Regulatory Induced Risk Aversion in Coal Contracting at US Power Plants: Implications for Environmental Policy

Abstract

Seminal work argues that electric utilities sign long-term contracts with coal suppliers prior to making relationship-specific investments in order to avoid the possibility of ex post hold-up. This paper provides empirical evidence that risk aversion also plays an important role in the coal contracting behavior of US power plants. Specifically, I show that plants facing more spot coal price uncertainty sign longer duration coal contracts, purchase contract coal from a larger number of origin counties, and pay higher contract coal prices. One plausible mechanism for this risk aversion is that regulators are less likely to incorporate high input cost realizations into the regulated output price they set for electric utilities. Using my estimate of plant-level risk aversion, I calculate that the ratio of the aggregate costs incurred by plants under cap and trade relative to a carbon tax is 1.27. This highlights the importance of implementing climate policy that limits carbon price volatility.