Can deregulated electricity markets provide reliability?
Posted by Daniel Hall on February 29, 2008
A new edition of Resources, the quarterly magazine from Resources for the Future, is now out. In it RFF Senior Fellow Tim Brennan has an article about the electricity market. Part of Brennan’s discussion deals with electricity reliability and whether deregulated electricity markets are going to be more effective at offering reliability than centrally controlled and vertically-integrated electricity markets.
He starts with the neoclassical argument that competitive markets should enhance reliability (referred to as “security” in this excerpt), or at least help ensure it for those who are willing to pay:
When it comes to security, markets should help, not hurt. Opening markets to new competitors and, over time, to new entrepreneurs and innovators should result in redundancy. And a region or nation should be less vulnerable to disruptions if it is not depending on the facilities and services of a single monopoly provider.
More directly, markets can actually help to provide security. Security of service, like any other product feature is one of the attributes that suppliers will offer in an open market, as long as the consumer’s willingness to pay exceeds the cost of furnishing it.
He goes on to acknowledge, however, that some of the particular features of the electricity grid may mean that there are insufficient incentives for electricity companies to ensure reliability:
[Electricity] reliability is, in economic terms, a critical “collective good.” Failures of my car, furnace, or computer to start may be serious problems, but they are ones largely between me and the firms I choose to supply and repair those items. If my electricity supplier fails to meet my demand, it is not just my problem; everyone on the grid is blacked out as well.
Although he doesn’t offer a straightforward answer to whether he thinks this is a major problem for deregulating electricity markets, he does include a nice analogy that helps frame the question at hand:
The nature of reliability as a collective good implies some degree of central control. …the key question is the degree to which such centralized control is consistent with the decentralized decision processes essential to entrepreneurial competition. At one extreme,we might need no more central planning than air-traffic controllers exercise in the airline industry. Air space can be policed to avoid collisions without precluding competition among carriers to transport passengers and freight. At the other extreme, a central controller may need to control dispatch of generators in the short run and investment in generation over the long run to ensure reliability as well as efficiency.
My guess is that newer technologies are going to be able to provide some of this differentiated service, e.g. real-time meters and pricing, smart appliances, programmable thermostats, etc. This will allow some consumers to pay a lower electricity rate in exchange for bearing some reliability risk, while allowing other customers who truly value reliability to pay a premium to always have the lights on. But do read the article, it’s a thought-provoking look at the electricity markets, and then drop back by to leave your thoughts on whether deregulated electricity markets can work.