Gaps in the grid

Ensuring a society’s electricity supply requires considerable planning. Electricity cannot be stored, which means that overproduction is wasted. But there needs to be enough supply to ensure that peaks of demand can be satisfied. This relatively straightforward challenge has become the source of major controversy.

When electricity supply is discussed outside professional circles, it is generally to decry its privatisation or to highlight the need for energy conservation. But these criticisms are misplaced, because neither starts from the aim to ensure sufficient energy to meet our needs.

Because the political case for meeting our energy needs is not being made, necessary investment is being avoided. The best example of this is in the USA, where matters came to a head in the Californian blackouts of 2001. The immediate crisis was resolved, but the patchwork of local, state and national regulation, together with elements of deregulation and marketisation, form a formidable barrier to sensible development.

Deregulation has been widely, and often rightly, criticised. But what the critics miss is how much the old centralised forms of regulation have been replaced by equally pervasive – and even more inefficient – new forms of regulation. A new strategic approach to electricity generation is in order.

Deregulation

Advocates of deregulation claim that markets can supply and distribute goods more effectively than planners. Deregulation in the US electricity market has been pursued since 1978, and was accelerated after the 1992 Energy Policy Act. In 1996 the transmission grid was opened up, which led to speculative developments of individual merchant power plants selling electricity into the wholesale market. There was an initial flurry of construction, caused partly by the significant competitive advantage of modern gas-fired power plants, which can undercut older coal-fired power plants. But given higher gas prices and localised excess of supply driving down prices, it is questionable whether this growth will be sustained.

Investments that are crucial for society as a whole are not always financially viable. Building power stations involves huge financial risk because a large proportion of the cost of electricity generation is in the initial construction. This means that the cost is incurred up front. If demand is lower than forecast, or if new technology makes the plant obsolete, the losses are colossal. Funding providers therefore require a high return on their capital to compensate for these risks.

Modern power stations are much more efficient, but the downside for merchant power plants is that this means that there is less scope to increase profits by boosting efficiency further, and they are more sensitive to input costs. Fuel costs represent 76 per cent of the operating costs of a 300-megawatt coal fired power station, but 93 per cent for a combined cycle gas generator. These risks can be mitigated with fuel derivatives, but these cannot be fixed for the long term, and there is a cost involved that is ultimately passed on to consumers. No surprise, then, that the states that have gone furthest in deregulation such as Texas and California, tend to be those with the highest electricity prices.

The careful management of financial risk is likely to avoid the destructive cycle of boom and bust that characterised the development of, for example, railways in the nineteenth century. But the positive outcome in the nineteenth century was that national rail networks were established, which were the basis for exponential growth in trade and improved living standards, as long-distance travel became possible for a growing part of the population. The danger for today’s energy industry is not boom and bust, but a sustained period of unexciting development that will constrain growth elsewhere in the economy.

It makes sense for society to underwrite the financial risks involved in electricity generation. The costs will be lower if they are shared more widely and if risks are managed through a planned approach to generation. While extra generating capacity has been built following deregulation, there has not been a corresponding increase in transmission capacity. This is in part because of the financial structure of the industry, which rewards producers but provides little incentive to develop transmission infrastructure. But to understand the full story we must look to the new kinds of regulations that have proliferated at the same time as the formal regulatory regime has been rolled back.

Re-regulation

Electricity transmission capacity has grown half as quickly as generation capacity since the 1970s, at a time when deregulation has encouraged greater use of the network by private power plants selling electricity to the grid. Since 1989, sales of electricity to consumers have risen 2.1 per cent per annum, but transmission investment has risen by just 0.8 per cent per annum. In the next 10 years the energy plan of US president George W Bush forecasts a 10 per cent increase in electricity demand, but only a four per cent increase in transmission capacity.

Most new generating capacity is gas-fired. To get gas to the generators, pipelines are required, which can take years to agree due to the large numbers of overlapping authorities that need to be consulted, and the difficulty of compulsory purchase of land. An additional 38,000 miles of gas pipelines are already needed.

These needs are not being met because infrastructure is politically controversial. There are enough wide, open spaces in the USA that power stations will usually get approval somewhere. But power lines have to cross populated areas. Overhead power lines, for example, are often opposed by residents who have spurious fears about the impact on their health. Gas pipelines are opposed on the basis that they might be a target of terrorist attacks. Cross-cutting authorities at local, state and national levels in the USA provide expanding opportunities for opposition to infrastructure projects. Micro-regulation of the planning process has created bottlenecks that threaten the provision of an adequate electricity supply to consumers.

Neither regulatory authorities nor power producers want to challenge environmental criticism openly. It is much easier to act tactically and retreat on individual challenges. But talking about environmental risk and demanding energy conservation is an evasion of the question: how can we provide enough energy to meet current and future need?

It is ironic that environmental criticism is getting more shrill, while environmental efficiency has been getting better. Carbon dioxide emissions have risen gradually but steadily, although their impact on the environment is less certain than is generally thought. But other emissions are falling – sulphur dioxide from 14,337 metric tons in 1992 to 9941 in 2002 and nitrogen oxides from 6717 in 1992 to 4680 in 2002.

Overall energy use is increasing as people are enjoying the use of more and more consumer goods, but the energy efficiency of these goods is improving. Refrigerators have improved energy efficiency by a third in 30 years. Air conditioning units increased their efficiency, measured by the Seasonal Energy Efficiency Ratio, from 7.34 to 10.66 between 1978 and 1997. Over this period electricity used in air conditioning rose from 0.31 quadrillion British Thermal Units (Btu) to 0.42 quadrillion Btu, which was a major contributor to the overall increase in energy use. But this is not a bad thing.

Even when adjusted for relatively more rapid population growth in the hottest parts of the USA, increasing energy use in air conditioning implies a significant increase in overall living standards. In much of the USA summer is hell without air conditioning. And this hell will be enforced on people living in hot areas if electricity generation is curtailed. We need more of these goods, not less. Those who are arguing for cutting energy consumption need to explain how we can continue to power air conditioning units. Telling people to take the heat is not an option.

At present, the energy debate is about minutiae – where should the pipeline go? (clue: not my backyard), what is the risk of this project? Or else it is about problematic effects on people’s health or on the environment. Instead of saying, ‘what is the impact on the environment?’ and ‘what are the risks?’, we should be asking ‘what do we need and how can we best provide it?’.

James Greenstein works for a major bank.