The Electricity Market’s Design: An Unnecessarily Distorting and costly Mechanism to Overcome

Abstract

The present marginalist design for the wholesale electricity market in most OECD countries emerged over the last 1990s within the wave of ‘liberalisation’ of the national electricity sector. This liberalisation meant the State to privatise its so-far public-owned electricity enterprises (which usually operated as vertically integrated monopolies: generation, transport, and distribution), at the time that the then-existing direct regulation on the price per kWh to final consumers was removed.

The so-called marginalist ‘competitive’ rules established for the electricity market’s wholesale price have led to distorting results, especially since the end of 2020, in the way of erratic skyrocketing prices and high extraordinary profits for power companies. This is because of the peculiar pricing design established, which is surmised to respond to the ‘marginal cost pricing’ proposition (MCP) of mainstream modern neoclassic economics.

It is argued here why the present pricing design, besides challenging economic common sense, is not even ‘marginalist’ as it is so claimed; it entails misapplying the MCP proposition itself; besides that basic features of the sector would make, nevertheless, such a proposition scarcely relevant. It is also argued how the assumption of old economics myths about the sector makes, besides, the present market operation unnecessarily cumbersome and costly. Consequently, elements for a more rational alternative market design & workings are finally presented.

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Keywords: Electricity market’s operation and design, Electricity market’s pricing design, Marginal Cost Pricing, ‘Windfall’ profits, Peak-load pricing, States’ energy policies.

JEL Classification: L11, D47, L51, G61, L94, Q48, D24