FUEL adjustment mechanisms used in electricity and natural gas pricing are formulae that provide for automatic adjustments in output prices in response to changes in the factor prices of boiler fuels and wellhead gas, respectively. Because these adjustments are made automatically, regulatory commissions do not exercise direct review of the appropriateness of the adjustments although they do generally have authority to determine the form of the formulae used.' The purpose of this paper is to investigate the implications of these mechanisms for economic efficiency, and the analysis will focus on fuel adjustment clauses for electricity rates, since they have been the subject of the most concern in the US. 2 Fuel adjustment mechanisms were first utilized in the US during World War I to enable the regulatory process to function in response to the rapid increase in coal prices.3 'By 1958, the vast majority of electric utilities had adopted fuel clauses. .. most fuel clauses, however, were limited to commercial and industrial users . .. The percentage of utilities having residential fuel clauses rose from 35% in 1970 to 65% in 1973' [19, p. 5]. As an indication of the pervasiveness of these mechanisms, they are currently allowed in all but five states, Montana, Oregon, Utah, Washington and Wyoming, and in Idaho and Nevada 'FACs are not used or are denied to some categories of utilities' [20, p. VI]. Of the 82 electric utilities responding to an October 3rd, 1974, questionnaire of the Edison Electric Institute, 8I reported that an FAC was included in their tariffs [8]. 'An FPC survey as of January Ist, 1974, showed that 65% of the larger privately owned utilities had fuel adjustment clauses in their residential schedules, 77% had such clauses in their commercial schedules, and 83% in their industrial schedules' [13, p. 315].