WHEN THE CALIFORNIA PUBLIC UTILITIES COMMISSION approved a price-cap plan for Southern California Edison's distribution operations, it lamented the lack of a "distribution-only" study on productivity. So we prepared one.
Unlike electricity generation, electricity distribution will remain a regulated business. But the form of regulation likely will change to price caps, mirroring events in telecommunications regulation here and energy regulation abroad.
With price caps, rates are reviewed formally only at set intervals. In the meantime, rates move via a pre-set formula which looks at inflation and productivity (i.e., Retail Price Index minus "X"). Price caps break the link between costs and prices by providing more competition-style efficiency incentives for regulated companies.
Key to the price cap formula is "X," which reflects productivity growth. The best and most objective basis for such an index is "Total Factor Productivity." That is, the TFP for an industry, minus the corresponding TFP for the economy, reveals the best measure of X to calculate a price cap.
Electricity distribution presents a challenge for measuring productivity since, as a rule, the industry is vertically integrated. Only a few electric utilities operate separate distribution businesses.