Lloyd’s building in London

The tragedy of the winter storm that hit Texas in February of 2021 only begins with the death toll that may never be fully determined. Residents of Texas lost their lives to car accidents, hypothermia, and carbon monoxide poisoning. Hospitals had to evacuate patients due to pipe bursts from the lack of heating and a shortage of potable water, while smaller clinics were forced to close, diverting patients to healthcare services further away. According to the Texas health department, at least 57 people died due to the winter storm, close to the estimate for Hurricane Harvey, but the winter storm had a psychological impact on far more people. Millions of Texans were forced to go without power while simultaneously, tens of millions had their water service disrupted by frozen pipes and low water pressure. Unlike a hurricane, the winter storm was less of an unpredictable force of nature that inspires humanity to come together in the face of adversity, but a lesson how fragile society can be when the institutions we trust fail to work for us.

Disaster expert Angela Blanchard, of Brown University’s Watson Institute, described the situation in the Houston Chronicle: “when you have leaders who believe they only have to perform like heroes in their own lane, they miss the inter-dependencies and the risk of a cascading set of events of the pandemic and the freeze that leaves us further vulnerable heading into hurricane season.” Not only are public leaders to blame, private utilities who stood to make millions of dollars if they had the foresight to winterize also did not make the investments they were supposedly encouraged to fund. Although critics have been quick to blame deregulation, Energy Fellow Ed Hirs notes that “all these free-market Texans go into rapture over competition and deregulation, but the fact is the market is still heavily regulated. It’s not deregulated, it’s just regulated differently.” Josiah Neeley, a senior fellow at the R Street Institute, a libertarian think tank, remarks in Reason magazine that “the problem was not a lack of incentives but a lack of imagination.” The failure of both public regulation and private markets suggests that there are structural flaws in how energy is regulated in Texas.

The failure of the Texas grid boils down to a lack of natural gas supply due to frozen gas wells, causing a 20 gigawatt drop in gas-fueled power generation. The drop in supply caused the Electric Reliability Council of Texas (ERCOT), which manages about 90% the state’s electricity consumption, to demand utilities to initiate rolling blackouts to preserve the grid, but those same blackouts also cut off power to gas wells, resulting in a shortage of gas delivery to powerplants, cascading into a power generation “death spiral”. Other energy sources, such as wind, solar, and coal slightly underperformed due to the winter storm, with wind turbines and coal piles freezing also due to a lack of winterization.

The system’s cascading failures are well beyond the realm of what could be reasonably expected for a Texan to not only grasp, but to mitigate on their own. As Richard J. Pierce, Jr. states in The Regulatory Review, “given consumers’ lack of prior knowledge, it is unfair and unrealistic to blame consumers for making poor decisions in this market environment.” Despite a Texas mayor’s suggestion to “think outside the box to survive” losing access to water and electricity, no stockpile of food and batteries will overcome situations that demand emergency healthcare, especially in the middle of a pandemic (the mayor resigned soon after his statement). No one plans to drive to five different healthcare facilities to see a doctor, especially on treacherous icy roads. “Preppers” propose long lists of recommendations to be ready for a future storm, ignoring the substantial outlay for preparations that may never be used. Homeowners do not have the time to investigate systemic deficiencies, they just assume that the grid will work and that elected officials will keep it running.

Future homebuyers are unlikely to start checking if they are downstream of a sewage treatment plant in case a generator fails during a power outage and causes one million gallons of untreated sewage to be discharged. Those downstream residents that relying on wells were forced to boil their water for safety. The reality is that household well prepared with a diesel generator, bottled water, and seasoned firewood is not going to be able to unfreeze hydrants or restore pressure to water mains so firefighters can put out house fires during the winter storm. Even the most ardent survivalist should recognize that a single person salting and plowing roads cannot repair a “severe disruption in the supply food chain”. As one Texas resident has realized, “the fact that interdependence saves lives is clearer to me now than ever before.”

Michael Banschbach, an oil and gas marketing consultant, insists that the death spiral was unavoidable because Texans cannot expect “all the entities in the chain [to] expend the money to protect against an event that happens once in a hundred years”. While the cost of mitigation for this particular storm will remain hypothetical, the estimated $18 billion insurance bill after the storm is all too real for the insurers taking a loss and the policyholders that will have to pay increased premiums in the future. If money is not spent on prevention, it will be spent on repair, and insurance companies should be capable of translating that risk assessment into everyday costs.

