When Daniel and Jordan married and moved into an Austin apartment, the electric power part of the move was simple: a city utility was the only choice. A few years later, having saved some money and with their first child on the way, they bought a house in the suburbs north of the city. (Full disclosure: Daniel and Jordan are a real couple related to one of the authors.)

This move required them to make a new decision: picking an electric supplier. You might think of it as a hassle—one more thing on a “to do” list which was long enough—or as an opportunity to choose the electric power deal you want.

Daniel talked to his colleagues at work about choosing a plan, then sorted through plans on the state’s Power to Choose website (www.powerto- choose.com) looking for a low rate and 100 per- cent renewable content. The Power to Choose site was useful, Daniel said, but frustrating, too.

The average price numbers prominently featured were sometimes misleading. A contract might offer low prices up to 1,000 kWh but absurdly high prices after. He found himself digging into the details of each contract he was interested in and doing his own math to avoid a bad deal. They liked the plan they found, but after a few years it was discontinued.

Again, Daniel found the Power to Choose site both useful and frustrating. Daniel and Jordan had discovered their home sometimes required quite a bit of electricity to keep cool in the summer, so plans were scrutinized for extra charges at high rates of consumption.
Ultimately, they selected a new plan offering 100 percent renewable content at a price that rose from about 7.5 cents to 8.5 cents per kWh.

The state’s Power to Choose website makes it easy to search for offers with high renewable content, or especially low prices, or long-term contracts with stable prices.

Some retailers have special offers directed at consumers with home solar power systems, or prepaid contracts that don’t require credit checks or up-front deposits, or contracts with prices that vary month-to-month with the underlying power market.

If not quite something for everyone, the competitive Texas retail market offers many more options than available to consumers elsewhere.

For a long time in the electric power industry, in Texas and elsewhere, almost all electric power consumers had just one choice: the local monopoly electric utility designated by state regulators to serve an area and to keep power supply and demand in real-time balance.

One company built the power generators, transmission and distribution lines, and billed consumers under rates regulated by state or local governments.

In many parts of the country, the system still works that same way: one company, with a monopoly territory protected by state regulators, with rates overseen by state regulators.

In most of Texas and a handful of other states, retail consumers have a choice among competing retail power suppliers. Most Texans can choose from among dozens of suppliers and face as many as two hundred different plans.

The Texas approach is recognized among industry specialists as being different — some experts say it is one of the best.¹

Our goal in this report is to describe the Texas approach and what makes it work. The market is not perfect, of course, and is under constant pressure to adapt and grow.

We also discuss some of the pressures facing the Texas electric power industry, and how market players and regulators can respond to those pressures while preserving the character that helps it succeed.

THE TEXAS ELECTRIC POWER INDUSTRY works differently enough to be worth explaining what makes it different, why Texas policymakers switched (most of) the state from monopoly to competitive supply, and what it all means for consumers. Here we introduce the Texas model, give some background, and then evaluate how the Texas system has been working.

Monopoly has been common in electric power for so long that some people find it hard to imagine alternatives. In fact, the electric power market was once a hotbed of competition. At the very beginning of the 20th century a large city like Chicago might have had 20 or 30 small power companies competing for business. Electric power was slower to come to smaller towns, but by 1920 even a small West Texas town like Lubbock, with only a few thousand residents at the time, featured two competing electric suppliers. As the industry matured, commercial and political pressure ensured that state-protected monopolies quickly dominated the industry.

Monopolies had real advantages. Economies of scale and scope allowed bigger companies to capture technical efficiencies and have cost advantages. In addition, the electric power system is composed of several parts that must be carefully coordinated to maintain reliable service. The electric power industry traditionally has three basic parts: electric power generators, end users, and the transmission and distribution systems connecting them. Before the age of computers and advanced communication technologies it would have been difficult to maintain the coordination necessary to operate a competitive system.

Today the electricity landscape is more diverse. Homeowners and businesses may have solar power systems or other energy-generating capabilities, or electric vehicles that both consume power and store it. Widespread competition has emerged in the power generation segment of the industry. These and other innovations make it possible to reform the monopoly model and allow for wholesale competition among generators and retail electric choice.

