Price Formation and Legal Provisions in Electricity Contracts: An Empirical Study

The paper empirically analyses the effects of legal provisions (setting penalties and incentives, and regulating the parties’ obligations and risks) on electricity contracts price formation. Using 27 California long-term electricity contracts for the trade of electricity between generators, we perform an econometric exercise and target the main determinants that affect electricity price. The general result is that provisions increasing (decreasing) the trading risk for the seller, increase (decrease) the price. Those provisions setting penalties (incentives) for the seller decrease the price. These effects are stronger for the contract maximum price. Our 2SLS results can be interpreted in the theoretical framework of transaction cost economics, where provisions regulating risks are set in order to allow for ex post adaptation to uncertainty and complexity of transactions and institutional settings. The paper is, therefore, an attempt to endogenize uncertainty and complexity