The Perryman Group estimates that the financial toll of the winter storm could cost between $195 billion and $295 billion, a range that puts the storm as more damaging than Hurricane Harvey. The projection is significantly higher than the estimates based on property damage because it also includes lost income due to business interruption. An analysis of electric utilities by BlackRock in 2019 concludes that “climate-related risks are real for utilities, but mostly not priced in.” In addition, ERCOT did not have the regulatory power from the Texas legislature to enforce winterization, so the miniscule fines it did levy did not remedy the deficiencies in preparation by the utilities. The Public Utility Commission of Texas (PUCT) shares some of the blame for not prioritizing grid reliability and reducing the climate risks. The deregulatory energy policies in Texas have not served the people of Texas during the winter storm of 2021, resulting in extended rolling blackouts, loss of potable water, and excessive electricity prices. As Ed Hirs remarks in the Dallas Morning News, “if the market was designed to bilk consumers out of $50 billion at prices 300 times the average, providing only 60% of the service, to cause dozens of deaths, to rack up tens of billions of dollars in economic losses and damages, and to line the pockets of some energy traders with billions of dollars at the expense of consumers, then his mission was accomplished.”

The primary criticism of the current regulatory regime is that the high prices during extreme temperatures did not incentivize power generators to winterize their equipment. Instead, many producers failed to meet their contracted output, which forced ERCOT to initiate rolling blackouts to keep the grid from an even worse catastrophic failure. The simplest path forward is to mandate winterization to prevent a similar crisis, a move that Texas Governor Greg Abbott has already called for. Yet it is still worth examining the various paths that stakeholders could have traversed that could have also culminated in winterization. Ultimately, the consequences of the winter storm are a case study in how the financialization of catastrophe has yet to grapple with managing systemic and regulatory risk.

Michael Skelly, a Houston renewable energy entrepreneur, comments that “the problem with relying on scarcity pricing is that it works with normal events, but this go-round everything that could go wrong went wrong.” The basic reasoning behind the ERCOT’s scarcity pricing rule is to incentivize the retention of extra power generation capacity in times of high demand. “Essentially, the system is designed to reward plants with a high price per megawatt hour if they end up being needed,” according to The New Republic. This policy is designed for the summer months where demand is traditionally highest. But during the winter storm of 2021, generators failed due to the extreme cold temperatures, so in market terms, there was both high demand for heating and a low supply due to cascading failures from the rolling blackouts. Although the capacity already physically existed, “frozen plants weren’t going to work at any price”. The scarcity policy also assumes that generators are relatively independent, but the many utilities and cooperatives that existed before deregulation that owned generators and produced more electricity than their own retail needs were essentially overpaid for their reduced power production. At the same time those utilities were mandated by ERCOT to institute rolling blackouts to preserve grid safety. When combined, these two policies price-gouged utilities arbitrarily, benefiting those with more functional power generation and more mandated blackouts.

If scarcity pricing does not incentivize winterization before a storm, could it incentivize winterization after? The insolvency of utilities that failed to winterize suggests a consolidation of power generation across Texas. With more capacity is more exposure to risk, larger operators should winterize their newly acquired, non-winterized generators. Yet it is unclear why they would winterize their entire fleet if the scarcity pricing rule exists – the high prices are due to a lack of supply, and winterizing more power generation adds supply, so it only makes sense to winterize enough to make more money, and not enough to actually reduce the price. It is basically a government-mandated Enron scheme.

Looking at the bigger picture, future winter storms would cause more insolvencies due to firms misestimating the precise amount of winterization needed to maximize returns. Further consolidation would result in a monopoly or oligopoly, “and with less competition, consumers can certainly get hurt,” according to Houston Public Media. This is in stark contrast to the desired outcome, which is a market of producers that is fully winterized and no need for scarcity pricing after the failure of non-winterized producers. If the goal is a winterized grid, a lower cap on scarcity pricing may work better, because the only way to make more money would be to generate more power. The generators that fail to winterize would be poorer rather than driven to bankruptcy by the spot market. After the storm, regulators reduced the cap “from $9,000/MWh to the higher of either $2,000/MWh or 50 times a natural gas fuel index price.” Richard McCann, a consultant in energy utility resource planning, puts an upper bound of $5,000/MWh on the scarcity price.

