Electric Experts Wed to Regulation (continuation of prior discussions)

By Robert Bradley Jr. -- April 15, 2021

“By definition a free market means open access and competition. Your interpretation of Hayeck [sic] is flawed.” (Robert Borlick, below)

“Rob … I don’t think you have the foggiest idea of how the Austrian school of economics is relevant to electric power systems.” (Robert Borlick, below)

In the ‘never too late’ category, it’s time to introduce insights from the Austrian School of economics to electricity. Here is a running exchange with some power-market experts on my attempt to do just this.

I should emphasize that I am learning from them, as I hope they are learning from me. I have tested their patience with the notion that regulation/planning/renewables has hurt the Texas system–and hurt it enough to have caused the Great Blackout.

I am introducing new ideas to them, which really aren’t so new (see Raymond Niles in 2008 here). I have tried to explain that physical planning of electricity does not require regulation and central planning; that “natural monopoly” was not so natural before franchise protection; and competition is defined by open entry, not by the number of distinct rivals.

Austrian-school economics, really. Revisionist regulatory history, too. All with a basic reminder that private property rights are just that, with electricity as elsewhere. It’s all there if the PUCT/ERCOT defenders want to check their premises.

Previous exchanges on this topic are here and here. (The overall discussion link at LinkedIn is here.)

I report, you decide….

Borlick: Rob, do you understand the role that network constraints play in power systems? There is no way that those constraints would not be violated in the “free” market you just described. The grid would go dark very quickly in the absence of a system operator (like ERCOT) to direct the traffic. I apologize for being a bit hard on you but you need to appreciate that power systems are very complex machines. MWhs are not bushels of corn.

Bradley: Yes, I understand the need for control areas and coordination for reliability. My point is that outsourcing reliability to experts/planners/regulators and having a fractured, disintegrated industry utterly failed.

We need electricity majors and natural gas majors to ensure reliability and price correctly. This is where Hayek and Austrian economics comes into play.

Cooperation, not only competition. Market prices, not regulated prices. Private property rights, not mandatory open access. Free industry structure, not enforced divestment.

Borlick: What are these “majors” you refer to? Integrated electric and natural gas companies? Integrated companies have a tendency to self-deal and they do not produce solutions that maximize social welfare.

Where we have vertically integrated electric utilities it is not uncommon for customers served by different companies that live across the street from each other to pay very different prices for electricity. How can that be efficient?

Borlick: “Cooperation, not only competition. Market prices, not regulated prices. Private property rights, not mandatory open access. Free industry structure, not enforced divestment.”

This statement is internally inconsistent. By definition a free market means open access and competition.

Your interpretation of Hayeck [sic] is flawed.

Bradley A free market is defined by private property rights and voluntary exchange, not forced access to created a (contrived) market. Go ahead and argue for the superiority of mandatory open access and the Texas system over a true free market, but don’t go against the common definition of a free (government unregulated) market.

Bradley: The point is that there are different pricing designs and experts/regulators/planners have to pick–that is central planning over large market areas such as PUCT/ERCOT’s 90 percent share of Texas. This is Hayek’s fatal conceit versus a true free market.

Yes, I know I am repeating myself …. but to say this is not central planning is disingenuous. Electricity can be provided reliably within companies without price and access regulation.

Whether or not this is the best policy, that is another debate where we disagree and can leave it at that.

Borlick: “The reliability function in a true market would rest with companies, not regulators/planners.”

I think the most recent ERCOT blackout reveals what happens when reliability is left to companies with no regulatory oversight.

The natural gas industry and, to a lessor extent, the electric generators ignored the recommendations to winterize their assets because they calculated that it would reduce their profits. The polar vortex was a low probability event whose risk they were willing to take.

The result of their calculations is that several hundred people died and millions went without electricity for days on end. The water supply has been contaminated in many cities and the property damage to homes and businesses from frozen water pipes runs into the billions of dollars.

Coase would argue that the industry participants be held liable for the damage they created. But they won’t be because (1) retail customers have a legal right to firm, uninterrupted service, (2) many contracts to supply gas or electricity contain Force Majeure clauses and (3) even if this were not so the guilty parties could simply declare bankruptcy and walk away from the mess they created.

So what’s you non-regulatory solution?

Bradley: Electricity is one of the most regulated and centrally planned industries in the U.S. You desire more and new regulation to address the problems created by prior regulation. The PUCT/ERCOT system failed miserably. The reliability function got outsourced–and failed historically. The fatal mix was renewables and mal-planning.

The debate should include not only what we have today and the old public utility model but, thirdly, a true deregulation model, No franchise protection, no rate regulation, no restrictions on company structure. No PURPA, PUHCA, and mandatory open access … and no renewables subsidies.

Corporate guarantees and performance, not expert/regulator/planner edicts, will best solve the economic calculation problem under planning.

Shubert: Rob, are you talking about a private use network? Doable, but often inefficient and prone to monopoly power.

Bradley: Yes. Not really a ‘private use network’ as much as an unregulated market ‘design.’ What we would have in a true free market.

We are making progress in our discussion. “Doable” says that reliability and coordination can be ‘insourced’ as it now stands. Given that, we are then in a debate about which is better. That is a different question that I am prepared to address. Again, it has taken awhile, but you get my initial point about Grade A corporations addressing reliability and efficient pricing in place of PUCT/ERCOT.

One point regarding monopoly power. Hayek and Mises and the Austrians, Israel Kirzner, being prominent, censure perfect competition, marginal cost pricing, and more-firms-the-better. Equilibrium efficiency is not real-world (disequilibrium) efficiency where profit/loss creates whole new means/ends frameworks.

