kim.html

Do Market Forces or Politics Drive Electric Utilities to Go Green?

Eun-Hee Kim

International Business/Business Economics

Stephen M. Ross School of Business

University of Michigan

eunheek@umich.edu

My paper focuses on what motivates investor-owned electric utility companies in the United States to produce renewable energy. Between 2001 and 2006 renewable electricity consumption increased by more than 30 percent, while total electricity consumption increased by less than 10 percent (EIA, 2005). At the state level, recent studies have shown that various state policies, especially renewable portfolio standards, encouraged renewable energy development (Blair, et al., 2006; Kneifel, 2006; Menz and Vachon, 2006; Bird, et al., 2005). At the firm level, however, Delmas, et al. (2007) find that retail restructuring of the electric utility industry presented some firms with an opportunity to differentiate, i.e., to produce renewable energy. In particular, two kinds of firms increased renewable generation upon restructuring: previously inefficient firms and firms with customers who are more than willing to pay the greater costs of renewables.

The foregoing findings are consistent with the literature on generic strategies, according to which firms in a competitive environment should seek either cost leadership or differentiation strategies rather than being “stuck in the middle” (Porter, 1980). They are also consistent with the literature on strategic change, which argues that firms make strategic changes upon a dramatic shift in the external environment to realign their internal resources with a changing environment (Zazac, et al., 2000; Zazac and Shortell, 1989; Smith and Grimm, 1987). Contrary to the state-level studies, however, Delmas, et al. suggest that market forces---instead of institutional forces and the regulatory environment---drive renewable energy generation. Although interesting, this explanation does not seem to be supported by the evidence on the effects of retail restructuring. Upon retail restructuring, it was mostly large commercial and industrial customers who took advantage of retail competition and switched electricity suppliers to lower their energy costs (Joskow, 2005). Switching among residential and small commercial customers was limited perhaps because the expected gain was ignorable. As a matter of fact, even residential customers appear to have changed their electricity suppliers out of economic motivation, not out of environmental stewardship. In Ohio, for example, residential customers whose default electricity suppliers were subsidiaries of America Electric Power (AEP) or Dayton Power and Light did not change their suppliers, whereas more than 50% of residential customers whose default suppliers were First Energy subsidiaries changed their suppliers (Joskow, 2005).1 It turned out that AEP and Dayton subsidiaries had very low retail prices, lower than the wholesale-market price, whereas First Energy subsidiaries had high retail prices to recover its stranded costs. It seems then that retail restructuring, because it drives price competition, does not promote renewable generation. This is so because the average costs of renewable generation are typically higher than those of non-renewable generation such as coal or nuclear. Thus, the finding that restructuring itself encouraged some firms to generate more renewable energy for the purpose of increasing profits is intriguing yet puzzling at the same time. This paper revisits the question by studying the drivers and performance implications of renewable energy generation at the firm level.

My paper draws on the literatures on renewable energy, strategic change and corporate social responsibility. The literature on renewable energy, mostly economics-based, focuses on its social welfare implications and accordingly pays little attention to how firms' production of renewable energy might affect their financial performance. Examining the effects on firm performance has important policy implications for further promotion of renewable energy. The literature on strategic change posits, not surprisingly, that firms make strategic changes upon a dramatic shift in the external environment. Motives for strategic change suggested so far, however, are limited to those of efficiency and profitability. The possibility that political factors might drive strategic change has not been explored yet. Also, politically motivated changes might affect firm performance differently than those induced by market forces. The literature on corporate social responsibility explores the motives for and consequences of corporate greening (see Lyon and Maxwell (2007) and Margolis and Walsh (2003) for reviews). Yet, how heterogeneous firms might respond differently to political pressure to go green, and how these responses might affect firm performance, has not been much explored.