There are other, less obvious paths to winterization than supply and demand during a catastrophe. Class-action lawsuits have been filed against ERCOT for failing to plan for the winter storm. As ERCOT may have sovereign immunity, the liability for non-winterization could land on the utilities themselves. The idea is that utilities will proactively winterize to reduce their liability, and perhaps to reduce the cost of their liability insurance. Yet after the winter storm of 2011 that also caused blackouts in Texas, the Federal Energy Regulatory Commission (FERC) noted that “generators were generally reactive as opposed to being proactive in their approach to winterization and preparedness.” Nobody happened to sue, liability did not increase, and winterization was not taken seriously. Ultimately, winterization is a systematic issue even larger than the wildfires in California, so customers would essentially be suing the utilities for a service that was not provided to most people and money that was not made, so only the lawyers would win. This is especially relevant for the many utilities that are run as cooperatives in Texas.

Another line of thought stems from the downgrading of creditworthiness of utilities in Texas by the ratings agencies. S&P Global downgraded the credit rating of seven entities, while also “placing 21 public power and electric cooperative utilities’ ratings on CreditWatch with negative rating implications.” ERCOT itself had its issuer rating downgraded from A1 to Aa3 and also had its outlook lowered to negative. The primary motivation behind the change is the substantial obligation that power retailers have to generators. In turn, the thermal plants have to pay back the natural gas suppliers, as prices spiked due to high demand.

As a result, Brazos Electric Power Cooperative went bankrupt while CPS Energy is suing ERCOT because of the exorbitant wholesale prices set by PUCT, contributing to the uncertainty around financial obligations between all the entities involved. Making the issue more complicated, ERCOT has a policy of “uplift”, “which would force all those on its system to pay for its losses during the winter storm.” In summary, exactly who is going to pay is being shifted around, while utilities are going to have a harder time borrowing money because credit agencies have adjusted for the systemic risk unearthed by the winter storm. Reducing that systemic risk via winterization should restore the creditworthiness of the utilities.

Without ignoring the loss of life and health of the people of Texas, property insurers are predicted to suffer losses of $10-20 billion due to the winter storm due to burst pipes and business interruption. Insurance premiums represent a significant, albeit mostly invisible, cost of living in a geographical area, and they are likely to increase after the storm. Homeowners may be familiar with high premiums associated with living in flood, wildfire, and earthquake zones. In general, homeowners are incentivized to adequately prepare for disasters instead of pursuing claims because claims will increase their deductible. Where risk is high, homeowners may vote for regulation and projects that reduce their risk and hopefully their premiums. With the California wildfires, this is already happening the form of community-wide mitigation standards.

In the Texas power crisis, it is almost certain that the cost of winterization is less than the cost of repairing burst pipes and associated insurance payouts. Yet the usual course of action for an insurer is not to proactively reduce risk, but to charge higher premiums unless mandated not to, in which case the insurer leaves the market due to a lack of profitability (unless they are mandated not to do that too). It is only recently that insurers have offered rebates for protection against wildfires or good driver behavior. Perhaps insurance companies could incentivize purchasing generators and installing battery packs, but the type of person interested in reducing their dependence on the grid is probably not interested in shelling out for insurance they need less of.

The elephant in the Texas energy deregulation room is the political desire to keep the Texas Interconnect separate from the other North American power grids. According to Alexandra Klass, professor at University of Minnesota Law School, “Texas could not call on energy resources from other parts of the nation, as is done everywhere else in the country, because of its physical and regulatory barriers.” The lack of transmission capacity not only prevents Texas from purchasing electricity when needed, it prevents Texas from selling excess capacity. Arguably, electricity prices are only low in Texas because cheap generation, such as wind, cannot be sold to neighboring states that have higher electricity costs. But research has shown that deregulation alone has not saved money for Texans, possibly due to some combination of scarcity pricing and the fact that excess capacity must be built within the state. This makes winterization especially expensive because the costs cannot be shared with another power grid.

