By Kevin D. Williamson
Wednesday, February 17, 2021
As practically every Texan and much of the rest of the
country now knows, Texas’s electrical grid is managed by the comically misnamed
Electric Reliability Council of Texas. To the extent that its reliability is
the issue, what it is is reliably incompetent. As Texas shivers in the dark,
there’s plenty for everybody to hate in this story. But it does present an opportunity
to consider three concepts that can shape our public policy for better and for
worse.
Hedging Risk
Hedge
investments are investments meant to mitigate risk. The original idea behind
hedge funds was that they would provide a place for big-money investors to park
some of their assets and earn a decent rate of return while avoiding certain
risks, such as stock-market downturns or inflation. Hedging can get
complicated, but the idea is pretty simple: If you own an airline, for example,
fluctuations in the price of jet fuel can wreak havoc on your profitability,
and so you might invest in jet-fuel futures (or oil futures, or other
instruments) to offset some of that risk: In the event of a price spike, your
operating expenses will increase, but you’ll make some of the money back on
your hedge investments. Airline stocks and oil prices are negatively correlated, meaning that news that boosts oil prices is
bad news for airlines, and news that hurts oil prices is good news for
airlines.
One of the principles of hedge-fund-portfolio management
is the pursuit of such negatively correlated positions or simply non-correlated positions. If two assets
are non-correlated, then market developments that influence the price of one
will (in theory!) have no effect on the other. That’s the idea behind portfolio
diversification: A failed clinical trial may be bad news for your
pharmaceutical shares, but it probably will not change gold prices one way or
the other.
What you don’t want in your portfolio is a lot of
positively correlated assets, i.e. investments that are likely to rise and fall
together, amplifying your overall risk rather than mitigating it. If you have
half of your portfolio in GM shares, you probably don’t want to put the other
half in Ford shares, because major changes in the automotive industry that are
a risk for GM are also a risk for Ford.
As a way of thinking about risk, hedging and correlation
are not limited to the schemes and shenanigans of Wall Street types. And while
there is financial
hedging at play here, what I am interested in is the management of risk
that is not exclusively financial.
The fundamental reason for Texas’s blackouts is
correlated grid risk: The kind of winter storm we currently are experiencing —
unusual but hardly unprecedented — drives up demand for electricity while
simultaneously driving down the available supply of the stuff. The system can
withstand a spike in demand, and it can withstand a dip in supply, but it
cannot withstand both at the same time. Hence the blackouts.
In addition to the usual troubles of downed power lines
and the like, electricity plants are having a hard time getting fuel or using
the fuel they have, including natural gas and coal. So-called renewables such
as wind power and solar perform poorly, or do not perform at all, in such
conditions, while natural-gas, coal, and nuclear facilities have been shut down
or hampered by pipelines, instrumentation, and other equipment that is
inadequate to the current conditions. Texas has more than enough natural gas to
power itself through a storm such as this one, but it does not have sufficient
capacity to get that fuel where it is needed or to use it in the current conditions.
If you can’t get the gas where it’s needed, you may as well not have it at all.
Texas could have an infrastructure that is better
prepared for this kind of thing, but the upgrades would be expensive. Nobody
wanted to pay for them a week ago. Nobody will want to pay for them a week from
now. But today, millions of Texans wish the money had been spent — preferably
by someone else, of course.
One model for thinking about that infrastructure is a
very common hedge used by millions of Americans: life insurance. Life insurance
is a risk-management tool, a premium you pay in order to provide a financial
hedge against the possibility that you die before you can make adequate
financial provision for your survivors. There are two ways of looking at that proposition:
Some people will live to 102 with plenty of money in the bank — was all that
money spent on life insurance they never needed wasted? Depends on how you think about it.
Similarly, some people have responded to criticism of the
situation in Texas with this line of argument: Why should cities such as Dallas
and Houston, which rarely see snow, or the state of Texas as a whole, where
most of the people live in metros that rarely see much snow, make costly
preparations for rare events? Why should the utility companies serving these
people make costly preparations for rare events, knowing that it is the very
customers who would benefit during a blue norther in February who will in April
and May most bitterly criticize any costs passed along to them?
That’s not a question that can be answered empirically,
because it is a matter of disposition:
Would you be more irritated by paying for something you end up not needing or
by not having paid for something that you end up needing? One of the many
shortcomings of democracy, including the regulation of industry by democratic
institutions, is that people will change their minds about that depending on
their own momentary situation.
This presents an ideological challenge for conservatives:
Are we to be “conservative” in the sense of penny-pinching, or “conservative”
in the sense of risk-averse? Both? Neither? There are legitimate, good-faith
cases to be made for many different approaches. Money spent on improving
Texas’s electricity infrastructure might prevent some loss of life and loss of
economic activity, but the money thus spent cannot be spent on other needful
things — road improvements, preventative health care, etc. — that also could
prevent loss of life or of economic activity.
Don’t ever let anybody tell you that the choices are
obvious. They aren’t.
Corporatism
So, is this a failure of Big Government or a failure of
Big Business?
Yes!
In Texas, as in most of the country, utilities are run on
classic corporatist models, meaning that formally private (in the case of
ERCOT, nonprofit) corporations, heavily regulated in what’s alleged to be the
public interest, serve consumers on a monopolistic or near-monopolistic basis.
As in the case of the old telephone monopoly, this is only partly a matter of
political preference — the situation is determined largely by the physical facts
of running wires and pipes into houses and industrial facilities. There is no
practical way to have 25 competing utility providers with 25 independent,
privately owned sets of pipes and wires. The situation for Texans who have some
notional choice of utility providers is more like the situation with parcel
shipping: You can choose between FedEx and UPS, but the roads are the roads,
and if the roads are unpassable, then one will be just as completely sidelined
as the other.
