Journal Article

Indexation, investment, and utility prices

Richard Brealey and Julian Franks

in Oxford Review of Economic Policy

Published on behalf of The Oxford Review of Economic Policy Ltd

Volume 25, issue 3, pages 435-450
Published in print January 2009 | ISSN: 0266-903X
Published online January 2009 | e-ISSN: 1460-2121 | DOI: http://dx.doi.org/10.1093/oxrep/grp030
Indexation, investment, and utility prices

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This paper explores how different risk-sharing arrangements between utility companies and consumers can contribute to better investment decisions and reduce utility prices. The main idea is that utility prices should be largely indexed to changes in the company's cost of capital. The rationale is that companies have little influence over the cost of capital and, because of the uncertainty about future capital costs, regulators use crude upward adjustments to the cost of capital, often termed headroom, to mitigate any under-investment problems. Indexation would largely or even completely avoid the need for headroom and, we believe, lead to lower prices. Indexation would also result in more efficient investment and consumption decisions since headroom can only be a crude and inefficient method of dealing with the uncertainty around the cost of capital.

Keywords: cost of capital; regulation; indexation; G31; G38; L51

Journal Article.  6615 words.  Illustrated.

Subjects: Economic Development and Growth ; Public Economics ; Political Economy ; Public Policy

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