Energy Price Shocks and the Failures of Neoliberalism
Why it’s time to rethink electricity market design to make sure a clean and equitable energy future
This post was originally published on the Law and Political Economy blog.
The global energy price shocks of the past two years have made it painfully clear that energy can’t be treated as an odd commodity and that many governments have been insufficiently attentive to energy security. Given its dependence on Russian gas, the EU has been ground zero for the crisis, with natural gas and electricity prices rising to unimaginable levels over the past eighteen months. However the crisis has rippled internationally, as EU member states have rushed to fill storage reservoirs to secure adequate supplies of natural gas for the approaching winter, driving up prices and diverting much needed Liquified Natural Gas (LNG) cargoes from other buyers. All of that is coming on top of record high inflation and a post pandemic global economy marked by rising levels of precarity and unrest.
The EU and its member governments have intervened in various ways, providing direct subsidies to households, bailing out energy firms, proposing to cap some energy prices, and searching for to claw back windfall profits. The quantity of spending by European governments is staggering, greater than 7% of GDP in some cases. One report from October found that total spending across the block was around $700 billion, near what these governments spent on pandemic relief. Such numbers, after all, mask the uneven levels of spending across the EU member states, with some countries comparable to Germany spending way over others, raising greater than a number of eyebrows amongst those that recall Germany’s previous lectures to fellow member states on the virtues of austerity and monetary responsibility. For governments within the Global South, after all, such spending is pure fantasy given rather more limited fiscal capability and a looming sovereign debt crisis.
While the EU seems to have avoided the worst-case scenario this winter, the long term supply outlook stays dire. Several countries are rushing to construct recent LNG import terminals. Plans to shut down nuclear reactors in Germany have been placed on hold. Coal-fired electricity has made a brief comeback in some regions. And the EU itself is joining member governments to double down on support for clean energy in recognition that a clean energy future can be a safer energy future.
The tendency to view the present crisis solely as a supply shock, nonetheless, misses necessary questions on market design and the distinctive ways of price making at the middle of natural gas and electricity markets. Particularly, the present crisis has raised fundamental questions on the viability of current electricity market designs within the face of a growing dependence of electricity markets on natural gas. Because natural gas generation typically sets the clearing price in a lot of these electricity markets, extremely high natural gas prices are resulting in extremely high electricity prices, delivering huge windfalls to non-gas generators and causing enormous pain for retail customers.
This post, which continues a series of previous LPE posts on energy prices (see here, here, and here), argues that the present moment offers a critical opportunity to rethink a few of the basic commitments which have underwritten the push to liberalize energy markets over the past forty years, and particularly the usage of markets for electricity provisioning. As we move to electrify an increasing number of elements of on a regular basis life and transition to an electricity system that’s increasingly dominated by renewable energy, the time is ripe for a reconsideration of such markets and their place in a clean energy future.
Neoliberal Electricity: A Short History
As with most things neoliberal, the primary efforts to denationalise electricity and subject it to market competition took place in Chile under the Pinochet dictatorship through the early Nineteen Eighties. Margaret Thatcher followed together with her own effort to open up the UK electricity sector within the late Nineteen Eighties. In each cases, the goal was to denationalise formerly state-owned enterprises and to unbundle generation from transmission and distribution with a view to create competitive markets for wholesale electricity.
Judged against the benchmark of consumer welfare, the outcomes of those early efforts have been disappointing to say the least. In Chile, privatization led to massive concentration within the ownership of generation assets and really limited gains for consumers, because the recent private actors captured extraordinary profits. Within the UK, the experiment has stumbled along for several many years with multiple interventions to take care of chronic underinvestment, rising prices, and a growing backlash against the general public asset stripping that has been the hallmark of privatization. Indeed, certainly one of the good ironies of the UK experiment is that the buyers of most of the formerly state-owned power sector assets were large state-owned enterprises from the continent comparable to Électricité de France. Britons will take cold comfort from the proven fact that the high electricity bills they’re paying this winter will go partially to the French government.
In america, California took the lead on electricity restructuring under Republican Governor Pete Wilson, who was desirous to prove his pro-market bona fides as he prepared for a possible Presidential run. Within the mid-Nineties, Wilson appointed Daniel Fessler, on the time a professor of contracts law at UC Davis, to the state Public Utilities Commission and charged him with leading the hassle. Fessler, who had no background or experience in electricity, was a committed free marketeer from Wyoming and an unabashed anglophile. After a visit to the UK as a part of a delegation of electricity industry leaders and regulators from California, Fessler got here back committed to the concept of harnessing the worth system to create a recent marketplace for electricity within the Golden State. All of which found support from longstanding proponents of deregulation and a growing push by economists to embrace markets for electric power.
