Energy Transitions in Regulated Markets

This paper asks how rate-of-return (RoR) regulation in U.S. electricity markets affects the speed and efficiency of energy transitions, specifically the transition from coal to combined-cycle natural gas (CCNG) generation driven by fracking-induced cost declines. The authors build and estimate a structural model of regulated utility behavior in which utilities optimize investment, retirement, and hourly operations decisions against an incentive structure set by state Public Utility Commissions (PUCs).

The regulatory environment combines two instruments: (1) an allowable rate of return that is decreasing in consumer electricity rates (incentive regulation), parameterized as s = (r/r₀)^{-γ}, where higher γ penalizes high-cost outcomes more severely; and (2) a “used-and-useful” standard in which a coal plant’s contribution to the rate base depends on its capacity utilization via a logit function. These two instruments create a tension: utilities want to lower costs to earn a higher RoR, but also want to run existing coal plants—even when uneconomical—to prove they are “used and useful” and thus maximize their rate base and profits.

Mar Reguant | Macro Paper Warehouse

Energy Transitions in Regulated Markets