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Announcements•Mid‐semester survey on bCourses.•ESG teams announced on Thursday•Schedule for next weeks:Thursday March 13Introduce ESGTuesday March 18ESG Q&APractice rd 0No class/ Spring BreakApril 1Portfolio auctionRd 1
Electricity industry regulation andrestructuringMarch 2014
Economic regulation of a naturalmonopoly•In principle, regulators want to promoteefficiency.•On the one hand, we want to have a single firm inthis industry in order to benefit from least‐costproduction/exploit economies of scale.•On the other hand, a monopolist will price abovethe efficient price leading to welfare loss from thegood being underprovided.
We have discussed price regulation intheory•Linear pricing•Non‐linear pricing•Ramsey pricing•Peak‐load pricing
How are natural monopolies regulatedin practice?•Traditionally, regulated monopolies subject to “rate ofreturn” (ROR) or “cost—of‐service” regulation.•Under rate of return regulation, the firm is allowed toearn no more than a “fair” rate of return on all prudentinvestments.•ROR regulation adjusts overall price levels according tothe operator’s accounting costs and costs of capital.
Cost‐of‐service regulation is currently usedto set rates in many markets:•Electricity markets•Generation (in most states)•Transmission and distribution (everywhere)•Retail Services (in most states)•Natural Gas markets•Transmission and distribution (everywhere)•Retail Services (in most states)•Crude Oil markets–Pipelines for crude and refined products (everywhere)
Primary actors in this process:•The producers.•The regulatory agency or agencies.•Any other interest groups with a stake in theregulatory process (e.g. rate payer advocates,environmental groups, low income groups).
California Public Utilities Commission•CPUC employs almost 1000economists, engineers, administrators,lawyers, judges, etc.•Regulates electric, natural gas,telecommunications, water, railroad, railtransit, and passenger transportationcompanies.•The Commission serves the publicinterest by protecting consumers andensuring the provision of safe, reliableutility service and infrastructure atreasonable rates, with a commitment toenvironmental enhancement and ahealthy California economy.
Role of the CPUC•Decide on fair rate of return for regulated firms (ie a rate thatallows a “fair” return on investment)•Determine what goes into the rate base ( this determines therevenue requirement)•Given this, determine prices and rate structure that will yield s –Inorder to set price structures, the PUC must forecast demandandstipulates prices.•Overall objective: PUCs want to set rate of return at the minimumlevel that maintains the firm’s financial viability and allows the firmto amass enough funds to finance required future investment.
Rate of return regulation•The idea is to calculate the utility’s total costs that need to be