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

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  • Steve Cicala

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.

Suggested Citation

  • Steve Cicala, 2013. "When Does Regulation Distort Costs? Lessons from Fuel Procurement in U.S. Electricity Generation," Working Papers BFI_2013-006, Becker Friedman Institute for Research In Economics.
  • Handle: RePEc:bfi:wpaper:bfi_2013-006
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    References listed on IDEAS

    as
    1. Guerriero, Carmine, 2013. "The political economy of incentive regulation: Theory and evidence from US states," Journal of Comparative Economics, Elsevier, vol. 41(1), pages 91-107.
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    Citations

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    Cited by:

    1. Steve Cicala, 2017. "Imperfect Markets versus Imperfect Regulation in U.S. Electricity Generation," NBER Working Papers 23053, National Bureau of Economic Research, Inc.
    2. Jenya Kahn-Lang, 2016. "The Effects of Electric Utility Decoupling on Energy Efficiency," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4).
    3. Stratford Douglas & Seth Wiggins, 2015. "Effects of Acid Rain Regulations on Production of Eastern Coals of Varying Sulfur Content," Working Papers 15-38, Department of Economics, West Virginia University.
    4. repec:eee:resene:v:52:y:2018:i:c:p:153-172 is not listed on IDEAS
    5. Corrado Di Maria & Ian A. Lange & Emiliya Lazarova, 2014. "A Look Upstream: Electricity Market Restructuring, Risk, Procurement Contracts and Efficiency," CESifo Working Paper Series 5124, CESifo Group Munich.
    6. Jason Allen & Robert Clark & Jean-François Houde, 2014. "Search Frictions and Market Power in Negotiated Price Markets," NBER Working Papers 19883, National Bureau of Economic Research, Inc.
    7. Christopher R. Knittel & Konstantinos Metaxoglou & Andre Trindade, 2015. "Natural Gas Prices and Coal Displacement: Evidence from Electricity Markets," NBER Working Papers 21627, National Bureau of Economic Research, Inc.
    8. Evangelina Dardati & Julio Riutort, 2016. "Cap-and-Trade and Financial Constraints: Is Investment Independent of Permit Holdings?," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 65(4), pages 841-864, December.
    9. Joseph E. Aldy & Todd D. Gerarden & Richard L. Sweeney, 2018. "Investment versus Output Subsidies: Implications of Alternative Incentives for Wind Energy," NBER Working Papers 24378, National Bureau of Economic Research, Inc.
    10. repec:eee:jeeman:v:89:y:2018:i:c:p:1-28 is not listed on IDEAS
    11. Chan, H. Ron & Fell, Harrison & Lange, Ian & Li, Shanjun, 2017. "Efficiency and environmental impacts of electricity restructuring on coal-fired power plants," Journal of Environmental Economics and Management, Elsevier, vol. 81(C), pages 1-18.
    12. Stefan Seifert, 2015. "Measuring Productivity When Technologies Are Heterogeneous: A Semi-Parametric Approach for Electricity Generation," Discussion Papers of DIW Berlin 1526, DIW Berlin, German Institute for Economic Research.
    13. Yin Chu & J. Scott Holladay & Jacob LaRiviere, 2017. "Opportunity Cost Pass-through from Fossil Fuel Market Prices to Procurement Costs of the U.S. Power Producers," Working Papers 2017-02, University of Tennessee, Department of Economics.
    14. Matthew Doyle & Harrison Fell, 2016. "Fuel Prices, Restructuring, and Natural Gas Plant Operations," Working Papers 2016-03, Colorado School of Mines, Division of Economics and Business.
    15. Hancevic, Pedro Ignacio, 2016. "Environmental regulation and productivity: The case of electricity generation under the CAAA-1990," Energy Economics, Elsevier, vol. 60(C), pages 131-143.
    16. Chan, H. Ron & Chupp, B. Andrew & Cropper, Maureen & Muller, Nicholas Z., 2015. "The Net Benefits of the Acid Rain Program: What Can We Learn from the Grand Policy Experiment?," Discussion Papers dp-15-25, Resources For the Future.
    17. Jonathan Eyer & Matthew E. Kahn, 2017. "Prolonging Coal’s Sunset: The Causes and Consequences of Local Protectionism for a Declining Polluting Industry," NBER Working Papers 23190, National Bureau of Economic Research, Inc.
    18. Catherine Hausman & Lucija Muehlenbachs, 2016. "Price Regulation and Environmental Externalities: Evidence from Methane Leaks," NBER Working Papers 22261, National Bureau of Economic Research, Inc.
    19. repec:eee:indorg:v:57:y:2018:i:c:p:35-83 is not listed on IDEAS
    20. Linn, Joshua & Anna Muehlenbachs, Lucija & Wang, Yshuang, 2014. "How Do Natural Gas Prices Affect Electricity Consumers and the Environment?," Discussion Papers dp-14-19, Resources For the Future.
    21. repec:eee:jeeman:v:88:y:2018:i:c:p:180-209 is not listed on IDEAS
    22. Steve Cicala & Ethan M.J. Lieber & Victoria Marone, 2017. "Cost of Service Regulation in U.S. Health Care: Minimum Medical Loss Ratios," NBER Working Papers 23353, National Bureau of Economic Research, Inc.
    23. repec:eee:enepol:v:106:y:2017:i:c:p:222-232 is not listed on IDEAS

    More about this item

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L43 - Industrial Organization - - Antitrust Issues and Policies - - - Legal Monopolies and Regulation or Deregulation
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
    • L98 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Government Policy
    • Q4 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy
    • Q48 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Government Policy

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