The blades of the wind turbines on the mountain range opposite my window are turning especially energetically today. Last night’s storm has abated but high winds continue, contributing extra kilowatts to the electricity grid at precisely zero additional cost (or marginal cost, in the language of the economists). But the people struggling to make ends meet during a dreadful cost-of-living crisis must pay for these kilowatts as if they were produced by the most expensive liquefied natural gas (LNG) transported to Greece’s shores from Texas. This absurdity, which prevails well beyond Greece and Europe, must end.

The absurdity stems from the delusion that states can simulate a competitive, and thus efficient, electricity market. Because only one electricity cable enters our homes or businesses, leaving matters to the market would lead to a perfect monopoly – an outcome that nobody wants. But governments decided that they could simulate a competitive market to replace the public utilities that used to generate and distribute power. They can’t.

The EU’s power sector is a good example of what market fundamentalism has done to electricity networks the world over. The EU obliged its member states to split the electricity grid from the power-generating stations and privatise the power stations to create new firms, which would compete with one another to provide electricity to a new company that owned the grid. This company, in turn, would lease its cables to other companies that would buy the electricity wholesale and compete among themselves for the retail business of homes and firms. Competition among producers would minimise the wholesale price, and competition among retailers would ensure that final consumers benefited from low prices and good service.

Alas, none of this could be made to work in theory, let alone in practice.

The simulated market faced contradictory imperatives: to ensure a minimum amount of electricity within the grid at any point in time, and to channel investment into green energy. The solution proposed by market fundamentalists was twofold: create another market for permissions to emit greenhouse gases, and introduce marginal-cost pricing, which meant that the wholesale price of every kilowatt should equal that of the costliest kilowatt.

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The emission-permit market was meant to motivate electricity producers to shift to less-polluting fuels. The cost of emitting a tonne of carbon dioxide would be determined by the market. In theory, the more industry relied on terrible fuels such as lignite, the larger the demand for the EU-issued emission permits. This would drive up their price, strengthening the incentive to switch to natural gas and, ultimately, to renewables.

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Marginal-cost pricing was intended to ensure the minimum level of electricity supply, by preventing low-cost producers from undercutting higher-cost power companies. The prices would give low-cost producers enough profits and reasons to invest in cheaper, less-polluting energy sources.

Reality bites

To see what the regulators had in mind, consider a hydroelectric power station and a lignite-fired one. The fixed cost of building the hydroelectric station is large but the marginal cost is zero: once water turns its turbine, the next kilowatt the station produces costs nothing. In contrast, the lignite-fired power station is much cheaper to build, but the marginal cost is positive, reflecting the fixed amount of costly lignite per kilowatt produced.

By fixing the price of every kilowatt produced hydroelectrically to be no less than the marginal cost of producing a kilowatt using lignite, the EU wanted to reward the hydroelectric company with a fat profit, which, regulators hoped, would be invested in additional renewable-energy capacity.

Meanwhile, the lignite-fuelled power station would have next to no profits and a growing bill for the permits it needed to buy in order to pollute.

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But reality was less forgiving than the theory. As the pandemic wreaked havoc on global supply chains, the price of natural gas rose, before trebling after Russia invaded Ukraine. Suddenly, lignite was not the most expensive, motivating more long-term investment in fossil fuels and infrastructure for LNG. Marginal-cost pricing helped power companies to extract huge rents from outraged retail consumers, who realised they were paying much more than the average cost of electricity. Not surprisingly, the public, seeing no benefits – to them or to the environment – from the blades rotating above their heads, turned against wind turbines.

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It’s time to wind down simulated electricity markets. What we need are public energy networks in which electricity prices represent average costs plus a small mark-up. We need a carbon tax, whose proceeds must compensate poorer citizens. We need a large-scale investment in the green technologies of the future. Last, we need municipal-owned local networks of existing renewables that turn communities into owners, managers and beneficiaries of the power they need. © Project Syndicate/DM168