Electricity deregulation needs to respect physics

An article in The Industrial Physicist entitled What’s wrong with the electric grid? eloquently states what I’ve believed all along:

In the view of Casazza and many other experts, the key error in the new rules was to view electricity as a commodity rather than as an essential service.

A normal competitive market requires tension between buyers and sellers. Buyers are trying to get the lowest possible price; sellers are trying to get the highest possible price. The “sweet point” in the market maximises profit for the seller; lowering the price lowers margins and reduces profit, while raising the price drives away buyers, reducing revenue.

That last part is why competition in essential goods and services cannot work; if a buyer cannot choose to not purchase, then there is no force acting to reduce prices. We need to consume a minimum amount of energy; for example, if we don’t purchase one of heating oil, electricity, or natural gas, then we freeze to death. We can conserve energy and reduce consumption somewhat, but we cannot stop using it altogether, and that means that energy cannot be traded in a truly competitive market.

Instead, energy automatically becomes scarce, and prices rise. This happens for two reasons. First, when energy prices are low, there is no incentive for energy producers to invest in new generators; they won’t make any money doing so. When energy prices are high, there is no incentive to invest, because new generators will lower prices, reducing both the “free” profit margin on the existing generators, and reducing the profit available to pay for the new capacity.

Second, this kind of good creates an incentive to “game the system”: producers (or traders) can create artificial shortages and watch prices rise as buyers scramble to secure the power they need. In fact, we experienced both of these outcomes:

“Under the new system, the financial incentive was to run things up to the limit of capacity,” explains Carreras. In fact, energy companies did more: they gamed the system. Federal investigations later showed that employees of Enron and other energy traders “knowingly and intentionally” filed transmission schedules designed to block competitors’ access to the grid and to drive up prices by creating artificial shortages. In California, this behavior resulted in widespread blackouts, [and] the doubling and tripling of retail rates […]. In the more tightly regulated Eastern Interconnect, retail prices rose less dramatically.

After a pause following Enron’s collapse in 2001 and a fall in electricity demand (partly due to recession and partly to weather), energy trading resumed its frenzy in 2002 and 2003. Although power generation in 2003 has increased only 3% above that in 2000, generation by independent power producers, a rough measure of wholesale trading, has doubled. System stress, as measured by TLRs and frequency instability, has soared, and with it, warnings by FERC and other groups.

The blackout on August 14th was an inevitable result, and the subsequent outages in London and Italy should show even the optimists that August 14th was not an isolated event.

posted at 7:57 pm on Friday, October 10, 2003 in Rants | Comments Off on Electricity deregulation needs to respect physics

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