Early electric companies had just two or three generators, and at the time larger generators could be much more efficient than smaller ones. These economies of scale at the power plant meant that a single company with a few large power plants could operate more cheaply than several smaller

companies with smaller power plants. The logic of efficiency drove the industry to larger and larger power plants. The five-megawatt steam turbine installed in Chicago in 1903 was the largest of its time and produced power at half the cost of smaller power plants.²

But by the 1970s, new power plants were being built that were 100 times larger, and sometimes even bigger than that. Small power plant technologies also improved over the century, and also by the 1970s sometimes a small power plant – when fit to the right situation and the right location – could be just as cost effective as a large power plant.³ By the 1990s with the combined cycle gas turbine, smaller plants could compete effectively with large coal-fired plants in many situations.⁴ The economies of scale justification for bigger power plants owned by one large monopoly, once a major force encouraging monopoly, faded in importance.

At the retail end of the industry, where electric power is sold to the end user, simplicity rather than economies of scale drove monopolization. With a single company owning the power generators and the wires linking that supply to consumers, it was natural enough that a single company would sell to the final consumer. Those retail consumers spanned from large industrial consumers on one end to small individual households on the other, with a wide range of businesses in between the extremes. As regulated monopoly became the dominant system, regulated rates applied to three defined customer categories: industrial, commercial, and residential. Sometimes within a customer class there would be two or three options but increased variety made regulation more difficult so offerings were limited.

The wires connecting generators and end consumers still show significant economies of scale (“wires” is a catch-all term for all kinds of equipment including poles, transformers, relays, some very high-tech electronic components, meters, and yes, a lot of actual wires). High voltage transmission systems connect distant power generators to big cities, while lower-voltage distribution systems cover cities and towns to deliver power to end-users. The electric meter, almost always owned by the distribution company is the traditional “end of the line” so to speak.

While the generation business and the retailing business quickly became venues for potential competition in states that reformed, the wires business in the middle has remained a regulated monopoly. The wires business has been changing, with digital meters most obvious to end consumers, but high-tech components are growing in importance for efficient and reliable operation of transmission systems as well. Growth of consumer-owned generation like rooftop solar also creates new challenges for the distribution system. Still, economies of scope seem to dominate the wires business, since power delivery requires producing and coordinating man specific actions so the logic of monopoly and regulatory oversight remains.

Economies of scale for generation, economies of scope for the wires part of the business, and the need to coordinate generation with consumption while managing the wires systems to prevent overloads, all pointed to monopoly as the way to do things for most of the twentieth century.

But a century of technological growth had created alternatives. Economies of scale are not as important as they once were. Digital communications and computer technology can manage the necessary coordination between generators, consumers, and the wires business (with some oversight). In today’s high-tech interconnected world the old justifications for monopoly are no longer dominant.

The federal Public Utilities Regulatory Policy Act of 1978 (PURPA) set in motion a variety of changes in the electric power industry, opening the possibility of competition in wholesale and retail power. In Texas in the mid-1990s, most large electric power monopolies were physically connected to each other and a state-regulated Independent System Operator (ISO) called ERCOT took over scheduling and oversight of the transmission grid. ERCOT formed a wholesale market as part of the ISO to help the system work at least cost.

Elsewhere in the United States other ISOs were formed, eventually covering about two-thirds of the electric power grid. Similar developments were happening in other countries, too, in some cases even before they were developed in the United States. ISO management of the grid removed monopoly control over use of the high-voltage transmission part of the wires business, and set the foundation for wholesale competition.

Regulatory reform came to the retail level in Texas via Senate Bill 7 (SB7) passed in 1999, with a start date set for January 1, 2002.⁵ SB7 required investor-owned electric power monopolies to separate the wires part of the business from the power generation and retailing segments. The wires business remained state-regulated monopolies, but use of the transmission grid was now overseen by ERCOT. Power generation and retail sales were opened up to competition for most Texans.

As a political compromise city-owned electric utilities and rural electric cooperatives were given the opportunity to choose whether to remain as traditional monopolies, and almost all of them have done so. In addition, some electric utilities distant from the major population centers were not connected to the ERCOT system and lacked access to a competitive wholesale market in 2002, and these utilities were also allowed to remain as regulated monopolies. Overall, however, about 90 percent of the electrical load in Texas is served by the ERCOT system, and about three-quarters of ERCOT power consumption occurs in the competitive retail power market in Texas.⁶

In addition to Texas, 12 states and the District of Columbia allow some form of retail customer choice for residential customers. A few more allow retail choice for large industrial and commercial customers. In many respects reforms in these states resemble what Texas has done, but two main differences set Texas apart. First, much more so than in most other reformed states, Texas insisted upon full corporate separation between the monopoly wires business and the other segments of the industry. Some states merely required separating segments of the industry into different divisions of a single company. In addition, most state policies allow consumers to remain on a state-regulated “default service ” provided b an affiliate of the incumbent regulated wires company. Texas explicitly phased out this kind of standard offering. Instead, Texas required all retail billing and customer interaction to be performed by independent retail companies (Retail Electric Providers), and while those companies who were or had been affiliated with regulated incumbent utilities could continue to serve their customers, they were required to do so for several years at a higher price to encourage customer shopping for competitive offers. In fact, this last resort service has been only rarely used, considering the robust number of competitive offerings available.