Does there exist an economic mechanism that can incentivize full winterization in the face of catastrophe? The peril of financializing risk is twofold: financial institutions are less knowledgeable about operational risk than the utilities themselves, and since they specialize in finance, they prefer financial solutions rather than regulations. More broadly, the market is reactive rather than proactive – once risk is securitized, the security is traded and the valuation of the risk stays in the financial space rather feeding back into the “real world”. A proactive approach would seek to reduce the risk, regardless of its valuation.

The most glaring example how risk is securitized is the catastrophe bond, which is issued by insurers to cover payouts in the case of a catastrophe. A relatively recent invention, the catastrophe bond comes in many forms, but it is commonly issued for a 3-year term for a specific location, and the insurer is only paid (the bond is technically in default) if the catastrophe reaches a certain payout. The bond serves as a form of reinsurance when the disaster is so large the insurer needs help paying claims. It distributes risk to the broader capital markets so that insurance companies are not stuck trading different types of risk in various places to balance out their exposure to disaster.

At first glance, a catastrophe bond represents the aggregate risk of a hurricane, earthquake, or other natural disaster. Therefore, the primary job when pricing a catastrophe bond is the difficult task of determining how often the associated natural disaster happens with a sophisticated model. Build a better model? Make more money. The enormity of natural disasters implies that the modelling of physical processes dominates the accuracy of estimates, and that the main reason why a catastrophe is a catastrophe is the sheer quantity of destruction. It seems that so far, the catastrophe modeling industry is focused on building better physical models, which are at least significantly better than the statistical models that they superseded.

Hidden in an article about catastrophe bonds in the New York Times, writer Michael Lewis comments on expert Karen Clark’s $13 billion estimate of Hurricane Andrew’s impact in 1992: “if builders in South Florida had ignored the building codes and built houses to lower standards, the losses might come in even higher.” The final $15.5 billion in losses imply that building codes were not “strictly enforced.” Even though the absolute losses from physical damage dominate, the $1.5 billion difference due to building code enforcement is a form of regulatory risk. That lack of enforcement in South Florida is eerily like the Texas legislature’s reluctance to raise fines and the Texas governor’s calculated effort to gut enforcement and force winterization of power generators, regulatory incompetence exposed a systemic risk that resulted in the near collapse of the power grid.

In a way, regulatory risk has always been a kind of systemic risk. Policyholders and voters are one and the same. Perhaps high property insurance premiums motivated Texans to deregulate their utilities to lower their electricity bill, resulting in burst pipes after the winter storm, further raising their premiums. The aggregate self-interest of millions of policyholders in Texas could not save themselves from disaster because each individual could not understand the entire system on their own. Everybody just assumed that regulators would regulate, generators would generate, pumps would pump, heaters would heat, and insurers would pay if it all went wrong.

The hidden risk of catastrophe bonds and other excess of loss policies is the systemic risk that may cause aggregate risk to balloon beyond the pre-determined retention limit. If the houses in South Florida in 1995 were built to code and the energy infrastructure in Texas in 2021 was winterized, the insurance losses would have been significantly lower. Because the problem is endemic and insurance companies need a large risk pool, it is impossible for a primary insurer to select policyholders to avoid systemic risk without exiting the market, if they are even aware of the risk in the first place.

The availability of insurance itself can distort the market; a phenomenon generally known as moral hazard. The National Flood Insurance Program (NFIP) requires flood insurance in floodplains, but also subsidizes premiums, not only incentivizing homeowners to build in risky areas but also paying them if their homes are flooded. Astoundingly, the NFIP via the U.S. Federal Emergency Management Agency (FEMA) has secured over a billion dollars in reinsurance coverage in 2021 and a large part of that is through issuing catastrophe bonds. Private investors should already be aware of the outdated flood maps used by FEMA, but it is possible that proprietary models have concluded that flood reinsurance is appropriately priced. As the NFIP transitions to Risk Rating 2.0 in October 2021, homeowners are likely to see a substantial increase in their premiums that more accurately represents their risk of flooding.

