More On Regulatory Arbitrage

A friend of Knowledge Problem who is extremely knowledgeable about the electricity regulation and the dynamics of the industry in the past decade offers this response to my earlier post. I think he’s right:

On your latest post re arbitrage, I think the spirit of your post is right, but the facts might not be. Vertically integrated utilities cannot move assets between rate base and unregulated subs with any ease whatsoever. Indeed, it would be the mother of all transfer proceedings for them to try to do so, and most states would stop it. Rather, their going-forward investment incentives are affected by what regime looks most attractive. Thus, from 1998-2001, they put their capital in unregulated merchant subs; since then, they have put their capital in the regulated side because the return is better.

Your basic point is right, a world half-regulated, half-free cannot stand and indeed is the worst of both worlds and reflects a deep ambivalence toward competitive power markets. That said, the utilities’ investment decisions are being influenced where they think they can get the greatest return.