29 results for Guthrie, Graeme, Scholarly text

  • Options Provided by Storage can Explain High Electricity Prices

    Evans, Lewis; Counsell, Kevin; Guthrie, Graeme (2006)

    Scholarly text
    Victoria University of Wellington

    Generators supplying electricity markets are subject to volatile input and output prices and uncertain fuel availability. Price-risk may be hedged to a considerable extent but fuel-risk - water flows in the case of hydro and gas availability in the case of thermal plants - may not be. We show that a price-taking generator will only generate when the output price exceeds its marginal cost by an amount that reflects the value of the option to delay the use of stored fuel. The corresponding offer price is different from the theorized offer prices of static uniform auctions and more akin to pay-as-bid auction prices. We argue that the option value of delaying fuel use which is an increasing function of spot price volatility and the uncertainty about fuel availability must be considered when evaluating whether market power is present in electricity markets. The engineering approach to simulating an electricity supply curve which has been used in market power evaluations to date may lead to supply curves that are quite different from those that recognize possible fuel availability limitations even in the complete absence of market power.

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  • Sunk Investments, Regulation and the Cost of Capital

    Evans, Lewis; Guthrie, Graeme (2004)

    Scholarly text
    Victoria University of Wellington

    Professor Lewis Evans presented Sunk Investments, Regulation and the Cost of Capital at an ISCR Auckland seminar: Calculating the Cost of Capital: A Revisionists' Appraisal.

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  • Asset Stranding is Inevitable: Implications for Optimal Regulatory Design

    Evans, Lewis; Guthrie, Graeme (2003)

    Scholarly text
    Victoria University of Wellington

    The irreversibility of much infrastructure investment means that some assets will stop earning revenue before the end of their physical lives; they will be stranded. Under traditional rate of return regulation firms are guaranteed the ability to recover the costs of investment insulating them from the consequences of asset stranding. Under modern incentive regulation firms are allowed to earn revenue just sufficient to cover the costs of a hypothetical efficient firm which provides services at minimum cost exposing them to the risk of asset stranding. By actively encouraging competition regulators increase this risk. We suggest two conditions applicable to both regimes which must be met if regulation is to be "reasonable": the regulated firm must not lose value from investment and it cannot collect more revenue than would the lowest cost alternative provider. This implies that regulated firms should be allowed to earn the riskless rate of return on the historical cost of their assets under rate of return regulation and a different (generally higher) rate of return on the replacement cost of their assets under incentive regulation. The risk premium depends on both the systematic and unsystematic risk of demand shocks. Since customers bear the risk of asset stranding under rate of return regulation and shareholders bear this risk under incentive regulation welfare is higher under incentive regulation as long as customers are more risk-averse than shareholders. We show that when there is a choice between reversible and irreversible technology there is no price specification under rate of return regulation that will induce the firm to choose the efficient bundle of technology while under incentive regulation the firm will choose the efficient mix of technologies. That is incentive regulation allocates the risk of asset stranding efficiently and also gives firms the incentive to reduce this risk to efficient levels. Finally incentive regulation has less demanding information requirements than traditional rate of return regulation.

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  • A Dynamic Theory of Cooperatives: The Link between Efficiency and Valuation

    Evans, Lewis; Guthrie, Graeme (2006)

    Scholarly text
    Victoria University of Wellington

    Cooperatives and mutual organisational forms arise for reasons which include contracting problems between parties. Economic literature suggests a variety of allocated inefficiencies implied by these forms that largely have their origins in poor investment decisions. We demonstrate that a multi-period model and the supplier and cooperative valuations it implies are essential for understanding the sources of inefficiency and solutions to them. Using the case of a supplier cooperative we show that economic inefficiency arises because of the over-supply of input induced by suppliers responding to average rather then marginal revenue and that investment is actually efficient given the supply of input. The presence of unowned capital is an important source of over-supply. We show that if cooperative's shares are priced at the present value of expected dividends and supplier entry and exit decisions are taken solely on the basis of profitability of membership then there is no inefficiency and we describe a functioning example. Finally our valuations show that there is no "time horizon" investment problem at least from an industry prospective.

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  • Electricity Spot Price Dynamics: Beyond Financial Models

    Guthrie, Graeme; Videbeck, Steen (2004)

    Scholarly text
    Victoria University of Wellington

    An increasing number of researchers attempt to model the behavior of electricity spot prices using statistical models commonly used to model financial asset prices. In this paper we reveal properties of electricity spot prices which such models cannot capture. Using six years of half-hourly price data from the New Zealand Electricity Market we find that the half-hourly trading periods fall naturally into five groups corresponding to the overnight off-peak the morning peak daytime off-peak evening peak and evening off peak. The prices in different trading periods within each group are highly correlated with each other yet the correlations between prices in different groups are lower. Models adopted from the modelling of security prices that are currently applied to electricity spot prices are incapable of capturing this behavior. We use a periodic autoregression to model prices instead showing that shocks in the peak periods are larger and less persistent than those in off peak periods and that they often reappear in the following peak period. In contrast shocks in the offpeak periods are smaller more persistent and die out (perhaps temporarily) during the peak periods. Current approaches to modelling spot prices cannot capture this behavior either.