Home values in coastal areas continue to rise as “people’s desire to live near water is often unaffected by whether it makes financial sense.” Investor confidence in the Federal government’s unwillingness to allow NFIP to fail is perhaps bolstered by the irrational desire of voters to live in flood-prone areas. Residents in safer areas may simply not know they are subsidizing the residents of risky areas, especially if they are unaware that the NFIP is tens of billions of dollars in debt. In places such as Avon, on the Outer Banks of North Carolina, the interdependency of areas at high risk of flooding and areas of lower risk is thrown into sharp relief as neighbors fight over the cost of beach nourishment to protect their communities. The politics of inequity are more powerful than the rationality of the markets.

Unlike the regulatory effect a reinsurer can have on cedents, the investors in a catastrophe bond are not limited by insurance regulation. The prevailing assumption is that investors in insurance-linked securities are looking to diversify by looking for uncorrelated assets. Yet the power crisis in Texas revealed that energy production is inversely correlated to winter storms, so perhaps passive investors should look elsewhere. The systemic risks in catastrophe bonds and other insurance-linked securities (ILS) reveal an opportunity to value systemic risk. A bondholder of an indemnity-triggered catastrophe bond could seek out systemic risks and proactively work to reduce them. This should reduce the modeled damages and increase the value of the bond.

An investor in catastrophic bonds for Texas storms captures the value of winterization because of the resulting reduction in systemic risk. The securitized reduction in risk is possibly greater than the cost of winterization, but utilities would rather be paid after a catastrophe rather than being the payee when they need the money the most. Nevertheless, it an example of a potential mechanism for motivating individual actors to cooperate in the common interest.

One proposed security for investing in infrastructure improvements is a resilience bond, which is structured like a catastrophe bond, but with a rebate mechanism used to fund projects that reduce risk. The rebate itself is funded by “capturing a portion of the insurance savings created by resilience projects.” Note that the bond issuer still pays a reduced premium to the bondholder, which suggests that the benefit of preventative measures is smaller than not doing anything at all. This gap could be covered by an increase in asset value due to the same reduction in risk. Yet the most difficult aspect of the resilience bond concept as a funding mechanism is the public-private negotiation needed to determine which projects to pursue to reduce risk.

Perhaps the strangest outcome of the increasing financialization of risk is that the reinsurers, who aggregate different types of risk but are often specialized by location due to regulatory and experience concerns, have not sounded the alarm around systemic risk. The insurance industry from 2005 to 2015 only covered approximately 30% of losses from catastrophes, while the remaining 70% is handled by individuals, businesses, and governments. This lack of exposure is in part because the government is often the insurer of last resort, either through federally run insurance programs like NFIP or simply through aid after a disaster. In the worse case scenario, the federal government could bail out an insurer, leaving taxpayers on the hook for risks that should have never been taken. But more commonly, insurers can simply limit coverage or leave a market if they deem it too risky.

Even without resilience bonds, property and casualty insurers in the United States are already invested in localities through municipal bonds, dedicating 38.7% of their assets as of 2010. An article in Nature Climate Change notes that “ironically, investment decisions by insurers do not usually consider the climate risk knowledge gained on the underwriting side.” Green municipal bonds are one example of an investment aimed at reducing the impact of catastrophes caused by climate change through infrastructure improvements. By investing in green municipal bonds, insurers can fund the work of local governments using the premiums from the same residents. Although this seems to violate the usual governance processes, it facilitates financing that benefits a municipality’s neighbors to come from the neighbors themselves, without the overhead of forming a special-purpose district like the Port Authority of New York and New Jersey. In this way, insurers can streamline financing of mutually beneficial projects, but this level of public-private coordination is rare.

The problem with insurers as investors is that it is invisible to both policyholders and municipalities; homeowners are not choosing insurers based on their investment strategy, and municipalities do not limit bond sales to local insurers. Insurers are also basically paid twice by homeowners – once from the interest from the municipal bonds and again from the insurance premiums, although this can be reinterpreted as the cost of managing risk. What should also happen is that once the insurer buys a bond that reduces risk, premiums should go down, but this sort of price signaling is far from transparent.

