Last week saw the coldest temperatures for decades in the Midwest. In Detroit, the mercury dipped to -14 degrees, and that was still 20 degrees warmer than some places in the region. The governors of Michigan and Wisconsin declared energy emergencies.
And, yet, energy prices — both natural gas and electricity — remained unusually low. What gives?
Suffused with government interventions, our market is failing to send consumers accurate price signals. This much was clear when Michigan Gov. Gretchen Witmer took to the airwaves to plead that people turn their thermostats down to 65 degrees, as the system groaned under the stress of home and commercial heating demands.
Consumers’ reward for heeding her call? Bupkis — at least apart from the good feeling one gets for pitching in when needed. Yet many consumers rightly felt that reliable heating service at the coldest moment of the year was just what they were paying their utility for. Why would their utility and their governor now come, begging bowl in hand, asking them to dial it down? Shouldn’t they be getting something for the assist?
On the electricity side of things, the results were similar. On January 31, at the depths of the polar vortex, the Chicago pricing hub of regional grid operator PJM recorded a peak price of $126 per megawatt-hour. That’s about four times higher than the average annual price, but it hardly reflects an emergency or anything close to it.
Here, the problem is that customers have paid to lavishly overbuild the system. State and federal policymakers have mandated that new power plants enter the system. And some of the same policymakers, including in Illinois, have also doled out subsidies to keep old power plants hanging around. In fact, the entity responsible for reliability standards and audits — the North American Electric Reliability Corporation (NERC) — estimates that each region of the country had significantly more power plants available than were needed when compared to total consumer demand, even while including a margin for emergency reserves.
Consumers might look at the low prices that exist during very cold times and ask what there is to complain about. But there is no such thing as a free lunch, and ratepayers are merely the proverbial frogs in the gradually warming water. They are paying rates mandated by state governments for all this excess capacity. That’s one of the reasons why the PJM market has seen wholesale energy prices fall by 40 percent over a decade, even while the regulated retail rates — which consumers pay, and which are a dumping ground for the cost of subsidies — have risen.
The only exception is the Texas market, which operates on a tighter margin. There, policymakers have avoided power generation mandates and subsidies. Equally important, the Texas market only pays power plants when they actually deliver energy or are called up for short-term operational reliability.
Other parts of the country should move gradually in Texas’s direction in this regard. Consumers should not be a backstop for a retrograde industrial policy that keeps power plants in operation needlessly. But at the same time, if the market does not pay a premium for energy to avoid outages during those hours when the weather is inclement or the system faces stress, consumers will eventually get what they pay for.
This is not to say consumer rates must be volatile — consumers could still face an average price. But the utility that buys from the wholesale market and the generators that sell into it should face prices that reflect system conditions, giving them strong incentives to reduce demand and produce energy.
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