One other reason that Texas is different is that the ERCOT power system is contained entirely within the state of Texas and the system is almost wholly regulated by the Public Utility Commission of Texas (PUCT). Reliability rules are under federal jurisdiction, but much of the rest of the industry is regulated by the PUCT. Elsewhere in the continental United States both federal and state regulators have separate but partly overlapping authority. The separate authority and diverse perspectives among federal and state policymakers sometimes adds to the challenges of overseeing the industry. Texas has benefited from the more unified regulator system it has maintained.

When citizens and policymakers in areas with a traditionally-regulated power industry consider introducing competition one of the first concerns is reliability .

Modern American society relies heavily on constant access to electric power supplies. Few would be interested in the promised benefits of competitive power markets if they meant unreliable power supplies.

Texas and other states allowing customer choice have dealt with reliability the same way. The companies that own the transmission and distribution wires part of the business remain regulated public utilities with a duty to serve end users and rates regulated by the state utility commission. While the power generation sector and the retail supply sector of the business have seen competition grow, the wires part of the business is still seen as a regulated natural monopoly business. In addition, U.S. law requires electric companies to comply with reliability standards issued by the North American Electric Reliability Corporation, the FERC-designated electric reliability organization for the United States. The grid in Texas operates under the same reliability rules as the rest of the United States.

Because end-use customers all draw power from the same electric power grid, in theory the reliability of service is the same for all. Retail competition does introduce a few complications. For one thing, a competitive retail supplier can go out of business. Customers of a failing retail supplier do not lose power. State rules provide for these customers to be transitioned to a provider of last resort until they pick someone new.

Allowing these badly-managed companies to fail provides valuable discipline in markets. One difficulty with the traditional monopoly system is that badly-managed regulated monopolies are hard to reform. Regulators try to encourage efficiency but cost-of-service rate regulation is a cumbersome tool that can hamper the regulator’s ability in this respect so inefficiency can grow. In most of the economy, good companies thrive and badly run companies fail. The Texas market shows how this important mechanism for customer-oriented improvement can work in electric power retailing as well.

In fact, the restructured market in Texas has allowed some commercial consumers to get better reliability service than provided by the regulated distribution grid. Regional grocery store chain H-E-B paired up with energy services company Enchanted Rock to install small onsite natural gas generators.¹⁰ When grid services are out, the generators kick in and keep a store’s lights on and refrigerated food cold. When the grid is operating normally, Enchanted Rock uses the generators to provide reserves and other grid support services. Such systems are also in place in traditionally regulated states. In regulated states utilities sometimes block innovation that undercuts their position, while in restructured markets innovation is just about “business as usual.”

The market design in Texas does not specify a particular amount of generation that has to be held in reserve for reliability purposes, and relies instead on price signals in the wholesale market to communicate that buyers should conserve and sellers should generate more power. Compared to other wholesale power markets, Texas has a high price cap of $9,000 per megawatt-hour, allowing high prices to signal scarcity.¹¹ On August 12, 2019, Texas had a heat wave and reached its highest ever peak load of 74,280 MW. Peak real-time prices were high and reserves were low, but there were no involuntary blackouts. As Alison Silverstein notes in her analysis of reliability in Texas, “even under the pressure of August heat and record peak load the OT market worked as designed.”¹²

In a traditional vertically-integrated regulatory framework, demand is assumed to be inelastic or unresponsive to price changes. Rates are cost-based and fixed by regulation refecting the average cost of providing standard service and generally are not vary- ing over the course of the day even though the marginal cost of generating energy does vary. Changes in technology and the competitive regulatory framework in Texas are challenging that assumption.

