Cutting Carbon: The Central Planner Fallacy

, Kendall Science Fellow | February 2, 2016, 12:30 pm EDT
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I’ve figured out the best way to reduce carbon emissions![1] Now can I just make it happen?

The central planner fallacy

The need for steep cuts in carbon emissions is established law. How do we achieve those cuts?

I’ve read scholars who advocate for a 100% renewable energy system, and those who advocate for adding 60 to 115 nuclear plants per year to eliminate carbon emissions by 2050. Or even deploying solar power satellites. I’ve suggested that at least one piece of the puzzle could be using flexible loads that can align demand with variable energy supply; in my estimation this would be less expensive than dedicated stationary batteries.

Scientists and engineers tend to look at a problem and advocate an end-state solution. It’s tempting to look at the system, treat our best estimates as perfectly accurate, and say “If I were in charge, I’d just build X, Y, and Z. That’s the optimal way to do it.”

But the real world isn’t SimCity. And the U.S. is not a centrally planned economy.

It can be useful to discuss an end state for illustrative purposes, but that’s a far cry from committing to a specific set of technologies on the grid thirty years out and dedicating all necessary resources to get there. It’s hard to predict how technology development will play out over time.

If you say that “we” need to build nuclear power plants to combat climate change, or massive battery banks to integrate solar into the grid, be specific. Who is this “we”? Do you envision a role for markets or a command-and-control economy? What incentives are you asking for? How do you propose to address environmental externalities? If you are whole-heartedly embracing the role of a central planner, do you intend to re-evaluate every five years? If so, how? Do you intend a pilot project to test out a more speculative option, or full-scale deployment?

Maybe your favored technology really is the best option for a low-carbon electricity system. But I strongly doubt it’s the only option, and I would need to hear more about the process by which it would be deployed. It’s not as simple as “we should build this.”

Smart charging – how to get there

When I talk about “smart charging” for grid services and renewables integration, I am suggesting three steps.

The technology ultimately needs to be competitive in a market environment to succeed, so each action addresses one or two “market barriers.” By addressing these, we hope to bring the electricity markets slightly closer to “perfect competition.” (The electricity market differs from “perfect competition” in many ways, sometimes for good reasons, but the barriers below are worth addressing.)

  1. First, conduct pilot projects to demonstrate proof of concept and to increase familiarity with the technology among local utility personnel and state officials. If there have been successful pilots elsewhere, it’s useful to share lessons learned, but even then you can’t simply say “Replicate what they did in California/Texas/Delaware/etc.” The real world doesn’t work that way. Pilots help reduce the effect of imperfect information, a textbook barrier to perfect competition.
  2. Second, and most importantly, design rules to let this technology compete in markets. For example, demand response has renewed life thanks to the recent Supreme Court ruling clarifying that federal rules allow payments for reducing electricity usage during times of peak demand. Local market rules determine whether smaller loads (such as EV chargers) can provide this service through aggregation. Rules changes can reduce the effects of barriers to entry and transaction costs, known to impair markets.
  3. Third, establish incentives where the value can be clearly demonstrated. Suppose a “smart charger” costs the EV owner an extra $100, but by reading signals from the grid avoids $150 in utility expenses that would otherwise have been passed on to all ratepayers. In that case, a “smart charger” rebate of $125 from the utility to the EV owner provides a net benefit to the ratepayers and the EV owner. Such a rebate would limit the effects of externalities (in this case, the externality is related to the way in which distribution costs and benefits are allocated).

I am not suggesting settling on this as the one and only solution to grid integration of renewables and just making it happen by decree.

The role of markets in meeting policy goals

The electricity system requires an approximate balance between supply and demand. Much of the balancing (“regulation”) involves communications between equipment to perform this automatically, equipment that may be put into place by market competition.

The method New York uses to decide how to match supply and demand.

The method New York uses to decide how to match supply and demand.

In competitive markets, independent companies can build power plants, energy management systems, or other devices to perform regulation. These investments are not dictated by the state, nor are investors guaranteed a rate of return. The companies calculate that by providing what the market needs, they will be able to earn a profit. If they are wrong, they will lose money.

What does this mean for integration of solar power into the grid?  It means that we don’t need to decide exactly which systems should be built. Competition decides.

If there is a serious short-term mismatch between energy supply and demand, there will be a high price for regulation services. This incentivizes companies to install batteries, manage loads, build fast-acting power plants, or deploy other solutions. A company in California was recently selected through a competitive auction to provide demand response by managing EV chargers. A vehicle-to-grid system in Delaware provides regulation services, again through a market mechanism. With enough independent market participants (another of those “perfect competition” ideals that isn’t always met), this competition should drive down costs.

Markets do need rules to make sure they are functioning efficiently and fairly. Still, well-designed markets have repeatedly proven effective in achieving energy and environmental policy goals.

Making space for innovation

As an omniscient central planner, I would know all the costs and benefits, and could skip the messy process of competition, startups, and bankruptcies, and just select the best option.

I’m not omniscient, and I don’t know the specific trajectory of innovation.

I am not convinced that nuclear power is the only way to deal with climate change. I am not convinced that grid-scale battery banks are the only way to integrate large amounts of renewable energy into the grid (see this study).

Nor do I even think markets are the only tool we can use to make these decisions. Systems analysis has a role to play, for example. But there is already a thriving market of competitors helping balance supply and demand. So let’s use it.

I’m looking to open that market up to more competitors. I don’t see a need to declare one and only one technological solution for a clean, reliable grid. I have far more faith in the ability of competition to drive innovation than I have in my own ability to predict the future.

[1] Not really.

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  • Ben

    I completely agree – but I was surprised to see that the term “carbon tax” doesn’t appear anywhere in your article. The only way that the market will efficiently address our need for low-carbon energy is if carbon emissions are priced appropriately, accounting for their negative externalities. At present, with no price on carbon, the message the market is sending is “there’s no need to develop clean energy technologies at all, because oil and natural gas are ridiculously cheap!” That needs to change before we will see the market – as opposed to central planning, which you rightly oppose – really kick in as a source of solutions.

    • Pete O’Connor

      Thanks for your comment! I do agree that pricing carbon is a necessary step to achieving the emission reductions we will need, and accounting for negative externalities is entirely appropriate. There are other UCS researchers with much more expertise on specific carbon pricing approaches. Between not wanting to step on other people’s area of expertise, and the fact that the post was running long, I decided against an explicit call for one particular mechanism. But in general I agree with the need to price carbon.

      • Ben

        Good, we’re in agreement on that then. Because of the lack of any mention of carbon pricing in your article, I actually took you as saying more or less “the market will fix this automatically if we just don’t interfere with it with central planning” – i.e., I thought you were implicitly saying that a price on carbon was not needed. I’m glad to hear otherwise. :->