Entry into the electric power industry

Entry of new firms into the electric power industry is becoming commonplace. The entrants typically are unregulated firms that compete with regulated electric utilities only in the generation stage of the latter's vertically integrated structure. Because of the asymmetric regulatory treatment of the incumbents and entrants, there is the possibility of biases either against efficient entry or for inefficient entry. A model of a vertical integrated utility subject to rate-of-return regulation is used to illustrate the biases, and several implications for regulatory policy are discussed.     

Regulatory regimes in the electric power industry: Implications for capacity

We construct a model of the electric power industry which consists of two utilities faced with uncertain demand and a variety of regulatory regimes. Two technologies are considered, base-load and peaking, and the transfer of bulk electricity among utilities is permitted. The purpose of the paper is not to determine optimal regulatory regimes but to provide a framework for analyzing existing and contemplated regulatory initiatives. The conclusions are that long run survival mandates an authorized rate of return above the cost of capital and that excess investment will result. Furthermore, it is highly unlikely that current regulatory instruments such as Used and Useful, distribution of profits from bulk sales, and pricing of wholesale electricity can lead to a socially optimal capital stock.     

The effects of regulation on stochastic systematic risk

There is recent evidence that systematic risk measures for most firms are stochastic, and that non-stationarity in systematic risk characteristics for regulated firms is related to the presence of regulation. Prior empirical evidence, which suggests that regulation reduces risk, did not incorporate the stochastic nature of the risk/return relationship. There are also problems with the modeling of regulation in this earlier work, and there is evidence that regulated firms may have recently grown riskier. These issues are addressed here by examining a stochastic model that structurally incorporates regulation. Differences in the risk structure of regulated and unregulated firms are identified. Analytic results, simulation results, and actual empirical estimates provide evidence that regulation reduces, but does not eliminate, stochastic systematic risk. The actual empirical results suggest that regulators do reduce stochastic systematic risk, which should lead to lower required rates of return for utilities.     

Shadow prices of $$\hbox {CO}_{2}$$ emissions at US electric utilities: a random-coefficient,random-directional-vector directional output distance function approach

We estimate the shadow prices of \(\hbox {CO}_{2}\) emissions of electric utilities in the US over the period from 2001 to 2014, using a random-coefficient, random-directional-vector directional output distance function (DODF) model. The main feature of this model is that both its coefficients and directional vector are allowed to vary across firms, thus allowing different firms to have different production technologies and to follow different growth paths. Our Bayes factor analysis indicates that this model is strongly favored over the commonly used fixed-coefficient DODF model. Our results obtained from this model suggest that the average annual shadow price of \(\hbox {CO}_{2}\) emissions ranges from $61.62 to $105.72 (in 2001 dollars) with an average of $83.12. The results also suggest that the firm-specific average shadow price differs significantly across electric utilities. In addition, our estimates of the shadow price of \(\hbox {CO}_{2}\) emissions show an upward trend for both the sample electric utilities as a whole and the majority of the individual sample electric utilities.     

Deregulation,news releases,and price discovery

We hypothesize that the firm’s regulatory environment influences the sensitivity of its equity value to information. Using intraday stock price data of utilities operating in differing regulatory environments we test for systematic differences between the responsiveness of stock prices of utility firms operating in deregulated and regulated environments to a common information set. Our findings reveal sharp differences in responses, with those of utilities operating in deregulated environments the strongest, and the responses of utilities in highly regulated environments the weakest. While the evidence supports our hypothesis, in a broader sense, the evidence suggests that deregulation aids in the process of price discovery. We also find evidence that suggests that deregulation, per se, does not lead to higher stock price volatility.      

Contagion effects in the electric utility industry following the Fukushima nuclear accident

This article examines intra-industry information transfers in the European and Japanese electric industry in the wake of the Fukushima nuclear accident. For European conventional utilities, the downward price drift is relatively small and transient in nature. Yet, we find positive and lingering effects of the accident on the shares of alternative electric utilities. Japanese utilities were hit the hardest and the shock seems to be long-lasting. An interesting finding of this article is the abrupt increase (decrease) in the systematic risk of conventional (alternative) electric utilities following the event. In Europe, we could only document a decrease in the idiosyncratic risk of conventional utilities, pointing to enhanced return synchronicity in the conventional power industry. In turn, total risk seems to be stationary around the accident. In rebuttal, idiosyncratic and systematic risks (and consequently total risk) have substantially risen in Japan since the event. Finally, intercept values related to European utilities remained stable around the accident while Japanese utilities incurred a substantial decline in their daily average returns as captured by alpha shifts.     

