energy Market Design

February 15, 2022

When Winter Storm Uri arrived in Texas last February, a series of miscalculations, missteps, and regulatory barriers led to deadly power outages. The Electric Reliability Council of Texas (ERCOT) experienced generation shortfalls on an unprecedented scale. Rolling blackouts and extended outages created an infrastructure failure that led to more than 200 deaths. While Texas reformed some parts of the market, several problems remain.

In a new study, a coalition of researchers, including University of Colorado Denver’s Lynne Kiesling, found that as extreme weather events multiply, decentralized energy markets like ERCOT need to reduce vulnerability through reforms like focusing on the allocation and sharing of risk, and regulatory improvements to facilitate contracting along the supply chain.

“You’re never going to be able to forecast weather with 100% accuracy, and you’ll always face some risk,” said Kiesling, PhD, research professor in the College of Engineering, Design and Computing and co-director of the Institute for Regulatory Law & Economics at CU Denver. “But good markets give participants ways to trade that risk with each other. We need to design market rules and regulations to acknowledge the increasing risk and allow participants to figure out how to manage it.”

The study was published in Joule.

Building Resilience in the System

In the late 1990s, several U.S. states restructured their electricity regulation from fully regulated (using averaged, fixed prices to charge consumers year-round) to wholesale power markets, which function as auctions for fluctuating energy needs. These decentralized markets rely on investors to anticipate demand for all conditions and build appropriate resilience into the system. They allow prices to soar during extreme events to incentivize preparedness.

“Decentralized markets allow for changes in the underlying cost of providing energy at any point in time to be communicated more quickly and more transparently to participants,” said Kiesling. “It allows you to coordinate and adapt to changing costs and benefits much more quickly. The problem is that there are rules or laws in place that can affect how well that coordination happens.”

The interdisciplinary team of co-authors, with expertise in industrial engineering, macro energy system models, economics, and law, include lead author Jacob Mays of Cornell University; Michael T. Craig of the University of Michigan; Joshua C. Macey of the University of Chicago Law School; Blake Shaffer of the University of Calgary; and Han Shu, a doctoral student in the field of systems engineering at Cornell University.

Using Interdisciplinary Action to Address Vulnerabilities

The researchers argue that decentralized energy markets are prone to underinvestment in resilience against rare events. They say real-world gaps in risk-trading undermine the markets’ idealized assumption of what economists call complete markets in risk.

To address that vulnerability, the researchers found that ERCOT and similar systems must do a better job of translating high spot prices into stable, long-term contracts with more certain returns on investment. Their proposed fix: mandatory contracting to require advanced energy purchases, preferably through financial contracts rather than requiring investment in new generation capacity.

Through their research, they also found reducing vulnerability means supply chain weatherization (a recommendation that followed outages in February 2011 but was never implemented fully in Texas), a robust set of long-term forecasts and their consequences, clearinghouse rules to reduce the likelihood of revenue shortfalls during extreme events, and retail contracts for customers.

Ultimately, Kiesling believes the best solutions will be found by interdisciplinary collaboration.

“We were surprised at our complementary approaches to the same question,” said Kiesling. “Energy grids and markets are such sophisticated, engineered systems. Engineering, economics, public policy, and law are needed to answer important energy questions.”