The glaring exception has been electricity. At the retail level, efforts across the country to allow buyers to get electricity from new competitors to traditional utilities more or less ground to a halt after the California debacle in 2000–2001. Buyer reluctance has been particularly pronounced in the third of the market that is residential. In my home state of Maryland, which nominally has open retail markets, only about 7.6 percent of residential electricity was supplied by entrants in April 2010, compared to 92.5 percent of the electricity used by large commercial and industrial users. And a good bit of that 7.6 percent was likely supplied by affiliates of incumbent electricity or gas utilities.

The wholesale market, where generators sell electricity to distribution utilities or, in open states, their competitors, has avoided disaster for the most part, leaving aside the August 2003 blackout that took down most of the Northeast. However, despite operating under Federal Energy Regulatory Commission regulations going back to 1996 to open transmission grids to independent generators, the nation as a whole has not opened bulk power markets. Some regions of the country retain the old vertical monopoly structure. Others have opened markets, but with different rules — all FERC-approved — for how prices are set, sales are made, and capacity costs are covered. FERC and congressional attempts to bring uniformity to this disparate process have been blocked, likely by local regulators and utilities that do not want to cede their political turf.

It don’t come easy One might think opening electricity markets would be simple; I certainly did when I first began to look at the grid after having studied telecommunications. Nothing is less differentiated than the electrons flowing through a wire. Its use seems no more complicated than flipping a switch so the light or TV can come on.

So why has opening electricity markets been so difficult? Fundamentally, it is because electricity uniquely combines three attributes: First, it is crucial; even a minimally developed economy cannot function without it. Second, it is fragile; because storage in meaningful quantities is prohibitively expensive, supply has to be kept exactly equal to demand essentially continuously. Third, avoiding this fragility by making the grid reliable is a public good. Transmission networks that deliver power are interconnected to improve the overall efficiency of the system, but unlike telephone traffic, it is somewhere between costly and impossible to route high voltage current over specific lines. As a consequence, electricity takes multiple paths to get from generators to customers, making the grid, even if parts are operated separately, essentially a single big energy system. If one supplier fails to meet its customers’ demands because of unanticipated surges, inadequate capacity, or equipment failures, not only are its customers blacked out, but everyone is.

The tension between central control to protect this reliability and the entrepreneurial independence needed to realize the promise of competition is exacerbated by natural monopoly characteristics of the wires. Laying multiple local distribution grids to get power to all but the largest users would be wasteful; one grid can do the job. As just mentioned, interconnected transmission grids are essentially single entities. Fostering competition on the generation and sale of electricity requires that the interface be managed to ensure access to the wires on reasonable, non-discriminatory terms. But the separation of generation ownership from control over transmission and distribution lines may itself inhibit efficient grid operation. Peter Van Doren and Jerry Taylor of the Cato Institute have suggested that the costs of separation are less than the benefits, concluding that deregulation of wholesale markets should be reversed if transmission and distribution cannot or will not be deregulated as well.

Dynamic prices, static consumers Electricity markets are further complicated by the enormous variance in wholesale prices over time. Because capacity has to be in place to meet demand at any time, some capacity is used only during a few critical hours a year, e.g., to power air conditioners on the hottest, most humid summer afternoons. It is not uncommon to find that 10 to 15 percent of capacity may come into service less than 1 percent of the time. Covering the cost of that capacity implies that at those critical hours, the wholesale cost of electricity can easily be 50 to100 times the off-peak price. But when capacity is tight, individual generators could find it profitable to reduce supply, especially when the absence of effective meters and monitors offers no incentive to users to cut demand. If regulators limit wholesale prices out of fear of market power, as they have, there might not be enough money to cover the cost of critical peak generation. A typical response has been to set up “capacity markets” to provide revenues to cover generation costs that peak prices cannot.

This is not all. The homogeneity of electrons that should make competition simple also makes it difficult for new entrants to come up with ways to persuade consumers to switch away from incumbent utilities. This is especially so for residential consumers, for whom a relatively small savings on monthly electricity bills may not be enough to make it worthwhile to evaluate the merits of different offerings from suppliers they may never have heard of.

Consumer resistance to shopping for electricity, after decades of having to give it no more thought beyond paying the monthly bill, undoubtedly plays a role. Policies to hold down incumbent prices as part of political bargains to open markets surely have not helped, leading to low residential adoption rates in most of the states that bothered to open markets at all. Moreover, electricity prices have risen during the last 10 to 15 years, during the open market era. The degree to which this is just a correlation — other energy prices have risen dramatically as well — or whether higher prices encouraged open markets, or vice versa, remains hotly debated.

Don’t mess with Texas By and large, many states are not opening markets, and some that did in the 1990s are reversing course. But as co-editors Lynne Kiesling and Andrew Kleit say in the introduction to Electricity Restructuring, “No state, that is, except Texas.” The subject of their important book is why Texas appears to have succeeded where the rest of the country has failed.

Texas stands out from other states for numerous reasons. When it comes to electricity, far and away its most distinguishing feature is that it is the only state in the continental United States that is essentially not under the jurisdiction of the federal government. Unlike the other lower-48 states, the Texas grid, under the control of the Electricity Reliability Council of Texas (ERCOT), is essentially not connected to the rest of the United States. David Spence and Darren Bush note in their chapter that the history is minimally more complicated because of two “asynchronous connections” between transmission lines in Texas and Oklahoma, but as Jess Totten notes in his chapter, these connections avoid the multiple-path effect that justifies treating connected transmission grids as single entities. The result is that Texas’s transmission grid and wholesale markets are regulated by the same entity that sets its distribution policies. This has helped to avoid jurisdictional disputes regarding authority over market design and access — even if the ERCOT grid operates under rules similar to those FERC applies nationwide, as Totten also describes.

