How Should We Think About Pricing Electricity in the Context of Potential Life-Threatening Weather Events?

This paper argues that in markets characterized by highly inelastic demand, such as markets for electricity, market-clearing can force some individuals—particularly those with limited financial resources—out of the market, subsequently exposing them to significant risk. In the particular case of abnormally cold temperatures, as with the Texas deep freeze, or particularly hot temperatures, as may become more common with climate change, these risks can be life-threatening. Market-clearing therefore implies that society accepts a gamble where one of the possible outcomes entails loss of life. This possibility induces a risk premium that suggests a tradeoff in the analysis of appropriate incentives to mitigate the missing money problem.