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By A. Lawrence Kolbe

It is usual to say that application traders are compensated within the allowed price of go back for the danger of huge disallowances, corresponding to come up for investments came upon imprudent or no longer `used and useful'. although, this e-book develops a brand new thought of uneven regulatory danger that indicates that infallible estimates of the price of capital are bound to supply downward-biased estimates of the mandatory allowed premiums of go back within the presence of such regulatory dangers. The publication makes use of the hot concept of regulatory threat to appreciate fresh advancements within the hazard of usual fuel pipelines and different regulated industries.

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Extra resources for Regulatory Risk: Economic Principles and Applications to Natural Gas Pipelines and Other Industries

Sample text

Application of that test, the issue decided by the Court in Duquesne, of course, bears implications for investors and for utilities' ability to raise capital. ECONOMIC GROUNDWORK This part of the chapter sets out the economic terms and arguments upon which our analysis relies. We define four terms: (1) promised (or target) rate of return; (2) expected rate of return; (3) realized rate of return; and (4) regulatory risk. To define regulatory risk, which comes in two varieties, we contrast the traditional economic paradigm of rate regulation with the regulatory rules endorsed by Duquesne.

In this case, the rate of return has to be set high enough so the plant's worth to investors is more than one and one-half times its cost if it is put into the rate base without any disallow- S9 The regulatory risk premium proposed herein has legal precedent in decisions preceding Duquesne. See Washington Gas Light v. C. , 1950), cert. S. Ct. 571: Here, the Commission adopted the prudent investment theory of rate base valuation rather than the reproduction cost method. Appraisal of the former theory reveals that the "used and useful" standard is no necessary part of it.

_ 60% 80% 700% 120% 740% Percent of Amount Invested J= -:\ 760% 780% 200% The second is a retroactive shift in the distribution of possible disallowances due to a change in regulatory oversight, the issue that brought this case before the Court. This is depicted in Figure 2-10, which postulates that the compensated 20 percent loss case of Figure 2-8 has been in effect,62 but that a new, more severe range of possible losses under the disallowance case is established by a regulatory rule change. Even if the no-disaIIowance distribution remains at the point where it provided fair compensation under the old rules, it is now inadequate under the new rules: the new value distribution with a 20 percent chance of a disallowance has an expected value below 100 percent (96 percent in this example).

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