I found a good resource for economic analysis of the California
electrical power crisis. It is the UC Energy Institute at Berkeley,
http://www.ucei.berkeley.edu/ucei/. Their working paper #074, from
February, 2000, presciently describes the difficulties facing electrical
markets in periods of shortages:
The combination of very inelastic short-run demand and supply (at peak
times) with the real-time nature of the market (costly storage and
grid reliability requirements) make electricity markets especially
vulnerable to the exercise of market power.
To see why this is the case, think about the dreadful summer afternoon
when the temperature and humidity are at peak levels and the grid needs
virtually all resources in production in order to meet the tremendous
demand for electricity to run air conditioning units. If the grid
has only a few percent margin of reserve capacity at that time and
there is a producer that is supplying more the a few percent of the
total output, then that producer is pivotal in meeting the demand. Put
differently, that producer can ask for an extremely high price in order
to deliver the power and consumers--more specifically the local utility
that represents them in the wholesale power market--will pay it.
In most markets, there are other constraints that keep a single firm
with a fairly small percentage of production from driving up the
price by a large amount. If the good is storable, then the buyers,
or marketers in the middle, can store product to defend against such
vulnerability. If end-use consumers receive the price information
before buying, then their own hesitancy to pay extreme prices
discourages the seller from asking such a price. If there is supply
elasticity, then one firm demanding a high price for its output will
just shift market share to another supplier. Each of these attributes
is much less prevalent in electricity markets than in nearly any other
industry. The result is that the ability of firms with even modest
market shares to exercise market power is greater than in most markets.
Other papers in the series present evidence of market power (price
manipulation beyond competitive levels) in the detailed data available on
the California markets. They also offer some remedies, including price
stability through futures markets, and increased use of real-time pricing
(which requires special electric meters which report hourly use).
The one I quoted above concludes, "The movement towards less regulation
and more reliance upon market processes in the electricity industry has
enormous potential benefits, and also potential risks. A move toward
deregulation that does not take the issue of market power seriously can
undermine the goals of industry restructuring and even, as in the case
of England, produce a regulatory backlash." Unfortunately it appears
that this prediction is being borne out very accurately.
Hal
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