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  • High Frequency Electricity Spot Price Dynamics: An Intra-day Markets Approach

    Guthrie, Graeme; Videbeck, Steen (2002)

    Scholarly text
    Victoria University of Wellington

    In this paper we develop a new approach to understanding the behavior of high frequency electricity spot prices. It treats electricity delivered at different times of the day as different commodities while recognizing that these commodities may be traded on a small number of intra-day markets. We first present a detailed analysis of the high frequency dynamics of prices at a key New Zealand node. Our analysis which includes the use of a periodic autoregression model supports the treating of electricity as multiple commodities and also reveals intrinsic correlation properties that indicate the existence of distinct intra-day markets. Conventional models cannot adequately capture properties that have important implications for derivative pricing and real options analysis. We therefore extend the literature by introducing a state space model of high frequency spot prices that preserves this intra-day market structure.

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  • Carbon Subsidies and Optimal Forest Management

    Guthrie, Graeme; Kumareswaran, Dinesh (2003)

    Scholarly text
    Victoria University of Wellington

    We consider the effect of carbon subsidies and taxes in the form of carbon credit allocations on forest owners' land use and harvest decisions. We introduce three possible credit allocation regimes: one where credits are allocated according to the annual flow of carbon another where annual credits are proportional to the stock of carbon and a third involving lump sum payments. Using a real options model with uncertain future timber prices we examine the effect on the timing of harvest the replanting-abandonment decision and the value of a forest. We show that forests are less likely to be converted to alternative land uses under all three regimes relative to the situation without any carbon credit allocation. We also show that the flows and stocks schemes lengthen optimal rotations while lump sum allocations shorten them. Thus the objectives of reduced deforestation and longer rotations are best met by the flows and stocks schemes. Our numerical experiments suggest that these two regimes yield very similar outcomes.

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  • My Kingdom for a Horse: Resolving Conflicts of Interest in Asset Management

    Boyle, Glenn; Guthrie, Graeme; Gorton, Luke (2006)

    Scholarly text
    Victoria University of Wellington

    Racehorse trainers operate asset management businesses in which the assets owned by outside clients compete with those owned by managers for the latter's time care and attention. Although this potentially leads to serious conflicts of interest we find no evidence of an agency problem: in a sample of 8000 racehorses and their associated stables client-owned horses perform no worse than trainer-owned horses on average. However this outcome is not uniform across stables: the average performance advantage of client-owned horses over their trainer-owned counterparts is positive in big stables where client-owners provide much of the trainer's income but is negative in small stables with relatively few outside clients. Agents with more to lose apparently behave better.

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  • Estimating the WACC in a Regulatory Setting: An Assessment of Dr Martin Lally's paper 'The Weighted Average Cost of Capital for Electricity Lines Businesses' of 8 September 2005

    Boyle, Glenn; Evans, Lewis; Guthrie, Graeme (2006)

    Scholarly text
    Victoria University of Wellington

    In September 2005 the New Zealand Commerce Commission (NZCC) released a document (TheWeighted Average Cost of Capital for Electricity Lines Businesses by Dr Martin Lally referred to as LINES hereafter) that estimates a weighted average cost of capital (WACC) for New Zealand electricity lines businesses and proposes a means for detecting future excess earnings. At about the same time the NZCC also began seeking submissions on another document (Draft Guide- lines: The Commerce Commission's Approach to Estimating the Cost of Capital 2005) that addresses the topic of an appropriate framework for the WACC in the New Zealand regulatory environment. Although no specific author is attributed to the latter its material content is drawn from LINES. In this paper we undertake a detailed analysis of the approach followed in LINES. We do so from the perspective of a referee who has been asked to provide a review of that report in order to assess its suitability for publication in an edited book or journal that adheres to conventional academic standards. Although LINES has not of course been submitted for publication orreview of this kind its contents and recommendations should nevertheless meet minimum standards of accuracy thoroughness and consistency. It is these criteria we use to assess LINES. Our report is motivated by a simple but important concern: although the cost of capital is a critical element of the revenue and price settings that materially determine the social net-benefit of income-control regulation there are presently no institutional arrangements in New Zealand that allow for reports such as LINES to be thoroughly reviewed and debated. On the basis of our review we conclude that such institutional arrangements are sorely needed. Our assessment of LINES comprises two parts. In Section I we provide an overview of what we consider to be the critical areas of concern in LINES. Section II then discusses specific errors in detail.

