From Climate Etc.

by Planning Engineer (Russ Schussler)

Part 3 of this series examines power markets, promoted by policymakers (FERC) and industry advocates to lower costs through competitive bidding and merit-order dispatch. While markets can optimize resource allocation in many sectors, they struggle to deliver affordability and reliability in electricity systems dominated by intermittent renewables. This post first explains how power markets operate, then highlights their challenges, and finally explores why they amplify the cost challenges associated with wind and solar.

In Part 1 of this series, we explored how the fat tail problem undermines the cost-saving potential of wind and solar.  It’s easy to supply electricity most of the time.  The fat tail occurs in the rarer periods of maximal demands, when wind and solar are not available.  These periods, not savings during easy times, drive system economics.  Part 2 discussed how rate structures distort perceptions of affordability for solar applications. 

How Power Markets Work (and Fail)

Power markets use a merit-order dispatch system, where generators bid their costs, and the market sets prices based on the most expensive unit needed. During “easy” times—when demand is low or renewable output is high—wind and solar often dominate. Their near-zero marginal costs (no fuel expenses) allow them to bid low, displacing higher-cost fossil fuel plants and driving down market prices. This creates the appearance of cheap electricity and fuels the narrative that renewables are inherently cost-effective.

However, during peak or extreme conditions, wind and solar often underperform due to weather or diurnal constraints. For example, wind speeds may drop during heatwaves, or solar output may be negligible at night or during cloudy winters. When demand spikes or renewables falter, markets rely on dispatchable resources—combined cycle plants, combustion turbines, or even older coal units—to meet the shortfall. These resources have higher marginal costs and are often called upon during the most expensive hours, driving market prices skyward. During Winter Storm Uri in February 2021, ERCOT prices surged to $9,000/MWh as renewables underperformed and demand soared. As discussed in the first posting, doing well most of the time is not enough. The challenge in providing costly backup during peak shortages exposes the limitations of power markets, as explored below.

The Promise and Limits of Power Markets

I am a big fan, in general, of markets over central planning and the wonders of the Invisible Hand.  Markets are powerful tools for aligning supply and demand, often outperforming centralized planning by incentivizing competition and innovation.  However, it should be understood that markets do not work well for every good and service at every time and place.

Listed below are conditions which increase the likelihood of markets being superior to centralized planning:

• Availability of Substitute goods
  • Electricity lacks viable, cost-effective alternatives, unlike commodities with multiple options, limiting market flexibility
• Low barriers to market entry
  • Building power plants requires substantial capital and expertise, limiting new entrants.
• Short lead times for production/investment
  • Long lead times for plant construction
• High price elasticity
  • Small demand fluctuations based on price signals, overall inelastic
• Clear and accessible information
  • Possible for real time costs, not for backup, emergency power, future needs…
• High potential for innovation
  • Energy markets rarely drive innovation; global R&D, not regional competition, fuels renewable advancements, while subsidies distort market signals for wind and solar
  • In terms of market advantage, innovation is used in regard to product features, characteristics, functionality or appeal, not the production of the good
• Low externalities
  • Environmental impacts of generation are relatively large
• Low concerns of social equity
  • Electricity has a major impact on quality of life. System must support all.
• Low risk from market failures
  • Huge risk from market failures
• Forecasting demand is challenging
  • Forecasting annual peaks and energy consumption is relatively easy for electric supply as compared to other goods and services

Electricity differs from most commodities, with highly inelastic demand and a need for instantaneous balance between supply and demand to maintain grid stability. Unlike markets for goods like wheat or electronics, where substitutes abound, electricity has few viable alternatives. Storage technologies, such as batteries, remain costly and limited, unable to support seasonal needs, leaving utilities reliant on traditional generation (e.g., natural gas, coal, nuclear) to fill gaps left by intermittent wind and solar. This complexity makes electricity a poor fit for market-driven systems.

