When Does Regulation Distort Costs? Lessons from Fuel Procurement in U.S. Electricity Generation

77 Pages Posted: 6 Oct 2013 Last revised: 11 Oct 2013

Multiple version iconThere are 2 versions of this paper

Date Written: August 10, 2013

Abstract

Under what conditions does cost-of-service regulation lead firms to distort costs? This paper analyzes changes in fuel procurement practices by coal- and natural gas-fired electricity generating plants in the United States following state-level legislation that ended cost-of-service regulation among investor-owned electric utilities in the late 1990s. I construct a detailed dataset that links confidential, shipment-level data on the price of virtually all of the fuel delivered to coal- and gas-fired electricity plants in the United States from 1990-2009, with plant-level data on operations and regulatory status. Using a matched difference-in-difference estimation strategy to account for confounding shipping costs, I find the price of coal drops by 12% at deregulated plants relative to matched plants that were not subject to any regulatory change, whereas there was no relative drop in the price of gas. Deregulated plants disproportionately switch to burning low-sulfur coal rather than install capital-intensive abatement equipment to comply with environmental regulations, and expand imports from out of state by 25% if they were initially burning in-state coal. I show how these results lend support to theories of asymmetric information between generators and regulators, regulatory capture, and capital-bias as important sources of distortion under cost-of-service regulation. I then show that the drop in the price of coal is associated with a reallocation of purchases to more productive mines, rather than simply a transfer of regulatory rents from coal producers to electricity generators. Although only one quarter of U.S. coal-fired capacity has been deregulated, the end of cost-of-service regulation has reduced the price of fuel by about one billion dollars per year for these plants.

Keywords: Rate of Return, Interest Groups, Rent Capture, Asymmetric Information, Technological Choice, Administered Price, Public Utilities, Regulated Industries, Deregulation, Electricity, Energy, Power Plants

JEL Classification: D24, D72, D82, L11, L43, L51, L94, L98, Q48

Suggested Citation

Cicala, Steve, When Does Regulation Distort Costs? Lessons from Fuel Procurement in U.S. Electricity Generation (August 10, 2013). Available at SSRN: https://ssrn.com/abstract=2336558 or http://dx.doi.org/10.2139/ssrn.2336558

Steve Cicala (Contact Author)

University of Chicago ( email )

1155 East 60th Street
Chicago, IL 60637
United States

HOME PAGE: http://home.uchicago.edu/~scicala

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