Study Quantifies Agency Costs in Fuel Pass-Throughs
A 2015 American Economic Review Paper highlights the higher fuel costs passed through by regulated coal-fired power plants versus their deregulated counterparts. The paper looked at regulated power plants that have become deregulated, and found that the deregulated plants “save about $1 billion a year compared to those that remained regulated . . . because a lack of transparency, political influence and poorly designed reimbursement rates led the regulated plants to pursue inefficient strategies when purchasing coal.” The study attributes the savings to the fact that the deregulated plants have a strong incentive to shop around on price.
Interestingly, however, natural gas power plants in the study that became deregulated did not experience the same drop in fuel procurement costs:
Although power plants that burned natural gas were subject to the exact same regulations as the coal-fired plants, there was no drop in the price paid for gas after deregulation. Cicala attributed the difference to the fact that natural gas is sold on a transparent, open market. This prevents political influences from sneaking through and allows regulators to know when plants are paying too much.
There’s also a lesson about the air-quality compliance choices that utilities face at the margin:
What’s different about the buying strategy of deregulated coal plant operators? Cicala dove deep into two decades of detailed, restricted-access procurement data to answer this question. First, he found that deregulated plants switch to cheaper, low-sulfur coal. This not only saves them money, but also allows them to comply with environmental regulations. On the other hand, regulated plants often comply with regulations by installing expensive “scrubber” technology, which allows them to make money from the capital improvements.
Ultimately, Dr. Cicala draws the correct conclusion:
“Regulations are not created equal. Instead of debating for or against ‘regulation’ in general, it would be more productive to figure out how to separate the good from the bad,” said the author of the study, Asst. Prof. Steve Cicala from the Energy Policy Institute at Chicago. “If we know what forces make a regulation unsuccessful, then we can avoid designing new ones in a similar way.”