The debate over restructuring the electric industry has encompassed a revisiting of the traditional rate-of-return (ROR) pricing model. Parties of widely divergent interests increasingly advocate alternatives. Under the label "performance-based regulation," these new pricing models share the objective of strengthening incentives for electric utilities incentives to pursue some specified "socially desirable" outcome. Conservationists, for example, argue that ROR regulation provides utilities with a disincentive to promote energy efficiency on the demand side of the meter.1 Economists also consider ROR regulation an inferior mechanism for promoting economic efficiency, especially when a utility lacks complete monopoly power.2 Overall, interest groups and independent analysts seem to agree that ROR regulation, at least in its current form, will not survive the transition to a more competitive power industry.
Revenue caps are one alternative that has gained some credibility in the regulatory community.3 The major privately owned electric utilities in California as well as utilities in several other states currently operate under revenue-cap-type plans.4 Advocates argue that revenue caps operate similarly to price caps, but produce greater energy efficiency.5 Price caps, they contend, give utilities an incentive to oversell electricity (em an outcome that runs counter to the objectives of a proconservation, environmentally benign industry.