Texas experienced an electricity crisis following a polar vortex that brought unusual snow and freezing temperatures across the state. The result left Texans without electricity and water for days as the state scrambled to fix the power grid.
Insights@Questrom spoke with Nalin Kulatilaka, Wing Tat Lee Family Professor of Management, Professor of Finance, and Co-Director of the Susilo Institute for Ethics in the Global Economy, to learn what caused the power outages, the current gaps in that state’s energy system, and how they can prevent these disasters in the future.
Question 1: What caused the massive power outages in Texas during the winter storm?
Kulatilaka: The main problem was on the supply side. About 50% of the generating capacity of mostly thermal generators fired with natural gas failed because they were not sufficiently weather-proofed to withstand the cold temperatures.
The brunt of the cold weather-related increase in demand was not for electricity, but natural gas, as needs for heating and power generation increased. Unfortunately, gas supplies were also hampered by freezing valves in gas pipelines, starving gas power plants. This was the perfect storm affecting both gas and electricity systems. Had it been only a demand increase or a smaller failure in electricity production, the system may have coped by rotating loads (rolling blackouts) and avoided the long blackouts.
It is worth pointing that this supply shortfall was quickly reflected in wholesale prices, driving them sky-high – from normal levels around 2 – 3 cents/kWh to nearly $10.00/kWh.
Wholesale electricity prices though aren’t immediately visible to retail customers. In fact, residential customers in Texas are increasingly purchasing their electricity from retail electricity providers, REPs (e.g., Green Mountain Energy, Just Energy, Bounce Energy, TXU Energy). REPs purchase energy from wholesale markets and sell to customers at prices that are fixed over several years. Because of high costs, REPs don’t always hedge their exposure and are extremely vulnerable to volatile prices. Meanwhile, retail customers who did not go with REPs are in for a big shock when the high wholesale prices make their way to customer bills.
Question 2: Why was the available capacity insufficient? Was the demand that much out of ordinary and beyond the planning contingencies?
Kulatilaka: When planning generating capacity, what matters is the highest (peak) demand. There must be sufficient capacity to meet the peak. Historically Texas is a “summer peaking” grid. High air conditioning demand during the hot Texas summers create very high peak levels of demand (> 75,000 MW). So, the system plans enough capacity to meet these high peaks. Historical winter peaks, however, are much lower (~ 65,000 MW). As a result, high-cost producers choose to seasonally shut down or mothball their units for the winter to save on costs, much like the way you would shut down a summer house for the winter or stow away your winter jackets in mothballs for the summer. This year, nearly 10,000 MW of coal and gas thermal generators were seasonally mothballed and were not available to be called on during this cold wave.
An important consideration when looking ahead is whether climate change and the resulting instability of the polar vortex will make such events more frequent and historical demand will not be adequate for capacity planning.
As I mentioned earlier, about 35,000 MW of the non-mothballed capacity that the system depended on to meet demand failed to perform as expected. They were not weatherized to operate in cold temperatures. Generators in colder regions are compelled by federal or state rules to protect their plants from extreme weather. Texas plants can leave their pipes, valves and pressure gauges exposed. In fact, Texas’s grid operator called for generators to weatherize their facilities after a 2011 cold snap led to blackouts. But system operator can’t force the companies to do so. From a generator perspective, the only incentive is to bring energy to market as cheaply as possible.
Question 3: What is the Electric Reliability Council of Texas (ERCOT) and how does it differ from electricity systems in other states?
Kulatilaka: Texas is a power “island.” While the electric grids in the rest of the country are interconnected and draw from each other when needed, the Texas grid functions independently. It was designed to keep the state’s energy system independent of Federal regulations and isolated from other markets. An independent authority called the Electric Reliability Council of Texas (ERCOT) has the responsibility of coordinating the energy flows and maintaining reliability. A consequence of this independence is that during critical weather events, it doesn’t have the infrastructure to import energy but instead is largely dependent on its own resources.
ERCOT’s operations have come under heavy criticism on several counts. One aimed at policymakers, in general, is that the regulatory design in Texas has given high priority to low costs, at the expense of reliability. In other jurisdictions, the corresponding system operators (e.g., ISO-NE, the system operator for New England) place reliability of service as the prime objective and are willing to pay the necessary price premium to ensure quality of service.
Question 4: How can Texas prevent future outages like this in the future?
Kulatilaka: Much of this is in the hands of policymakers. My list would include:
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- Encourage the development of more local, distributed generation resources, microgrids, and energy storage that provide redundancy and reduce the systematic risks of centralized generation. I would recommend reforms that would create incentives for developers to meet local needs.
- Shift the focus of market design from low cost (at any cost to quality) to one that accommodates a price premium reliability. This would create the necessary incentives for generators to reliably serve demand needs.
- Texas be part of a nationally connected grid and allow for imports and exports from other parts of the country and introduce industry best practices to create a resilient power system.
Recognize the changing climate realities and increased severity and frequency of extreme weather events in capacity planning.
Question 5: Will this crisis lead Texas to invest in more sustainable energy? If so, how can the state, which primarily relies on oil as both their main energy source and a major export, transition to sustainable energy without losing GDP or jobs?
Kulatilaka: At the outset of the crisis, some people, including Governor Abbot, blamed frozen wind generators as the culprit. This criticism came from anti-renewables lobbies. Fortunately, this claim was quickly discredited. Although a few wind generators failed, they were by no means the main source of the problem.
Overall, wind provides about 20% of energy overall in Texas. But less wind during the winter months lowers this fraction. Most of the failures occurred in thermal plants using natural gas where the gas supplies themselves were affected adversely by the freezing weather.
However, as the penetration of renewables like wind and solar increases, the grid resilience must also be improved to accommodate their intermittent nature.
Although the economic activity and jobs in Texas were historically dependent on oil and gas, recent growth has come from technology and manufacturing. Recent high-profile examples include Tesla, Plantir, and Oracle’s moves to Texas. A reliable grid is vital to their success. In fact, investments in the grid infrastructure itself can be an engine of growth.
These events highlighted the critical dependence of our society on a resilient electricity system. Every other infrastructure – water, communications, gas – is built on the back of the electric grid.
About Our Expert
Nalin Kulatilaka is Wing Tat Lee Family Professor of Management and Professor of Finance at Boston University Questrom School of Business where he also serves as the co-director of the Susilo for Ethics in the Global Economy. Nalin’s current research interests include social impact investing and financing distributed energy.
He has published over 75 papers in top academic journals as well as influential managerial publications. His book, Real Options (HBS Press), has received wide acclaim. He has co-founded several companies including FirstFuel Software (energy data analytics), and Certain Solar (aka Nine Dot Energy, community distributed generation for congested urban grids). He also serves on the Board of Directors of Assette. Nalin holds a PhD from MIT.
