Capacity, investment and market power in the economic value of energy firms

- Propose an indicator for regulators, to design and evaluate regulatory policy.
- Model the contribution to value of adjustment costs of investments and from market power.
- Adjustment costs represent sixty per cent. Market power explains forty per cent of economic value over book value.
- To lower energy prices, regulations should care of market power, and also adjustments costs. Regulators should be alert on the use of free cash flows by energy firms; investments in financial assets reduce Tobin'sq.

Regulation of energy firms faces the complex problem of balancing private (earning a fair rate of return on investment) and public (assure safe and reliable supply of energy at the lowest possible costs) goals. Tobin's q is a forward looking indicator on investment opportunities and on market power of firms that energy regulators can use for more effective regulation. This paper presents the empirical evidence on the determinants of differences in observed values of Tobin's q for a sample of large listed energy firms from 10 different countries in the period 2000-2006. We find that adjustment costs represent around sixty percent of the difference between economic and book value of the assets for the representative firm, while rents from market power represent the other forty percent. Therefore, across countries there is room for regulatory actions aiming at reducing energy prices, but less than what may be inferred from the observed average q values.