Regulation of network infrastructure investments: an experimental evaluation
- 1.2k Downloads
This paper reports the results of an experiment evaluating three regulatory schemes for network infrastructure, in terms of their ability to generate efficient levels of capacity investment. We compare the performance of (1) price cap regulation, (2) a regulatory holiday for new capacity, and (3) price cap regulation with long term contracts combined with a secondary market. The setting is one in which network users can benefit from acting strategically, and are better informed than the network operator about demand growth. We find that the regulatory holiday creates an incentive to underinvest relative to optimal levels. Long term contracts also fail to improve on single price-cap regulation, and may reduce investment by providing noisier signals about future demand.
KeywordsInfrastructure investment Experiment Price cap Regulatory holiday
JEL ClassificationC9 L51 L95
The authors thank two anonymous referees, Christoph Engel, Machiel Mulder, Jo Van Biesebroeck, Christian von Hirschhausen, David Newbery, Stef Proost, Juan Rosselón and Ingo Vogelsang, as well as seminar participants at Tilburg University, Groningen University, the Research Institute of Industrial Economics Stockholm, K.U. Leuven, the 2009 International ESA Conference inWashington DC, the Toulouse Energy Conference 2009, the 2009 Infraday Conference in Berlin, the 2010 CLEEN workshop in Amsterdam, the 2011 IAEE conference in Stockholm, the 2011 ESA Conference in Luxemburg, the 2011 CRNI Conference in Brussels for their comments. The authors are responsible for any remaining mistakes. Bert Willems was the recipient of a Marie Curie Intra European Fellowship (PIEF-GA-2008-221085). He thanks the Electricity Policy Group at Cambridge University for their hospitality. Funding by the NMa and CentER for conducting the experiments is gratefully acknowledged. This paper builds upon TILEC report 2010-01, a project conducted in collaboration with the ERGEG’s Gas Regulators Initiative North-Western Europe (GRI NW).
This article is distributed under the terms of the Creative Commons Attribution License which permits any use, distribution, and reproduction in any medium, provided the original author(s) and the source are credited.
- Armstrong M., Sappington D. (2007) Recent developments in the theory of regulation. Handbook of industrial organization. Elsevier, AmsterdamGoogle Scholar
- Averch H., Johnson L. L. (1962) Behavior of the firm under regulatory constraint. American Economic Review 52(5): 1052–1069Google Scholar
- Carr, T. (2005). FERC’s natural gas pipeline “open season” policy, memorandum to the transmission regulatory principles group (TREG).Google Scholar
- Cleveland W.S. (1979) Robust locally weighted regression and smoothing scatterplots. Journal of the American Statistical Association 74(368): 829–836Google Scholar
- Cremer, H., Cremer, J., & De Donder, P. (2006). Legal vs ownership unbundling in network industries. CEPR Discussion Paper no. 5767.Google Scholar
- Draaisma, T., & Noussair, C. (1997). Optimal bidding in a uniform price auction with multi-unit demand. Economics Letters, 157–162Google Scholar
- ERGEG. (2008). Draft guidelines on article 22: An ERGEG public consultation paper. E07-GFG-31-07.Google Scholar
- ERGEG. (2009). European regulators’ experience with article 22 exemptions of directive 2003/55/EC 2008: Update of ERGEG’s internal survey. Report E08-GIF-02-03.Google Scholar
- European Union. The European Parliament and the European Council. (2003). Directive 2003/55/EC concerning common rules for the internal market in natural gas and repealing Directive 98/30/EC. Official Journal of the European Union, L176/57.Google Scholar
- Fluxis. (2010). Annual financial report. http://www.goo.gl/0Ff3F. Accessed on October 2011.
- Fréchette, G. R. (2007). Session-effects in the laboratory. Working paper, New York University.Google Scholar
- Gans J., King S. (2003) Access holidays for network infrastructure investment. Agenda 10(2): 163–178Google Scholar
- Grether D., Isaac R. M., Plott C. (1981) The allocation of landing rights by unanimity among competitors. American Economic Review 71: 166–171Google Scholar
- Holmberg P. (2011) Strategic forward contracting in the wholesale electricity market. Energy Journal 31: 169–202Google Scholar
- IEA. (1999). World energy outlook. International Energy Agency, http://www.iea.org/textbase/nppdf/free/2009/WEO2009.pdf. Accessed on October 2011.
- Joskow, P. (2005). Incentive regulation in theory and practice: Electricity distribution and transmission networks. AEI-Brookings Joint Center Working Paper No. 05-18.Google Scholar
- Krogmeier J., Menkhaus D., Phillips O., Schmitz J. (1997) An experimental economics approach to analyzing price discovery in forward and spot markets. Journal of Agricultural and Applied Economics 29: 327–336Google Scholar
- Léautier T. (2000) Regulation of an electric power transmission company. The Energy Journal 24(1): 61–92Google Scholar
- Nagel, T., & Rammerstorfer, M. (2008). Price cap regulation and investment behavior—How real options can explain underinvestment. Journal of Energy Markets 1, (4).Google Scholar
- Noussair, C. N., Pfajfar, D., & Zsiros, J. (2011). Frictions, persistence, and central bank policy in an experimental dynamic stochastic general equilibrium economy. Working paper, Tilburg University.Google Scholar
- Oxera. (2011). Cost of capital for GTS, annual estimates from 2006 onwards. Report prepared for the NMa, http://www.nma.nl/images/Cost%20of%20capital22-187985.pdf. Accessed on October 2011.
- Phillips O., Menkhaus D., Krogmeier D. (2001) Laboratory behavior in spot and forward auction markets. Experimental Economics 4: 243–256Google Scholar
- PJM. (2009). Financial transmission rights, PJM Manual 06. http://pjm.com/documents/manuals.aspx. Accessed on October 2011.
- Vogelsang, I. (2010). Incentive regulation, investments and technological change. CESifo Working Paper Series no. 2964.Google Scholar
- Williamson, D., Jullien, C., Kiesling, L., & Staropoli, C. (2006). Investment incentives and market power: An experimental analysis. Economic analysis group discussion paper, United States Department of Justice.Google Scholar