The results of the California experiment, nonetheless, was a disaster of truly epic proportions. In 2000-01, prices within the spot market increased by greater than 1000 percent. Considered one of the state’s largest utilities failed for bankruptcy and one other was forced into quasi-receivership with the state’s Public Utility Commission. Rolling blackouts were common, while manipulation of gas and electricity markets reached “epidemic” levels in accordance with FERC. Overall, Californians paid an estimated $40 billion in excess energy costs through the crisis. Litigation to recuperate a few of these costs is ongoing, greater than twenty years after the crisis.
Within the wake of the California crisis, other states that had been actively pursuing deregulation pulled back, leaving the U.S. with a fragmented regulatory landscape. Nevertheless, the fundamental model of wholesale electricity markets that was first attempted in California has survived with various adjustments. Today, about two-thirds of U.S. electricity consumers receive their power through organized wholesale power markets run by Independent System Operators or Regional Transmission Organizations.
Within the meantime, electricity restructuring has also spread all over the world, from Australia and Latest Zealand to Scandinavia, South Africa and Turkey. A concerted effort throughout the EU, implemented through three major directives in 1996, 2003, and 2009, has also succeeded in establishing a single electricity market within the region.
Windfalls, Windmills, and the Contradictions of Electricity Auction Design
Although the precise details vary, most of those jurisdictions have organized their wholesale energy markets across the so-called uniform price auction (sometimes called the only price auction or pay-as-clear auction). Under this design, the last increment of generation needed to fulfill demand (or load) sets the clearing price for all other generation resources that bid in below that price. The virtue of this particular design is that it creates incentives for generators (sellers) to make offers at their short-run marginal costs in order to make sure that they may clear the market if the clearing price meets or exceeds their costs. The only price auction also creates the chance for inframarginal generators (that’s, those generators which have offered to sell power below the clearing price) to receive inframarginal rents, which in theory are alleged to provide incentives for brand new investment.
In practice, nonetheless, there are several major problems with this auction design as applied to electricity markets. First, due to the requirement that generation and cargo be balanced in real time, generators can game the only clearing price during times of constrained capability, resulting in much higher prices. Second, because natural gas is nearly all the time on the margin setting the clearing price in most electricity markets, massive increases in the worth of natural gas will result in very large increases within the clearing price for electricity, which implies that even low-cost non-gas generators will receive the upper price set by expensive natural gas generation. This has been happening in Europe through the current crisis. It has happened in California during extreme heat events each of the last two summers. It happened in Texas during Winter storm Uri. And it could occur this winter in Latest England and other states if one other polar vortex develops, leading some to fret about truly extraordinary increases in prices. Third, as we move toward a system dominated by renewables, which have zero marginal costs, the only price auction will start to interrupt down. Because wind and solar don’t have any fuel costs, they don’t have any short run marginal costs. Moderately, these projects are all essentially fixed capital costs. Even economists would must admit that a market design built on the concept of marginal cost pricing cannot work if there are not any marginal costs.
Decommodifying Electricity?
Recent history suggests that when the present crisis eventually passes, the good neoliberal experiment with electricity markets will proceed to limp along. But there may be not less than some basis for believing that the present conjuncture is different. We’re initially stages of a global-scale energy transition—the sort of transition that comes around just once every few generations. The system we’re moving towards is one during which the prices of providing electricity will likely be virtually all capital costs. Even with a big buildout of storage, the marginal costs of operating the system will likely be very low. And as that system is built out and eventually settles down, the absence of volatile fuel costs should result in stable and inexpensive prices for consumers.
The duty before us is to mobilize investment on an enormous scale and to seek out ways to socialize the prices of those investments in a fashion that’s fair. This requires a basic normative commitment to a system of electricity provisioning that treats electricity as a necessity moderately than a commodity. Here, public utility regulation and outright public ownership each hold great promise as ways to mobilize large investments at relatively low costs of capital and to protect against excessive profits for personal actors. Redesigned markets and price signals surely have a job to play on this as well and there may be much work to be done on that front. But any effort to repair the markets and improve the worth signals should be subordinated to the duty of constructing a shared infrastructure that may support the approaching age of electricity.
