Lights out, but what about the markets?

The Power to Choose: Demand Response in Liberalised Electricity Markets
OECD Observer

After the recent North American blackouts, US energy secretary Bill Richard told CNN that “the United States is a world power, but it has the electricity grid of a third world country”. begged to differ, observing that third world countries can generally put up with frequent minor blackouts, whereas OECD countries require a very reliable, interconnected, very first world grid.

Does today’s ongoing deregulation of energy make for more or less volatility in the power supply business? Could the recent electricity breakdowns in New York and London have been avoided in an even more liberalised energy market?

While many critics blame fast and furious deregulation, The Power to Choose argues that deregulation has not yet gone far enough in OECD countries. It says that too much attention has been paid to the supply side of the market and not enough to the demand side, with no room for a price mechanism to work. In the process of deregulation, the tendency has been for suppliers to compete fiercely for customers by offering low and fixed prices. At the same time, in the wholesale markets where electricity is traded, prices have fluctuated wildly from hour to hour, day to day, and season to season. Customers, seeing only a fixed price, have had no incentive to help moderate these swings by reducing their demand at peak times.

The Power to Choose shows that if customers are more exposed to real market prices they will respond. It cites studies showing that a 5% reduction in demand would have reduced the highest wholesale prices in California’s power crisis two years ago by 50%. But the technology to monitor or manage electricity demand in real time, and hence to measure and reward changes in consumer behaviour, has been considered too expensive for demand response to be cost-effective. Yet the estimated costs of transmission congestion, according to a report from the US Department of Energy, are about US$450 million per year. The Power to Choose argues that when prices fail to play their normal role of balancing natural swings in supply and demand, the result is excessive price volatility, over-investment in peak supply capacity and, ultimately, a greater risk of system failures.

©OECD Observer No 239, September 2003

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