An alternative approach to resilience bonds is to look directly into the catastrophe bond for capital. A catastrophe bond is typically issued by a special purpose vehicle structured by an issuance group. The proceeds from the investor are deposited into a collateral account that is then invested into low-risk securities, like treasury bills. This structure eliminates the credit risk of the issuer, but also means that a significant amount of money is effectively held in escrow for the length of the bond. Using the collateral to invest in resilience at the same site as potential catastrophe is very risky, since the money being used for resilience projects would be needed for disaster recovery if one occurs. It is basically a bet that catastrophe mitigation would be complete before the disaster strikes. On the other hand, “making infrastructure resilient to climate change [is] a high return investment, yielding on average a 4-to-1 return” according to Andrew Steer, President and CEO of the World Resources Institute. In the United States, “federal researchers reported that for every $1 the government spent to protect a community before a disaster, it saved $6 later,” according to the New York Times. A high-risk, high-return security that can capture some of that value would certainly be appealing to investors.

Catastrophes are inseparable from the climate change causing the increase in natural disasters. Strategies to reduce global warming by limiting carbon emissions will also reduce the number of catastrophes, but there is a substantial risk of market failure as the places at highest risk of catastrophe are not necessarily the largest contributors to global warming. Despite the uneven distribution of destruction, the Paris Agreement seeks to reduce emissions of greenhouse gasses globally. This is facilitated in part by carbon pricing, which seeks to capture the externalities of carbon emissions, one of which is an increase in natural disasters. Catastrophe risk comes from climate risk.

A working paper from the International Monetary Fund (IMF) on climate change mitigation says that “private investment in productive capital and infrastructure faces high upfront costs and significant uncertainties that cannot always be priced.” A report from the World Bank on carbon pricing observes that due to “incomplete financial and risk markets, innovative or large-infrastructure projects often struggle to secure the necessary funding.” The IMF paper adds that “the large gap between the private and social returns on low-carbon investments is likely to persist into the future, as future paths for carbon taxation and carbon pricing are highly uncertain, not least for political economy reasons.” The suggestion by the IMF is to securitize climate mitigation itself, in addition to carbon pricing, so that investors have a public guarantee of future returns.

The difficulty of financing climate change mitigation suggests that catastrophe mitigation will also be hard to finance directly. Even though the potential loss and mitigation of a single catastrophe is localized, the overall risk is spread throughout a region and over a long period of time. A reinsurer trading risks between regions may not be considering the greater climate risk that would cause a more frequent occurrence of catastrophes in both regions. Yet an investor aggregating catastrophe risk through insurance-linked securities may start looking at reducing global climate risk rather than naively improving local climate resilience. The accumulation of systemic risk from catastrophes provides a mechanism for realizing climate risk through insurance-linked securities, rather than from regulation-driven securitization of carbon.

Climate change mitigation is such a “complex collective action problem” that the Bank for International Settlements (BIS) came to the conclusion in 2020 that “the development and improvement of forward-looking risk assessment and climate-related regulation will be essential, but they will not suffice to preserve financial stability in the age of climate change: the deep uncertainty involved and the need for structural transformation of the global socioeconomic system mean that no single model or scenario can provide sufficient information to private and public decision-makers.” The “staggering complexity” of climate risk represents a “green swan” that demands the cooperation of financial and regulatory bodies around the world. As Ezra Klein remarks, “when a global risk is unhedgeable, the danger it poses is existential.” Despite the seeming futility of the effort Commissioner Allison Herren Lee of the U.S. Securities and Exchange Commission (SEC) suggests that the SEC focus on “climate risk as systemic risk” and coordinate with other federal regulators to restore financial stability in an increasingly volatile world.

Financial regulators are inherently inclined to recommend more financial regulation to address climate risk, yet the complexity of their suggestions supports the argument that it is capitalistic pursuit of profit that creates climate risk and prevents climate change mitigation. The Marxist economist Michael Roberts instead recommends that “under democratic planning we can control unnecessary consumption and return resources to the environment in a way to keep the planet, human beings and nature as balanced as possible.” In other words, “the problems we face, the problems of ‘planet management,’ can’t be solved by individual choice in the marketplace”, according to economic historian Richard Smith. There is some truth to this, as analyst Amanda Levin of the Natural Resources Defense Council (NRDC) has found that “Texas retailers employ promotional pricing systems that encourage wasteful electricity use, sometimes to the point of literally paying bonuses to customers who increase consumption significantly.” Her colleague Ralph Cavanagh says that “the fastest, cheapest and cleanest ways to relieve power grids’ weather-related stresses are on the demand side.” In contrast to free market supporters that recommend “dynamic pricing” to reduce consumption, the eco-socialist approach focuses on direct regulation of behavior to achieve climate goals.

