IUE e-chapter 8: Competition, utility concessions and utility regulation – the main options in practice


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Chapter 8 reviews the main options found in practice for utility concessions and utility regulation viewed from the perspective of the theory of sunk costs outlined in Chapters 3 and 4 and the effective absence of competition that will result from unregulated absolute or parallel monopolies.

The chapter begins by describing the origins of modern competition laws in the anti-trust laws of the the USA against Standard Oil, before highlighting the key modern European competition powers and penalties. The fundamental aims and constraints of injecting competition into a natural monopoly are explained, bearing in mind the evolution of sunk costs described in Chapter 4, before the different kinds of concession (temporary monopoly) agreement are described and evaluated against the fundamental requirements. There is a general diagram of the product space map for all utility concessions, which is used later in Chapter 12’s account of the various forms of rail privatization. The problems and opportunities afforded by each type of concession are reviewed against each other, and against the alternatives of fully privatized regulated monopoly, and publicly-owned monopoly.

The basic aims of regulating private monopolies are explained, along with the constraints that come from private ownership of assets that can be regarded as stewardship of part of a nation’s permanent infrastructure, along with the asymmetric risks and responsibilities that devolve to the investors, managers and customers of such infrastructure. Principal Agent models of regulation are reviewed and dismissed as unhelpful, and more holistic managerial models are developed. The traditional ‘Cost of Service’ or ‘Rate of Return’ model commonly used in the USA is explained, along with its more modern ‘Gains Sharing’ variant. The theoretical evolution of Shleifer’s price-cap yardstick regulation is explained diagrammatically, and the pragmatic evolution of this in the UK and Chile in the 1980s discussed.

Finally the text discusses how implementers of price-cap regulation have overcome some of the practical problems to do with the regulatory period, the optimal time for keeping allowed efficiencies, valuing past sunk costs, the Cost of Capital (a summary only) and valuing the whole Regulatory Asset Base so as to arrive at objectively-defensible, yet politically realistic, price levels.

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