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Indexation, investment, and utility prices

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  • Richard Brealey
  • Julian Franks

Abstract

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. Copyright 2009, Oxford University Press.

Suggested Citation

  • Richard Brealey & Julian Franks, 2009. "Indexation, investment, and utility prices," Oxford Review of Economic Policy, Oxford University Press and Oxford Review of Economic Policy Limited, vol. 25(3), pages 435-450, Autumn.
    • Handle: RePEc:oup:oxford:v:25:y:2009:i:3:p:435-450
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    File URL: http://hdl.handle.net/10.1093/oxrep/grp030
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    Cited by:

    1. Christine Mawia Julius & Timothy C. Okech, 2021. "Moderation Effect of Government Regulation on the Joint Influence of Water Pricing, Infrastructure Financing, Utility Efficiency and Subsidies on Financial Sustainability of Water Service Providers in," International Journal of Economics and Financial Issues, Econjournals, vol. 11(3), pages 72-80.
    2. Ian Dobbs, 2011. "Modeling welfare loss asymmetries arising from uncertainty in the regulatory cost of finance," Journal of Regulatory Economics, Springer, vol. 39(1), pages 1-28, February.

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