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Table of Contents Preface xi Part I: Principles 1 Chapter 1: A Brief History 3 1.1 Introduction 3 Chapter 2: Economic Concepts of Regulation 15 2.1 Introduction 15 2.2 The Fundamental Economic Goal of Regulation 16 2.3 The Competitive Ideal 18 2.4 Factors that Preclude a Competitive Outcome 21 2.5 Profit Maximization Under Monopoly 26 2.6 The Contestability of Markets 28 2.7 The Regulator?s Pricing Challenge 30 2.8 Other Complicating Factors 33 2.9 How Deregulation Can Lead to More Regulation 37 2.10 Chapter Summary 39 Chapter 3: The Role of the Revenue Requirement 41 3.1 Introduction 41 3.2 Meeting the Regulatory Challenge 42 3.3 Key Regulatory Principles 43 3.4 Why Revenue Requirements Underlie All Regulatory Structures 46 3.5 Revenue Requirement Components 53 3.6 Other Issues 60 3.7 Chapter Summary 63 Chapter 4: Alternative Regulatory Structures 65 4.1 Introduction 65 4.2 Common Aspects of Regulatory Structures 66 4.3 Cost Differences and Operating Environments 68 4.4 Cost of Service 68 4.5 Performance-Based Regulation 71 4.6 Yardstick Competition 75 4.7 Comparing Different Regulatory Regimes to Set Tariffs 76 4.8 Chapter Summary 78 Chapter 5: Cost Measurement 79 5.1 Introduction 79 5.2 Why Regulators Measure Costs 79 5.3 Estimating and Regulating Operating Costs 86 5.4 Estimating and Regulating the Rate Base 102 5.5 Estimating the Regulated Rate of Return 112 5.6 Deferred Costs and Regulatory Assets 126 5.7 Chapter Summary 127 5.8 APPENDIX: Depreciation Mechanics 128 Chapter 6: Cost Allocation 139 6.1 Introduction 139 6.2 Cost Functionalization 140 6.3 Cost Classification 144 6.4 Cost Allocation 146 6.5 Chapter Summary 153 Chapter 7: Rate Setting Principles and Procedures 155 7.1 Introduction 155 7.2 Billing Determinants 157 7.3 Tariff Design 165 7.4 Alternative Design Structures 167 7.5 Tariff-Setting Methods 173 7.6. Pricing and Social Policy 185 7.7 Electric Restructuring and Default Service 187 7.8 Chapter Summary 189 Chapter 8: Rate and Tariff Adjustment Mechanisms 191 8.1 Introduction 191 8.2 Pass-Through Mechanisms 191 8.3 Inflation Adjustments 193 8.4 An Alphabet Soup of Adjustment Factors 194 8.5 Shared-Savings and Off-Ramps 201 8.6 Chapter Summary 202 Chapter 9: Market Power in the Electric and Gas Industries 203 9.1 Introduction 203 9.2 Defining Market Power 205 9.3 Dominant Firms 207 9.4 Horizontal and Vertical Market Power 208 9.5 Remedies for Market Power 216 9.6 The Essential Facilities Doctrine 219 9.7 Chapter Summary 220 Part II: Extensions and Applications 223 Chapter 10: Dealing With Uncertainty 225 10.1 Introduction 225 10.2 Key Issues 225 10.3 Making Investment Decisions Under Uncertainty 228 10.4 Measuring Price Volatility 242 10.5 Nonmarket Uncertainties 245 10.6 Chapter Summary 248 Chapter 11: Environmental Regulation of the Energy Industry 251 11.1 Introduction 251 11.2 Environmental Costs and Environmental Externalities 253 11.3 Regulatory Responses 255 11.4 Measuring Environmental Costs and Benefits 263 11.5 Environmental Costs and Energy Prices 266 11.6 Externality Adders 267 11.7 Current Regulatory Policies: Renewable Energy and Global Climate Change 269 11.8 Chapter Summary 274 Chapter 12: Regulating Electric System Reliability 277 12.1 Introduction 277 12.2 Direct Current Circuits 278 12.3 Alternating Current Circuits 282 12.4 Defining Reliability 283 12.5 Reliability and Installed Capacity Markets 286 12.6 International Capacity Markets 292 12.7 Chapter Summary 293 Chapter 13: Regulation and Reform in International Markets 295 13.1 Introduction 295 13.2 Transition Mechanisms 296 13.3 Alternative Privatization Arrangements 297 13.4 Establishing the Regulatory Framework 299 13.5 Renegotiation and Change 300 13.6 International Arbitration 301 13.7 Chapter Summary 302 