Are Municipal Electricity Distribution Utilities Natural Monopolies?

The purpose of this study is to analyse the cost structure of the Swiss electricity distribution utilities in order to assess economies of scale and density and the desirability of competition in the distribution of electric power. A translog cost function was estimated using panel data for a sample of 39 municipal utilities over the period 1988–1991. The results indicate the existence of economies of density for most output levels and the existence of economies of scale only for small and medium-sized electric utilities. The empirical evidence suggests that franchised monopolies, rather than side-by-side competition, is the most efficient form of production organization in the electric power distribution industry. Further, the majority of the utilities analysed do not operate at an optimal service territory size. Therefore, the consolidation of small utilities whose service territories are adjacent is likely to reduce costs.     

Deregulation of the Electric Power Industry: The Earnings,Risk, and Return Effects

This study tests whether recent reforms of the electric power industry reverse the predicted effects of regulation on profits, risk, and return for electric utilities. The analysis also considers potential variation in the effects of the reforms across utility sizes. The empirical predictions are derived from theories of economic regulation which argue that regulation reduces earnings variability and risk, and enhances share value by buffering the regulated firms against the profit effects of cost and demand shocks and by shifting the burden of inefficiencies to consumers. These views motivate an opposite argument that reductions of regulation would reverse the predicted effects of regulation. The results reveal (1) a reversal of the buffering effects of regulation, (2) the existence of subsidies attributable to regulation, and (3) a redistribution of shareholder wealth during the reforms.     

Privatization and Utility Regulation in Developing Countries: the Lessons So Far

The privatization of utilities has grown in developing countries in recent years. Privatization transactions for the utilities sector have accounted for over a third of all sales in developing countries since 1988. The introduction of privatization has not necessarily meant more competition. Consequently, utility privatization has led in many cases to the creation of regulatory structures that aim to protect consumers from monopoly abuse and to provide incentives to firms to maintain efficiency. Case studies drawing on examples from the telecommunications, electricity and water sectors indicate that creating effective regulation and a competitive environment is a difficult and slow process. The cases have shown that regulation rather than privatization achieved the largest gains. Similarly, although the variety of regulatory measures that have been introduced have made a difference, the most tangible benefits, particularly to consumers, result from the establishment of competition. The case studies have shown that privatization has preceded the development of effective regulation and competition. The development of regulatory structures is constrained by the capacity of governments to enforce regulatory rules and monitor contracts. Fostering conditions that encourage competition and lessen anti-competitive behaviour by incumbents is a beneficial but slow process.     

Inventories,inflation dynamics and the New Keynesian Phillips curve

We introduce inventories into an otherwise standard New Keynesian model and study the implications for inflation dynamics. Inventory holdings are motivated as a means to generate sales for demand-constrained firms. We derive various representations of the New Keynesian Phillips curve with inventories and show that one of these specifications is observationally equivalent to the standard model with respect to the behavior of inflation when the model's cross-equation restrictions are imposed. However, the driving variable in the New Keynesian Phillips curve – real marginal cost – is unobservable and has to be proxied by, for instance, real unit labor cost. An alternative approach is to impute marginal cost by using the model's optimality conditions. We show that the stock–sales ratio is linked to marginal cost. We also estimate these various specifications of the New Keynesian Phillips curve using GMM. We find that the predictive power of the inventory-specification at best approaches that of the standard model, but does not improve upon it.     

R&D expenditures and firm growth – is small beautiful?

