The UN Climate Change Conference (COP 26) in Glasgow drew the world’s attention to climate change, highlighted clean energy alternatives to fossil fuels, and further clarified the need for the U.S. to maintain its leadership position in clean energy technology.
One of the strategies the parties to the United Nations Framework Convention on Climate Change ought to give more consideration in the future is the benefits of increased adoption of competitive wholesale energy markets.
This approach to emissions reduction has the broad political appeal required to tackle the global problem of climate change. Glasgow, for example, was host to the first-ever Global Conservative Climate Summit, where over 160 free-market leaders from 60 countries signed the pro-markets International Declaration on Market Environmentalism.
U.S. Energy Innovators Can Set an Example
The U.S. is a world leader in carbon emissions reductions thanks to the ingenuity of American energy innovators. American renewables are now inexpensive and efficient. Power generation using fossil fuels, like natural gas, has become cleaner by incorporating techniques and technologies that produce fewer emissions.
The U.S. must continue to set an example for other countries by encouraging renewable development, innovating new and better technologies, and striving to achieve an optimal balance between emissions reductions, affordability, and efficiency.
The way power is bought and sold can help the U.S. achieve these sustainability goals. How energy is distributed directly affects energy prices and emissions. By establishing market structures that encourage competition among utility companies, policymakers can lower costs, boost economic competitiveness, ensure grid reliability, and make greater progress in lowering emissions.
How Energy Market Structures in the U.S. Differ
There are essentially two different energy market structures in the U.S. One, the competitive wholesale model, requires power generators to compete, which can lower costs for consumers and encourage utility decisions that reduce emissions.
The other, the vertically integrated model, is made up of monopoly utilities, where one company builds most or all of the power grid and generation, and regulators set the rates and the return to the utility in a cost-plus manner. A vertically integrated utility owns all levels of the energy supply chain, giving it complete control of the production and sale of the electricity it generates. Ratepayers have little or no choice in who generates their power. There is usually no competition between the generators who provide power into the grid.
Instead, public officials guarantee utilities a monetary return on their investments, and customers are liable for risks associated with those investments, infrastructure build-out, and maintenance when utilities recover their costs through rate increases.
There are benefits to this structure, however, such as more affordable service in rural areas where electricity demand is lower, and utilities may otherwise be unable to make a profit serving those communities. Adding more competition to the mix in most cases, however, is shown to lead to reduced emissions.
The Regional Transmission Organization’s (RTOs) and Independent System Operators (ISOs) who manage non-monopoly electric grids promote wholesale competition by purchasing electricity at market-determined wholesale prices. Different suppliers are forced to compete, which can result in a better deal for consumers and easier market entry for clean energy technologies. Customers under this model choose a supplier that meets their desired combination of price, reliability, and generation.
Competitive Wholesale Electricity Markets Have Climate Benefits
Studies verify the climate benefits of competitive wholesale electricity markets. Dr. Wayne Winegarden of the Pacific Research Institute recently released a paper analyzing state emission levels based on EIA data between 2008 and 2018. It not only found that emissions in competitive states declined more—on average 12.1 percent compared to just 7.3 percent in monopoly states.
One report from the firm Energy Innovation looked at the Southeast, a region of the country with little market competition in electricity, and found that emissions reductions will be more significant in a competitive wholesale market. Specifically, the report concludes that emissions in the region would be 46% lower in 2040 compared to the “business-as-usual” scenario in which companies build out resources through integrated resource plans (IRPs) used by regulated utilities.
Moreover, the lack of standard business incentives present in competitive markets means that regulated utilities lack the motivation to invest in least-cost clean energy projects when they do put forward plans to innovate.
That the competitive wholesale model also led to substantial, lasting declines in wholesale electricity costs by avoiding the cost-plus pricing model. Dr. Winegarden writes that cost-plus pricing by monopoly utilities created, “…a “heads I win, tails you lose” investment environment for monopoly utilities where customers bear the investment risks through higher utility bills rather than the utility bearing these risks through lower profits.”
Expanding competitive power markets is an important step in the process of modernizing energy grids here in the U.S. Embracing the competitive model ourselves and touting its environmental benefits will be a great way to improve the world’s ability to protect the environment while balancing efficiency, sustainability, and energy costs.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Sarah E. Hunt is CEO of the Joseph Rainey Center for Public Policy—named after the first African-American elected to Congress—she leads public policy research and leadership development programs by and for women, minorities, and mavericks.