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Price Regulation and the Incentives to Pursue Energy Efficiency by Minimizing Network Losses

This paper examines the incentives embedded in different regulatory regimes for investment by utilities in energy efficiency programs that aim to reduce network losses. In our model, a monopolist chooses whether to undertake an investment in energy efficiency, which is not observable by the regulator. We show that, in equilibrium, the monopolist chooses to exert positive effort more often under price cap regulation than under no regulation or mandated target regulation and that she exerts no effort under rate of return regulation. This result contrasts with an extensive literature that focuses on end-user energy conservation and shows that price caps are ineffective for achieving energy efficiency as utilities have an incentive to maximize sales volume. Thus, policies that are designed to promote demand-side energy conservation may diminish the utilities' incentives to pursue supply-side energy efficiency through minimizing network losses. Keywords: Energy efficiency, Regulatory incentive, The electricity sector

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Energy Specializations: Electricity – Transmission and Network Management; Electricity – Local Distribution; Electricity – Markets and Prices ; Electricity – Generation Technologies; Energy Efficiency – Barriers to Adoption; Energy Efficiency – Residential and Commercial Buildings

JEL Codes:
D44 - Auctions
D42 - Market Structure, Pricing, and Design: Monopoly
Q2 -
Q59 - Environmental Economics: Other

Keywords: Energy efficiency, Regulatory incentive, The electricity sector

DOI: 10.5547/01956574.37.4.jdut

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Published in Volume 37, Number 4 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.