Markets are great… IF you let them work

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She looked at me intently and said; ” I know there are a lot of people who want electric markets to be just like any commodity market, but electricity is different”. While acknowledging the difference, I told my then-colleague, you rely upon the markets to set prices efficiently and to attract capital for investment and thus these markets HAVE to behave like other commodities.

 

Capital is fungible – that is its greatest virtue and allows us to avoid barter or finding other things people will value to get something we need or want. The fungibility eases transactions. But since it is fungible, making any market “different”, or to intervene to make them do something other than set an efficient price, invites disaster or lack of investment. Capital will go in quantity where rules are easily understood. Interventions by well-meaning politicians or regulators will ultimately lead to either; 1) a lack of investment or 2) high prices over time that must be paid by someone.

 

So, let’s first talk about what makes electricity “different”. Well, it isn’t easily stored on an economic basis. No informed person will debate that. This difference is why we embrace the concept of “capacity” which is really a proxy for storage. However, we have further complicated what could be a very straightforward auction to supplement bilateral arrangements with everything from artificial sloping demand curves to outright regulatory interventions on behalf of “preferred” resources.

 

You might think this last point is a slap to renewable resources. Not true. The recent proposal from DoE that required FERC to consider benefiting so-called “resiliency” needs (translation – Coal in northern Ohio) is an example of positive discrimination that is similar to positive discrimination by a state like California on solar, wind or batteries. I submit that direct interventions like these are wrong because merely ordering that a resource be given a certain place in a market stack – either through outright subsidy or through a regulatory fiat – will come back to haunt customers at some point.

 

I thought about this recently after getting off a call with our WPTF consultant on changes afoot in Mexico. The fairly straight-forward and bold attempt by Mexico to reform its electric market is being slowed and hurt by the complex way Mexico is trying to ween its customers (industrial and residential) off of subsidized prices. The original intervention was well-intended… help customers and help internal industry. The problem is that subsidies are either a drain on the budget of the nation (or the nationalized utility) or they result in prices so low that nobody invests and infrastructure decays over time. However, moving away from the well-intended intervention or subsidy is difficult. In less economically developed nations, moving away from subsidies can be a “to the barricades” moment. In developed countries like ours, it results in complex “transition” methodologies to buy-off interests that undermine the market signals.

 

Am I saying states or national policy makers should not try and achieve certain policy outcomes in markets? No, we do this all the time but the best ways to do this are when we seek to “price” the goal through a separate input or product. You want fewer emissions? Fine, pricing carbon is a great tool – through an outright tax or a cap and trading platform.

 

California likely has the most complex and movable approach to resource procurement that exists in the United States. What is needed is very straight-forward procurement rules that can still allow the state to pursue its policy goals on the environment but does not undermine investment in all the kinds of infrastructure California will need. Investment that won’t hurt customer choices but also won’t deter capital in favor of less opaque markets or shifting regulatory rules. It could be an auction for resources in the near future so that customers can hedge price and suppliers can count on prices to be around. It could be an auction that also informs customers of what a competitive price is that will allow for a bilateral contract.

 

What is needed is a clean-sheet review by the CPUC and CAISO with stakeholders to re-set the market. If we don’t do that, it will eventually end badly for California… either in cost down the road or lack of investment.

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