ABSTRACT

This paper examines how efficiently different groups of firms use their R&D expenditures. To this end, it investigates how the empirical relationship between firms' R&D expenditures and their sales growth varies with different values of firm size, firm age, and the number of firms in the respective industry. Using panel data for Switzerland ranging from 1995 to 2012, the paper finds that smaller, more mature firms show a more positive relation between R&D expenditures and sales growth than both relatively larger or younger firms. The paper argues that, on the one hand, these firms can benefit from various small size advantages in the R&D process, such as more motivated researchers, caused by a stronger connection to the firm's fate. On the other hand, these firms can also benefit from a well-established R&D department that allows absorbing the latest technological developments. The paper further finds that industries consisting of many small firms show a more positive relation between R&D expenditures and sales growth than industries consisting of only a few large firms. The intuition behind this result is that industries consisting of many small firms imply more independent innovative trials, which then together result in a higher probability of discovering successful innovations. In sum, the paper finds that groups consisting of a large number of small, more mature firms spend their R&D in the most efficient way.     

Tax compliance and firm response to electronic sales monitoring

This paper analyzes how firms respond to an Internet of Things technology that reduces significantly the tax authorities' marginal cost of monitoring firm activity. More precisely, we analyze how mandating every restaurant of a single Canadian province to have sales recording modules (SRMs) affects restaurant sales, expenses and profits. We estimate that SRMs increase reported sales by 5.8% to 9.8% on average and that this increase is almost completely offset by an equal increase in expenses, including wages. As a result, the firms' taxable income remains mostly unchanged. Our results suggest that sales tax remittance enforcement at the firm level spills over to other firm stakeholders, such as employees and suppliers. Overall, the one-time cost of the device needed to monitor sales more efficiently is small compared with the recurring benefits for tax authorities.     

Reviving and assessing the Kuznets law on innovation

We apply a panel vector autoregression model to a firm-level longitudinal database to observe the co-evolution of sales growth, employment growth, profits growth and the growth of research and development (R&;D) expenditure. Contrary to expectations, profit growth seems to have little detectable association with subsequent R&;D investment. Instead, firms appear to increase their total R&;D expenditure following growth in sales and employment. In a sense, firms behave ‘as if’ they aim for a roughly constant ratio of R&;D to employment (or sales). We observe heterogeneous effects for growing or shrinking firms, however, suggesting that firms are less willing to reduce their R&;D levels following a negative growth shock than they are willing to increase R&;D after a positive shock.     

Incentive regulation and investment: evidence from European energy utilities

This paper investigates the relationship between investment and regulatory regimes (incentive vs. rate-of-return regulation) for a sample of EU energy utilities from 1997 to 2007. We control for the effect of firm ownership and for cross-country differences in the underlying energy demand and energy supply. To deal with potential endogeneity of the regulatory regime, we apply instrumental variable methods (2SLS and GMM). Our results show that investment rate is higher under incentive regulation than under rate of return regulation. Using original data on the regulatory tools (X factor and WACC), we find that investment of incentive regulated firms appears highly sensitive to the X factor, consistent with efficiency- and profit-seeking motivations. Electric utilities investment is also sensitive to the level and change in the weighted average cost of capital (WACC). Finally, we find that the positive relationship between private control and investment is not robust to IV estimations, suggesting that in Europe regulation may have reduced the differences between private and public firms’ incentives to invest.     

Productivity and Firms’ Sales Destination: Chinese Characteristics

In the trade literature, it is often assumed that there is little or no trade cost within a country's borders, but large trade costs across a country's borders. Thus, productive firms self‐select into exporters and the less productive firms can only serve domestic consumers. This paper presents a similar but different case in China, whose domestic markets are segmented by provincial borders mainly owing to the various (hidden) protective measures favoring local firms. These discriminative measures are de facto trade barriers. It applies the heterogeneous trade theory to examine the effects of firms’ productivity on their sales choices in both the international and domestic markets, in the presence of intra‐national and international trade costs. We find that productive firms not only self‐select into exporters, but also into sales in other provincial markets. This pattern is sensitive to firms’ locations and ownerships. For foreign direct investment (FDI)‐controlled firms, increases in productivity are associated with a higher probability of selling into other provincial markets, rather than into international ones. Productivity increases for firms operating in the inland area exhibit different patterns than those in the Eastern area.     

