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Viewpoint: In Defense of Markets

The latest resistance to deregulation is built on a foundation of lies.

Fortnightly Magazine - June 2007

all people. This led to a number of severe errors, both of omission and commission, including the imposition of fixed retail obligations and generation divestiture without any hedging of wholesale requirements.

The design failed badly. Markets, as with buildings, bridges, or any other product of human thought, can be designed well or poorly. The former requires the application of both intellectual rigor and thorough analysis. The failure of the California market does not serve to refute the value of market competition, just as a bridge collapse does not serve as a condemnation of the entire profession of civil engineering. It does, however, reinforce the importance of good design.

If You Can’t Cancel the Game, Shoot the Umpire

Reading recent press, it would appear that the anti-market sloganeers are building up to a new crescendo. Their latest argument is that the providers of essential market infrastructure—the system and market operators—are too costly.

Before directly addressing some of the arguments that have been advanced, however, it is useful to examine the importance of market infrastructure.

At the heart of any market are the providers of the essential infrastructure to facilitate operations and trading. Imagine, for a minute, air travel without air-traffic control, or stock trading without exchanges. Both are possible, though they would be massively less efficient, and dramatically more risky. Market infrastructure solves these problems, allowing the players in these industries to get on with their core business. Electricity markets have similar infrastructural needs.

Electricity systems are complex networks, consisting of thousands of interdependent resources, and requiring centralized system control by expert system operators. Traditionally, this role was performed by the incumbent monopoly utility. However, as competition emerges, it is no longer appropriate for any party with a vested interest in the outcome of operational decisions to play this role, creating the need for a separate and independent system operator. Additionally, as flows between old utility-based control areas increase, and become more interdependent, it is essential that system operations be managed on a more regional basis 8 by a common infrastructure provider—a regional system operator.

Equally important is the infrastructure to facilitate trading. Independent, price-transparent marketplaces provide a venue for liquidity and price discovery, both of which are essential to the development of a robust and competitive market, be it in securities, commodities, or any other type of product. As trading approaches real-time, electricity markets are linked integrally to the processes of physical delivery, which in turn are driven by the constraints of electricity system physics and network topology. Consequently, tight integration between system operations and spot-market operations is essential, whether contained within the same organization (as is common in the United States) or separate entities. 9

Markets without infrastructure are a hollow shell. Nowhere is this demonstrated better than in Germany. In April 1998, the German Bundestag passed a law declaring the electricity market to be 100 percent open. No action was taken, however, to establish market infrastructure or guarantee open and equal access to transmission. As a result, competition virtually was non-existent, and when coupled with increasing consolidation of players, the