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  • Real Options and Transmission Investment: the New Zealand Grid Investment Test

    Boyle, Glenn; Guthrie, Graeme; Meade, Richard (2006)

    Scholarly text
    Victoria University of Wellington

    Responsibility for approving proposed transmission investment programmes in New Zealand has recently been placed in the hands of a newly-formed government regulator. In this paper we develop an analytical framework for conceptualising the investment test proposed by this regulator. Our framework reveals that the test involves a complex set of tradeoffs between economies of scale the time value of money and flexibility in the timing level and location of transmission investment assessment of which requires explicit recognition and valuation of real options.

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  • Efficient Price Regulations of Networks that have Sunk Costs: Should Caps be Based on Historical or Replacement Costs

    Evans, Lewis; Guthrie, Graeme (2002)

    Scholarly text
    Victoria University of Wellington

    Incentive regulation allows decentralised decision-making under regulatory settings that are based upon industry characteristics. This study considers the design of regulatory profit caps and the choice of historical or replacement cost for incentive regulation when there is uncertainty sunk costs and flexibility in the timing of investment. It demonstrates that which of historical or replacement cost regulation is desirable depends upon the sources and extent of supply and demand uncertainties and trends and thereby characteristics of the industry. The welfare optimising level of the cap differs between historical and replacement cost regulation the caps are generally higher than the weighted average cost of capital and welfare is degraded much more if the cap is set below as opposed to above the optimal cap.In the presence of uncertainty and sunk costs investment thresholds that exceed the standard WACC are required to enable investment. The WACC just reflects systematic risk. It does not reflect the probability of bankruptcy or idiosyncratic risks that firms prudently consider when making investment decisions. From society's point of view the WACC is frequently too low to act as an investment hurdle rate. In practice hurdle rates are often distinctly higher than equity holders' average rates of return and much higher than return on debt.We have considered a situation where the firm has no competition. The presence of competition will generally mean that firms' investments are desirably timed from society's point of view although investment will not occur immediately. The imposition of a cap to improve welfare may if it is too tight reduce welfare substantially even relative to the situation of no regulation and no competition. It arises because investment is delayed. In such circumstances the regulator may respond by removing scope for decentralised investment by forcing investment or reaching some regulatory pact with the firm. It is easy to show that such regulation does not remove the issues of specific risks and timing considered in this paper: they are intrinsic to the industry. Unless the regulator agrees to pick up the costs of risks - eg the costs of stranded assets - a reasonable rate of return under regulatory investment requirements should cover the real options that these risks imply.We have focussed on encouraging the optimal timing of sunk investments. While the approach has been cast as provision of the entire network the same approach applies to maintenance of an existing network that is also sunk. Unless maintenance expenditure is allowable in line with the optimal caps considered in this paper networks may deteriorate or require forced maintenance by regulation. The issues are the same.

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  • Risk, Price Regulation, and Irreversible Investment

    Evans, Lewis; Guthrie, Graeme (2005)

    Scholarly text
    Victoria University of Wellington

    We show that regulators' price-setting rate base and allowed rate of return decisions are inextricably linked. Once regulators switch from traditional rate of return regulation the irreversibility of much infrastructure investment significantly alters the results of the usual approach to price-setting as exemplified by Marshall Yawitz and Greenberg (1981). In particular the practice of 'optimizing' inefficient assets out of the regulated firm's rate base as in total element long-run incremental cost (TELRIC) calculations in telecommunications exposes the firm to demand risk. The firm requires an economically-significant premium for bearing this risk and this premium is an increasing function of the unsystematic risk of demand shocks. In addition we argue that if the firm is to break even under incentive regulation then the level of the rate base will not generally equal the optimized replacement cost.

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  • Can Ex Post Rates of Return Detect Monopoly Profits?

    Boyle, Glenn; Guthrie, Graeme (2002)

    Scholarly text
    Victoria University of Wellington

    We review the ability of the ex post internal rate of return (IRR) to detect monopoly profits. When market values are used as entry and exit values the ex post IRR simply reveals whether the firm did better or worse than the market expected at the entry date. It says nothing about monopoly profits. When replacement costs are used as entry and exit values the ex post IRR can in principle reveal something about monopoly profits. However since the ex post IRR is a noisy measure of ex ante monopoly profits it will be very difficult to reject the hypothesis given the sample periods typically available. The benchmarks typically used are market-determined and therefore only comparable to IRRs calculated using market values - a situation when the ex post IRR reveals nothing about monopoly profits anyway. Furthermore there is ample empirical and theoretical evidence that these benchmarks do not even represent fair rates of return.

