Economic Principles and Applications to Natural Gas Pipelines and Other Industries.

• Author: Stewart, John F.

The book combines and expands several of the authors' published papers on regulatory risk and a report on risk in the interstate natural gas pipeline industry the authors prepared for the Interstate Natural Gas Association of America. The first four chapters of the book present the authors' theory of risk in regulated industries. The remaining five chapters provide a detailed analysis of risk under historic and pending regulation of the interstate natural gas pipeline industry. An appendix provides an excellent, detailed and highly annotated regulatory history of interstate natural gas pipeline regulation from roughly the Natural Gas Policy Act of 1978 to 1990.

In some 350 pages this book appears to make two primary points. First, rate base regulation is a camel, where the definition of a camel is a horse designed by a committee, or in the case of utility regulation, a horse designed by congress, state legislatures, and the courts. The second point is that realized rates of return in regulated utilities are subject to a reverse Lake Wobegon effect. In humorist Garrison Keillor's mythical Lake Wobegon, all the women are strong, all the men are good-looking, and all the children are above average. In the regulatory world of Kolbe, Tye, and Myers all utility returns are below average.

The first point, that the institution of rate base regulation is fraught with logical inconsistencies, circular reasoning, inefficiencies and other foolishness, is familiar to anyone who has spent much time studying the issue. The second point requires some explanation that the authors repeatedly provide at regular intervals throughout the book. To understand their point, the reader must understand at least three concepts of returns. First the expected "realized rate of return" is what investors in the utility actually expect to earn. It is this return that provides the standard market signals for investors and determines the flow of investment into the industry and the market value of the ownership rights to firms in the industry. The second return concept is the "allowed rate of return." This is a number produced by the regulatory commission that is supposed to represent a "fair" return to investors. The final is the "cost of capital," which is probably best thought of as the economists terms the opportunity cost of using resources in a particular activity.

Put in its simplest form utility regulation, though a convoluted ceremony called the rate case, sets the...