Posted by: bmeverett | August 20, 2009

A real solution

I’ve spent most of the time on this blog debunking proposed solutions to our energy problems. Today, I’m going to offer my own proposal. Not a panacea, but something very helpful. Let’s price energy properly.
A good place to start would be electricity. Despite decades-long efforts by the Democratic Party, prices for most goods and services in the US are still set by the market and vary with supply and demand. Electricity prices, however, are still heavily regulated. One characteristic of this regulation is that consumers tend to pay a single average price for electricity. For US residential customers, the price of power currently averages 11.4¢ per kilowatt-hour (kWh).
Average pricing is a problem in the power industry because electricity cannot be economically stored, but must be produced on-demand. Demand varies dramatically during the course of the day and over the course of a year. Power companies must therefore build and operate a set of power plants to meet this variability.
Nuclear, coal and hydroelectric plants are generally used for what is called base load, i.e., the demand that continues 24/7. These power plants are very expensive to build, but their fuel costs are very low (zero in the case of hydroelectric plants). Once a company invests the money in these facilities, it makes sense to run them all the time. Coal and nuclear plants produce electricity at a cost of 4-6¢ per kWh.
Natural gas plants, particularly new combined cycle plants, are much less expensive to build, but the fuel is expensive, so their total cost is 7-8¢ per kWh. Power companies use these plants to meet the growing electricity demand over the course of the day, so-called intermediate load. Finally, power companies have generating plants for peak load, those infrequent times late in the afternoon on hot summer days when air conditioning places huge demand on the generating system. Many companies use simple cycle turbines which are very inexpensive to build but require very expensive diesel fuel. Many of these plants cost over 30¢ per kWh to operate.
Charging everyone 11¢ per kWh makes no sense. Even charging a slightly lower price at night or in the winter doesn’t help very much. We would use electricity much more efficiently if we priced it according to the marginal cost of generation. In other words, if you ran your dishwasher during the middle of the night, you might pay 5¢ a kWh. If you insisted on running your dishwasher at 5:00 on a hot summer afternoon, you might pay 30¢. If it’s worth it to you, fine, but you ought to pay what it costs. We have all the computer control technology we need to manage such a system with ease and convenience for both the power company and the consumer.
Think about having a read-out on your PC that tells you how much electricity costs from minute to minute. You could program your computer to manage your household power use in any way you want. For example, if power is available at 10¢ per kWh, you could cool your house down to 70° F. If power costs 20¢ per kWh, your computer would reset the thermostat to 72°. If power cost 50¢, you could shut it off entirely. By the same token, your computer could decide (based on your preferences) when to run your appliances to keep your electric bill low.
Efficient use of electricity would bring costs down significantly, since power companies would need less machinery. Looked at another way, why build a power plant to generate electricity at 30¢ per kWh if nobody is willing to pay that much?
Simple as this approach sounds, many people on the left side of American politics simply don’t like the price mechanism, which they regard as unfair, uncontrollable and chaotic. Their view is that centralized controls can manage the production and allocation of resources better than the market can. (For more on this point, review the history of the Soviet Union.) In California, for example, there have been a number of proposals to allow power companies or government agencies to shut off your air conditioning if the load on the system becomes too great. This approach is ludicrous when there is a simple alternative that would achieve the same end (better efficiency) while allowing consumer preferences to determine how and when electricity is generated.
Prices in a market economy are carriers of information to consumers. If consumers know how much something truly costs, they can make sensible decisions about how much of the product to buy. Unfortunately, most of our existing and proposed energy policies seek to hide information from consumers so that consumers make the choices government wants. Take, for example, Renewable Portfolio Standards (RFPs) which require an electric power company to produce a certain share of its electricity from renewable sources. Solar and wind, for example, tend to be very expensive compared to other types of power generation, so nobody will opt for them if given the choice. RFPs keep that information from consumers. Subsidies do the same thing. An S-class Mercedes is a cheap car if someone else buys it for you.
The value of the price mechanism seems to have been lost in our public debate. No Democrats and very few Republicans will defend free markets these days, but prices ensure the we, not our government, make the decisions on how to spend our money.



  1. You mean how they do it in France!

    • I think the idea of proper electricity pricing is so good, I’m support it even if it’s done in France!

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