Active demand, including demand response either to changing prices or to an administrative RTO program yields several benefits. By reducing quantity demanded when prices are high, demand response reduces the frequency and magnitude of prices spikes, reducing energy costs both to those engaged in active demand response as well as those who do not respond but pay lower prices due to the impact of reduced demand on the grid. High prices tend to occur in peak hours, so by shifting demand to other hours, demand response reduces peak demand, which consequently reduces the chance of outages and overall transmission and distribution system costs. These s stem benefits are the main motivation for administrative demand response programs that pay customers for reducing consumption when the

RTO requests it. RTOs in the US, including ERCOT, have such administrative demand response programs that have been designed for large commercial and industrial customers, but also enable the participation of aggregations of residential and small commercial customers.

Active demand and demand response from residential customers are now easier and cheaper than before because Texas utilities in the ERCOT territory have implemented digital metering. With guidance from the Public Utility Commission of Texas, distribution utilities began installing digital meters in 2008 and completed the digital meter roll- out in 2012, replacing all of the analog meters in their service territories. Digital meters enable residential customers to send and receive data in 15-minute intervals. The data from the meter can be sent to devices in the home, which can be automated to change their settings in response to real-time data from the meter, which is called transactive energy. For example, if there’s a price spike during a heat wave, sending that price to a household’s thermostat can trigger an automatic temperature setting change in the thermostat, reducing energy consumption and protecting the customer from paying that high price. Such distributed small-scale demand response can add up to a big enough response to dampen price spikes during heat waves, saving money for customers while also conserving energy at the exact times when generating it is the most expensive.

Cost-effective energy storage has long been the holy grail of the energy system. Energy storage would reduce some of the costly real-time coordination between generation and consumption, between supply and demand. In an electricity system with a growing share of intermittent renewables, economical energy storage becomes all the more valuable because it mitigates some of the costs of intermittency while enabling access to the environmental and resilience benefits of those resources.

Wind and solar resources are intermittent, and thus need to be part of a broader generation mix with complementary fuel sources. The chief complement to renewables thus far has been natural gas. But increasingly it will be storage as costs fall and investments increase. Energy storage technologies range from pumping water uphill (which has been used for millennia) to newer and more portable lithium-ion batteries. Improvements in battery energy efficiency and production costs in the past five years have increased investments in battery storage, particularly at larger scales.

Independent storage companies are beginning to invest in Texas, drawn to the state by the high amount and share of wind and solar in the resource portfolio as well as ERCOT’s market design and low entry costs (although ERCOT is generally viewed as a rivalrous, competitive environment for suppliers). For example, in 2018 Vistra Energy built a 10 MW capacity battery storage system alongside a solar facility in West Texas.²⁷ More recently, GlidePath Energy has built a 10 MW storage system south of Houston,²⁸ and is adding storage to wind farms in North Texas (in the Southwest Power Pool wholesale market, not ERCOT) that it purchased from Exelon Generation.²⁹

Storage arbitrages price differentials across time and across regions in Texas and provides flexibility that will become increasingly valuable as the share of renewables increases. It also increases capacity utilization across all resources in the system thus improving efficiency. In Texas where generation reserve margins have been below ERCOT’s target of 13.75% in recent years and summer price spikes in heat waves have hit the $9,000 price cap, investors see battery storage as a potentially profitable way to increase capacity in the system and make energy available in high price hours. Storage is thus a reliability resource as well as a means of improving economic efficiency in the system.

For most of the 20th century, investor-owned electric utilities in the United States have been regulated monopolies that are vertically integrated with a single firm performing generation, transmission, distribution, and retail functions. In the 21st century, falling transaction costs due to digital technologies are changing the footprint of the regulated utility. Texas is a leader in taking advantage of innovation to enable competition to serve the interests of electricity consumers.

Digital devices bring embedded sensors and automation to the core and the edge of the distribution grid, which means that more people can take more control of their own energy use and energy budgets, and can use digital technologies to automate that control. Digital technologies reduce transaction costs and make it easier and cheaper for more people to participate in markets, especially in a state like Texas that already has a well-established retail market with retail energy suppliers. Digital technologies also enable easier DER interconnection, reducing the cost of installing residential rooftop solar and working with a retailer to be able to sell energy into organized markets with little effort.

Texas has done a better job than the other restructured states of quarantining the monopoly.³⁰ The phrase “quarantine the monopoly ” arises from the work of William Baxter, who in his position as Assistant Attorney General in the U.S. Department of Justice in the 1980s was the primary architect of the settlement of the U.S. vs. AT&T case that led to AT&T’s divestiture in 1982. One of Baxter’s principal concerns regarding the welfare effects of the AT&T monopoly was what came to be known as Baxter’s Law or the Bell Doctrine – if there is sufficient rivalry or potential rivalry in that related market, then allowing monopolist participation in that market could reduce or stifle competition enabling the monopolist to extend its monopoly into the related market. Baxter’s argument was that the best feasible approach to such a situation, in which a regulated monopolist sits in the middle of a vertical supply chain with competitive or potentially competitive markets on either or both sides, is to quarantine the monopoly by restricting its market participation to its regulated functions.

