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Generation adequacy

Written by Thomas-Olivier Léautier

As I am reading Sebastian Mallaby’s excellent new biography of Alan Greenspan, former Chairman of the US Federal Reserve, I am reminded how central and complex is the question of the appropriate role of governments and law-makers in the operation of the economy. Since Industrial Organisation economists debunked the Chicago critique in the late 1980s, no one really doubts that markets are imperfect: left to their own devices, they are likely to lead to concentration and inefficient risk-sharing. On the other hand, the debacle of the Soviet Union, but also countless examples of underproductive government interventions and regulations, are evidence that governments, law-makers, and bureaucracies are not able to run economies.

Thus, like Alan Greenspan at the helm of the Fed, we are struggling to find the appropriate level of government intervention. This applies to all industries, but perhaps more so, to the power industry. Since the electricity fairy has enlightened millions of us on her patch, we emotionally consider electricity a necessity, hence expect governments to guarantee its provision.

This FSR topic of the month explores governments’ intervention in four aspects of the power industry: (i) generation adequacy, (ii) generation mix, (iii) organisation of the transmission grid, and (iv) asset ownership.

Generation adequacy

Following an afternoon of tight supply and demand conditions, which almost led to rolling blackouts in Great Britain in October 2015, David Cameron, then Prime Minister, called an emergency cabinet meeting to ensure that the “lights remain on”. I found this particularly startling, coming from Prime Minister who appeared not to be overly concerned by a widening income distribution or by cuts in the NIH.

To meet that government promise, Great Britain, like many other countries and US states, has implemented a capacity market. Over the years, I have read most of the academic literature on these capacity mechanisms. All articles start from the premise that setting a generation adequacy standard (i.e., setting an acceptable number of hours of rolling blackouts per year on average) falls within the governments’ responsibilities.

A generation adequacy standard was a legitimate engineering practice when spot markets did not exist, hence when consumers had no information to reduce their consumption in response to scarcity. It is no longer required today. And yet, we continue to use a generation adequacy standard, and furthermore entrust our governments with the responsibility of setting it. Should we not at least discuss whether we need such standard, and who should set it? We may conclude, after carefully weighing the pros and cons, to continue with the current practice. Or we may conclude, like the people of New Zealand, that a generation adequacy standard is no longer required. Whatever the outcome, we would at least collectively make a conscious decision.