Futures Trading and Fuel Adjustment Clauses

Donald Lien and Lihong Liu

Journal of Regulatory Economics, 1996, vol. 9, issue 2, 157-78

Abstract: Despite many criticisms and potential problems, wide-spread and, in many cases, long-standing use of fuel adjustment clauses (FACs) continues. The paper proposes replacing use of the FAC mechanism with permission to allow the utility to hedge its fuel price risk(s) in the futures markets. By pursuing a hedging strategy, the utility can achieve higher welfare, while shifting price change risk to speculators in the futures market, provided certain conditions are met. By efficiently transferring risk to speculators, the utility can improve the welfare levels of ratepayers. Thus, the use of futures trading may provide a Pareto improvement over the use of an FAC. Copyright 1996 by Kluwer Academic Publishers

Date: 1996
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