For the past seven years or so, the phrase “resource adequacy” has received increasing attention in electricity policy. The basic idea is this: before the Energy Policy Act of 1992, vertically-integrated utilities met their future regulatory “obligation to serve” mandate through integrated resource planning (IRP). Customers paid fixed, average, regulated retail rates, and utilities ensured reliability entirely through focusing on supply-side adequacy, particularly generation adequacy. But technological change and the incentives to over-invest in order to get more assets in the utility’s rate base (aka Averch-Johnson) meant that generation no longer had economies of scale as in the past, and the cost of providing such a high level of reliability had gone up.
Thus the development of independent generation and the sale of power through wholesale markets over the past decade has raised this question: if utilities are not doing IRP any more, how do we ensure future reliability?
There are a lot of dysfunctional dimensions to this question, and the question has led to similarly dysfunctional policy responses. In most vertical supply chains, when vertical integration is no longer the cheapest organizational approach and it becomes efficient to transact through markets instead (thank you, Mr. Coase), we use contracts to stipulate terms, and that is the foundation of the reliability of supply chain delivery. In this sense, electricity and future commitments to deliver it are no different from any other service. Sometimes people invoke the long construction time for new generation or transmission assets as a problem, but is that more of a problem in electricity than in other service industries? I don’t think so, particularly when you consider that transactions are two-sided, and there is a demand side here, and developing that capability is unlikely to take as much time as building new generation or transmission.
I also bristle when I hear the “ensure reliability” language. What is the cost of such a high guarantee? Would some of us be willing to accept lower reliability and pay less for the service? Probably. Right now that’s still a technological hurdle, but we’re getting closer to being able to sell reliability as a differentiated product to customers with heterogeneous preferences.
But this discussion of contracts, demand, and product differentiation is very different from the policy discussion of resource adequacy for the past five or so years, in which the discussion and action have all been on the supply side, and have involved construction of elaborate capacity markets as a substitute for forward contracts in financial markets. In electricity, policy has not applied the lessons and tools of other industries, the most relevant of which being that integrated spot and forward markets provide the most robust and fluid way to send those investment signals that lead to network reliability. The focus on building generation also retains the narrow physical asset definition of the “electric power network”; it does not acknowledge that the network is actually composed of assets and humans, and the network is a function of the interaction of physical assets and human actions. Is it any surprise that when you ignore humans you end up with policy focused on building more assets?
This is helping to clarify my thinking, but one thing really puzzles me about electricity. Look at all of the other network industries that have been liberalized over the past two-plus decades: airlines, railroads, trucking, natural gas pipelines, telecommunications. None of these industries has had the hand-wringing, the anxiety, and the dirigiste policy commanding a particular approach to resource adequacy. Yet in each of these industries, investment occurs and resources are generally deemed adequate (in some instances, like telecom in the 1990s, more than adequate!). Why are our policymakers so terrified, so risk averse, about applying the lessons of these other industries in electricity? The need for real-time balancing in electricity does not imply that investment dynamics we see in other industries will not apply here. The fear and the inertia are massively costly, but much of that cost is Bastiat’s unseen cost. How can we make that cost seen? Will that be enough to move policy?