Power Market Design
The Role of
Regulators
in Electricity
Markets
Paul Joskow, President of the Alfred P. Sloan Foundation
and a longtime member of the MIT economics faculty
(1972–2010), believes regulators intervening in electricity
markets should always balance the costs of market imperfections against the costs of regulatory imperfections.
Photo: courtesy of Exelon Corporation
Text: Justin Gerdes
Living Energy · No. 8 | July 2013
23
Power Market Design
Power Market Design
Paul Joskow
“When you do
choose to regulate,
there are better
and worse ways of
doing it.”
Born on
June 30, 1947
in Brooklyn, New York
Background
As a longtime Professor of Economics and Management at the
Massachusetts Institute of Technology (MIT) and Head of the
MIT Department of Economics
(1994–1998), as well as Director
of the MIT Center for Energy
and Economic Policy Research,
Joskow is a leading US econo-
mist whose writings on industry
regulation and the energy sector have had an international
impact. He has been the President of the Alfred P. Sloan Foundation since 2008.
Born in New York, Joskow holds
a BA from Cornell University
(1968) and a PhD in Economics
from Yale (1972). He has published numerous books and articles in academic journals and
acted as an advisor to government agencies, corporations,
and nonprofit organizations.
here are very few perfect markets, and there are very few
perfect regulators,” says Paul
Joskow. “When you do choose to regulate, there are better and worse ways
of doing it.” Among Joskow’s dozens
of published papers, two in particular, “Market Imperfections Versus
Regulatory Imperfections” (June 2010)
and “Challenges for Creating a Comprehensive National Electricity Policy”
(September 2008), have shaped contemporary thinking on electricity
markets.
Joskow believes that developed countries, especially the USA, need to
renew efforts begun in the 1990s to
restructure and deregulate their electricity sectors. Policy makers, Joskow
says, “were reluctant restructurers
and deregulators. Neither the industry structure nor the regulatory
framework adapted either quickly or
very well to supporting a restructured electric power sector with competitive wholesale and retail markets
and well-functioning transmission
networks and unbundled distribution
networks.”
“I think there’s plenty of blame to go
around here,” he goes on. “A lot of the
incumbent companies were resistant
and tried to convince governments
that they could handle things with
partial restructuring and partial deregulation. Some of the regulators
were to blame because they didn’t
know what they were doing either,
or were marching to many different
drums with different goals. And the
existing structure of the industry was
challenging, especially in the USA,
where we had a mix of state and federal regulation, investor-owned utilities, municipal utilities, governmentowned utilities, and a sometimes
incomprehensible mix of regulatory
responsibilities between the states
and the federal government. It is still
true today.”
A New Nationwide Rulebook
The USA needs a national electricity
policy, says Joskow, to replace outdated rules from the 1930s ill suited to
24 Living Energy · No. 8 | July 2013
Photo: Penn Law/University of Pennsylvania Law School
T
today’s challenges. In “Challenges for
Creating a Comprehensive National
Electricity Policy,” Joskow writes that
policy makers rely on the electricity
sector to do four things: 1) provide an
abundant and reliable supply of electricity; 2) ensure that electricity prices provide incentive to consumers to
use energy wisely and that revenues
will be sufficient to encourage efficient investment and operations;
3) play a major role in reducing greenhouse gas emissions; and 4) improve
energy security and reliability. The
US electricity sector, he says, “lacks a
comprehensive national policy framework consistent with achieving these
goals.”
Policy makers have instead implemented piecemeal reforms that favor
some technologies over others and
distort the market, Joskow believes,
often in well-intentioned attempts to
achieve environmental goals. “The
electric power sector has become
inseparable from environmental
policies,” he says. “Many regulators
couldn’t resist the power to engage
in taxation by regulation. To basically
force utilities to subsidize one thing
or another thing and then bury the
redistributive taxes in the distribution charges. That continues to go
on – in fact, it’s accelerating, as far
as I can tell.”
Joskow says that policy makers
should favor market-based solutions
that put a price on carbon over picking technologies and subsidizing
them on a state-by-state basis. “If the
primary goal is to reduce CO2 emissions,” he says, “the primary policy
ought to be to price them. CO2 is a
global pollutant. It makes no sense
for Rhode Island to have a climate
change policy. It creates interest
groups. It doesn’t satisfy any of the
efficiency criteria of trying to find
the cheapest ways of reducing emissions.”
Free Riders in Europe
The phenomenon is not limited to the
USA. “The UK, which I thought had
the most pristine system when they
“For generators in the
free market, the burden
is on the plant owner.”
Paul Joskow
started in 1990, is slowly taking it
apart based on climate change goals.
The same thing is happening in parts
of continental Europe,” says Joskow.
Air-quality regulations, volatile fuel
prices, and deeper penetration of solar and wind electricity into the grid
threaten the viability of nonrenewable power plants, merchant plants
operating in the market, and regulated fleets alike.
“We’ve seen a lot of plants close down
for economic reasons,” Joskow says.
Regulated fleets “will have to make a
deal with their state regulators as to
how the residual costs will be recovered” to retire old, noncompliant
plants or to install pollution-control
equipment. “For those generators
that are in the free market – most of
them in Germany and the UK – the
burden is on the plant owner.”
With so much base load generating
capacity coming off-line and intermittent wind and solar electricity taking its place, Joskow is concerned
about system reliability and the lack
of incentives for investment in new
generating capacity. “The way intermittency has been handled has essentially been to free ride on the existing
stock of fossil fuel-generating plants,”
he says. “Who is going to pay to build
new plants to provide backup when
the wind doesn’t blow on a hot day in
Texas?” In Germany, he adds, “it’s a
race between how fast they can build
wind generators and other kinds of
backup technology and how much
more coal they have to import to keep
the system running.”
With policy makers focused on increasing supply, demand management has been neglected, Joskow
says. Citing the promise of smart
meters and the smart grid, he says,
“I think there are a lot of relatively
lower-cost opportunities there that
are being exploited more quietly.
There are growing opportunities for
customers to express their preferences for reliability by entering into contracts where their consumption is
limited or reduced entirely or their
air conditioners are cycled.”
“Customers in the USA and Canada
consume a lot more electricity per
capita than countries like Germany
or Denmark or Japan,” he says. “I’d
be betting on the demand side, and
technologies we haven’t yet seen, to
cut into the trend lines for greenhouse gas emissions if we’re looking
for an 80 percent reduction.” p
Justin Gerdes is a freelance journalist who
writes about energy and climate change from
northern California.
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