The Portland Democratic Socialists of America (DSA) build on this idea, demanding that after the power outages in Texas and Portland, “our energy sources must be democratically-operated, in order to provide ample opportunity for communities to learn about complex systems and to weigh in on comprehensive ways to improve the power structures.” But Griddy, a retail power company, surprised customers with bills as high as $16,000. since they were exposed to real time wholesale prices. Customers were warned ahead of time to switch to other power provider, but some did not have time to switch. But the lack of preparation for such high bills is compelling evidence that residents are not jumping at the chance to save money by learning how to hedge the complex systems that make up the Texas power grid. Matt Levine, author of Bloomberg’s “Money Stuff” newsletter, comments that “in some theoretical sense they accepted higher price volatility in exchange for usually lower prices, but in a much more practical sense they wanted the usually lower prices and couldn’t afford the higher price volatility. And then when prices rose they were wiped out.” Richard J. Pierce Jr. continues this line of thinking, concluding that “regulators placed too much faith in the ability of consumers to make intelligent choices among electricity options in a complicated market.”

Peter Van Doren, a senior fellow at the Cato Institute, suggests in a podcast that the current Texas deregulation regime is fundamentally flawed. According to him, since most retail customers are on fixed-price contracts, there is no demand elasticity, which means that “the point of deregulation is sort of lost, because we are back to total free wholesale pricing and total rigidity on the retail side.” Even though Griddy provided a tiny bit of demand elasticity and some customers tried to conserve power, for most consumers, “you basically have to black out whole areas rather than individual customers even though the capability is there to do that,” Van Doren notes.

Although the analogy of “voting with your wallet” is distinctly neoliberal capitalist, a democratically operated municipalized grid is not automatically better than a poorly regulated market structure. The Independent Market Monitor (IMM) for ERCOT, Potomac Economics, is also the market monitor for more reliable independent service operators (ISOs), such as ISO New England (ISO-NE) and New York ISO (NYISO). PUCT, the regulator for ERCOT, ignored recommendations by the IMM after the storm to reverse the extra 32 hours of pricing at $9,000/MWh set by PUCT. When a less extreme winter storm in Texas in 2011 also caused similar problems, the Federal Energy Regulatory Commission (FERC) and the North America Electric Reliability Corporation (NERC) produced a report that also recommended that regulators mandate winterization. The report recalls an earlier event in 1989 which was more severe than the 2011 storm, noting that “many of the generators that experienced outages in 1989 failed again in 2011” since after the 1989 storm, “recommendations were not mandatory, and over the course of time implementation lapsed.” Whether federal regulators failed to regulate PUCT or PUCT refused to implement recommendations is just a blame game – the regulatory regime failed to work, even though they were aware of the problems.

Ironically, Smith’s paper from 2016 states that the electric utilities in the U.S. have “the strictest, most elaborate and detailed system of regulation anywhere.” Furthermore, Smith remarks that “regulation of large-scale utilities is a real-world example of something like a ‘proto-socialism.’” On the other hand, the associate director of AARP Texas asserts that “even well-intentioned PUC staff are outgunned by armies of power company lawyers and their experts. The sad truth is that if power companies object to something, in this case simply providing information about the durability of certain equipment, they are extremely likely to get what they want.” A month after the power crisis, the newly-appointed PUCT chairman, Arthur D’Andrea, promised he would protect the profits of the energy traders and gas providers that benefited from the $16 billion market mispricing by PUCT. In addition, the “revolving door” of staff between the regulators and regulated reinforce the perception of collusion between the government and businesses.

