Center for the Study of Energy Markets

This paper first describes those features of the electricity supply industry that make a prospective market monitoring process essential to a well-functioning wholesale market. Some of these features are shared with the securities industry, although the technology of electricity production and delivery make a reliable transmission network a necessary condition for an efficient wholesale market. These features of the electricity supply industry also make antitrust or competition law alone an inadequate foundation for an electricity market monitoring process. This paper provides examples of both the successes and failures of market monitoring from several international markets. More than ten years of experience with the electricity industry re-structuring process has demonstrated that market failures are more likely and substantially more harmful to consumers than other market failures because of how electricity is produced and delivered and the crucial role it plays in the modern economy. Wholesale market meltdowns of varying magnitudes and durations have occurred in electricity markets around the world, and many of them could have been prevented if a prospective market monitoring process backed by the prevailing regulatory authority had been in place at the start of the market.

This paper analyzes the short-run effects of time-varying retail electricity prices on wholesale prices, consumer surplus, generator profits, efficiency, and emissions. We apply a model of real-time pricing (RTP) adoption in competitive markets to the Pennsylvania, New Jersey and Maryland (PJM) electricity market.

Consistent with theory, our simulations show that RTP adoption improves efficiency, reduces the variance and average of wholesale prices, and reduces all retail rates. In addition, we find that RTP adoption would increase the average load since increases in off-peak loads are large relative to the reductions in peak loads. Operating profits for all fossil-fired generation decrease with the largest decreases for oil-fired generation (59% when all customers adopt) and for gas-fired generation (34%). When all customers adopt RTP, the consumer surplus gain is approximately 2.5% of the energy bill, but the welfare gain is only 0.24% of the energy bill. The modest short-run gains, their dispersion across many customers, and free riding may explain the ambivalence of many customers toward RTP adoption.

The changes in emissions from RTP adoption follow the shifts in supply. Since coal-fired generation increases and has relatively high emissions of SO2 and NOx, emissions of these pollutants increase. However, CO2 emissions decrease with RTP adoption.

We find that much of the efficiency gains of real-time price variation could be attained by varying the flat rates monthly instead of annually. Monthly flat rate adjustment would have many of the same effects as RTP adoption and would reduce the deadweight loss by approximately 30% using installed metering technology. Furthermore, flat rates that vary monthly are superior to rates that vary by time of use.

The results are robust to different assumptions about demand shifters, demand elasticities, import supply elasticities, and generator outage factors.

We argue that today’s primary focus on energy efficiency may not be sufficient to slow (and ultimately reverse) the growth in total energy consumption and carbon emissions. Instead, policy makers need to return to an earlier emphasis on “conservation,” with energy efficiency seen as a means rather than an end in itself. We briefly review the concept of “intensive” versus “extensive” variables (i.e., energy efficiency versus energy consumption), and why attention to both consumption and efficiency is essential for effective policy in a carbon- and oil-constrained world with increasingly brittle energy markets. To start, energy indicators and policy evaluation metrics need to reflect energy consumption as well as efficiency.

We introduce the concept of “progressive efficiency,” with the expected or required level of efficiency varying as a function of house size, appliance capacity, or more generally, the scale of energy services. We propose introducing progressive efficiency criteria first in consumer information programs (including appliance labeling categories) and then in voluntary rating and recognition programs such as ENERGY STAR. As acceptance grows, the concept could be extended to utility rebates, tax incentives, and ultimately to mandatory codes and standards.

For these and other programs, incorporating criteria for consumption as well as efficiency offers a path for energy experts, policy-makers, and the public to begin building consensus on energy policies that recognize the limits of resources and global carrying-capacity. Ultimately, it is both necessary and, we believe, possible to manage energy consumption, not just efficiency in order to achieve a sustainable energy balance. Along the way, we may find it possible to shift expectations away from perpetual growth and toward satisfaction with sufficiency.