Monopoly power to them is franchise protection and government as monopolist regulator/planner. And then there Public Choice on regulator/planner incentives, capture, and so forth.

This gets to many issues regarding the theory of natural monopoly, the historical development of firms prior to regulation, and real world regulation… We had better put that aside for now!

Pokalsky: Robert it’s apparent now that Rob is playing you to get unpaid industry professional feedback on as premise for a new book or series for his website. I’d leave it alone. Even if you convince him he’s on the wrong track, he won’t admit it.

Borlick: That is an interesting insight. I kept wondering what his motive is in presenting these vague concepts.

Bradley: Joe–The greatest debacle in the history of electricity occurred. I have laboriously presented a viewpoint–a tradition really–that no-one seems to know much about on this thread.

I have been patient and have looked the other way with some insults (from Mr. Borlick; Mr. Shubert is very polite, and you have been okay until recently).

We are not going to resolve our differences on regulation versus deregulation. B, but we have reached agreement, I believe, that reliability from firms without mandatory open access is a viable alternative to the external expert/regulation/planning approach.

Pokalsky: We’ve agreed on nothing.

I believe the industry professionals you’re critiquing know a lot more about the subject matter and the history thereof than you give them credit for. The primary reason for the discord is that you’ve continued to flog some poorly defined notion regarding “firms”, “regulation” and “planning” without specifics or making a relevant comparative analysis between the current state of affairs and how you propose to improve them.

Given this, as well as that you’re in the writing and publishing business, I can only surmise that you’re bouncing ideas around for feedback on some future publication.

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Borlick: Why are you so hung up on Sam Insull? The regulated, vertically integrated utility model that he pioneered is essentially obsolete. Why? Because it is difficult to provide management with incentives to make efficient decisions under rate-of-return (ROR) regulation. Numerous scholarly papers have been published on the incentives issue and the associated Averish-Johnson effect.

Furthermore, during the 1980s we witnessed the excessive costs that the regulated ROR model imposed on utility customers. That was the primary reason for substituting market competition for regulation. Read the California “Blue Book.”

We live in different times than Insull lived in. The electric power industry was in its infancy then. It has since matured and substantially evolved. The Insull model is no longer relevant.

Bradley: Your argument forgets that the Insull era was compromised by public utility regulation. There should not have been franchise protection. There should not have been cost-based rates inviting a future generation(s) to provide ratebase incentives for overly reliable (yes) generation. Nuclear plants and all of it.

So I do not disagree with your criticism of the old system. But it was not Insull’s as practiced. Insull priced below cost-of-service to turn power from a luxury into a necessity for millions, one of the greatest business stories in American history. I am familiar with the literature you cite above. Lived through the Blue Book and have written about it all in Enron Ascending.

We need all the ingenuity and effort now going into electricity regulation and planning to go into how companies would perform in a free market world. What would contracts look like in regard to price and reliability? How would open entry in place of franchises exert competitive pressures on vertically integrated providers? How would monopsony by organized consumers check a locational monopoly.

There would still be work to be done by experts/lawyers in terms of contracts between buyers and sellers at retail for sure.

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Bradley: … Government franchises were the monopoly blemish, not the market. Austrian competition theory is quite different from equilibrium-centered neoclassical theory. Open entry is key, not the number of firms. Perfect competition is actually not competition at all or a welfare ideal–there is no entrepreneurship and process.

Borlick: Rob, that’s a word salad that is unintelligible. Start by describing the specific differences between the Austrian school and the neoclassists. Also, are you advocating open entry for utility companies? That was the situation 100 years ago. Because networks are natural monopolies they resulted in inefficient redundancies. Eventually one entrant emerged as the strongest, ran the others out of business and emerged as the monopoly provider.

Lastly, what do you accept to be the welfare ideal? How do you measure it?

Bradley: 1) Pardon the word salad: Austrian-school economics might be unfamiliar, and it does require explanation and jargon.

2) I am advocating entry against utilities, not only for utilities.

3) The standard natural monopoly view is open to a quite different interpretation. Competition was never ‘over’ in the manufactured/natural gas industry (See my essay in New Horizons) The Insull history with electricity shows that Insull did not need to be regulated, and he should not have gotten franchise protection either.

4) The welfare ideal for competition & entrepreneurship is open legal entry. Government traditionally has been the monopolist both in itself (a monopoly!) and in dispensing business favors. (Who regulates the regulators is an important ‘monopoly’ question.)

5) Competition as a welfare ideal cannot be measured. The HHI is a perverse standard for such measurement. Entrepreneurial discovery to change means/ends frameworks is the holy grail, not perfect competition where competition is over and entrepreneurship does not exist.

Borlick: Rob, my patience with your comments has ended. I don’t think you have the foggiest idea of how the Austrian school of economics is relevant to electric power systems. Have since day.

Appendix: Prices and Planning

The choice between spot-price payments to the lowest bidder of electricity and a payment for standing ready for reliability is an inherently subjective one. The “energy” versus “capacity’ payment question is one that central planners must answer–but can they? Texas’s PUCT/ERCOT ‘energy’ payments failed the entire system—hurt in part by renewables winning the bid day.

Borlick: “So there IS an indirect negative effect from renewables on reliable generators.” [Bradley]

Actually the effect is direct in that fossil generators collect less net revenues from the energy market in most hours to contribute to fixed cost recovery. But the ERCOT market design offsets this loss by increasing in net revenues earned when scarcity pricing is invoked. ISOs with capacity markets offset that loss through higher capacity payments. You keep beating this dead horse.

Bradley: The point is that there are different pricing designs and experts/regulators/planners have to pick–that is central planning over large market areas such as PUCT/ERCOT’s 90 percent share of Texas. This is Hayek’s fatal conceit versus a true free market.

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