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  • Incomplete Contracts: Implications for the Organisation of the Public Sector' presented by Neil Quigley 6 Sept 2012.

    Quigley, Neil; Evans, Lewis; Guthrie, Graeme (2012)

    Scholarly text
    Victoria University of Wellington

    This paper was presented at the ISCR seminar 6 September 2012 by Professor Neil Quigley.

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  • Incentive Regulation: Asset Valuation and Investment in Advance

    Guthrie, Graeme (2005)

    Scholarly text
    Victoria University of Wellington

    Graeme Guthrie presented Incentive Regulation: Asset Valuation and Investment in Advance at the Contemporary Issues in Regulatory Theory and Practice half day workshop held in Wellington in March 2005.

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  • Payback Without Apology

    Boyle, Glenn; Guthrie, Graeme (2006)

    Scholarly text
    Victoria University of Wellington

    When interest rates are uncertain the net-present-value threshold required to justify an irreversible investment is increasing in the length of a project's payback period. Thus slowpayback projects should face a higher hurdle than fast-payback projects just as investment folklore suggests. This result suggests that the widely disparaged use of payback for capital budgeting purposes can be an intuitive response to correctly perceived costs and benefits.

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  • Assessing the Integration of Electricity Markets Using Principal Component Analysis: Network and Market Structure Effects

    Evans, Lewis; Guthrie, Graeme; Videbeck, Steen (2006)

    Scholarly text
    Victoria University of Wellington

    The major difficulties in assessing market power in electricity wholesale spot markets mean that great weight should be placed upon assessing market outcomes against the fundamental determinants of supply demand and competition. In this spirit we study whether the New Zealand market has been a national market or a set of local markets since its inception in 1996. Electricity markets generally have loop flows that require simultaneous assessment of prices at all nodes thereby limiting the informativeness of pair-wise nodal comparisons. We introduce principal component analysis to this application and show that it is a natural tool for the qualitative and quantitative assessment of the presence of local markets. We find that increased competition induced some separation into local markets that was eliminated by transmission enhancement and the introduction of generation downstream from the constrained circuits. For most of the period New Zealand has had one national market.

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  • Regulating Infrastructure: The Impact on Risk and Investment

    Guthrie, Graeme (2006)

    Scholarly text
    Victoria University of Wellington

    The last thirty years have witnessed a fundamental change in the regulation of infrastructure industries. Whereas firms were subject to rate of return regulation and protected from entry in the past now they face various forms of incentive regulation competition is actively promoted by many regulators and both regulators and the firms they regulate must often confront rapid technological progress. This paper surveys the literature on the investment implications of different regulatory schemes highlighting the relevance of modern investment theory which puts risk and intertemporal issues such as the irreversibility of much infrastructure investment center stage. It discusses the impact on regulated monopolists' investment behavior of key regulatory characteristics namely the price flexibility allowed by the regulator the length of the regulatory cycle and the costs the regulator will allow the firm to recover at future regulatory hearings. It also considers the impact of competition especially the situation where a vertically integrated firm has its operation of a bottleneck asset regulated on investment by regulated firms and their competitors.

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  • Human Capital and Popular Investment Advice

    Boyle, Glenn; Guthrie, Graeme (2005)

    Scholarly text
    Victoria University of Wellington

    Popular investment advice recommends that the stock/bond and stock/wealth ratios should rise with investor risk tolerance and investment horizon respectively prescriptions that are difficult to reconcile with the simple mean-variance model. Canner et al. (1997) point out that the first piece of advice can potentially be explained by human capital considerations but only by invalidating the second piece of advice. We show that extending the mean-variance model to include human capital without any other modifications can simultaneously justify both recommendations so long as the correlation between human capital returns and stock market returns lies within a range determined by market and investor-specific parameters. Historical data from 11 countries generally satisfy this requirement although the statistical precision of our estimates is fairly weak.

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  • Commodity Price Behavior With Storage Frictions

    Evans, Lewis; Guthrie, Graeme (2007)

    Scholarly text
    Victoria University of Wellington

    We present a competitive storage model of commodity prices featuring frictions that introduce an element of irreversibility into storage decisions. This leads to situations in which speculators do not trade in the spot market even though total storage is positive. As a result the market value of the stored commodity which is determined in the (financial) market for ownership of firms operating storage facilities can diverge from the spot price. Such price separation leads to the existence of an endogenous convenience yield which we show equals the expected excess return on a real option embedded in each unit of the stored commodity. The outputs of our model are consistent with the stylized facts regarding commodity price distributions including serial correlation and GARCH characteristics. Samuelson's hypothesis - that forward prices are less volatile than spot prices - does not hold in general.

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