Cap prices or cap revenues? The dilemma of electric utility networks

Highlights: • The difference between a price cap and revenue cap plan is analysed. • Price changes are more volatile under a revenue cap. • A revenue cap is welfare-reducing but facilitates energy conservation. • A price cap is a better option for regulators under certain conditions. - Abstract: In this paper I analyse the behaviour of a monopoly electricity provider that serves three distinct markets under a price cap or revenue cap plan. I make comparisons in terms of their effects on price setting, energy conservation, and social welfare. In addition to contravening the Ramsey pricing rule, I find that under conditions of information asymmetry, when demand becomes more elastic or marginal cost increases, revenue cap price increases are larger relative to price cap regulation. In this specific setting, revenue cap price increases can encourage energy conservation but is less likely to do so when marginal cost is large in a market that is more elastic relative to others. In contrast to a price cap plan, these overall results show that revenue cap schemes are welfare-reducing. For public policy decision-making purposes, price cap regulation is more desirable especially in developing economies that often experience substantial inflationary pressures from global oil market developments but is less suitable than revenue cap regulation when electricity supply constraints and climate change are major policy concerns.