Private ownership form and productive efficiency: Electric cooperatives versus investor-owned utilities

Property rights theory predicts that private firms whose ownership shares are not tradable will not be managed efficiently. This paper tests that theory by comparing the costs of rural electric cooperatives (RECs) and investor-owned electric utilities (IOUs). Separate translog cost functions are estimated for the RECs and the IOUs. The estimated costs of producing several three-product output bundles are then compared across ownership form under the assumption that all firms face identical input prices. The empirical results suggest that the cooperative sector of the electric power industry produces its output in a much less efficient manner than does the investor-owned sector.I would like to thank David Kaserman, Steven Caudill, T. Randolph Beard, Daniel Gropper, and David Laband for their many helpful comments on earlier drafts of this paper. This research was partially funded by the Auburn University Utilities Research Center. The views expressed here are the author's and do not necessarily reflect those of the New York State Public Service Commission.     

On adjusting for risk changes when assessing the profitability effects of regulatory changes

Since regulatory changes affect the profitability and the systematic risk of regulated firms, standard ‘residual’ analysis may not uncover the true impact of regulatory changes. This paper presents a method, based on the CAPM which uses pre- and post regulatory change information, to differentiate risk from profit related changes in stock market valuations.     

VERTICAL AND HORIZONTAL ECONOMIES IN THE ELECTRIC UTILITY INDUSTRY: AN INTEGRATED APPROACH

ABSTRACT ** :  The empirical literature on the cost structure of the electric utility industry traditionally focused on the measurement of specific technological properties: 1) scale economies in generation or distribution; 2) multi-product (or horizontal) scope economies at one particular stage; 3) multi-stage (or vertical) scope economies. By adopting an integrated approach, which simultaneously considers both horizontal and vertical aspects of the technology, we find the presence, on a sample of Italian electric utilities, of both vertical integration gains and horizontal scope economies at the downstream stage. In the light of recent regulatory reforms aiming at restructuring European electricity markets, our findings have important policy implications as for the proper configuration of the industry. Moreover, this methodology can be usefully applied to the study of the production structure of other public network utilities involved in similar vertical and horizontal reorganization processes.     

NUCLEAR POWER, SYSTEMATIC RISK, AND THE COST OF CAPITAL

Previous studies of the effects of adoption of nuclear technologies by electric utilities have concentrated on the period following the catastrophe at Three Mile Island (TMI) in 1979. The purpose of this study is to test whether increased risk effects on equity costs of nuclear-adopting utilities existed prior to that event. This study, using panel data and beta measures of systematic risk, concludes that a positive, significant, and persistent nuclear adoption effect existed even prior to TMI. Nuclear adoption increased equity costs, on average, 0.8 percent for periods following the adoption event. This is of the same order of magnitude as adoption effects estimated in other studies for the post-TMI period.     

FOUR REVOLUTIONS IN ELECTRIC EFFICIENCY

Demand prospects for electricity are being altered profoundly by four synergistic types of revolutionary change: new technologies for improved end-use efficiency, new ways to finance and deliver those technologies to customers, cultural change within utilities, and regulatory reforms to reward efficient behavior. Dramatic energy savings achieved so far have been largely in direct fuels and not in electricity, mainly due to price distortions and unique market failures. Resulting inefficient use of electricity is misallocating some $60 billion a year to unnecessary expansions of U.S. electric supply. Yet the best technologies now on the market could save about 92 percent of U.S. lighting energy, about half of motor energy, and much of the electricity used for other purposes. Complete retrofit could deliver equal or better services with only a fourth of the electricity now used. The levelized cost of that quadrupled end-use efficiency averages about 0.6 cents/kWh– well below short-run marginal cost. Analogous oil-saving potential from the best demonstrated technologies is about 80 percent of present oil consumption at an average cost below $3/bbl, partly because two of the 9–10 prototype cars already tested at 67–138 miles per gallon are said to cost nothing extra to make. Many utilities already save large amounts of electricity very quickly and cheaply by financing customers' efficiency improvements through loans, gifts, rebates, or leases. Even more promising is an emerging “negawatt market” making saved electricity a fungible commodity subject to competitive bidding, arbitrage, derivative instruments, secondary markets, etc. Utilities can make more money selling less electricity and more efficiency. They can earn a spread on the difference in discount rates between themselves and their customers. They can save operating and capital costs while avoiding the associated risks and, under emerging regulatory reforms, can even keep as extra profit part of what they save. They also can generate tradeable emissions rights under the new Clean Air Act. Some utilities now properly ignore sunk costs and seek to minimize marginal variable costs. These utilities, driven by economic– not accounting–principles, find this approach both profitable and operationally advantageous.