January 6, 2016 3:25PM

Will the Natural Monopoly in Energy Distribution Come to an End? Here’s Hoping

Dr. Ben Ho’s piece in Tuesday’s New York Times entitled “The Conservative Case for Solar Subsidies” is certain to raise a few eyebrows amongst the conservative crowd. But Ho asks a valid question that I’m not sure conservatives have seen fit to fully address in the last few years: What, precisely, should free market denizens hold true about energy policy?

The facile response--that there should simply be no government role--doesn’t quite work here. To be fair, few conservatives suggest such a thing. Ho points out that when there are negative externalities to the production of a good or service the economically efficient policy response requires a tax, and our carbon-based fuels emit a variety of pollutants when burned. This holds true regardless of one’s opinion about the verities of carbon emissions and climate change: Smog--which results mainly from automobile emissions--remains a key contributor to myriad health problems in the United States, and particulate matter resulting from coal burning bedevils asthmatics.

But the libertarian solution is not quite as simple as imposing a tax that covers the socialized pollution costs of burning fossil fuels. We have a nationwide energy grid, one that the federal government played an integral role in conceiving and constructing. Without eminent domain, such a thing would have been all but impossible. The federal government’s regulatory apparatus also has an integral role in regulating power providers, and since the provision of power is a natural monopoly, it’s hard to conceive of an alternative, at least for the moment.

One victory libertarians managed to achieve in the last twenty years has been to convince regulators that the inherent natural monopoly lies solely in the distribution and not the production of energy, so the two have been disconnected in most states. These days, most utility customers can choose from where to get their power, which is a good thing, but it still leaves us with a fundamental economic problem: How do we get a natural monopoly--the operators of the energy grid--to behave as if it were subject to competition?

The basic regulatory solution is to allow the utilities to charge a price to recoup their costs plus some incremental profit. This may sound reasonable, but it creates lousy incentives--namely, the utility has zero incentive to control costs under such a scheme. In fact, they have an incentive to increase their costs and capital investments, since this boosts their attendant profits.

Dr. Ho alluded to the profound potential impact that solar energy could have on this monopoly in the future.  With the advent of Tesla’s home battery, it is possible that within the next decade (provided the batteries continue to improve--far from a sure thing) we could see some houses begin to go off the grid entirely, with solar energy producing all the energy they need. If this were to occur at a large scale, we might see utilities being forced to act as if they were a competitive firm and strive to boost efficiency where possible in order to distribute energy at the lowest possible costs to keep customers from cutting the power cord.

The other possibility in such an environment is a downward spiral: as people leave the grid, the costs of maintaining it gets spread over fewer people, boosting the cost and, in turn, nudging more people to get off the grid until only those without any other viable energy option are left holding the bag and paying sharply higher costs for energy.

The answer to such a potentiality is to embrace technology and apply a modicum of foresight to regulatory activities. While the utilities would prefer that home solar just go away, Ho points out that its costs are now competitive with gas and coal, and prices seem poised to drop further in the future. The potential of solar energy--and solar energy that can be stored--is that it can allow utilities to dramatically reduce their investments. If energy storage were to allow utilities to close marginal power plants that produce only at the peak demand each day, the savings to power companies would be enormous. What’s more, having distributed power across the grid would also allow utilities to reduce their own capital investment along the grid by smoothing out the fluctuations in power distribution: in essence, doing one of the utilities’ jobs for them.

We are entering a brave new world in energy production, one that threatens to upend the century-old regulated utilities monopoly and replace it with something that could be much less expensive to run--but only if we get the right policies in place to let it develop. The one worry is that the biggest player in this market has absolutely no incentive for these changes to happen, and its regulator more often than not takes its cues thusly.  This is the conservative’s task for the next decade--keep a watch on regulators to act in the long-term interests of the customers and not the utilities. It’s easier said than done.