Tuesday, August 19, 2003


Late last week I was able to do a number of interviews on blackouts and the power grid. Any time you take electricty -- something that is as essential to the economy as oxygen is to a person -- away from 50 million people, it is big news.

The interesting thing about the power grid is that it demonstrates a fascinating hole in capitalism. To understand the hole, imagine that you are a small power company. You have one power plant, and that power plant is an isolated system that serves one small city. If that is your setup, then you have a problem. If you ever need to take your power plant down for maintenance, or if the plant has a problem that requires an emergency shutdown, the city goes dark.

So you install a transmission line to a neighboring power company and form an agreement with that company. When you need to take your plant offline, you will buy power from your neighbor. And vice versa. This form of beneficial sharing gives birth to the power grid, and it evolves into a very large and complex system involving hundreds of cooperating companies.

All of these cooperating companies are also economic entities. For an economic entity, the goal is 100% utilization. That is, each power company is going to build enough capacity to handle peak demand and no more. By doing that, a company makes the maximum profit. The assumption on the grid is that, if something fails, there is always extra power available from your neighbor. With everyone searching for the best economics, the system drives itself tighter and tighter so that everyone can create maximum profit by depending on everyone else.

The problem with this approach is that, if several things fail at once during a period approaching peak demand, there is not enough capacity in the system to handle the failures. There is, in other words, no overcapacity, because overcapacity is unprofitable. Without any overcapacity to handle problems, the whole system becomes vulnerable to system-wide collapse.

The same thing is happening in the gasoline refinery space. Our refinery capacity is precisely balanced with gasoline demand because 100% utilization yields maximum profit. However, if a couple of refineries were to go offline simultaneously, we would have a big problem in the U.S.

We see this phenomenon all around us. When there is an emergency, the cell phone system saturates and becomes useless in the emergency area because there is no overcapacity. In most cities there are traffic jams during commute times because there is not enough overcapacity in the highway system to handle the peak demand.

Although there is no economic value in overcapacity, there is big societal value in it. Overcapacity helps to foster reliability. It also makes a system less vulnerable to attack (for example, by terrorists). If there were lots of overcapacity in the electrical grid, blackouts would be less likely. We would all have to pay a little more for electricity (and gasoline, and cell phone service), but these systems would work better and we would avoid meltdowns like we saw on the grid last week. Right now we choose not to build overcapacity to save money. It will be interesting to watch and see if we, as a society, start to change our minds about that. Are we being penny wise and pound foolish?

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