Capital budgeting, technological innovation and the emerging competitive environment of the electric power industry

Abstract

For most of this century the electric utility industry has operated as a regulated natural monopoly which produced a commodity product in an environment of low technological progress and sold it to a homogeneous captive market. Given these conditions, the primary capital budgeting issues involved the timing of capacity additions and the mix of base load and peaking capacity. This relatively simple and stable situation, however, has been eroded by market, regulatory and technological changes. As a consequence, old embedded capital budgeting approaches are hindering the pursuit of efficiency with respect to the production and distribution of electric energy. Our purpose in this paper is to assess traditional utility capital budgeting procedures and to explore possibilities for improvement. We begin with a review of traditional capital budgeting decision processes. Next, we overview the changes that have emerged over the last two decades and explore capital budgeting processes more appropriate to this ‘early competitive environment’. Finally, we project the changes a bit further and explore the capital budgeting techniques that may be useful in an ‘advanced competitive environment’.