#21 – Market Failure

Artificial island - NECG

When merchant nuclear plants are threatened with closure, you should think about market failure and ways to stop market failure to preserve the public benefits of nuclear power.

The New Jersey plan to provide additional revenue to the nuclear power plants at Artificial Island should prevent market failure in that state.  Meanwhile, market failure in Ohio and Pennsylvania looks almost certain.

This NECG Commentary is explains market failure and how it applies to nuclear power.[1]

Market Failure

Market failure is a general economic term that could be applied to any market.

The “market” in market failure refers to the overall approach to an industry, including type of ownership (i.e., private companies), how these companies operate to earn revenue / profits in the relevant market, and how the relevant market works.

Market failure does not mean that a specific market is failing, but that the outcome of that market does not maximize the public good.

Public good refers to the benefit and well-being of the public (e.g., clean air is a public good).

A market can work well to achieve its stated objectives, but still result in market failure. This is often explained by externalities – negative or positive impacts of an industry – that are not reflected in the market.

In electricity, the direct (private) costs of generating power do not usually include the costs of negative externalities (e.g., emissions, system costs due to intermittent operation, land use, harm to view-sheds, noise, etc.) or the benefits of positive externalities (e.g., knock-on economic activity from jobs, system reliability, fuel diversity, etc.).[2]

Electricity markets rely on direct/private costs to dispatch (i.e., turn on and turn off) generators to meet varying real-time demand for power.[3]  Meeting real-time electricity demand is difficult and challenging process. The electricity markets do this, but do not reflect the externalities of the generators participating in the market and may result in market failure.

An electricity market with efficient short-term spot prices should not be expected to achieve other objectives such as lower emissions, long-term system reliability, or implementation of national policy.

Nuclear Market Failure

Merchant nuclear is a term used to describe those nuclear power plants that rely on sales of output into electricity markets for revenue and profits. Merchant nuclear plants/companies are different from regulated or government nuclear plants/companies that do not rely on electricity market revenue.

Nuclear power plants provide a range of benefits to society that are not compensated in the commodity electricity market revenue stream. These public benefits include emission-free electricity, long-term reliable operation, system stability, system fuel diversity and fuel price hedging, and economic benefits from employment.

Market Failure is when merchant nuclear power plants:

  • Earn revenue in commodity electricity markets that does not cover fixed generating costs;
  • Experience current and projected financial losses in electricity markets;
  • Are closed by private owners in order to stop financial losses; and
  • Stop delivering significant public benefits due to closure.

Fixing Market Failure

Generic approaches to fix market failure include imposing costs on negative externalities, providing compensation to support positive externalities, and government ownership of sectors likely to experience market failure.

Market failure is about the public good, so these approaches usually involve government action.

Carbon pricing is an example of imposing costs on a negative externality. Carbon pricing may increase the cost of electricity from carbon-emitting generating technologies, which will increase electricity market prices, and this may indirectly increase the value of electricity from generating technologies that do not emit carbon (e.g., nuclear power) in those electricity markets.

ZEC payments are an example of providing compensation for positive externalities.  In New York, Illinois, and New Jersey, the state recognized that the positive contribution of nuclear power to air emissions was not compensated in commodity electricity markets and implemented ZEC payments to provide compensation for these benefits.

The federal tax credits for renewable energy and state mandates and credits for renewable energy are also efforts to provide compensation for positive externalities.  These programs provide additional revenue to renewable energy projects to address concerns that the electricity market would not provide enough revenue to support renewable generation development.

Government ownership of the electricity and nuclear power sectors, as in France, China, Korea, Russia, the UAE, and other countries, is an example of government ownership to resolve market failure and maximize the public good.

Example 1 – Market Failure

In the first example (Figure 1), assume that a merchant nuclear plant operates in an electricity market with costs that are $35/MWh and earns revenue of $25/MWh.  The losses of $10/MWh result in tens of millions of dollars in annual financial losses.

Assume that the same nuclear power plant also produces public benefits that have a net value to society of $75/MWh.  The private owner of the merchant nuclear generator gets no financial benefit from these public benefits.

If the owner of this merchant nuclear power plant stops the financial losses by closing the plant, all net public benefits generated by the nuclear power plant will be lost.  This is market failure.

Example 2 – ZEC Payments

 

In the second example (Figure 2), a ZEC payment is provided to the merchant nuclear plant. Some of the net public benefits produced by the nuclear power plant are used to compensate the nuclear power plant in the form of ZEC payments. These ZEC payments are enough to return the nuclear power plant to profitable operation so that it remains in operation and continues to provide $60/MWh of net public benefits.

Market failure has been averted by this approach.

Example 3 – Regulated or Government Ownership

In the third example (Figure 3), the merchant nuclear power plant is returned to regulated or government-owned status.  Ratepayers pay the full cost of generating nuclear power, so that the $10/MWh shortfall between the value of electricity generated is recovered from ratepayers.

Significant net public benefits remain. Market failure has been averted by this approach.

 

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When merchant nuclear plants are threatened with closure, you should think about market failure and ways to stop market failure to preserve the public benefits of nuclear power.

[1]              The issue of market failure is covered in NECG Commentary #14.  See https://nuclear-economics.com/wp-content/uploads/2016/06/2016-06-NECG-Commentary-14-Market-Failure.pdf.

[2]              The new NEA report – The Full Costs of Electricity Provision (https://www.oecd-nea.org/ndd/pubs/2018/7298-full-costs-2018.pdf) provides a good explanation of how electricity markets may not reflect the full costs, including externalities and system impacts, of generation.

[3]              A critical part of this is the mix of fixed and marginal costs for each generator.  This is discussed in NECG Commentary #2 (https://nuclear-economics.com/wp-content/uploads/2014/10/2014-10-01-NECG-Commentary-2-Nuclear-Power-SRMC.pdf)

PDF version of this Commentary