Chapter :14 The Future of Economic Regulation in the Electric and Natural Gas Industries 305 14.1 Introduction 305 14.2 The Regulatory Clash of Politics and Economics 306 14.3 The Future of U.S. Regulation 308 14.4 Concluding Thoughts 311 Select Bibliography 313 Index 323 List of Figures Figure 2-1: Individual and Industry Equilibrium?Perfect Competition 18 Figure 2-2: Consumer?s and Producer?s Surplus 20 Figure 2-3: Natural Monopoly 24 Figure 2-4: The Monopolist?s Output Decision 27 Figure 2-5: The Regulatory Challenge 30 Figure 2-6: One Regulatory Solution: Average Cost Pricing 31 Figure 2-7: Pricing When Average Costs are Increasing 33 Figure 2-8: Regulation When AC is Uncertain 35 Figure 2-9: Effect of Regulatory Policies on a Firm?s Cost Structure 36 Figure 4-1: Three Sets of Rules to Determine Regulated Rates 66 Figure 5-1: The Framework for Developing Regulated Services and Prices 80 Figure 5-2: The Five-Step Procedure to Calculate Regulated Prices 81 Figure 5-3: The Three Sets of Books 85 Figure 5-4: Data Envelope Analysis 90 Figure 5-5: OLS and COLS 92 Figure 5-6: Stochastic Frontier Analysis 94 Figure 5-7: Effect of Depreciation Rate on Revenue Requirements 101 Figure A.5-1: Percentage Equipment Surviving Over Time 129 Figure A.5-2: Stub Survivor Curve 130 Figure A.5-3: Derived Stub Survivor Curve 135 Figure A.5-4: Iowa ?L3? Survivor Curve and its Derivative Curves 137 Figure 6-1: Cost Functionalization 141 Figure 6-2: Cost Classification 145 Figure 6-3: Cost Allocation 148 Figure 7-1: Determining Prices 156 Figure 7-2: Observed Temperature Distribution 163 Figure 7-3: The Pricing Dilemma 166 Figure 7-4: Two-Part Tariff Pricing 168 Figure 7-5: Block Rate Design 169 Figure 7-6: Block Rate Design Under Increasing Marginal Costs 170 Figure 7-7: Selected International POLR Experience 188 Figure 9-1: Diagram of Market Power in the Electric Industry 211 Figure 9-2: Optimal Supply Curve Under Imperfect Competition 218 Figure 10-1: The Future Price of Electricity 231 Figure 10-2. Value of Option to Invest 233 Figure 10-3: Increased Price Uncertainty 233 Figure 10-4: A Decision Tree and Outcomes 236 Figure 10-5: Extended Decision Tree with Additional Information 237 Figure 10-6: Coal Plant Decision Tree 240 Figure 10-7: Henry Hub Daily Average Closing Gas Prices (2005) 243 Figure 10-8: Comparing Multiple Projects 248 Figure 11-1: Inefficiency in Private Production 256 Figure 11-2: Effects of an Output Tax 259 Figure 11-3: Determination of the Optimal Emissions Tax 261 Figure 12-1: A Simple Electric System 279 Figure 12-2: Impact of Higher Voltage 281 Figure 12-3: Load Duration Curve and Generating Resources 287 Figure 12-4: NYISO Locational Capacity Demand Curves 291 List of Tables Table A.5-1: Surviving Equipment Over Time?Original Group Method 128 Table A.5-2: Summary of Plant Account Activity by Year 132 Table A.5-3: Annual Exposures and Retirements 133 Table A.5-4: Observed Life Table 134 Table 6-1: Typical Accounts for an Electric Utility 143 Table 6-2: Sample Gas Distribution System Plant and Expense Accounts 144 Table 6-3: Natural Gas Distribution Company?Estimation of Customer and Energy Allocators (2006 Test Year) 151 Table 6-4: Electric Distribution Company?Estimation of Demand Allocators (2006 Test Year) 153 Table 8-1: X Factors in Values and Methods in Selected Countries 198 Table 9-1: Delivered Price Test 214 Table 10-1: Distribution Planning Costs 229 Table 10-2: Expected Costs of Alternative Investment Strategies 229 Table 10-3: Decision Matrix 235 Table 10-4: Critical Event Matrix 247 Table 11-1: Types of Environmental Policy Instruments 257 Table 13-1: Increase in Average Maximum Tariffs for Mexican Natural Gas Distributors 299
Library of Congress Subject Headings for this publication:
Energy industries -- Government policy -- United States.