Regulatory Economics & Market Design

Regulatory Economics

Our regulatory economics consulting practice weds fundamental economic principles with a detailed understanding of the dynamics of evolving deregulated markets. London Economics International LLC’s unique blend of commercial experience and academic credibility enables us to provide policy alternatives which are both practical and economically sound.

Performance Based Ratemaking

Despite gains to consumers from the creation of competitive wholesale power and natural gas markets in the US, many jurisdictions continue to face high costs for electricity relative to nearby regions. These anomalies are forcing regulators to focus on the non-generation portions of customer bills. Increasingly, incentive-based ratemaking is seen as the next step in providing further reductions in delivered energy prices.

Historically, rates for monopoly network industries have been set using cost-plus rate of return regulation. This rate structure has tended to blunt incentives to improve efficiency, since few utilities were actually at risk on any portion of their investment. Incentive based structures provide a mechanism for shareholders and consumers to share gains from efficiency improvements. Rates are set with reference to industry productivity growth targets. Companies that exceed these targets keep a portion of the profits; companies that fail to achieve them can lose money. Targets are reset periodically to insure that incentives remain effective.

Drawing on a wealth of international experience, LEI is able to provide comprehensive analysis and design of incentive-based regulation mechanisms. Using tools such as data-envelopment analysis (DEA) or other appropriate techniques, we are able to normalize and compare utility productivity growth across companies throughout North America and in other jurisdictions. We advise state and Federal regulators on how such mechanisms can be designed; we work with companies required to file tariff proposals in response to regulatory incentive-based initiatives; and we incorporate knowledge of PBR in our valuation of distribution companies for potential acquirers.

Electricity Market Design

London Economics is one of the world’s leading experts in power market design. The issues surrounding design of power markets are complex, with potentially costly implications for a diversity of stakeholders. Challenges range from the structure and timing of bidding in wholesale energy markets, to the design of transmission tariffs and congestion charges, to market power and trading in ancillary services. Having dealt with these questions repeatedly since the inception of wholesale power markets in the late 1980s in the UK, LEI is uniquely positioned to provide solutions tempered with the knowledge of experience in other regions.

Our market design engagements in North America have taken place in, among other regions, California, New England, Texas, Alberta, and Ontario. We work both for the institutions responsible for establishing wholesale power markets and for the companies affected by them. The North American market is diverse, and trading arrangements for one region are not always appropriate in another. LEI is able to use its global expertise to recommend solutions based on international best consulting practice rather than just abstract economic theory.

Unbundling

The process of restructuring and creating electricity markets is complex. LEI has substantial experience in grappling with the challenges of unbundling, including estimation of stranded costs and benefits, approaches to retail competition, estimation of consumer benefits from restructuring, and examination of affiliate relationships codes. Clients have included regulatory agencies, affected utilities, industrial groups, and consumer organizations. Our ability to apply economic principles in a sound and independent fashion enables us to present credible policy alternatives which clients can use to influence the course of restructuring.

Market Power

Evolution of the electric power industry from a regulated monopoly to an unbundled set of inter-related production, supply and distribution businesses has forced participants to examine what constitutes market power and how it can be constrained. Traditional tools, such as the Hirschmann-Herfindahl Index (HHI), are of limited application to electricity markets because of the difficulty in defining the market appropriately. To date, these questions have arisen mainly in generation markets; ultimately, they may also be of concern in creating competitive retail markets as well.

Our detailed knowledge of issues such as market definition, concentration ratios, and price tests has been frequently applied to regulatory filings before state commissions, the Federal Energy Regulatory Commission (FERC), and regulatory and market institutions worldwide. For example, we helped to draft Section 203 and Section 205 filings under the Federal Power Act associated with the acquisition of US generating capacity.

LEI has developed sophisticated models which move beyond simplistic concentration ratios to focus on the actual impact individual firms can have on market prices. We have also helped to develop contractual mechanisms to mitigate market power in jurisdictions where divestiture is unfeasible. In addition, we have created a wide range of policy position papers for a variety of clients which analyze market power in key markets, assess policy alternatives, and identify implications for return on investment.

Indicative Work
  • Analysis and authorship of pool rules;
  • Implications of auction theory and the role of iterative markets;
  • Institutional structure of ISOs and power exchanges;
  • Identification and amelioration of market power in generation;
  • Transmission tariff design, including congestion/capacity charges;
  • Role of generation capacity markets;
  • Calculation and recovery of stranded costs;
  • Design of transition contracts;
  • Economically rational approaches to provision of ancillary services.