Electricity utilities are less likely to invest under ‘liberal’ regulators
Regulation is a popular topic right now. Whatever else might be going in Washington D.C., deregulation is proceeding apace. As J.D. Tucille wrote for Reason yesterday,
Largely lost in headlines about Russians, campaign dirty tricks, and Trump’s alleged shock at his own victory is his administration’s follow-through on deregulatory promises. Soon after taking office in January 2017, Trump ordered federal agencies to make sure that “for every one new regulation issued, at least two prior regulations be identified for elimination, and that the cost of planned regulations be prudently managed and controlled through a budgeting process.” That was followed by an order to conduct cost-benefit analyses of federal regulations. In September, the Office of Management and Budget instructed agencies to prepare budgets representing reductions in total regulatory costs.
“Compared to previous presidents, Trump’s agencies have issued significantly fewer new regulatory actions and have even begun to look back at existing regulations with an eye toward cost-saving modifications or outright rescissions,” wrote Susan E. Dudley, director of the George Washington University Regulatory Studies Center, after reviewing the results. “Whatever you think of Trump’s chaotic first ten months in office, it is undeniable that he is moving aggressively to fulfill his campaign promises to reduce regulation.”
Regulation and electricity distribution
One problem is time inconsistency, or ‘regulatory holdup’. A regulated utility might be considering a big capital investment, such as burying power lines in an area, the returns from which depend on future regulated prices. To encourage this investment, regulators might promise a stream of high rates of return. But once the investment is made, the regulators may be tempted to reduce the regulated electricity price to benefit consumers. If electricity utilities anticipate this and if there is no legal commitment device available, the utility would not make a significant investment.
Another problem is moral hazard. Electricity utilities lose approximately 7% of electricity that they procure to technical line losses. In theory, they could try to reduce this loss by, for example, procuring electricity from sources that are closer to final users and employing high-quality systems engineers with appropriate incentives. But the regulatory regime in the US discourages such efforts. The convention is to grant near full pass-through of input electricity costs to the consumers. As a result, utility managers have no incentives to exert efforts that will reduce the cost of input electricity.
To quantify some of these effects, Yurukoglu and Lim look at levels of investment under Public Utility Commissions (PUC) of different political compositions. The different parties, Republican (conservative) and Democrat (liberal), are assumed to act differently towards price regulation. They find that PUCs with a large share of Republicans tend to adjudicate a significantly higher rate of return. As a result, utilities tend to make more investments, which in turn leads to better reliability. By contrast, utilities incur a significantly higher level of energy losses when the PUC has a large share of Republicans. This suggests that conservative regulators are slacker in monitoring how utilities behave. This, in turn leads to less effort for cost-saving through reducing technical line losses. Overall, higher returns help to reduce under-investment in infrastructure, but they come at the cost of more technical line losses.
Federal regulation is a major burden, estimated to cost $1.9 trillion annually. When businesses have to factor in, not only market risks, but political risks as well, they provide fewer goods and services. This holds back economic growth, so the administration’s current drive is to be welcomed.
John Phelan is an economist at the Center of the American Experiment.