The most substantive innovation in Texas is that it covers generation costs through an “energy-only” market. That this is innovative should be puzzling to those familiar with markets for anything else, in which production costs are covered by revenues from sales of the products. But in electricity, as mentioned above, capacity markets are commonly used because of the view that electricity rates cannot be allowed to go high enough to cover the costs of peaking units. Some in Texas wanted to go that route but, as Eric Schubert, Shmuel Oren, and Parviz Adib describe in the most thought-provoking chapter in the volume, by the time capacity markets could be implemented, ERCOT had been working on an interim basis with energy-only cost recovery, and similar markets in Australia and Alberta had been working well for some time.

Market power mitigation remains a concern. Kleit notes that, at peak demand periods when generation capacity is at its limit, an electricity generation company with a relatively small market share might nevertheless be able to raise price by withholding output. He also suggests that other nominally independent wholesale market operators may help energy suppliers suppress competition. Caps on prices are projected to rise in 2011 to $3,000 per megawatt hour or $3 per kilowatt-hour, roughly 27 times the current average retail electricity price, with some adjustments if annual returns exceeded an estimate of revenues needed to cover capacity costs. Kleit describes a specific episode in which TXU, the largest supplier, operated a “rational bidding strategy” that included fixed cost recovery. He suggests that this practice would trouble economists, but I would add that it should bother only those who do not think prices should be high enough to cover long-run average costs as well.

A last question is why Texas bucked the trends against legislative adoption and consumer acceptance of retail entry. Former Texas Public Utility Commission chair Pat Wood and co-author Gürcan Gülen of the University of Texas portray the political development consistent with the view that Texas’s culture was a prime contributor. Co-editor Lynne Kiesling finds that despite extensive consumer education and a decision of the incumbent utilities to keep retail prices high — even after the price of natural gas, the marginal fuel, had fallen — only 40 percent of residential customers had switched. The importance of this should not be exaggerated. Overall, only about 35 to 40 percent of load is residential, and much if not most of the benefits of open markets go to large commercial and industrial buyers, for whom it pays to shop and sellers want to compete. Opening electricity markets can be successful even if most of the public is unaware that it has happened.

Inside baseball Informative as this book is on these important topics, it is often limited to those in the know, with regard to both authors and audience. Having insider insights from such people as the Texas Public Utility Commission’s past and present chairs, market monitor, director of its Competitive Markets Division, and leader of its wholesale market design proceedings, along with a former commissioner and senior policy adviser, make the book useful and frequently entertaining. More outside academic assessments, along the lines of Steven Puller’s chapter on competition in wholesale markets, would complement the insider perspectives. Moreover, in a sector as complex as this, as evidenced by the distinctiveness of the Texas experience, there must have been dissenters who would put different spins on the institutional developments and evidence supporting the generally favorable assessments in this volume.

One missed opportunity was to revisit the debate in Texas between paying for transmission at rates set for traversing a relatively small number of geographic zones or charging prices at every node in the network. Although nodal pricing sounds much more complicated, it has received the lion’s share of academic support, allows more efficient management of congestion in the grid, and proved workable in other wholesale markets. Texas initially adopted a simpler zonal system, which Eric Shubert and Parviz Adib report was on the advice of the Texas Public Utility Commission’s Market Oversight Division, chaired by Shmuel Oren of Berkeley, one of the leading electricity economists. This approach was later rejected in favor of the nodal approach, but in the following chapter on supply reliability, Oren (with co-authors Shubert and Adib) passes on the opportunity to let readers know the basis for his unorthodox view.

This “zonal vs. nodal” debate represents another insider bias. The editors implicitly assume that readers will be familiar with the fundamental issues associated with opening wholesale and retail electricity markets. Impediments to opening electricity markets go beyond bureaucratic rent extraction, special interest protection, and naïve aversion to markets. From some of the chapters, readers might get some sense of the legitimate complexities in balancing efficient coordination and entrepreneurial independence or price flexibility and mitigating market power, but there is no overview of the issues to provide context to the less informed reader. Leaving the book’s audience to presume that deregulation ought to work undercuts its central message of just how special Texas is. The book also lacks a short description of the Texas market itself — e.g., which suppliers sell in which area, market shares, wholesale and retail pricing over time — to give readers their own sense of what is working.

Finally, the book shares a flaw inevitable in any review of electricity markets (one I know well, having co-authored a couple of them): it can be only, in Kiesling’s apt phrase, a “current snapshot.” The book does not cover the leading issues of the present, driven largely by climate policy. These include obligations to use non–fossil fuel generation such as solar and — as T. Boone Pickens reminds us in his television commercials — wind. Many states are looking at measures to improve energy efficiency, often predicated on beliefs that consumers systematically make “wrong” choices. The book also does not discuss what Texas is doing regarding a “smart grid” that would allow time-varying prices, reduce the need to construct peaking plants used only a few hours a year, and facilitate the use of renewable energy sources that tend to have highly variable output.

The tale thus has no final chapter in sight. The question for the next few years is not whether Texas can continue to build on its successes, but how it copes with these added pressures. Kiesling and Kleit have assembled a clear and significant introduction to how Texas got to where it is. It will be a useful guide as the story develops in Texas and, whether in contrast or lockstep, across the country.