Investment under Regulatory Uncertainty : U . S . Electricity Generation Investment 1996 - 2000

We investigate how uncertainty surrounding the timing of possible comprehensive regulatory restructuring may affect firm investment behavior in the industry. We argue that such regulatory uncertainty can create an option value that leads to firms delaying their investment decision in order to gather more information concerning future regulatory changes. We empirically examine this claim using data on U.S. electricity generation investment during the transition period 1996-2000. Using state-level, aggregate investment data, we find evidence that is consistent with the presence of substantial option value: a strong link between lesser aggregate generation investment and greater restructuring enactment uncertainty. Using data on firm-level generation investment decisions for a sample of major U.S. independent power producers (IPPs), we estimate an investment model that explicitly incorporates this regulatory uncertainty option value. Comparing estimates from this model with those from two alternatives, including the standard NPV model, we show that failing to account for the option value can significantly alter the policy-relevant inference drawn from the data. The estimates from the model also suggest that if sampled IPPs had perceived markets as being committed to restructuring, the number of investments may have been greater by 68% during the study period. 309 Converse Hall, Amherst, MA, 01002, E-mail: [email protected]; 1000 El Camino Real, Menlo Park, CA 94025, E-mail: [email protected]. Part of this paper was written while Jun Ishii was a visiting researcher at the U.C. Energy Institute (UCEI) Center for the Study of Energy Markets (CSEM). We are grateful for support and comments from the extended UCEI community. The paper does not represent the opinions of Cornerstone Research.