Energy Industry Exhibits Classic “Market Failure” – Deregulated Markets Rife With Fraud
Amid Billion Dollar Ripoffs by Corporate Energy Giants, Christie Admin. Prosecutes Alternative Energy
Implications of “Social Costs of Carbon” Ignored Again
Some of the core justifications of the Obama EPA greenhouse gas rule – i.e. “market failure” and “the social costs of carbon” – have gone completely ignored by media and environmental activists alike.
And so was the expose of a multi-billion fraudulent scheme in electric energy auctions.
Yet while these literally earth shattering billion dollar elephants pranced about the room, the Christie administration received media praise for “cracking down on unscrupulous alternative energy suppliers“.
Let’s tackle those issues in that order to tell our three part story.
- Part I – Market Failure
Let’s begin with a few brief theoretical observations.
In economic policy circles, Thomas Piketty’s best selling book “Capital in the Twenty-First Century” is getting enormous attention. The focus of all that attention is almost exclusively on increasing wealth and income disparity and the reemergence of a hereditary oligarchic class, dubbed “The New Gilded Age” by Paul Krugman in his book review.
But Piketty has a lot to say about the practice of economics and the role of government and “free markets” that is being totally ignored.
Simply put: Piketty absolutely destroys the much cherished Neoliberal ideology of the “invisible hand” and the “unfettered free market” leading to optimal social and economic conditions – efficiency and equity – captured in that classic liberal utilitarian phrase: “the greatest happiness for the greatest number”.
Right off the bat, in his introduction, Piketty concludes that
… one should be wary of economic determinism in regard to inequalities of wealth and income. The history of the distribution of wealth has always been deeply political, and it can not be reduced to purely economic mechanisms. …[…] there is no natural, spontaneous process to prevent destabilizing inegalitarian forces from prevailing permanently.
In other words, there is no such thing as the “free market” or any “invisible hand” – and capitalist markets tend to produce inequality and concentration of wealth and income.
In this regard, Piketty is a muted and moderate echo of his predecessors, men like Karl Polanyi, who – in 1944 – called capitalism a “revolutionary force” that commodifies man and nature and thus destroys society. Polanyi noted that unfettered capitalist markets lead to:
… exploitation of the physical strength of the worker, the destruction of family life, the devastation of neighborhoods, the denudation of forests, the pollution of rivers, the deterioration of craft standards, the disruption of folkways, and the general degradation of existence including housing and arts, as well as the innumerable forms of private and public life that do not affect profits. (“The Great Transformation” @ p.133)
Which point perfectly takes us to the EPA greenhouse gas rule, which was justified – right up front – with this important finding:
1.2.3 Market Failure
Many regulations are promulgated to correct market failures, which lead to a suboptimal allocation of resources within the free market. Air quality and pollution control regulations address “negative externalities” whereby the market does not internalize the full opportunity cost of production borne by society as public goods such as air quality are unpriced.
GHG emissions impose costs on society, such as negative health and welfare impacts that are not reflected in the market price of the goods produced through the polluting process. For this regulatory action the good produced is electricity. These social costs associated with the health and welfare impacts are referred to as negative externalities. If an electricity producer pollutes the atmosphere when it generates electricity, this cost will be borne not by the polluting firm but by society as a whole. The market price of electricity will fail to incorporate the full opportunity cost to society of generating electricity. All else equal, given this externality, the quantity of electricity generated in a free market will not be at the socially optimal level. More electricity will be produced than would occur if the power producers had to account for the full opportunity cost of production including the negative externality. Consequently, absent a regulation on emissions, the marginal social cost of the last unit of electricity produced will exceed its marginal social benefit.
These are not theoretical abstractions – for example, I’ve written about how failure to consider market failures (e.g. the social costs of carbon, externalities, public goods) led to the rejection of an off shore wind project, allegedly for failing the “cost test”, see:
This is hard to believe, but, according to the BPU consultant who reviews wind, the costs of climate change and the environmental benefits of wind are – by definition – both set at zero.
The BPU consultant’s defined those benefits as zero by limiting the analysis to “market prices”. That is a fatally flawed approach that lacks credibility.
By definition, market prices do NOT reflect the social, environmental, and public health costs of fossil power sources. Those costs are significant and are described by economists as “externalities”, i.e they are “external” to or not considered in market prices and transactions. Here is how the consultant did that:
Environmental Benefits
Environmental benefits were not demonstrated because they are based on an estimation of the social benefits of displacing CO2, SO2, and NOx emissions from fossil-fuel generation, rather than a market price. To calculate social benefits, Applicant relies upon sources that estimate the health impacts of SO2 and NOx emissions, and attempts to calculate a social cost on a $/ton basis for these emissions. For the social cost of CO2, Applicant relies on an inter-agency federal government report that estimates the monetized damages associated with an incremental increase in carbon emissions in a given year. The report acknowledges the many uncertainties involved in determining these costs.
The calculation of environmental benefits should be tied directly to market prices because offshore wind is just one alternative way to cut emissions and its “benefit” occurs if, and only if, it is less expensive than the other alternative ways.
That limitation to tie the analysis to actual market prices excludes consideration of the costs of climate change and the benefits of wind. That approach lacks technical credibility (and is an example of ideological “market fundamentalism” which says that prices can never be wrong) and explicitly contradicts federal policy on cost benefit analysis methodology – see: Social Cost of Carbon for Regulatory Impact Analysis Under Executive Order 12866
But, just like Piketty, Polanyi, and EPA’s “market failure” findings, all that too was ignored.
- Part II – How electricity auctions are rigged to favor industry
This post is getting too long, so I will excerpt a must read story – again ignored by the press corps.
This was ignored, despite the fact that it involved fraud in the setting of energy prices in the PJM power grid, a ripoff of NJ consumers – as well as an aging NJ nuclear facility. Both should be major stories.
David Kay Johnston explains how electric auctions are rife with fraud
The latest major electricity auction demonstrates yet again how the industry, with help from Wall Street financial engineers, is gaming power markets, forcing customers to pay higher prices. You would not know that, however, from most news reports mentioning the auction.
Absent disclosures by the secretive markets, investigation and reform, you should expect your monthly electricity bill to rise sharply in the next few years as electricity industry investors reap outsize profits.
Losing is winning
The auction last week was not for electricity itself, but for promises to maintain the capacity to generate power in future years. The so-called capacity auction was conducted by PJM, the electricity market in 11 states serving 61 million people from New Jersey to Illinois.
Exelon informed investors that two Illinois nuclear plants and one New Jersey plant filed losing bids. The bids for these plants were higher than bids filed by other power plants owned by Exelon and other companies to provide the amount of generating capacity that PJM says will be needed for the 12 months beginning June 1, 2017.
PJM is a secretive market that does not disclose bid details even after an auction. But a list of all Exelon plants in the PJM area indicates that the losing bids affected just 17 percent of its generating capacity.
The capacity market is a so-called single-price or clearing-price auction. The highest bid needed to ensure capacity wins, with all those who bid less also getting the highest price. Those who bid above that price, like the two Exelon nuclear plants, get nothing.
Exelon alerted stock traders to these losing bids. When the markets opened on Tuesday, its share price jumped up, closing at 3.6 percent higher than on the previous trading day.
Why would losing bids make the stock price go up?
- Part III – Christie’s “crackdown”
So, while the multi-billion dollar EPA’ “Social Cost of Carbon” and the PJM energy auction fraud stories were ignored, Gov. Christie got favorable press for protecting consumers by“cracking down” of alternative energy providers.
Oh well, just another day in fair and balanced professional journalism.