Hold energy companies liable in Texas

John Wald is a professor of finance at UTSA whose research interests include law and finance, capital structure and corporate governance.

MARCH 3, 2021 — Editor’s note: This op-ed by UTSA finance professor John Wald originally appeared in the San Antonio Express-News.

Recent news reports have mentioned how William Hogan, the Harvard professor who helped design Texas’ energy grid, described it as “working as planned” during the winter storm. Such a statement seems bizarre considering the personal misery and financial losses caused by the loss of power during the storm. Cost estimates from the power outages have been estimated as high as $50 billion.

An analysis given the law and economics theory of legal liability provides a missing element in our understanding of the situation and implies the current system is not working efficiently.

“Texas rules allow them to stop providing energy at will, negating any liability they may have.”

Such an analysis can also help respond to the calls for lawmakers to mandate winterizing Texas’ energy infrastructure. Specifically, how much winterizing should lawmakers mandate, and how should these mandates be enforced?

Answers lie in the theory of legal liability: That if the producers of a product are forced to pay for losses suffered when the product fails, they will spend the right amount on prevention.

Liability rules can be based either on strict liability, with producers paying for any harm caused, or negligence. Either rule can produce incentives to create a reliable product, although negligence rules require that courts properly distinguish between sufficient and insufficient prevention. These rules apply across most consumer products, including cars, baby food and insulation.

Said another way, if Texas energy companies had been liable for the loss of life and damage to property from the winter storm, they would have been more likely to properly winterize their equipment. Instead, Texas rules allow them to stop providing energy at will, negating any liability they may have.

While liability rules help provide efficient incentives, if the potential losses are extraordinarily large, these incentives may still be insufficient.

Bankruptcy laws allow companies to escape liabilities that are larger than the firm’s value. In 2019, Pacific Gas & Electric filed for bankruptcy after liability from California fires caused losses greater than it could pay.

Thus, besides reallocating liability, Texas energy regulators should guard against energy companies that are undercapitalized or overleveraged. Such companies may take insufficient precautions, instead taking profits while they can and exiting the market if a winter storm forces them to take large losses. As a result of this problem, there is a role for regulators to monitor the general financial health of energy producers and possibly mandate some standards.

As long as regulations did not decrease energy producers’ liability, energy companies would have incentives to choose the efficient amount of care — that is, the proper level of winterization — when producing their product.

Free markets remain an excellent way to allocate scarce resources. However, lawmakers need to be aware of the environment in which these markets operate. The failures of Texas’ energy producers to provide energy when it was most needed should be a wake-up call for legislators to fix problems caused by a lack of liability and regulation.