Why Are We Still Using Coal For Energy?
Takeaway: Traditional regulatory rules give monopoly electric utilities strong financial incentives to keep running old coal plants, substantially delaying the transition to cleaner energy.
Key Points
Slow Retirements: Regulated electric utilities retire coal-fired power plants far more slowly than power producers operating in competitive wholesale electricity markets.
Perverse Operating Incentives: To earn guaranteed profits on past investments, utilities must prove old plants are "used and useful," leading them to burn coal even when natural gas or market power is cheaper.
Blunted Carbon Tax Policy: When faced with a carbon tax, regulated utilities reduce short-run coal generation by less than half as much as a purely cost-minimizing firm would.
Why are climate goals so difficult to achieve in the energy sector, and why do electricity bills remain high even as clean energy costs fall? A major part of the answer lies in the hidden financial rules governing local electric utilities.
In many parts of the U.S. and around the world, electricity is provided by regulated monopoly utilities. Public utility commissions set consumer rates designed to cover operating expenses and guarantee the utility a "fair" profit margin on its physical infrastructure investments.
While this framework was designed to keep the lights on at reasonable rates, it creates unexpected bottlenecks when energy technology changes rapidly, such as the historic drop in natural gas prices due to fracking, or the recent price plummets in solar and battery storage.
Research
The researchers set out to understand how rate-of-return regulation alters a utility’s choices to invest in new generation, run existing power plants out of order, and decommission legacy coal units during an energy transition.
To answer this, the authors collected extensive hourly and annual data from 2006 to 2017 across 39 regulated utilities in the Eastern United States. Their dataset tracked plant capacities, fuel prices, customer demand, hourly power generation, and utility revenues. They built an economic model simulating dynamic investment and operating choices, allowing them to compare real-world utility behavior against a cost-minimizing firm and a hypothetical "social planner" that accounts for carbon pollution damages.
Findings
The study reveals that traditional utility regulation inadvertently slows clean energy transitions. Because a utility's allowable profit depends on the size of its active capital base (its "rate base"), it must convince regulators that older plants remain "used and useful." To satisfy this rule, regulated utilities routinely operate coal plants out of economic dispatch order, burning coal even when cleaner alternatives are cheaper.
In the short run, if a carbon tax of $190 per ton is introduced, a regulated utility cuts its coal generation by only 48 percent of what a cost-minimizing company would cut. In the long run, 30 years after a sudden drop in natural gas prices, a cost-minimizing producer retires 71 percent more coal capacity than a regulated utility.
Interestingly, regulation also causes overinvestment in new power plants. Because capital builds profits, utilities willingly overbuild new natural gas capacity while simultaneously refusing to retire old coal capacity.
Limitations and Context
The study focuses primarily on the historic shift from coal to natural gas, as long-term hourly data on large-scale solar and battery storage systems is still emerging. Additionally, the authors note that simply removing regulatory coal-usage rules would dramatically shrink utility profits, which could threaten power grid reliability unless accompanied by financial transfers.
Why It Matters
If these findings hold true, relying solely on carbon taxes or market price signals will not green the power grid as fast as expected. For policymakers, this research highlights why direct clean energy incentives, such as the investment credits in the 2022 Inflation Reduction Act, or structural reforms to public utility regulation are necessary to accelerate the energy transition without endangering grid stability or causing consumer rate shocks.
Learn More
Paper Title: Energy Transitions in Regulated Markets
Authors: Gautam Gowrisankaran, Ashley Langer, and Mar Reguant
Journal: American Economic Review
Publication Year: 2026
URL: https://www.aeaweb.org/articles?id=10.1257/aer.20240094
Econ Today Explains
Economic Concept: Rate-of-Return Regulation
Rate-of-Return (RoR) regulation is a traditional system where government regulators set consumer electricity prices high enough to cover a utility’s operating costs plus an approved profit percentage (a "fair rate of return") on its physical capital investments, known as the "rate base."
Because total profits increase directly with the size of this rate base, utilities face an incentive to overinvest in physical infrastructure—a distortion known in economics as the Averch-Johnson effect. Furthermore, to keep legacy investments inside their approved rate base, utilities must satisfy "used-and-useful" standards, which incentivizes them to keep operating outdated power plants even when cheaper, cleaner options exist.
This article was written by AI but reviewed by a real human.
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