a non-green argument for efficiency standards, ctd.

Reihan Salam responds to my argument on efficiency standards. He’s not buying my arguments (though I’m not particularly surprised by that).

His rebuttal to my claim that the only way to eliminate the spillover effect where someone else’s consumption affects the cost of my energy:

I think it’s fairly easy to argue for [individual contracting for generation, transmission and distribution services]. In New York city, electricity prices are considerably higher than the national average and this has appeared to have a significant impact on consumption. Granted, it’s not entirely fair, but gas prices also reflect the consumption choices of others and this hasn’t deterred calls for higher gas taxes.

“Fairly easy to argue for” individual contracting of generation, transmission and distribution services? I have to disagree with that. Competition among generators is certainly possible, though historial experience (California in 2001, anyone?) indicates that deregulation of generation sources needs to be carefully managed. My former colleagues Dr. C.K. Woo and Michael King have catalogued the potential costs associated with deregulation in this paper. They’re not guaranteed dealbreakers, but they call into question the efficacy of deregulation.

But individual contracting in the transmission and distribution sectors? I’m not aware of anyone actually proposing this, and frankly, it doesn’t make much sense to me. I can think of two ways that such individual contracting would work: (1) a single transmission/distribution provider contracts with individuals, opening the door for massive price discrimination due to the transmission provider’s monopoly power; or (2) multiple wires companies compete for customers, each operating their own grid. The first option seems likely to just result in massive profits for the companies that have the infrastructure, as they can construct individual pricing schemes to extract as much consumer surplus as possible. The second, meanwhile, seems wildly inefficient and likely to lead to skies criss-crossed with transmission lines if consumers are actually going to have real choices between transmission/distribution companies.

This, I think, is where the analogy to the gas industry breaks down. It’s that last step between delivering their product to the neighborhood where you live and delivering to the actual place the energy is used. Because you drive your car to the gas station to refill your tank, gas companies have to compete to convince you to drive your car to their establishment. But you don’t have that same choice in electricity delivery, at least at this point. You can’t rely on one company to deliver power one day, and then choose another the next.

This is why I argue that there is a role for public policy in developing efficiency standards, because it seems unrealistic to me to eliminate the shared nature of electricity infrastructure. Looking at SCE’s most basic residential rate, $0.074/kWh (out of $0.173/kWh for baseline service) is for transmission and distribution service. That’s 43% of the rate (under the optimistic assumption that the generation component can be deregulated) that is determined by infrastructure investments that are made not on behalf of just one customer, but to serve a number of different customers in the area, leaving transmission and distribution investments open to the free-rider problems which I argue are justification for a public policy intervention.

Salam also says that this may be the difference between me and Postrel:

I think he misunderstood Postrel’s column: she was not suggest that “properly pricing electricity is the only solution to this problem.” Rather, she was suggesting that raising electricity prices would represent a more effective approach to addressing the problem addressed by advocates of the efficiency standards in question. It’s not clear to me that she was advocating the raising of electricity prices. Rather, I read the column as agnostic on whether the underlying “problem” merits a policy intervention. Given that, I’m confident that Postrel understands that raising electricity prices may well require using public regulatory authority. The claim is that this would nevertheless be a sounder, more appropriate intervention than imposing efficiency standards, at least in this instance.

Clearly, I believe that the underlying problem (in this case, the idea that someone else can choose to increase my electricity rates) merits a policy intervention. And Salam is right, I did read her article (which included the section heading “Only Use Matters”, which to me implies that she recognizes that the amount of electricity use matters) and conclude that she was not simply arguing that we could do nothing, but instead was making an affirmative argument for pricing reforms over any sort of efficiency mandate. So if you disagree with me (as Salam does) about those key aspects, then my arguments will not be convincing to you.

But given the fact that opening the transmission and distribution systems up to real competitive choice between providers seems impossible or wasteful to me, and that as a result of this, you will always have a tension between those who adopt efficient technologies and those who do not but still realize the benefits of the lower rates that result from the adoption of such technologies, I think efficiency standards are justified. As much as it may seem otherwise, I’m not trying to advocate for unlimited government meddling. But if an elected government isn’t allowed to resolve issues where markets fail, what is government there for?

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