Thread by @SteveCicala

🚨 Some new results from my work on deregulation out today in the AER: 🚨

Ungated version here: stevecicala.com/papers/fuel_di…

In my 2015 AER, I examined *when* regulation distorts costs by looking at the prices power plants paid for fuel.

I found it depends on cost-reducing opportunities and focused on the difference between natural gas and coal: Gas is homogeneous and traded on open markets, while coal varies along dimensions of heat, ash, sulfur, etc. and tends to be sold in bilateral contracts.

It then made sense that on average there was essentially no impact of deregulation on gas prices, but there were large reductions in how much power plants paid for coal:

When prices are not disciplined by transparent markets, regulated power plants can use various excuses to continue overpaying for inputs. ("It's expensive, but our plant is tuned to burn it...and we have a contract...I promise we tried to get out of it…")

Deregulation sharpens cost-reducing incentives by allowing plant owners to keep savings rather than pass them all on to consumers through the rate-making process.

But ultimately the impact of deregulation depends on the existence of cost-reducing opportunities.

I look at this prediction more directly now by plotting plant-level estimates of the impact of deregulation (by comparing with regulated neighbors) against how much deregulated plants were initially paying relative to those neighbors.

Plants that were already paying less than their neighbors would prospectively have fewer cost-reducing opportunities than those paying more. And that's exactly what's in the data.

Here's the figure for coal. To the left of zero it's essentially flat, and reductions closely follow the 45-degree line for plants that were initially paying more than their neighbors.

The picture is similar for gas: plants that were initially paying more than their neighbors had larger cost reductions after deregulation.

This reinforces the conclusion of the original paper: Larger cost distortions -> larger cost reductions with deregulation.

The null result from gas is the overall average of many plants that were already paying competitive prices, and a handful that were paying modestly more.

Coal plants saw reductions on average because there were more plants that had significant cost-reducing opportunities—the plants that were already competitive look a lot like the gas plants that were competitive.

Of course, if you exclude the plants with cost-reducing opportunities, it will look like deregulation didn't do much!

The reply focuses on Commonwealth Edison, the Chicago-area utility that was initially paying more than twice the market rate for coal.

The main point of disagreement between comment and reply is whether ComEd's cost reductions were pre-determined by a contract renegotiation that preceded deregulation. My reply digs into regulatory documents to make sure I get it right.

SEC reports, regulatory and case law all detail how ComEd finagled competitive prices only *after* they were able to keep the savings for themselves. Prior negotiations actually locked in the mines’ outsized margins—they did not phase them out.

My thanks go to the comment's authors for highlighting procurement at ComEd plants. It has turned out to be an excellent case study in regulatory distortions--which I suppose is in keeping with the company's history.

This research was possible because of the amazing data collected by @EIAgov. Their stats office was decimated in 2017, and they were forced to cease data sharing agreements with universities. I hope they get back on their feet in 2021.

Again, here's the ungated version, thanks for reading!

stevecicala.com/papers/fuel_di…