Electric Utility Restructuring, Regulation of Distribution Utilities, and the Fallacy of "Avoided Cost" Rules

Jonathan A Lesser and Charles D Feinstein

Journal of Regulatory Economics, 1999, vol. 15, issue 1, 93-110

Abstract: We show that commonly used "avoided cost" rules, which evaluate investment alternatives by comparing their costs to forecasts of future expected cost, are fundamentally flawed for choosing local area investments in distribution capacity. Use of avoided cost rules: 1) confuses cost-effectiveness tests with benefit-cost tests; 2) makes inappropriate marginal comparisons and violates necessary optimality conditions because of the "lumpy" nature of many distribution system investments; 3) fails to incorporate the effects of uncertainty properly; 4) necessarily leads to excess deferral of traditional distribution capacity investments with distributed generation and DSM investments; and 5) does not lead to lowest expected cost investment plans. We conclude by outlining a more appropriate approach to evaluating distribution investments based on evaluations of actual cash flows associated with investment alternatives under uncertainty. Copyright 1999 by Kluwer Academic Publishers

Date: 1999
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