Imperfect Markets versus Imperfect Regulation in U.S. Electricity Generation

Summary:

• With two-thirds of the electricity produced in the United States currently sold via wholesale markets, policymakers are confronted with an important question: Are markets reducing the cost of electricity generation relative to command-and-control regulated dispatch? This research uses a natural experiment to answer this question.
• The author constructs a virtually complete hourly characterization of U.S. electric grid supply and demand from 1999 to 2012 to infer gains from trade across power regions and the savings from using the lowest-cost power plants at any moment of time. The author then compares the data in wholesale electricity market versus regulated command-and-control areas before and after the market was introduced.
• The study finds that markets reduce the cost of generating electricity by about $3 billion per year through increased efficiencies and coordination both within and across areas.
• By using the lowest-cost plants 10 percent more often, markets reduce the costs from using uneconomical units by 20 percent per year. Additionally, the cost reductions from trading electricity across regions increases by 20 percent per year.
• The greatest gains occur in temperate months when this increased efficiency and coordination can best be utilized.
• As policymakers are faced with the question of whether the de-regulation of electricity markets should be expanded or scaled back, these findings suggest the benefits realized by more efficient allocation of output though market-based dispatch have far outweighed any imperfections in the market system.