Sub-Optimal Generation Portfolio Variance with Rate of Return Regulation
Author(s)
Stanley Keith Berry*
ABSTRACT
This paper demonstrates that continuation of traditional rate-of-return electric utility regulation of transmission and distribution assets will impede the ability of customers to optimize their generation portfolios. Under linear price regulation, with increasing (decreasing) returns to scale customers will choose a more (less) risky generation portfolio than they would with no transmission and distribution asset rate-of-return regulation. Similar problems arise under non-linear (two-part) pricing of transmission and distribution assets. When the per-unit price is set at marginal cost, with increasing (decreasing) marginal cost, customers will choose a more (less) risky generation portfolio than they would with no transmission and distribution asset regulation. With price caps the optimal generation portfolio is chosen.
This paper demonstrates that continuation of traditional rate-of-return electric utility regulation of transmission and distribution assets will impede the ability of customers to optimize their generation portfolios. Under linear price regulation, with increasing (decreasing) returns to scale customers will choose a more (less) risky generation portfolio than they would with no transmission and distribution asset rate-of-return regulation. Similar problems arise under non-linear (two-part) pricing of transmission and distribution assets. When the per-unit price is set at marginal cost, with increasing (decreasing) marginal cost, customers will choose a more (less) risky generation portfolio than they would with no transmission and distribution asset regulation. With price caps the optimal generation portfolio is chosen.
Cite this paper
nullS. Berry, "Sub-Optimal Generation Portfolio Variance with Rate of Return Regulation," Technology and Investment, Vol. 1 No. 2, 2010, pp. 114-117. doi: 10.4236/ti.2010.12014.
nullS. Berry, "Sub-Optimal Generation Portfolio Variance with Rate of Return Regulation," Technology and Investment, Vol. 1 No. 2, 2010, pp. 114-117. doi: 10.4236/ti.2010.12014.
References
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[1] P. L. Joskow, “Restructuring, Competition and Regulatory Reform in the US Electricity Sector,” Journal of Economic Perspectives, Vol. 11, No. 3, Summer 1997, pp. 119-138. [2] S. Angle and G. Jr. Cannon, “Independent Transmission Companies: The For-Profit Alternative in Competitive Electric Markets,” Energy Law Journal, Vol. 19, No. 2, 1998, pp. 229-279. [3] J. C. Bonbright, A. L. Danielsen and D. R. Kamerschen, “Principles of Public Utility Rates,” 2nd Edition, Arlington, Public Utilities Reports, Inc., Virginia, 1980, pp. 573-575. [4] C. F. Jr. Phillips, “The Regulation of Public Utilities,” Arlington, Public Utilities Reports. Inc., Virginia, 1988. [5] I. Horowitz, “Decision Making and the Theory of the Firm,” Holt Rinehart and Winston, Inc., New York, 1970. [6] A. C. Chiang, “Fundamental Methods of Mathematical Economics,” 3rd Edition, McGraw-Hill, Inc., New York, 1984, pp. 257-258. [7] J. W. Pratt, “Risk Aversion in the Small and in the Large,” Econometrical, Vol. 32, No. 1-2, January-April 1964, pp. 122-136. [8] W. J. Baumol and D. F. Bradford, “Optimal Departures from Marginal Cost Pricing,” American Economic Review, Vol. 60, No. 3, 1970, pp. 265-283. [9] J. P. Acton and I. Vogelsang, “Introduction: Symposium on Price-cap Regulation,” Rand Journal of Economics, Vol. 20, No. 3, 1989, pp. 369-372. [10] T. R. Lewis and D. E. M. Sappington, “Regulating a Mo-nopolist with Unknown Demand,” American Economic Review, Vol. 78, No. 5, December 1988, pp. 986-998. [11] K. E. Train, “Optimal Regulation: The Economic Theory of Natural Monopoly,” the MIT Press, Cambridge, Mas-sachusetts, 1991. [12] R. Coase, “The Marginal Cost Controversy,” Economical, Vol. 13, No. 51, 1946, pp. 169-189.