The Attraction – and Danger – of Market Intervention

This is my second effort to write a blog on this particularly sticky subject… the very real problems when policy makers intervene in markets. The reasons such a discussion is difficult in the context of the California electricity markets are emotional. First is the continuing psychic damage that was done in 2000-01. The second is that we want to electricity to be competitive but there is something about it that makes us want to “fix” it all the time. But the most damaging of all is a popular narrative that firmly states that the 2000-01 crisis was all about manipulation. That narrative is damaging because it leads to the entrenched belief that regulatory intervention is necessary to protect from the manipulation, and by extension a painful crisis, from happening again.

Narratives are hard to combat. They take on mythical elements that help us deal with painful memories and absolve our own roles. As a nominal Southerner (native Kentuckian), I’m reminded of those Southern apologists who like to maintain that the Civil War was really about states’ rights and tariffs. It makes it easier to believe “their people” were innocent. The situation was forced on them from the outside. Similarly, the common narrative on California’s 2000-01 Crisis allows for folks in California to believe it was evil outsiders who hurt them.

I won’t go into the alternative view – which I believe – because it would distract from the current market discussions. So why raise the issue now? Because California is making market design decisions that will affect the future going forward but which are based on very suspect views. What’s more is that California’s rules could cause market anomalies that could further undermine confidence in markets and spread to other areas in the West.

Let’s start with fundamental premises: setting up a market with ease of entry and ease of exit to ensure enough competition is key. Further, allowing all parties to transact and take on risk without the expectation of sudden intervention is necessary to get efficient results. Regulators often make mistakes when they do things like limit the kinds of contracts that can be executed (like term, speculation, etc.). Ordering buyers to procure specific types of technology is problematic. That does not, however, mean that certain attributes can’t be a factor for policy makers.

Markets are efficient when they function to procure a commodity. If an additional attribute to that commodity is desired – like low carbon – it is best to have a separate but transparent pricing mechanism for that which can be priced into the commodity market. So, having a cap-and-trade market adds costs to higher carbon-emitting resources which are the basis of an electric (commodity) market. The economically efficient result is that these units don’t clear as easily but the result is a transparent transaction. Based on such market inputs, those buying and selling electricity can make informed decisions. These decisions can be to hedge, buy more low-emitting resources or contract for price-responsive demand.

California has a carbon market, but it also has a command-and-control process to “order” resource procurement for the purpose of driving the goal of decarbonization to its lowest point. But the “ordering” without regard to pricing and the transparency that goes with it is based on a distrust of markets that goes back to that popular narrative: manipulation happens, and we need the “state” to intervene to protect us from another crisis like that of 2000-01.

Recent data points out how California’s command-and-control approach is not yielding the results of the market-oriented Texas electric market. Whether the measure is renewable resource use or prices, the ERCOT market approach in Texas is winning. An article this month in notes that “Texas produces more than double the amount of wind, solar and other renewable electricity as California while California’s retail electric rates were 89 percent higher than Texas’ in 2017.” Texas is clearly the “market” approach while California represents the “command” approach so the comparison is informative.

Now, some of these results, particularly on the cost side, have to do with easier development regulations, and certainly West Texas is good wind country. But double the production of renewables is a staggering figure. I knew the costs were much higher as even my friends in the congested DC area have default rates around 8 cents/kwh where as San Francisco is around 23 cents/kwh. Houston and Dallas come in around 5 cents/kwh. These are dramatic comparisons.

Further in the vein of analytical evidence of the consequences of market intervention is the recently published Green Book by the California Public Utilities Commission. It is an interesting study that recognizes the trend of customer migration from utilities. This is important because choice – in some corners of policymaking – can be viewed as a threat to centralized decision-making on things like renewable procurement. The Green Book at least attempted to compare different market platforms in existence as an exercise to consider how to move forward in meeting state goals such as decarbonization while dealing with customer choice and costs. Congratulations will be in order if the CPUC does not let the old narrative infect an important policy debate between choice and market intervention going forward.

An excellent summary of what is admittedly a long Green Book from “Energy GPS”. The authors clearly have a viewpoint that choice, as embodied in the Texas model, has achieved good result. However, they do give the CPUC kudos for at least engaging in a reasonable analytic exercise. Congratulation will be in order if the CPUC does not let the old narrative infect an important policy debate going forward.

One can easily imagine the next CPUC, particularly in an election year, may be tempted to undermine choice and plunge ahead with some form of centrally controlled procurement of renewable resources. The costs of such a direction would be hard to calculate and could very well affect prices in the adjoining West.  They would contribute to uncertainty in market outcomes further threating efforts of regional coordination. A “choice” approach might make market formation with California easier while a “command” approach might motivate the West to have a separate market adjoining California. The debate sparked by the Green Book bears watching.

So, let’s end on a humorous note about the emotion of “narratives”. The clip below from “Life of Brian” can suggest the attractiveness of a narrative, even if the facts undermine it.