THE EFFECT OF FUEL ADJUSTMENT CLAUSES ON ELECTRIC UTILITY PRODUCTION

Fuel Adjustment clauses in electric utility rate schedules automatically convert changes in fuel costs into electricity rate changes. These clauses reduce the financial burden imposed on utilities by regulatory lag during periods of fuel price escalation, and as a result reduce the cost of rate regulation by reducing the number of requests by utilities for rate of return hearings. However, a number of previous theoretical and empirical studies have indicated that fuel adjustment clauses may also induce inefficient production.; This dissertation focuses on obtaining improved empirical measures of the impact of fuel adjustment clauses on production efficiency. It builds upon previous studies by developing an empirical model with three key features. First, the model separates the effect of fuel adjustment clauses from the effect of all other forms of regulation on input use and production cost. Second, the model recognizes that utilities simultaneously sell power in and are subject to different adjustment clauses in retail power markets and wholesale power markets. Finally, the model allows utilities to substitute between own generation and purchased power for meeting customer demand. Fuel adjustment clauses and other forms of regulation may affect production efficiency not only by altering how electricity is generated within a utility, but also by altering the choice between own generation of electricity and the use of purchased power.; This model is applied to a 1978 data set containing information from seventy privately owned utilities throughout the United States. Estimation results indicate that the input mix bias induced by retail fuel adjustment clauses increases labor use by 5.73 percent, increases capital use by 5.77 percent, increases fuel use by 36.58 percent, reduces purchased power use by 56.90 percent, and increases total production cost by 2.96 percent. The combined effect of all forms of regulation is shown to increase labor use by 89.16 percent, increase capital use by 14.86 percent, increase fuel use by 92.49 percent, reduce purchased power use by 74.71 percent, and increase total production cost by 6.15 percent.