William Hogan on Electricity Markets, Solutions for Climate Change, and Carbon Tax Policy

August 2019. GrowthPolicy’s Devjani Roy interviewed William Hogan, Raymond Plank Research Professor of Global Energy Policy at Harvard Kennedy School and Research Director of the Harvard Electricity Policy Group, on electricity markets, climate change, and carbon tax policy. | Click here for more interviews like this one.

Links: William Hogan’s faculty page | ResearchHarvard Electricity Policy Group | Harvard University Center for the Environment

GrowthPolicy.org. You are an expert on electricity policy and competitive electricity markets. The power and utilities industries in the U.S. have been transforming rapidly, giving customers flexibility and control over energy usage using technological innovations. In what ways do the traditional regulatory structures underlying utilities need to adapt to these new business models? What regulatory changes and initiatives do you believe are much needed?

William Hogan: Electricity provided with existing technology requires a power-generation, transmission, and consumption system that constitutes the largest machine in the world.  The limited capability to store power for any appreciable duration means this integrated machine must provide just-in-time delivery.   Modern reforms to move from a pure monopoly structure to a more open market require special institutions to coordinate all the moving parts and maintain secure aggregate system balance.

The introduction of competition and choice was made possible by the creation of independent system operators that run a continuous series of auction markets that determine the real-time power dispatch and the associated supporting prices across very large regions.  These prices send the proper signals to all the market participants and are necessary to implement the regulatory principles of open access and non-discrimination.

The changing role of technology to create many more choices for both customers and power suppliers, great intermittency of many of the renewable sources of supply, and many diverse business models for market participants, will reinforce these needs and the direction of the development of electricity markets.

The utility monopoly role will continue to evolve into being more as the operator of the distribution wires than the supplier of power.  An important challenge is to change the pricing structure for the retail system in a manner much like what has already occurred in the wholesale electricity market.  This means moving away from average-cost pricing to a much more dynamic real-time system while moving the collection of costs for wires and related infrastructure to a system of connection fees.

The more technology provides increased choices, such as through the use of distributed energy resources, the more this reform becomes necessary to support efficient use and modernization of the electricity system.  The process will be driven by state and local regulators, working with the distribution utilities and diverse market participants.

Conceptually, the problem is easy.  But practical implementation will upset decades of political negotiation and compromises balancing the competing interests.  Not easy.

Growthpolicy.org. There has been much political rhetoric on climate policy as we move towards the 2020 elections. Beyond questions of politics, what fundamental policy changes do you believe candidates should consider as part of a forward-thinking and unified policy on climate change?

William Hogan: The electricity sector is a large emitter of the greenhouse gases that contribute to climate change.  In addition, many of the solutions anticipated to address global warming involve increased electrification such as through the conversion to electric vehicles. Hence, the evolution of the electric system is a major and necessary part of addressing the broader challenge.

An already complex system, the introduction of new technologies will increase the variety and number of choices that must be made in uncounted ways.  There are too many such choices and too many small decisions to have any hope of meeting the challenge through central planning and direction.  There must be a decentralized system that relies on prices to guide investments and coordinate operation of power systems.

Determining the prices, or designing the system of prices, to incorporate the external costs of greenhouse gases and other emissions will be a central and necessary task going forward.  This requires agreement on the external costs of the emissions, rather than setting any specific targets for emissions.  Creating a price to internalize the social costs will define how much is enough, while providing the stimulus for the learning-and-innovation economic machine to develop and deploy technologies that are sustainable and compatible with the broad goals of economic efficiency.

GrowthPolicy.org. In January 2019, forty-five economists collectively signed a bipartisan statement in support of a carbon tax that sends the proceeds from revenues to the consumer. Economists have long supported a carbon tax as a climate-change policy solution. What do you see as the hurdles and impediments in implementing such a tax policy?

William Hogan: A carbon price is necessary.  Without efficient carbon pricing, the policy problem is just too difficult: not enough will be done (e.g., the last two decades); and much of what will be done will be counterproductive (e.g., expensive residential roof-top solar installations).

A carbon tax policy as outlined in the bipartisan statement provides a coherent view of a collection of actions that would work in the right direction.

There are two principal hurdles.  First, we do not have a political consensus that the climate problem is real enough to demand the sweeping action that carbon pricing implies for the globe.  Without broad political agreement, the policy could not be adopted and sustained for the decades or centuries required.  Second, the argument is muddled at both ends of the political spectrum.  Climate denial is a head-in-the-sand approach and implies no action.  And the “Green New Deal” offers an impossible free lunch.  Until there is broad agreement and candor about the basic fact, there is little hope of sustained progress.

The basic fact is that meeting the climate challenge will likely be expensive, but worth it.

GrowthPolicy.org. How should we promote economic growth?

William Hogan: In the short run, this is about fiscal and monetary policy, managing shocks, and supporting markets.  In the long run, good institutions, trust, the rule of law, culture, and the broader social contract are important and too often taken for granted.

A major lesson of the post-WWII period is the persistence of surprise.  We don’t know what is going to happen; we don’t know what will grow and what will wither.  Good public policy would support markets that can adapt quickly, provide for the research needed to stimulate innovation, and address the other major gaps in markets, such as for the cost of greenhouse gas emissions.