September 11, 2022

When Market Fundamentalism Overcomes Common Sense: The Myth of Electricity Markets

Prabir Purkayastha

THE price of electricity has risen astronomically in Europe over the last two years: by four times over the previous year and ten times over the last two years. The European Union (EU) has tried to claim that this rise in prices is due to the increase in the price of gas in the international market and Russia not supplying enough gas. This raises the critical question: why should – for example – the German electricity price rise by four times when natural gas contributes only one-tenth of its electricity production? Why does the UK, which produces half the natural gas it consumes, also see a steep rise in the price of electricity? All this talk of Russia hides the reality that the electricity generators are making astronomical windfall profits. The poorer consumers, already pushed to the wall by the pandemic, face the cruel dilemma. As electricity bills may consume 20-30 per cent of their household budget during winter, should they buy food or keep their houses warm?

This steep rise in electricity prices is the other side of the story of the so-called market reforms in the electricity sector over the last 30 years. The cost of electricity is pegged to the costliest supply to the grid in the daily and hourly auctions. This is market fundamentalism, or what the neo-classical economists call marginal utility theory. For those interested in its history, this was Pinochet’s electricity sector reforms in Chile. The guru of these Pinochet reforms was Milton Freedman. That electricity price should be based on its “marginal price” was even a part of Pinochet’s constitution in Chile. The Chilean reforms led to the privatisation of its electricity sector, the objective of the reforms.

It was the Chilean model that Margaret Thatcher copied in the UK. UK dismantled its Central Electricity Generating Board (CEGB), which ran UK’s entire electricity infrastructure: generation, transmission and bulk distribution. It also shifted the UK away from domestic coal for its thermal power plants, breaking the powerful coal miners’ union. These were also the Enron market “reforms” in California that led to the summer meltdown of its grid in 2000-01.

In India, we may think that these issues have nothing to do with us. After all, we generate our electricity largely from domestic coal, rivers (hydroelectricity), and now renewables. So why should we be concerned with what is happening in Europe and the price of natural gas?

Here is why we need to think again. The current distribution “reforms” that the union government wants to introduce are a replica of what the UK and EU have done. The 2003 Electricity Act opened the doors for private power players, who borrowed heavily from the public sector banks to set up a large number of plants. With supply overtaking demand, it is the banks and institutions that provided the loans that have incurred huge losses, writing them off as bad loans.

The other part of inducting private players was transferring the burden of buying this high-cost power to the state-owned distribution companies. This is what shows up as huge losses for the state distribution companies. As the state governments have to face the people, they are forced to buy power, even costly power, and supply it to farmers and domestic consumers. To ensure some price stability, they buy the bulk of their electricity demand using long-term contracts and only a small amount from the day ahead and daily auctions.

The new Amendment to the Electricity Act, referred now to the parliamentary standing committee on energy, proposes what no country has tried: divorce ownership of electricity from the wires over which it flows. While the state governments will maintain the entire distribution infrastructure, the electricity flowing through it will be owned by traders buying and selling electricity in the “market”. While the state government will still be held accountable by the people, they will have the responsibility but no ability to either control the price or supply electricity to their people.

How will the electricity prices be fixed in these markets? It will be based on the marginal price of electricity fixed through auctions, the same one that has caused the current crisis in the EU and the UK.

The objective of the EU reforms was not a more efficient electricity sector but the privatisation of the electricity utilities. Before the EU reforms, each of the major countries like France and Germany, had an integrated grid with major state players generating, transmitting and distributing electricity. The major state-owned players set the rules of the grid. The EU wanted to privatise the electricity sector, and therefore the reforms of separating generation, transmission and distribution. While transmission and distribution were accepted as natural monopolies and remained with the state, the generators were privatised and made to compete with each other across the entire EU grid.

How do we make generators compete when electricity generation and supply have to balance at each instance of time and therefore need to be operated cooperatively? Earlier, the grid acted to balance the load and demand, increasing the most efficient sources when short of supplies, and shedding the least efficient ones when supply exceeded demand.

 Instead of the system existing then, the EU regulators substituted it with an artificial market in the name of so-called market reforms. The market is structured so that you can bid in advance for selling an amount of power for a particular time slot. Let us assume that there are 24 such time slots of one hour each per day, and you, as a generator, can quote your price for supplying an amount of electricity for a specific time slot. The highest price that leads to the full demand of that time bucket being met, then becomes the price for all the bidders quoting up to that price.

What happens if the prices of various modes of generation are significantly different and you need costly generation to meet your full demand? Then, the power produced from wind or the sun, whose incremental costs are virtually zero, is charged exactly the same as costly LNG required to meet the full demand.

The European Union banked heavily on natural gas as their preferred fuel to bring down their greenhouse gas emissions, ramped up renewable – solar and wind power – and phased out lignite and coal. It has imposed a series of sanctions, made public its plans for further sanctions on Russia and seized about Euro 150 billion of Russia’s reserves lying in EU banks. The EU has also made public its plans to cut down on Russia’s oil and gas supplies. Not surprisingly, Russia has sharply reduced their gas supplies to the EU. If the West thought they could weaponise their financial power, why did they think Russia would not retaliate with its gas supplies to EU?

With Russia’s supplies of natural gas to western Europe dropping, the price of LNG has risen sharply in the international market. Worse, there is simply not enough  LNG available in the market to replace the gas that Russia supplied to the EU through its pipelines.

With the price of gas rising by 4-6 times in the last few months, the price of electricity has also risen sharply. But as only a fraction of the electricity is powered by gas, all others – wind, solar, nuclear, hydro, and even dirty coal-fired plants – are making a killing. It is only now that the EU and the UK are discussing how to address the burden of high electricity prices on consumers and the windfall profits of the electricity generators.

It is not only the EU and UK consumers who are badly hit. It is also the European and UK industries. Stainless steel, fertiliser, glass making, aluminium and engineering industries are all sensitive to input costs. As a result, all these are shutting down in the EU and UK.

The former Greek finance minister, Yanis Varoufakis, in his article Time to Blow Up Electricity Markets (Aug 29, 2022, Project Syndicate website), writes, “The European Union’s power sector is a good example of what market fundamentalism has done to electricity networks the world over… It is time to wind down the simulated markets.”

Why then is the Modi government rushing into this abyss? Did it not learn from last year’s experience when the prices in the electricity spot market went to Rs 20 per unit before public outcry saw it capped at Rs 12? So why again push for these bankrupt policies of market fundamentalism in the guise of electricity reforms? Who will benefit from these market reforms? Certainly neither the consumers nor the states.