The poor fit becomes apparent as electricity’s complexity has required the creation of additional multiple market structures. Even so, these markets often fail to ensure reliability during high-demand or extreme conditions.  Below are additional key markets and their roles:

• Capacity Market: Ensures sufficient generation capacity is available to meet future peak demand, particularly during extreme events. Generators are paid to maintain plants on standby, but payments often fall short of incentivizing enough dispatchable resources to handle extreme conditions reliably.
• Ancillary Services Market (services ensuring grid stability): Provides critical grid stability functions, such as voltage support and frequency regulation, which renewables like wind and solar rarely contribute. These essential services increase costs as utilities procure them from traditional generators.
• Day-Ahead Market: Allows generators to bid for supplying power the next day based on forecasted demand. While efficient for planning, it struggles to adapt to unexpected renewable shortfalls, leaving grids vulnerable to price spikes.
• Intraday Market: Enables real-time adjustments to power supply within the same day. It helps address short-term renewable variability but cannot ensure reliability during prolonged extreme events, such as multi-day storms or heatwaves.
• Financial Transmission Rights (FTR) Market (Financial tools to manage grid congestion costs): Allows participants to hedge against price differences caused by grid congestion. While useful for financial planning, FTRs do not directly enhance reliability or address the physical shortages during critical events.
• Demand Response Market: Pays consumers to reduce usage during peak times, aiming to ease grid stress. However, its impact is limited during extreme events when demand remains inelastic, and widespread participation is challenging.
• Renewable Energy Certificate (REC) Market: Enables trading of credits for renewable generation to meet regulatory mandates. While promoting green energy, RECs inflate the perceived cost-effectiveness of renewables by masking their reliance on backup systems.
• Reserve Market: Ensures backup power is available for unexpected outages or demand spikes. These reserves are critical, but increase costs, as dispatchable plants must be kept online despite infrequent use.
• Bilateral Contracts and Power Purchase Agreements (PPAs): Long-term contracts between utilities and generators to secure stable supply. While offering some reliability, they often prioritize renewables, leaving gaps when intermittent sources falter.
• Emissions Markets: Trade carbon credits to incentivize low-emission generation. These markets raise costs for fossil fuel plants, indirectly increasing reliance on renewables and exacerbating the need for costly backup.

Overall, these complex market structures unfortunately tend to prioritize short-term efficiency over long-term reliability. As Part 1 showed, electricity is easy to provide most of the time but challenging during rare, high-cost periods. By focusing on real-time pricing, power markets fail to secure sufficient dispatchable resources, amplifying renewable costs and leaving markets ill-equipped to handle peak shortages or extreme weather, as explored below.

Why Power Markets Fail During Extreme Conditions

Power markets prioritize short-term economic efficiency, selecting the cheapest resources—like wind and solar—during periods of low demand or high renewable output. However, this focus fails to incentivize long-term investments in reliability, such as maintaining dispatchable plants (e.g., natural gas or nuclear) or building sufficient backup capacity. As a result, during fat tail events—when demand spikes or renewables falter—markets struggle to ensure supply, leading to price spikes and higher costs for consumers.

For example, in regions like Texas (ERCOT) or California, power markets have seen price spikes during extreme weather (e.g., Winter Storm Uri in 2021 or California’s 2020 heatwaves). These events exposed the fragility of systems reliant on intermittent renewables without adequate dispatchable capacity. During Winter Storm Uri, Texas consumers faced $10 billion in additional costs over a few days due to market price spikes. The resulting costs were passed to consumers. In contrast, regulated utilities can prioritize long-term reliability by maintaining diverse generation portfolios. Markets deem these costs inefficiencies, but regulated utilities view them as prudent reliability investments.

At the other extreme, power markets undervalue the “reliability services” provided by dispatchable plants, such as voltage support, frequency regulation, and ramping capability. Wind and solar, while cheap to operate, contribute little to these services, forcing utilities to procure them elsewhere at additional cost. This hidden subsidy for renewables further distorts market signals, making intermittent resources appear cheaper than they are.

