Dynamic Regulatory Distortions: Coal Storage at U.S. Power Plants

Abstract

This paper quanties the dynamic productive eciency gains in input procurement associated with introducing market mechanisms into a formerly price regulated industry. I do so within the context of the U.S coal-red power generation sector from 1983-2012. I formulate and estimate a dynamic plant-level model of coal purchase and storage decisions. Holding constant the plant’s pattern of input prices and output, I nd that it costs a regulated plant roughly 3% more per month to procure and store coal relative to the same plant facing market prices. This amounts to roughly $35 million per month saved in procurement costs if all price-regulated coal-red plants in the U.S instead faced market prices. This regulatory distortion stems primarily from two sources: regulators pass through a percentage of fuel purchase costs to electricity consumers and provide a working capital allowance for coal inventories held on-site. Empirically, I nd that the rst source is more important; changes in when and how much coal a plant buys under output price regulation explains more of the 3% regulatory distortion relative to changes in the level of inventories held. One of the primary concerns regarding output price regulation has been distortions in the level of investment due to the regulated return provided on capital; my ndings indicate that regulatory distortions to the timing of capital investments may be costlier.