The Electricity Reliability Council of Texas (ERCOT) estimates electricity reserves in Texas are expected to fall below target levels as early as 2013. At the same time, Texas is setting record rates of demand. In August 2011, Texas set an all time US national record with 66,867 megawatts (MW) of electricity demand.

Yet despite this growing demand and low reserve margins, investment in new generation is not occurring. Is Texas experiencing an electric market failure? According to Bill Peacock at the Texas Public Policy Institute, the problem is not market competition but existing government regulation.

Peacock cites regulations and subsidies that existed before full competition took hold in 2007, including the federal production tax credit, the state renewable portfolio standard, market power regulation and the state?s energy efficiency program. The market is also regulated by a wholesale price cap and PUC (Public Utility Commission) approval of mergers and acquisitions. Together these restrictions are the cause of the market?s reserve margin shortfalls.

Take the wholesale price cap established by the PUC: If the cap is too low generators can’t sell electricity at a profit during times of peak demand and they won’t build generation plants when more electricity is needed. This is why Texas recently raised the wholesale cap to entice more investment in new generation capacity. But since regulators can’t predict what the cap should be the cap should be eliminated.

Let’s look in detail at another market barrier to generation investment, renewable energy subsidies.  Wind generators in Texas can make a profit even if they give away electricity for free thanks to the renewable portfolio standard and the federal production tax credit. Subsidies distort the market by pushing overall electricity prices lower, reducing the revenues that generators need to build new generation.

Another reason for the lower investment is increased market efficiency. In an efficient market profits are harder to come by because easy to fix inefficiencies have been reduced. In this environment, any government intervention has a magnified impact because companies are dealing with a much smaller profit margin.

Since Texas fully unregulated its electric generation market, consumers have benefited from billions of dollars of new investment in generation, lower prices and a high level of reliability with robust reserves. The problems facing Texas right now were caused by regulation. Therefore the answer to boosting reserve margins and protecting reliability is reducing government intervention in the most successful electricity market in the world.