Regulating the Energy Transition: Lessons from Electricity Sector Restructuring

How should the grid evolve to accommodate growing demand and the increasingly competitive economics of renewable energy? Who should be responsible for making these decisions? This paper draws on lessons from electricity sector restructuring to examine how institutional frameworks influence investment decisions, contract negotiations, and power production. When regulated utilities are allowed to earn returns on capital investments that exceed their costs, they often overspend compared to scenarios where they bear the financial risk themselves. Additionally, they exert less effort in securing competitive contracts when they do not directly benefit from the savings. These inefficiencies are particularly pronounced when regulators face challenges in determining optimal actions. Evidence from the adoption of wholesale electricity markets highlights that traditional regulatory frameworks are poorly suited to capture the inter-regional efficiencies of renewable energy generation. Strategies to address these issues include implementing yardstick competition for local distribution utilities and expanding the use of competitive bidding for infrastructure projects. JEL Classification : L51, Economics of Regulation, L94, Electric Utilities