William B. Tye

Regulatory risk : economic principles and applications to natural gas pipelines and other industries

1. Introduction. 2. The Theory of Regulatory Risk. 3. Regulatory Risk: Objections to the Theory. 4. Sources of Asymmetric Risk in Regulated Industries. 5. Risk of the Interstate Natural Gas Pipeline Industry: Summary. 6. Recent Trends in the Interstate Gas Pipeline Industy. 7. Two Views of Pipeline Risk. 8. Risk Analysis for Natural Gas Pipelines. 9. Two Fundamental Questions. Appendix A: Risks that Affect the Cost of Capital. Appendix B: Summary of Recent History of the Interstate Natural Gas Pipeline Industry. Bibliography. Index.

Handle with care: A primer on incentive regulation

Regulators increasingly rely upon incentive regulation as a substitute or refinement of traditional cost of service regulation. Focusing on incentive regulation in the US utility industry, this article first identifies four desirable attributes for incentive mechanisms. It develops a taxonomy of the types of mechanisms that are available, identifies the issues that arise in the design and evaluation of these mechanisms, and then closes with a discussion of the risks associated with various mechanisms.

Compensation for the risk of stranded costs

Abstract Electric utilities now face the risk that existing assets, costs or contract commitments may be ‘stranded’ by increased competition, leaving shareholders rather than customers to bear the costs. An important policy question is whether shareholders have already been compensated for this risk under traditional cost of service regulatory principles. The economic principles of asymmetric risk imply that even if investors are fully cognizant of the risks of stranded costs, capital market prices fully reflected such risks and regulators always set the allowed rate of return equal to the true cost of capital, it is mathematically impossible for investors to have been previously compensated for these risks.

Stranded cost recovery and competition on equal terms

Abstract The weak competitive neutrality issue, which has heretofore been the centerpiece of the debate, should now be put aside. It is time to focus on getting the stranded cost number right, so that the transition to competition may truly begin on equal terms.

A simplified procedure for costing the financial risks of purchased power contracts

Abstract Purchased power contracts entail financial risk to electric utilities because their inflexible payment mechanisms involve debt-like obligations. Of course, building additional utility plant also involves risk. The cost of these risks must be netted out to arrive at a true avoided cost, or ratepayers may pay too much for purchased power.

Conditions for Investor and Customer Indifference to Transitions among Regulatory Treatments of Deferred Income Taxes

Despite a long debate over the methods regulators can use to treat deferred income taxes from accelerated depreciation, there appears to be no formal analysis of the conditions under which customers and investors will prefer each method and under which a transition among the methods will leave investors or customers indifferent to the change. This article demonstrates that regulatory selection of a deferred tax treatment method necessarily changes the wealth of investors or customers if their discount rates differ. Moreover, transitions among the various methods create further wealth changes for assets in existence at the time of the switch, at least for some groups. These changes can reverse the usual preferences among the methods.

Risk Analysis for Natural Gas Pipelines

This chapter attempts to pull the various threads from the previous chapters into a cohesive pattern. After this introduction, we consider in several stages the various logical arguments for and against the view that pipeline risk remains high. In the process, we present additional quantitative evidence on the risk of the industry, from stock market data. At the end, we present our views on the level of pipeline risk. This sets the stage for the discussion in Chapter 9 on what we think are the crucial issues that the pipeline industry and its regulators face in the 1990s. First, however, we review the risk debate.

Sources of Asymmetric Risk in Regulated Industries

Some background in the relevant economic principles is necessary for the analysis of the following Chapters 5 through 9 on gas pipelines to make sense. In particular, this chapter: 1. 1. Contrasts the prices charged for capital investments under competition and under traditional regulation; and 2. 2. Explores the kinds of risks that do and do not affect the cost of capital.1

Risk of the Interstate Natural Gas Pipeline Industry: Summary

Our analysis of regulatory risk for gas pipelines began when the Interstate Natural Gas Association of America (INGAA) commissioned the authors1 to study the risk of the interstate natural gas pipeline industry (hereafter pipeline industry).2 INGAA was concerned that there might be fundamental problems with the current system of pipeline regulation. Most particularly for this study, INGAA was concerned that there seemed to be a difference between regulators’ perception of the industry’s risks and the risks perceived by the pipeline companies themselves.

Two Views of Pipeline Risk

In Chapter 6, we sketched the recent history of the interstate gas pipeline industry. That history is developed more fully in Appendix B. We doubt that anyone reading that history would disagree with the conclusion that the natural gas industry, and particularly its pipeline segment, has experienced a much higher degree of risk since the Natural Gas Policy Act passed in 1978. Legal and regulatory standards and contractual and business relationships have been in flux. Pipelines have had losses of billions of dollars from take-or-pay contract litigation and settlements. Competition for what once were protected markets not only is growing, but is being actively encouraged by the regulatory agency in control, yet regulatory jurisdiction over rates remains in force.