Regulatory Induced Risk Aversion: Coal Procurement at U.S. Power Plants

Abstract

From 1983-1997, U.S. power plants consistently purchased most of their input coal from long-term contracts at prices higher than prevailing spot prices. I show empirically that plants facing higher spot coal price uncertainty pay higher contract coal prices; plants on average trade off a $3.82 increase in expected costs for a $1 decrease in their standard deviation of costs. I posit a new mechanism that rationalizes this plant-level risk aversion: price-regulated utilities express preferences for a lower variance in total cost because regulators are less likely to pass high cost realizations through to the output price paid by consumers.

Keywords: Output Price Regulation, Rate-of-Return Regulation, Cost-of-Service Regulation, Utilities, Commodity Price Speculation, Sharpe Ratio, Coal, Electricity

JEL Classification: K23, L43, L51, L94