Prices in the electricity system

Only the price system can solve the complexity of modern electricity

- AJAY SHAH

The electricity sector was once a domain of stability.

For decades, the technology of thermal generation remained static. This technological stagnation allowed for a specific institutional design: Central planning, Officials in state capitals determined capacity, location, and dispatch. The grid buffered the difference between supply and demand, shielding consumers from the physics of the network.

The involvement of private capital in generation was termed “private-sector participation”, but it lacked the features of a market economy. These were arrangements where returms on equity were guaranteed for 25 years. In a functioning capitalism, it is unusual to have a 25-year return locked in by state fiat. The centrally planned electricity system was guaranteed to perform poorly when faced with dynamism. This system is now being hit by three simultaneous shocks.

The first is the imperative of climate change. The scientific consensus on global warming is clear: Carbon-dioxide emission must cease. This is no longer just a moral constraint but an economic one, enforced by mechanisms like carbon pricing, the European Carbon Border Adjustment Mechanism (CBAM), which comes into force on January 1, 2026, and the clarity in the financial sector that fossil-fuel generation will stop at some point, therefore new projects are now unbankable. We see this in the paper by Borah, Jaitly, Sane 2025, which was unveiled at the recent Emerging Markets Conference (https://bit.ly/4sfKwcH).