'Markets' Test


We Called Them 'Markets.' Now We're Testing Them.

We Called Them 'Markets.' Now We're Testing Them.

Fortnightly Magazine - April 2017

I remember it well. The notion was as simple as it was compelling. What power plants were built, and what plants were run, had been determined by planners, regulators and system dispatchers. Instead, what plants were built and run would be determined by markets.

We're enamored of free markets. This was particularly true in the nineties. Communism had just been defeated politically and intellectually.

So, committees, consultants and competitors crafted "markets" to trade power in - essentially - commodity exchanges. The so-called deregulation was embraced by politicians, promised lower prices for consumers.

Many of us knew the markets were more sets of regulatory rules to mimic competition and coerce competitive behaviors, than they were like the freewheeling exchanges of pork bellies, silver and crude oil. And some of us knew the quest for a well-working set of rules, as problematic complexities revealed themselves, would be like an endless game of whack-a-mole (as said by Delia Patterson and Harvey Reiter, Public Utilities Fortnightly , May 2016).

Nonetheless, power markets provided substantial and lasting benefits to consumers, particularly during deregulation's first years. Would the enormous entry of efficient gas-fired combined-cycle plants have taken place absent deregulation? Would the impressive improvement in nuclear plant availability have taken place?

But the challenges were inevitable. Power markets cannot come close to emulating authentic competition. Why? They cannot satisfy the basic conditions of competition, the basic conditions taught in microeconomics 101.

Entry by efficient new plants and exit by inefficient existing plants is hardly free in power markets, as it is in authentic competition. This is especially the case in recent years, given the increasing barriers to siting and financing new plants.

Power plant owners hardly sell an identical product, as sellers do in authentic competition. This deviation from the basic conditions is unavoidable, given the physics of alternating current in complicated regional grids.

Marginal cost pricing is a characteristic of authentic competition. So, marginal cost pricing was made a standard rule in the power markets we crafted. Under marginal cost pricing, plants with relatively low variable costs are paid the same as the plants with high variable costs that enable supply to equal demand.

But those pesky conditions of competition must be satisfied. If the conditions of competition are not satisfied, marginal cost pricing can waste consumer monies.

Marginal cost pricing assumes that plants with relatively low variable costs will run more and that more of them will enter the competition. Meanwhile, it is assumed, plants with high variable costs will run less and that some of them will exit the competition.

That was never going to happen in power markets. Just because marginal cost prices were significantly greater than the variable costs of nuclear and hydro plants, more nuclear and hydro plants weren't going to be built.

Entry by new nuclear and hydro in power markets is hindered by virtually insurmountable