Policy Uncertainty and Supply Adequacy in Electric Power Markets

This paper examines policy uncertainty adversely affecting investment in the electric power industry, covering generation and network assets. We focus on asymmetric, systematic, non-diversifiable risk with spin-offs. In generation, a key uncertainty is the inability of governments to refrain from intervention if capacity becomes scarce and prices rise. The policy expectations can, in fact, be self-fulfilling. One issue in network investment is that price-cap regulation is less suited to handling market risk than rate-of-return regulation. Another issue is the apparent inability of regulators credibly to commit to pre-announced policy. With increasing importance of new investment, a case can be made that (used-and-useful) rate-of-return regulation will regain territory in the future. Furthermore, improving checks and balances within the structure of regulation should be a focus of policy and good governance.