An online monthly research publication by the Ivey Business School 

Previous Issues of Impact | Register for Impact

Volume 15, Number 12
December 2009

Setting the bar for clean energy

The research of Adam Fremeth shows that regulators and energy firms both win when they find opportunities to cooperate

President Barack Obama is urging Congress to pass a national energy bill that requires 25 percent of American electricity to come from wind, solar, biomass, and other renewable sources by 2025. Although some states are lobbying fiercely against this, others have already passed ambitious standards of their own. “This is an area that is moving quickly,” says Ivey Professor Adam Fremeth, who researches how regulators and firms interact with each other on energy issues. “Making the wrong bets could be costly.”

Fremeth, an Ivey HBA grad, recently joined the School from the University of Minnesota, where he completed his PhD in Strategic Management and Organization. The state of Minnesota has adopted a renewable portfolio standard (RPS) of 25 percent green energy by 2025, one of the most stringent in the country. Texas, for example, has an RPS of 5 percent by 2025, and half the states in the U.S. have no standards at all. For his PhD dissertation, Fremeth looked at why there was such variation among states, and what that means for utility firms thinking about investing in renewable energy.

Fremeth sees both utility firms and regulators as “strategic actors,” with clear incentives. Regulators, who are often quasi-political appointees, look good when they bring in policies that are challenging yet achievable. When regulations are too extreme for firms to comply, there is a public cost. Utility firms are very different from one another. Each is endowed with a set of “compliant specific capabilities” that enable it to meet the demands of a particular regulatory policy.

In his research Fremeth found that state policy tends to be shaped by the capabilities of the firms that operate there. These capabilities are made up of a firm’s know-how, experience, and practices. For example, Minnesota is dominated by Xcel Energy, a large electrical and natural gas company with experience in many different kinds of energy technologies. Minnesota has chosen a renewable policy that is extremely demanding, says Fremeth. “Regulators are leveraging off the strength of these firms. They know that companies like Xcel have the capability of responding proactively.”

Fremeth also found that firms with the technical know-how are more likely to be proactive when they’re faced with challenging policies. That’s why firms in one state invest in clean energy while firms in another do not. “A firm that faces a stringent policy is more likely to spend and be aggressive in the renewable technology sector,” he says. “The incentive structures of the firms and of the regulators come together, and you see a win-win.”

These findings have important implications for firms that are thinking about building know-how in a particular area. Because regulators tend to leverage off firm strengths, they might lead you in a direction you don’t want to head, says Fremeth. “A firm’s decision not to undertake greening activities may not be due to lack of concern about climate change, but rather a long-term forecast of where they might be pushed in the future.”

Fremeth also found that firms are sensitive to regulatory standards that exist nearby. When a state imposes high standards, firms in neighbouring states tend to ramp up their own renewable energy capabilities in the expectation that they may soon be facing the same thing.

Another key implication from Fremeth’s research is that a shift in the regulatory environment depends not only on a particular firm’s actions but also those of its competitors. “The competitive dynamics between firms is a driver of regulatory policy,” he says. In Minnesota, there are five smaller players that operate alongside Xcel. “These smaller firms are somewhere behind on the curve, so they have to know how the actions of Xcel may move policy in a particular direction.”

There is a dramatic reshaping of regulatory policy worldwide, not only in the environmental sphere but in many others. How firms influence and respond to policy will be a key priority, says Fremeth. He believes it’s important that managers seek win-win situations. “Firms and regulators who look for opportunities and creative ways to improve their competitiveness are the ones who are really going to win out.”
 

Professor Fremeth's Homepage