A Financial Analogy: The 90% Win Fallacy

The shortcomings of power markets echo the financial scam discussed in Part 1, where traders were promised wins on 90% of their trades. Just as frequent small gains were wiped out by rare but massive losses, the low costs of renewables during easy times are offset by the ongoing high costs of backup systems needed for their intermittency, further amplified during fat tail periods. No pension fund or institutional investor would adopt a strategy that ignores the risk of catastrophic losses, yet energy policymakers often embrace renewables based on their average costs, ignoring the reliability implications.

This raises a troubling question: Do advocates of ‘cheap’ renewables overlook the fat tail problem, or are they prioritizing short-term gains over long-term system costs?  Some may be well-intentioned but innumerate, focusing on short-term savings without grasping system-wide costs. Others may prioritize political or ideological goals over economic reality. Regardless, academics, policymakers, and regulators should be held to a higher standard. They have access to the same system models and real-world data that utilities use, which consistently show that heavy reliance on renewables increases electricity costs. Even though wind and solar are very competitive in the market, most of the time, that’s not reason enough to expect that they will lower overall costs. Having a market which grants wind and solar a high percentage of wins, makes it hard for more dependable resources to survive and be available for peak needs.

Common Perspectives on Energy Markets

What is the common take on market problems?  To understand the common perspective on power markets, I consulted an AI synthesis of prevailing views, which highlights both strengths and oversights. I received this response:

Power markets excel in driving competition and innovation but face volatility and reliability risks, requiring refined market designs and faster renewable integration. Traditional systems ensure stability and emergency preparedness but struggle with inefficiency and slow modernization. Balancing these trade-offs requires tailored policies for each system’s unique structure.

Let’s break that down:

• Power Markets excel in driving competition and innovation…
  • Global R&D, not regional markets, drives renewable advancements, while subsidies for wind and solar distort market signals
• but face volatility and reliability risks, requiring refined market designs and faster renewable integration.
  • Reliability is a prime virtue for a power system as is the ability to cope with volatility
  • Is required market design the answer? How about a return to planning for reliability and volatility?
  • Will faster integration of renewables help or hinder? (See past postings – they don’t help.)
  • Refined market designs may mitigate volatility, but they cannot eliminate the need for reliable dispatchable generation
• Traditional systems ensure stability and emergency preparedness but struggle with inefficiency and slow modernization.
  • Stability and emergency preparedness are the major goals
  • Stability and emergency preparedness are the major source of costs
    • Once system is in place for stability and emergencies additions costs are less significant
    • Incremental savings from market are not so large once peak and emergency
    • needs are considered.
  • Inefficiency or prudent steps to avoid extreme volatility and system crashes
  • Modernization is a red herring reflecting one perspective as to what the future power supply should be.
• Balancing these trade-offs requires tailored policies for each system’s unique structure.
  • That’s one perspective to deal with the issues, but there are other non-market approaches.

The markets invert priorities. The  least challenging service is providing power during easy times.  Markets prioritize easy periods, addressing reliable energy supply challenges only as an afterthought. When wind and solar dominate in the easy times due to lower costs it becomes difficult to impossible to maintain dependable dispatchable generation for more challenging times.  It’s generally best to plan for the major needs first and then optimize issues of less importance. These perspectives overstate market benefits while ignoring the fat tail, underscoring the need for reliability-focused planning.

The Evidence Is Clear

Energy markets work well to increase wind and solar penetration.  However, look globally, and the pattern is unmistakable: regions with high renewable penetration often face higher electricity prices. Germany, with its aggressive Energiewende, has some of the highest retail electricity rates in Europe, despite abundant wind and solar. Germany’s residential electricity prices reached €0.40/kWh in 2024, among the highest in Europe, despite heavy renewable investment. California’s rates have risen steadily as its renewable portfolio grows. In contrast, regions, like France, with balanced mixes, including nuclear and natural gas, often maintain lower and more stable prices. Power markets’ short-term focus exacerbates cost increases by neglecting reliability during high-cost events.

