Dynamic Regulatory Distortions: Coal Procurement at U.S. Power Plants

Abstract

Economists hypothesize that regulators provide utilities with a rate of return on capital far higher than the market cost of capital, distorting the level and timing of capital investments. I test this hypothesis by studying a frequently-adjusted form of working capital: coal stockpiles at U.S. power plants. I estimate a dynamic plant-level model of coal purchase and storage, finding that price-regulated plants incur far lower per-unit storage costs than similar market-based plants. This implicit regulatory subsidy on coal storage distorts plants’ coal procurement behavior, resulting in annual aggregate productive efficiency costs of 1.3 billion dollars (14% of coal purchase costs). The majority of this efficiency cost stems from dynamic distortions to the timing of coal purchases rather than static distortions to coal storage levels.

Keywords: Gold-Plating, Capital Bias, Output Price Regulation, Rate-of-Return Regulation, Cost-of-Service Regulation, Utilities, Industry Restructuring, Working Capital, Coal Storage, Power Plants, Electricity

JEL Classification: K23, L51, L94, Q48