Executive Insight, Policy & Regulation, Smart Grid

Economic Inquiry: Imagine a Market that…

Fundamental changes are occurring in the electricity sector driven by policy, technology, and the economy. These changes promise an environment very different than what was envisioned when restructuring began.

Competitive electricity markets incorporated a vision and are now struggling with a new reality that includes renewable integration, stagnant growth and energy storage.  The last article questioned whether the great experiment of competitive electricity markets has ended. Perhaps it is time we imagined a market that can address the changes that are occurring.  What would that market look like?

. . . has a flat supply curve

Although renewable energy was only 12.2 percent of total primary energy consumption in the United States in 2016, half of which was from hydroelectricity, market share of renewables is projected to rise. California is aiming for 100 percent renewable energy by 2045 while each of the New England states are targeting around 70 to 80 percent in order to meet their decarbonization goals by 2050. More than a majority of states have renewable portfolio standards–some more aggressive than others – with interim targets of 20 percent to 40 percent of load.

With so much renewable energy coming online, the marginal cost of production will be zero or negative during most of the hours in a year, raising the question of how generators will cover their fixed costs in a competitive market. Under the current construct, energy prices will either need to be very high when fossil-fuel plants operate and/or fixed costs will have to be covered by other revenue streams (e.g., capacity, ancillary services, and even a newer service yet to be determined).

Alternatively, competitive wholesale electricity markets may convert into a contractual market as Great Britain did, where willing buyers and sellers commit to price and quantity under bilateral agreements and the spot market covers a much smaller subset of unmet need when required. Or, simply look to the cellular phone service network where the marginal cost of a new customer is close to zero, so customers pay a fixed monthly price for unlimited service. Such incentives to use more may be important in a market with excess supply and falling demand. As the marginal cost of production falls to flat, expect contractual arrangements with fixed price plans, newly defined products embracing quicker response times, resiliency and reliability, and continuous attempts at side deals.

. . . has flat or declining load

A hallmark of the electricity industry from the beginning has been the religious belief in economies of scale combined with increasing demand for electricity. The former argues for lower costs as demand increases which motivated declining block tariffs for electric consumption–the antithesis of energy efficiency. Growing demand allowed for a rate structure under which electric utilities could enjoy revenue growth while maintaining regulated rates at constant price levels. With demand flattening and perhaps even declining in certain service territories as industrial load disappears, how can market players survive in a world with no load growth? Efforts already are underway to revamp the regulated rate structure so that utilities can be rewarded for reducing load. Competitive generators, however, are left to their own devices, prompting requests for state support, federal support and regulatory contracts that would insulate them from the ravages of low demand growth and falling supply costs.  It would be nice if a comprehensive solution could be offered–or if plants could be allowed to retire to allow the market to respond.  In the meantime, utilities roll out their grid modernization plans and seem to be the big beneficiary of the changing construct.

. . . does not need to match supply and demand

The power industry was an ideal testing ground for competitive market design because electricity could not be stored. Eliminating the complications of storage allowed for textbook supply and demand curves–whether in energy, capacity, or ancillary services.  Although hydroelectric power plants with reservoirs (think Pacific Northwest and Canada) and pumped storage (think Northfield Mountain in Massachusetts) were the exception to the rule, specifically incorporating storage into market design was not required. This has changed.  Energy storage technologies, although still undergoing commercialization, are here. With the advent of electric vehicles, bigger batteries, new materials and policy support, energy storage demands accommodation. FERC has been busy with dockets defining whether storage should be treated as generation or load (the answer is both), regulated or competitive (the answer is both) and with new or old compensation designs (the answer is both). More work is required.

. . .  does not always equilibrate

Over the long run, economists believe that markets equilibrate. But over the long run, as John Maynard Keynes famously declared, we are all dead.  “Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again.” Competitive electricity markets were designed for a purpose and with a plan. The purpose and plans are now being challenged. Yet, it is not time to throw in the towel and simply reregulate. Market outcomes are best and there are market designs that have yet to be tried.

Although today may seem uncertain, the optimal solution requires markets. Don’t wait for an answer to become clear when we can only look back and see what could have been.

 

About the author: Tanya Bodell is the Executive Director of Energyzt, a global collaboration of energy experts who create value for investors in energy through actionable insights. Visit www.energyzt.com. She can be reached at: [email protected] or 617-416-0651.