This is not how economics works

I recently came across an article in Quartz with the provocative title “It’s time to waste solar energy”. The article has all the hallmarks of a story journalists like. It refers to an expert who did a study that apparently showed that we all could pay up to 75% less for electricity and that businesses are either not thinking outside the box enough to realise that or are actively preventing these solutions to become reality in order to protect their profits. But, as H. L. Mencken already wrote in 1920: “There’s always a well-known solution to every human problem – neat, plausible and wrong.”

In this case, the story revolves around solar power and goes something like this. A Ph.D. student at Columbia wrote his thesis on the optimal energy grid in a world with renewable energy sources. In his thesis, he came to the conclusion that the ideal grid would significantly overbuild solar power plants. The rationale for an oversupply of solar power is that the source of power is essentially free and if we produce too much electricity from solar energy, we can just shut down the solar cells and let the energy go to waste. No need to build battery storage or smart grids to deal with energy fluctuations and energy spikes. With the right (over)supply of different renewable energy sources, 5% gas power would be sufficient to push electricity prices in the United States below current prices and in an ideal case, electricity prices could drop by up to 75% from current levels. 

Wouldn’t it be great if we could reduce the cost of electricity by 75% and switch to practically 100% renewable energy at the same time?

Yes, it would, but in my view, it is impossible to achieve that goal in the real world. 

You see, the problem with the study is that it looks at the electricity supply and the cost to the end consumer as the only goals of building the infrastructure. But in reality, someone has to build and maintain the solar power plants and electricity grid. And in the real world, the money to build these power plants and grids doesn’t fall from the sky. It is provided by firms who invest in this infrastructure with the goal to make a profit. And nobody builds a solar power plant that has three times the capacity of peak demand, which is what the optimal grid would require. Yes, shutting down a solar power plant costs essentially nothing, but that is not how economics works. Solar power plants have an initial investment cost that needs to be recuperated during the useful life of a solar cell. If a solar power plant just delivers one third of its maximum capacity on average, the investment costs will be amortised over much longer time frames, thus increasing the cost of solar power produced to the investor or reducing the return. If these costs cannot be recovered via higher electricity prices, the investment will end up being a loss and if there are enough losses for investors, funding will quite simply dry up.

In the end, electricity prices are a result of supply and demand but so is the supply of capital. You can have an enormous demand for capital, yet no supply if the return on investment isn’t high enough.

What really makes me angry about this article is not so much the underlying academic research. The assumptions of the model and the optimisation that is performed are clearly stated in the research. What makes me really angry is that this is yet another case where a journalist has not really understood how the economy (or in this case the green economy) works and just ran with a provocative story. From here, it is just a small step to see some left-wing nutjob politician like Jeremy Corbyn pick up that idea and run with it and campaign on a platform to force private utility companies to build solar power and sell the produced electricity at much lower prices than is economically viable. 

We have been here before when the UK nationalised the water utilities in the 1973 UK Water Act. The result of the nationalisation of water utilities in the UK was a lack of maintenance and constant degradation of the water infrastructure due to a lack of investment. In the end, water pipes leaked and environmental spills became commonplace until the water utilities were privatised again in 1989 and necessary investments were made in the private sector.

Yes, we all would like to have cheap electricity, and wouldn’t it be great if prices would drop by 75%. But a centrally planned green revolution is bound to fail. What we need is direct market forces to focus on investments in green technologies, but only to the degree that these investments have sufficient returns to investors (and as a result leads to higher prices for consumers). If we force the misallocation of capital in the name of political goals, we are going to ruin the green revolution and in my view likely miss our climate goals by a wider margin than by trying to achieve these goals by directing the productive use of capital through markets.