A newly released study by the Brattle Group suggests that policymakers’ fears of being held responsible for power outages leads to higher costs for consumers.
The study, conducted for the Federal Energy Regulatory Commission (FERC), finds that the “‘economically optimal’ reserve margin tends to be significantly below the planning reserve margins yielded by the traditional 1-in-10 resource adequacy standard unless regulators incorporate risk mitigation benefits into their decision making.”
Putting this into English, it means that regulators usually set reliability standards for electricity markets above the level that best balances the costs of outages with the costs consumers pay for electricity. The higher standard means consumers must pay more for electricity.
Of course, Brattle doesn’t lay the blame for the higher prices on the fear of policymakers. But that is clearly what has happened in the Texas debate over capacity markets. Back in 2012, two reports projecting very low reserve margins in the Texas electricity market triggered the push for higher electricity costs by Texas policymakers, most notably at the Public Utility Commission of Texas (PUC). The higher costs would have come in the form of a $3.2 billion electricity tax on Texas consumers used to fund subsidies to generators in a newly designed “capacity market.”
The problem is that both of the reports that fueled the push for the capacity market were flawed. The Electric Reliability Council of Texas (ERCOT) report was based on flawed projections of future demand, or load, that far exceeded the amount of electricity Texans would actually use. Newly released data from ERCOT verifies this, but it was obvious even at the time. The problems with the Brattle report were equally obvious, as it used flawed economic models and unrealistic assumptions to project future reserve margins much lower than Texas has ever experienced.
Instead of acknowledging these flaws, however, policymakers appear to have panicked, perhaps not wanting to be in charge when the lights went out. As often happens, however, the fear of power outages have pushed policymakers to favor a system that actually makes outages more likely to occur. The centralized control of capacity markets make them less efficient and less reliable than competitive markets. It is this centralized control, however, that perhaps gives policymakers the illusion of control and eases their fears despite the increased unreliability.
This phenomenon is the same in all areas of regulation. For instance, regulators fears that insurance companies would charge consumers too much for homeowners policies led to the Texas mold crisis a decade ago and hundreds of millions of dollars of higher costs for consumers.
A couple of caveats.
First, the Brattle report states, “Planning reserve margins higher than economically optimal will slightly increase costs but significantly reduce price volatility and customer cost uncertainty.” In other words, Brattle claims that policymakers’ imposition of a higher reliability standard won’t cost consumers much money. Brattle makes a similar claim in its recent Texas report. But these results are based on the same flawed economic model Brattle appears to use in all of its studies: a theoretical model of perfectly efficient markets used to project real world outcomes. Additionally, Brattle takes real world costs, such as the $3.2 billion a year Texas electricity tax, and offsets them with theoretical savings from its model. Those theoretical savings are not going to help Texas consumers when it is time to pay their electricity bill.
A second caveat is that in a competitive electricity market the reserve margin would not likely be as low as the ‘economically optimal’ level projected in the Brattle report. Consumers also have desires and fears, and these would be reflected in the price of electricity. Most likely, consumers would be willing to pay more for increased reliability. But the price would almost certainly be lower than the one set by policymakers.
One reason for this is that competitive markets are much more efficient than capacity markets, so the consumers’ preferred outcome could be achieved at a lower cost. We’ve also seen in Texas the high cost of implementing a capacity market that policymakers appeared willing to impose on consumers. Finally, the cost to consumers is likely to be higher in a regulated market because generators and Wall Street financiers will do everything they can to drive the costs higher to improve their bottom line.
Perhaps the most important thing to remember is that whatever the price of electricity turns out to be in a competitive market, the price will reflect the preferences of consumers, not of policymakers. They will be paying what they want to pay to satisfy their fears about reliability–the cost won’t be forced on them.
There are both practical and moral reasons against adopting a capacity market in Texas. These are something for lawmakers to consider as the debate over this issue heads towards the Texas Legislature in 2015.