Understanding the relationship between market players and regulatory bodies is crucial to recognizing regulatory risk. A cynical perspective could conclude that PUCT was simply a pawn in the game between unaware property insurers who lost mightily and nefarious energy providers who made huge profits. Although “the most common mistake in politics is to believe there is some level of suffering that will force responsible governance,” according to Ezra Klein, the resignation of every commissioner of the 3-member board of PUCT and at six members of the 15-member board of ERCOT at least brings hope to accountability for the energy regulators in Texas. Arthur D’Andrea resigned the same day after his pledge to investors. Yet the failure of PUCT to prevent blackouts, property destruction, and deaths is clear evidence that democratically driven regulation is not a panacea for systemic risk. As Steven Cohen of Columbia University recommends, “reimposing rigid rules is unlikely to result in better outcomes. We need to develop incentives and disincentives that result in private behaviors that meet the requirements of the public interest.”

The argument for public power in Texas is far more nuanced than a simple proposal for the municipalization of Investor Owned Utilities (IOUs). The two primary IOUs in Texas, NRG Energy and Vistra Corp, already “control more than 70% of the market share” and may end up with 80% of the market after the failure of other providers. Griddy filed for bankruptcy after being barred from the wholesale power markets by ERCOT for charging the exorbitant wholesale rates set by PUCT during the winter storm. The largest power cooperative in Texas, Brazos Electric Power Cooperative, also filed for bankruptcy after receiving a $1.8 billion bill from ERCOT. On the other side, the South Texas Electric Cooperative ended up in a “‘financially neutral’ position”, while Austin Energy, a municipal utility, made money during the blackouts.

The mixed performance of each cooperative and utility within the Texas Interconnect is due to their respective level of preparation for the winter storm, despite the poor regulation by PUCT and ERCOT. If the professionals responsible for managing a utility could not estimate their exposure to systemic risk due to extreme cold, such as the freezing of gas wells or the tripping of a nuclear generator, are communities, through democratic operation, expected to be even more conscientious stewards? Ownership of the South Texas Nuclear Generating Station is split between NRG Energy, CPS Energy, and Austin Energy. Although there are many legitimate criticisms of IOUs, the failures of the Texas power grid belong to the regulators already in charge, and municipalization will not fix the problems up top.

A wider perspective on the Texas power crisis reveals a lack of foresight everywhere. Insurers and reinsurers did not properly price the risk of a winter storm, although some of the risk was passed to catastrophe bonds. Energy regulators ignored the physical systemic risk of cold weather and did not strictly enforce the winterization protocols that were suggested after the winter storm of 2011. Finance regulators, expecting climate risk, did not incentivize climate resilience to reduce the impact of climate catastrophes. As Alexandra Klass states, “the fundamental problem last week was not ERCOT’s isolation or the lack of a capacity market but a failure of investment. A failure of investment in insulation of individual homes, businesses and pipes. A failure of investment in insulation of wind turbines, natural gas pipelines, wells, water lines, water treatment systems, natural gas plants, coal plants and nuclear plants.” It was a failure of leadership to predict and prepare for the risks that residents could not expect, and the people of Texas paid for it with their money, health, and lives.

Although resilience bonds offer a potential alignment of capital and climate change, the vastly different time horizon of climate risk and catastrophe risk will be difficult to overcome. Insurers and investors will continue to struggle to plug the gaps in their models that did not predict the full effects of the power crisis in Texas. At the same time, local municipalities and businesses lack the big picture awareness needed to grasp the interdependencies that preclude resilience. The securitization of risk offers a form of macroprudential regulation by translating long-term risks into short-term costs while also disaggregating systemic risks into localized expenses. It is unfortunate that in many cases, such as coastal areas, residents can ignore the effects of climate change longer than the market is able to or spend their resources on ineffective mitigation projects.

To tackle the hard problems faced by humanity, we need to look toward policies that do not require humans to grasp the entire scope of the dilemma at once. Every insurer, business, and person in Texas, except for Rick Perry, would have paid the cost of winterization to avoid the cost of repair after a lack of winterization. No one wanted the system to fail. Yet it did. Regulation that requires winterization is the solution, but it is worth investing further effort to design mechanisms that encourage finding and plugging the holes in the system. We need to bring foresight into the present and incentivize every individual to think collectively.