An econometric analysis of the impact of price level changes and commision procedure on the earnings of regulated electric and gas utilities

This study centered on the effect of price level changes and commission regulatory procedure on three separate measures of the earnings of regulated electric and gas utilities serving intrastate markets in the period 1961-1973. Specifically, three main questions were addressed: (1) what is the effect of price level changes on regulated utilities, (2) how do different ratemaking techniques affect these earnings, and (3) what is the effect of price level changes under the various forms of ratemaking procedure. The literature available on these topics suggested that increases in the general price level would reduce utility earnings, that the various regulatory procedures do produce significantly different rat es of return, and that price level inflation exaggerates these differences in rates of return.

Empirical analysis was accomplished through least-squares regression analysis employing data from 49 regulated electric and gas utilities. The results suggest that price level inflation does reduce utility earnings. Higher inflation rates produced lower earnings as measured by the one-period holding rate of return for common shares and the percentage change in earnings per share over the entire test period. In order to allow for the impact of decreasing real costs in the first half of the test period, which may have reduced the impact of price level inflation, additional tests were run on data from the last seven years of the period. These tests indicated a larger negative impact of inflation on the two dependent variables previously determined to be significantly affected and additionally produced a statistically significant coefficient for the inflation variable when rate of return on book equity was employed as the dependent variable.

The rate of return on book equity was significantly affected by the use of type of rate base employed--original cost, fair-value, and reproduction cost; the employment of year-end rate bases; the use of purchased gas and fuel adjustment clauses; the permission for normalizing tax expenses when accelerated depreciation was employed; the length of commissioners' terms in office; and the amount of resources committed to regulation by the state. Fair-value, reproduction cost, and year-end rate bases, normalized taxation, and purchased gas/fuel adjustment clauses all raised the rate of return. Longer terms for commissioners and higher commission budgets, on the other hand, lowered the return as predicted by the theoretical literature. With few exceptions, the findings do not support the hypothesis that procedurally-induced differences in earnings are exaggerated by changes in the price level.