But there was also a missed opportunity on the demand side. Texas has retail choice for electricity, but the overwhelming majority of Texas customers face electricity prices that are too static, too inflexible, and don’t respond to market conditions. Economists have been advocating dynamic prices for decades, but adoption has been slow.
Case in point. While wholesale prices in the Texas market climbed last week to $9,000/MWh, the overwhelming majority of electricity customers in Texas continued to pay retail prices close to $120/MWh, barely 1/100th of the true marginal cost.
Not seeing these high prices, Texas consumers had little incentive to conserve. You had a feast or famine — with millions of consumers at an all-you-can-eat buffet — while millions of others faced tragic blackouts and, essentially, an infinite price.
If everyone instead had turned their thermostats to a chilly, but manageable, 65°, this could have really helped the state manage the emergency. As Severin Borenstein pointed out after the California power outages last August, even modest adjustments to the thermostat can save a lot of electricity.
Dynamic pricing allows customers to pay lower prices throughout 99% of the year, in exchange for facing much higher prices when supply is tight. Numerous studies have documented that dynamic pricing yields substantial demand reductions (here, here, here, and here).
You may have read about households who paid enormous electricity bills last week. 29,000 out of Texas’ 11+ million customers buy their electricity from Griddy, a retailer that charges customers wholesale prices for a monthly fee of $9.99/month. This is a very extreme version of dynamic pricing. The evidence shows that you don’t need such extreme price changes to encourage conservation. Moreover, it is straightforward to incorporate hedging into retail contracts to protect customers from these outcomes.
With 28GW of forced outages in Texas last week, it is unlikely that dynamic prices alone could have closed the gap between demand and supply. But dynamic pricing is the fastest and cheapest way to build flexibility into the market, and can play an important role moving forward.
Here is more from Lucas Davis. Via Jonathan Carmel.