The best way to do this is to separate the ownership and control of the regulated functions from the other competitive or potentially competitive functions.

Other states struggle with costly cross subsidies arising from regulatory programs such as net energy metering, and restructured states continue to offer incumbent default retail service that makes it hard for competing retailers to enter their markets. Texas, however, quarantined the wires monopoly very clearly in its implementation of restructuring. Incumbents were permitted to provide retail service in their native regulated territories only through their affiliated retail providers. They also are only permitted to provide wires-related services, which includes metering, and must offer wires service on open-access terms to their affiliated retailers and to competing retailers. Texas has done a better job than the other states of applying the Bell Doctrine in electricity, and the wholesale and retail markets have thrived and created value for consumers as a result.

New technologies and economic growth of the kind occurring in Texas create new market opportunities, such as residential solar and electric vehicle charging. These industries are likely to see lots of entry and be competitive, yielding benefits for consumers. Regulated utilities though have incentives to build and own assets to provide services like these that could otherwise be competitive. Such utility participation in potentially competitive new markets would be a violation of the monopoly quarantine that has made the Texas model the most robust and competitive in the country.

The Texas model has been frequently recognized as one of the best wholesale and retail electric market designs. Texans are well-known to exaggerate the virtues of their state, so it is worth noting that experts far from Texas are among those singing its praises. Stephen Littlechild, former chief electric power regulator in the United Kingdom, has recognized the state for having “the most advanced and effective electric power market in the US.”31 Littlechild pointed to two contributing factors: first, Texans maintain a general “laisser faire political philosophy towards markets,” and second, policymakers have kept regulatory jurisdiction over ERCOT and competitive retail markets at the Texas Public Utility Commission (while in every other state jurisdiction is divided between state regulators and the Federal Energy Regulatory Commission).

Littlechild’s summary is solid, but it is worth clarifying what laisser faire (“hands off”) means in the context of the Texas electric power model. The Texas model is not deregulation, but rather regulatory reform that means “hands off” certain decisions – generator investments and retail contract prices, for example – but “hands on” in other areas – setting capital requirements to help protect consumers from defaults by their suppliers, discouraging the exercise of market power, and otherwise establishing a foundation for the emergence of a competitive market.

The Texas competitive electric market has been through evolutions and revolutions, and through them all has managed to deliver power at reasonable rates. The regulated electricity of the past was filled with “one size fits all” solutions that at best might have served the majority of consumers well. In Texas consumers sometimes now complain they face so many options it is hard to sort them all out. The latter is the better problem. Texas is a big state and its population is incredibly diverse. “Too many options” usually just means that there are a lot of offers better-suited to someone else’s circumstances. Among the many options, though, is likely a few that are better than the old “one size” selection. As the price data show, on average Texans are paying less while getting a wider range of options.
The revolutions and evolutions have not come to an end. As new technology comes along, new opportunities arise and old ones fade in significance. Electricity storage is coming onto the market. Texas is seeing increasing investment in solar, both large scale and small. Customized energy management systems, once the province only of the largest industrial and commercial customers is increasingly becoming possible for small residential customers. As technical advance reshapes the possibilities, old rules sometimes need adapting and new rules need developing. Policymakers and market participants should keep in mind the commitment to competition, which has been maintained even as the market rules have been revised and updated over the years. To the extent possible as changes are made, those parts that have remained as regulated monopoly should remain isolated from competitive sectors. Policymakers and market participants should avoid expanding monopoly services to the extent possible a regulated monopoly, and allow competition to serve customers to flourish as much as possible.

To electric power industry specialists, reliance on competition to regulate industry performance sometimes seems odd. It really isn’t. It is the same market approach to regulating prices and product quality that drives innovation in automobiles, housing, agriculture, and other important industries. Of course, none of these industries are unregulated, but the regulations in place are targeted to protect consumers from fraud or abuse and to address specific issues like pollution. Outside of these regulations, producers are free to compete to earn the business of consumers. The goal of policymakers and market participants when reforming the restructured Texas electric power market should be the same. Choose solutions consistent with the foundational commitment to competition.