The lesson of the utilities is a lot like the lesson of
health care and mortgage lending: Having some kind of consumer choice and
market competition may be helpful, but it works a lot better for some kinds of
goods than others; regulation “in the public interest” does not ensure that the
interests of the public are actually served; price controls can reduce
investment and create artificial scarcity; there are practical physical
limitations on the production and delivery of all goods, but these are
expressed in an especially acute way in some sectors relative to others.
Conservatives generally prefer free markets and private
enterprise to government-centered approaches, and generally prefer (at least in
theory) deregulation to regulation, consumer choice to enforced
standardization, etc. But the facts on the ground (and, in this case, the facts
in the ground) are complex and not
easily fitted into ideologically satisfying narratives.
It’s a great big world, with room enough for both public
and private incompetence.
Tragedy of the
Commons
When the Reliability Council goes wobbly, it immediately
calls on consumers to reduce their own electricity usage, i.e. demands that
they impose rationing on themselves in addition to the rationing that will be
imposed on the state at large by rolling blackouts and other service
interruptions.
But why should that be necessary? Why should we be
experiencing a tragedy of the commons in a fee-for-service situation? Texans
get utility bills. We pay for water, gas, and electricity — many will complain
that we pay far too much for them. So why aren’t we naturally thrifty? Why, as
some of our neighbors face danger and distress because of power cuts, do some
Texans still have their Christmas lights on?
I live in a 100-year-old house in Texas that is not
exactly airtight. The windows rattle a little bit loose in their frames,
there’s no insulation in the walls, and none of the major mechanical systems is
of the most efficient or economical kind. There are millions of people living
in millions of old houses like mine, and millions who live and work in modern
buildings that are no more energy-efficient — and in a surprising number of
cases are less energy-efficient —
than buildings put up a century ago. If economic incentives really work, why is
that the case?
There’s an answer to that mystery: Energy is cheap.
Thank goodness for it. Cheap energy gives us a lot of
choices about where we live, how and when we travel, what we eat, how we do
business, how we entertain ourselves, etc. Having come to rely more and more on
delivery services during the COVID-19 era, many Americans still do not really
appreciate how much cheap fuel contributes to their standards of living. That
$4.99 restaurant-delivery fee could be $20. Everything you consume via Amazon,
and everything that moves on a truck, train, or ship — meaning, roughly,
everything — could be 20 percent more expensive if energy cost more. It could
be five times as expensive. Cheap energy is a critical ingredient in cheap
everything.
Energy is cheap because of investment, entrepreneurship,
and excellence in engineering, along with some reasonably good public policies
that enable, in this area at least, prosperity to emerge. But environmentalist
critics might charge that energy is cheap because we don’t really pay the full price
for it — that negative externalities in the form of pollution or greenhouse-gas
emissions are as a practical matter priced at $0.00. And they would have a fair
point. That’s part of the case for a carbon tax.
The buying and selling of diesel and gasoline happens in
much more of a real, consumer-driven free market, one with lots of sellers and
buyers, than does the buying and selling of electricity at the consumer level.
But electricity and gasoline are both, for the most part, cheap. And so neither
the free market for automotive fuel nor the corporatist market for home and
business electricity has led to a lot of economizing behavior on the part of
consumers. As a friend of mine put it, “I don’t know what a gallon of gasoline
costs — why would I? It’s not like I’m going to stop driving.” Of course, there
is some point at which prices would influence consumer behavior, and we have
seen preferences for more fuel-efficient cars wax and wane vis-à-vis trucks and
SUVs as gasoline prices fluctuate. I’d probably drive a more fuel-efficient car
if I were paying European gasoline prices. I’d probably have a more
energy-efficient house if it meant savings that would improve my household
budget in some meaningful way rather than in a one-venti-latte-a-month way.
So, energy is cheap. Is it too cheap?
Again, this is a question of disposition and priorities,
not a question that can be answered empirically. If your priority is reducing
greenhouse-gas emissions, then, yes, energy is too cheap — far from the price
at which we might expect to see major changes in consumer behavior in the
United States or around the world. If you want people in San Antonio to build
more energy-efficient houses or for people in Dallas to live closer to their
offices, then energy is too cheap. If you want impoverished people in India and
China to cease closing the gap in their standards of living relative to the
United States and Europe, then, yes, energy is too cheap.
But focus for now on the domestic context: If an extra
$20 in your utility bill means $20 out of your grocery budget, then you
probably don’t think energy is too cheap. If you are in the airline business or
the trucking business, then you probably don’t think energy is too cheap. And
most of us, with the exception of a few radical environmentalists whose
convictions are metaphysical, probably don’t think that our standard of living
is too high, that we would be better off paying more for the things we use and
enjoy. That’s another way of saying that we don’t think energy is too cheap.
So we cannot agree about which energy-related risks ought
to be hedged against and how, don’t have a lot of promising avenues for
cultivating robust market competition and choice from wellhead to wall socket,
face real limitations on physical infrastructure that would be very expensive
to improve, and, to a considerable extent, disagree about what desirable
outcomes would look like even if we enjoyed unlimited policy discretion and
economic resources, which we don’t.
A few years ago, I was introduced to a very nice gentleman who told me that he was the head of strategic planning for the local utility company. “Is your strategic plan to keep being a monopoly?” I asked. “Because that would be my strategic plan.” It was a joke, of course, but the underlying dilemmas are real. They touch on a vital component of our prosperity and, occasionally, on urgent matters of life and death.
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