Competition has enabled capacity markets which encourage new transmission and generation construction to keep the lights on long-term. Yet consumers can do little to ensure their power stays on during a summer thunderstorm or ensure they are first in line for repairs. But what if markets could reduce these inconveniences?

Most recently, hurricane Sandy has left 1.9 million people without power, but in early July severe storms in the Midwest and eastern seaboard, left many without lights or air conditioning for days. The longest outages occurred for the customers in Maryland served by Pepco. There, tens of thousands of consumers went for six days without electricity.

Responding to the long-term outages, Maryland Governor Martin O’Malley proposed imposing new reliability standards on Pepco. The Maryland Public Utility Commission can regulate all it wants, but market forces would be much more successful at driving improvements in reliability.

The widespread outages revealed Pepco’s failure to keep a well-maintained distribution system? the distribution system is the physical infrastructure for delivering power including wires, transformers and substations. Markets could provide an incentive for Pepco to improve the maintenance of their distribution system and give consumers the ability to put their home or business near the top of the restoration list.

How does a market for reliability work? Economist Arnold Kling suggests charging consumers a fee in their contracts with a utility. Specifically, the utility could establish tiered pricing backed by reliability insurance.

Some consumers will value reliability more than others placing them in the top tier, while others will opt for a lower price that guarantees a lower level of reliability. For example, the top tier of households may have a guarantee that they will not be without power for more than eight hours in the course of year. The bottom tier gets a guarantee that they will not be without power for more than five days.

Setting the price for this reliability insurance s a bit tricky at the outset since consumers will have a tendency to over or understate how much they are willing to pay. To overcome this information problem Kling suggests households that bid at or above the median price would pay the top tier rate and households that bid below the median price would not be able to upgrade.

In most cases, one can imagine utilities will continue to place hospitals and police stations at the top of restoration list. After essential public services are restored, a utility with a reliability market would have a financial incentive to fix the substations and transformers serving those with reliability insurance first, rather than working on those that serve the greatest number consumers.

Failing to live up to their terms of eight hours a year would mean a utility loses money. Let’s say the utility will reimburse top tier consumers $10 an hour for each hour they go without power over the contract. If these households experience 16 hours without power in a year the utility would reimburse customers $80. The reimbursement or indemnity rate, will determine the incentive for a utility to spend resources on improving the distribution system.

Using market incentives to increase reliability for certain customers could also spur competition in the form of a contractor who believes they can better maintain the distribution system and profit from tier one reliability premiums and lower indemnity costs. The point is markets can be used to improve electricity delivery, not just electricity generation.

While it is impossible to know how many consumers are willing to pay extra for reliability, it is likely that those who frequently experience power outages would welcome a way to put their neighborhood at the top of the restoration list.