Market approaches have benefit.  In the electric power sector, originally rigid, monopoly-driven system entities relied largely on their own resources and only made sales and purchases with neighbors in limited situations. Now virtually all interconnected systems  reach a semi-optimal dispatch through sharing  real-time marginal cost data and make sales and purchases to share the savings this process generates. It’s semi-optimal dispatch because systems will keep units needed for later dispatch on-line and generating at minimums.  Lower cost resources will not kick off these resources or stop them from receiving financial benefit for what they generate.  This post explains how power marketers enabled utilities to lower costs through shared savings, optimizing resource dispatch across interconnected systems. This approach provides many advantages of markets without many of the drawbacks of a fully structured market system. 

It’s wrong to assume that the less constrained a market is, the better things will always be.  For many crucial reasons, electricity markets are poorly suited to ensure reliable and affordable power.  When markets fail, costs rise considerably. These limitations of energy markets are compounded by the complexity of providing reliable electricity.  Centralized planning has advantages as well, especially for power systems. A balance needs to be struck between market approaches and planning for reliability.  Perhaps we find the better balance looking backwards.

Looking Ahead

Power markets are powerful tools, but they are not a panacea for electricity systems. Their focus on economic efficiency during easy times leaves them vulnerable to the high costs of atypical events, where wind and solar underperform. Building on the fat tail problem (Part 1) and hidden solar costs (Part 2), the next post in this series will explore the costs of backup power and reserves, which further erode the savings of renewables. A final post will tie together these threads, offering a comprehensive view of why “cheaper” wind and solar lead to more expensive electricity.

For now, the takeaway is this: power markets amplify the cost challenges of renewables by prioritizing short-term gains over long-term reliability.  A sustainable energy system must prioritize reliability and affordability through regulated planning, market reforms, or other tailored approaches addressing power market limitations. Policymakers must prioritize reliability over short-term market gains for a resilient, affordable energy future.

Bonus – Memory of a Market Sham

Politicians and bureaucrats often claim market victories when the evidence is quite small. I remember back 25 years or so, claims of how allowing choice for large industrial customers resulted in lower costs.  The facts were that policy changes allowed large customers to shop for power prices versus taking rates from monopoly power providers.  It was widely claimed that benefits accrued because of the market.

Context is key: new generation can be cheaper or costlier than existing resources.  Historically when new generation was cheaper, power providers would push growth because bringing lower cost plants on line to serve newer loads lowered the cost for everyone.  When existing resources are more expensive, reducing demand makes sense because serving new customers will raise costs for all  as more costly resources are averaged into the mix.  Environmental concerns temper these relations somewhat.

In the late 1990s and early 2000s, combined cycle plants driven by natural gas enabled new additions to reduce average energy costs. As a utilities system load grew, this would work to lower costs. When industries came to the utilities with big loads, all consumers would benefit as new combined cycles were added to the mix to serve the extra load. 

The policy changes that allowed industry to shop for power enabled them to capture the benefits from the low-cost additions instead of sharing with all customers.  This appeal to “market choice” had little impact on overall efficiency, merely redistributing cost benefits.

Undoubtedly, this supported new industrial growth, but it increased costs for existing industrial, commercial, and residential customers. If new generation additions were costlier, industries would likely have stayed with utility rates, leveraging the cheaper existing base while existing customers bore most of the new costs. Subsidizing new industry may be a social good, but it’s critical to recognize that market choice didn’t reduce overall costs—it only changed who benefited, reshaping how the pie was divided. This example underscores how power markets can create the illusion of cost savings while failing to address system-wide costs, much like markets today obscure the overall cost impacts of wind and solar.