Distortions to Wholesale Electricity Supply Spur Blackouts
Reducing Misallocation of Output Across Power Plants Could Boost Supply to Indian Homes
Economic growth depends on energy consumption, but frequent blackouts impose substantial costs and hamper productivity in developing countries. A new analysis focuses on the role played by the upstream wholesale supply sector in the blackouts faced by households in India. In contrast to the developing world, where regulatory mandates require utilities to satisfy electricity demand, utilities in developing countries respond to wholesale electricity prices. Consequently, misallocation of output across power plants that increases wholesale procurement costs can lower the quantity of electricity supplied to end-use consumers. The increases in quantity supplied from reducing supply-side misallocation would be sufficient to power millions of additional homes, the analysis suggests.
The analysis was authored by researchers at Carnegie Mellon University (CMU), the University of Maryland (UMD), and the University of Chicago (UChicago). It was published as a working paper with the National Bureau of Economic Research.
“Wholesale electricity market institutions play a key role in determining the extent to which consumers face blackouts,” says Akshaya Jha, assistant professor of economics and public policy at CMU’s Heinz College, who coauthored the analysis. “Implementing market reforms to reduce supply-side distortions in the wholesale sector could greatly increase the quantity of electricity reaching consumers.”
Why do blackouts persist in the developing world? Previous research has attributed blackouts to insufficient electricity generating capacity and failing infrastructure. In this work, the authors suggest that utilities in developing countries are price sensitive, purchasing less electricity when wholesale procurement costs are high. If supply-side distortions raise wholesale procurement costs, the equilibrium quantity purchased from the wholesale market falls. Since electricity storage is cost-prohibitive, this leads to blackouts for consumers.
The authors demonstrate this concept in the context of India, home to the world’s third-largest electricity sector, where citizens experience frequent blackouts despite a surplus of generating capacity. Using data on the aggregate demand curve in the Indian Energy Exchange (IEX), the country’s largest day-ahead electricity market, the authors document that utilities are price sensitive. Moreover, the total quantity of electricity demanded falls as the share of electricity-generating capacity offline due to equipment failures increases, even when idle power plant capacity was available to produce.
“Together, these findings demonstrate that utilities in India have downward-sloping demand, responding to higher procurement costs by buying less electricity, which in turn causes blackouts for retail consumers,” explains Louis Preonas, assistant professor of agriculture and resource economics at UMD, who coauthored the analysis.
The researchers also demonstrate that “discretionary outages”—outages listed as being for economic rather than technical causes—created substantial misallocation across Indian power plants, which increases utilities’ procurement costs and lowers the quantity of electricity supplied to consumers. They compared the total variable costs of observed generation to a “least-cost” counterfactual scenario in which plants were redispatched each day in order from lowest to highest marginal cost. While this scenario is unlikely to be feasible because of technical constraints, it can serve as a benchmark for assessing sources of supply-side misallocation.
This comparison revealed that discretionary outages were responsible for a significant share of the difference between the total procurement costs observed in the data versus those constructed under the benchmark without supply-side misallocation. In a counterfactual exercise that eliminated discretionary outages at low-cost plants and returned these plants to service, the equilibrium quantity of electricity in the IEX increased by 12.8%. This single change would boost electricity consumption for the average Indian household by 1.7%, enough to power an additional 4.6 million households, the authors say.
“Our findings have implications for electricity markets outside of the developing world,” suggests Fiona Burlig, assistant professor of public policy at UChicago, who coauthored the analysis. “With the growth of intermittent wind and solar capacity, utilities around the world are facing greater fluctuations in wholesale procurement costs and are responding by implementing real-time pricing and automated demand response programs to better communicate wholesale market price signals to retail electricity consumers. The finding that supply-side distortions can substantially reduce the quantity supplied to electricity consumers may become increasingly relevant in high-income countries.”
The analysis was funded by the National Science Foundation, the Tata Center for Development at the University of Chicago, and Resources for the Future.
Summarized from an NBER Working Paper, Blackouts in the Developing World: The Role of Wholesale Electricity Markets by Jha, A (Carnegie Mellon University), Preonas, L (University of Maryland), and Burlig, F (University of Chicago). Copyright 2021. All rights reserved.
About Heinz College of Information Systems and Public Policy
The Heinz College of Information Systems and Public Policy is home to two internationally recognized graduate-level institutions at Carnegie Mellon University: the School of Information Systems and Management and the School of Public Policy and Management. This unique colocation combined with its expertise in analytics set Heinz College apart in the areas of cybersecurity, health care, the future of work, smart cities, and arts & entertainment. In 2016, INFORMS named Heinz College the #1 academic program for Analytics Education. For more information, please visit www.heinz.cmu.edu.