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Markets For Electricity

By Miro Gavin

Electricity is very much a regional business.  Beyond the national regulations, each region has its own regulations and philosophy on the best way to ensure a reliable supply of cheap and efficiently-produced electricity.  Because electricity production and delivery are so complex, there are a variety of ways to approach the problem. However, there are two general categories of approaches: regulated and deregulated.

In a regulated system, there is one standard price.  An oversight authority sets the price based on what can reasonably be expected and such that the utilities make some reasonable profit.  Historically, this has meant the local utility was vertically integrated to produce, transmit, and distribute the electricity (where transmission refers to transport of high voltage electricity from production facilities to substations, and distribution refers to the local delivery of electricity from substations to houses).

The term deregulated comes about because the norm since the Great Depression had been highly regulated utilities, and only in the 1980s did some countries like Chile [Rudnick 1994] began to deregulate electricity.  In the United States, the process started in the 1990s and is ongoing, with some states who deregulated their systems experiencing problems and deciding to revert back to a more regulated approach.  The idea is to separate what can be made efficient with a free market from what lends itself to a natural monopoly.  Of course, transmitting electricity over a set of wires is usually a monopoly.  However, it turns out that only the distribution of electricity to local houses is considered a monopoly, and even in deregulated markets, distribution is usually the responsibility of the local utility who charges a state approved “tax” on all electricity it distributes to cover the costs of up keeping the distribution network.  In contrast, transmission lines are generally not considered to be part of a natural monopoly because there are usually multiple redundant paths from generators to substations, and in fact, the transmission lines may not even be privately owned. Thus, power generators may bid on rights to use a certain percentage of a wire’s carrying capacity to transmit electricity to their customers.  And since the market has been deregulated, customers now have the ability to buy electricity from anyone who can produce and transmit it to them.

Another system for cheaply producing electricity and of special interest to this class is similar to the government contract auction style, where companies place bids and the lowest bidder wins. Instead there is a second-price auction with multiple slots similar to what we learned about when studying sponsored search markets (i.e. markets for buying advertising slots on search engines like Google). Each company places bids for how cheaply they can produce a given amount of electricity.  The market operator then starts with the lowest bid and successively accepts higher and higher bids until they have enough electricity for the expected demand.  They then pay each company based on the cheapest bid that did not win.

From here, the details can become quite complicated.  The supply must exactly equal the demand, or the transmission frequency of the electricity on the network will begin to travel outside the tolerance range expected and promised.  To ensure that this won’t happen due to unpredictable spikes in electricity usage, the market must also pay for back-up generators to standby at all times. There is, however, an international trend to deregulate the electric power markets as much as possible. For more information, please refer to the sources below.

 

Sources For Further Reading:

Electric Power Supply Association. https://www.epsa.org/industry/primer/ Accessed November and December 2014.

PA Power Switch http://www.papowerswitch.com/about-switching-power/ Accessed December 2014.

Joskow, P. California’s Electricity Crisis. Oxford Review of Economic Policy. Vol. 17. No. 3.

http://economics.mit.edu/files/1149 Accessed December 2014.

Rutnick, H. 1994. Chile: Pioneer in deregulation of the electric power sector. IEEE Power Engineering Review. 14(6):28

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