Economics of power market design compared unfavorably to climate science

Michael Giberson

From the Harvard Electricity Policy Group meeting in February 2011. By convention the meetings are off-the-record, so the speaker’s name is not identified in the summary:

I think the most important distinction between the fields of climate science and economics for me is the question of evidence. Science is characterized by a subtle interplay between conceptual models and the evidence that supports or contradicts them. There’s a rigorous process of analyzing and evaluating evidence and improving or discarding the conceptual models as the evidence dictates. In economics, evidence can often be harder to come by and more ambiguous in nature. This instance is a strong case in point. There is no real precedent. The markets are brand new. And with a few exceptions, the RTO regions have been basically in capacity surplus since the markets came into being for reasons having nothing to do with the capacity markets themselves.

Where evidence is lacking, theorists can find themselves somewhat less constrained. Under these circumstances, whichever side has the loudest voices or the most money or the most impressive resumes can dominate the conversation. This should never be mistaken as proof that their position are correct.


I’m aware that many will argue, and have argued, that a focus on market efficiency will in the long run lead to the greatest consumer benefit. This may be true in a nonexistent, two-sided perfect market with no barriers to entry. But it is a tenuous article of faith when applied to real electricity markets. And given the untold billions in costs to get to that uncertain future, it’s no wonder that consumer advocates basically unanimously are not eager to take that bet.

The implementation of capacity markets based on these unproven theories has already led, predictably, to the transfer of tens of billions of dollars of ratepayer wealth to generation owners. I say predictably because this outcome was clearly anticipated by all parties and articulated by many. The whole point was to raise costs. On the other hand, there’s not a shred of hard evidence that this process has led to new generation where it is most needed, or to avoided retirements of needed capacity or to cost-saving transmission investments. These are the ostensible purposes of the construct. There is no reason to believe that it would. It’s just too good an arrangement for existing generation owners as it is.

The speaker observes that capacity markets have also spurred development of demand-side resources, but this “positive benefit … has come at an astronomical cost.”

As an alternative to capacity markets, the speaker suggests a combination of state-sponsored investments, long term contracts, and short term spot markets. Not that he presents any evidence that this approach will work better for consumers, it just seems good to him. I wonder, scientifically speaking, why not just examine the existing evidence on prices and investments in “energy only” power markets in Texas, Alberta, and Australia?