How can electricity markets function more cost-effectively?
The transmission and distribution activities are natural monopolies as the same infrastructure (electricity grid) is used to serve the competitive production and supply activities.
This way, the product (electricity) marketed by the production and supply sector is transported through the electricity network from the production point to the point of consumption. At the same time, electricity is a social commodity and it is unacceptable in modern societies for any citizen not to have access to this commodity.
Given a finite electrical system, for an electricity market to operate efficiently and economically, either under a competitive regime or under a monopoly, three basic principles need to be met: (a) static efficiency, that is available resources to be utilised effectively for the operation of the market (e.g., more effort and less expenditure), (b) public choice, meaning the alignment of participants motivations (producers and suppliers) in the electricity market based on the collective interest and (c) dynamic efficiency, which is the increase in the rate of innovation within the electricity market and improvement in terms of both the service offered to the consumer and the reliability and quality of the product.
As far as the basic principle of static efficiency is concerned, an economically optimal allocation of resources is required so as electricity consumers pay the price of the cost, they burden the electricity system with, based on the principle of cost orientation.
For the basic principle of public choice, given the need to produce a social commodity (electricity), the electricity market can be a monopoly (a public or private enterprise) or a competitive one (with a number of companies).
Regarding which of the two options is more likely to act in the common interest (e.g. satisfaction of the basic principle of static performance), based on international examples, public ownership models is more likely to be able to work in an autonomous way motivated not by the common interest but the interest of its employees, its suppliers, in some cases, even its competitors.
The reason is that public ownership lacks a restriction, that is the incentive for the low-cost functioning of the electricity market. To address this restriction, regulatory intervention is always needed so that the public undertaking (whether in a monopoly model or in a competitive electricity market) can meet the basic principle of static performance.
To meet the third principle of dynamic performance, we need to ensure that there is an appropriate environment for innovation that creates growth for the benefit of consumers. It is known that growth is not created under equilibrium conditions even if they are effective in the short term. Growth is caused by imbalances, that is by innovations.
In addition, detecting, recording and influencing consumer behaviour are activities in which competitive markets are more successful.
In the case of electricity markets this is done by suppliers so that there is continuous improvement in the performance of their product (electricity) in the market.
These are the advantages offered by competitive markets, which meet the above principles and create rapid growth for the benefit of consumers by rewarding innovation.
That is to say, market forces with the participation of alternative producers and suppliers of electricity and the appropriate regulation can operate electricity markets in a cost-effective way for the benefit of consumers by introducing innovative technologies that can transform consumers from being passive participants to active participants through the digitization of the electricity sector and the installation of smart technologies and applications. Andreas Poullikkas is Chairman of the Cyprus Energy Regulatory Authority