DURING THE WEEK OF June 22 there was a major imbalance between supply and demand for electricity in the Midwest. Although demand was high enough to set a few records, the real problem may have been the lack of supply. Many generators were out of service and a few marketers reneged on contracts to deliver power. Market prices for bulk power allegedly soared as high as $4,000 per megawatt-hour. The industry was left in an uproar over these volatile prices, especially since a competitive market has been touted as a means to achieve lower prices, not higher ones.
Yet just as a multitude of competitive sellers can bid the price down to marginal cost of the supply curve in classical economics, a multitude of competitive buyers can bid the price up to the value of the demand curve. The principal is the same. These high prices should be viewed as the normal course of a competitive market for electricity. I agree with FERC Commissioner Hebert: The market works. The prices needed to get this high.
However, the prices may not have needed to stay as high as they were for as long as they did.
The market works better when the commodity is differentiated into finer increments, both with respect to the power sold and with respect to the duration of the delivery. Such a market needs to have a pricing formula that reflects the concurrent balance between supply and demand. The electricity market changes too quickly for all such deliveries to be negotiated one deal at a time. Further, the physics of electricity results in unscheduled deliveries that are not now priced.
Predicted Price Volatility