“Veering from this original intent of regulation — driven by overreaching politics — risks regulators’ ability to achieve their core objective of protecting consumers…. Unfulfilling these core obligations constitutes what I and others consider regulatory failure that raises doubts on the social desirability of public utility regulation.”
“… subsidies — often the result of increased politicization — can be unfair to funding parties (namely, ratepayers), economically inefficient, and unfair to competing energy sources. One common bizarre practice is for electric utilities to subsidize their customers to use less of their service via energy efficiency initiatives….”
Public utility regulation falls within the lexicon economic regulation with its main objective to protect consumers from the monopoly power of a utility. The presumption is that public utilities provide essential services that require strong service obligations and price controls. It is also inferred that a single private firm would be preferable to allowing the entry of a number of potentially competing firms.
Without regulation, utility services would presumably be excessively priced with no guarantee of availability for those who want it and willing to pay for it. Inefficiencies and inequities would occur if society allows the free market to operate on its own. While not universally accepted and empirically based, this view formed the basis for public utility regulation. [1]
Veering from this original intent of regulation — driven by overreaching politics — risks regulators’ ability to achieve their core objective of protecting consumers. Public utility regulation has expanded its domain far beyond its original mandate and, arguably, what is socially optimal.
Critics suggest that regulators should stick to setting just and reasonable rates, acting on behalf of the long-term welfare of utility customers, and eliminating barriers to entry in utility markets when warranted by economic and market conditions. Unfulfilling these core obligations constitutes what I and others consider regulatory failure that raises doubts on the social desirability of public utility regulation.
Attributes of Good Regulation
Good regulation requires well-informed regulators striving to advance the public interest. It requires the balancing of different objectives and stakeholder interests. For most of its history, public utility regulation struggled with balancing utility interest against consumer interest; more recently, consumer interest against environmental and other non-traditional interests. As a first-order proposition, good regulation places the public interest over the interests of individual stakeholders, even when it is unpopular like granting a utility a large rate increase.
This means that good regulation should avoid excessive politicization by directing its actions at the public interest, rather than bestowing undue favors upon any one interest group. (Of course, regulation cannot totally remove itself from politics, as its decisions affect the well-being of different groups in society, including the different classes of consumers, utilities and other stakeholders. Besides, regulation acts as the agent to the people of a state, whose welfare is the major concern of regulators.)
A major challenge for regulators is to “divide up the pie” so as to be fair to each stakeholder, while considering other objectives with the overall goal of advancing the public interest. This means not giving in to political pressures that emphasize short-term results and give undue weight to certain special interests.
Good regulation should avoid undue influence by any one interest group, which erodes regulation as an institution and instrument that promotes the public good. Politically expedient decisions tend to undermine the regulatory agency’s commitment to promoting the long-term interests of both utility consumers and society as a whole.
The Positive Side of More Politicization
While individual interests have legitimacy, the regulator must consider all the interests collectively to make decisions that advance the public good. By providing pertinent information from different perspectives, interest groups can help regulators make socially desirable decisions.
One positive aspect of politicization, therefore, is that it allows regulators to have access to more diversified information from stakeholders that could result in better decisions. One criticism of regulation is that it tends to stick with its policies and practices too long in spite of changing market and technological conditions. Additional stakeholders in the regulatory process could push regulators toward changes that are in the public interest but would not pursue on their own.
To wit, escalated politicization with additional stakeholders could actually assist in achieving this: The inherent inertia of utilities, regulators and some consumer groups may collectively endorse the status quo when changes in regulatory policies and utility practices would be socially beneficial. Other stakeholders, like environmentalists, third-party vendors and utility competitors, could propel regulators to support reforms that are more responsive to market, industry and public-policy developments.
As we observe, inertia can afflict regulators, utilities, and consumer advocates alike to the extent that they are risk averse toward change. This aversion can stem from uncertainty over the outcomes of change — for example, the effect of real-time pricing on residential customers who do not shift load between periods — in addition to the more obvious effects that would fall on certain stakeholders. The aversion by regulators may arise from the expected harm from a change on politically powerful stakeholders (e.g., residential customers) rather than on the public interest.
Utilities as Social Agencies
The domain of electric utilities responsibilities has expanded beyond the scope of reliable service at “just and reasonable” prices. According to most state statutes, regulators must assure the public that utility rates are “just and reasonable” and not unduly discriminatory. These requirements mean that consumers are charged no more than necessary to give a utility a reasonable opportunity to recover efficiently incurred costs, including a fair return on their investments.
Over time, legislatures/regulators require utilities to extend their sphere beyond a for-profit commercial enterprise by offering discounts to low-income households, accommodating, facilitating and even subsidizing their competitors (e.g., distribution generation) and renewable energy, investing in uneconomic new technologies, promoting energy efficiency, and achieving clean-air targets beyond federal and local mandates. These demands on utilities, which are costly, have made it more difficult for them to operate as profitable entities providing basic services reliably and economically.
A major topic in the policy debate centers on the utility business model, addressing, for example, the extent to which utilities should broaden their functions to satisfy society’s demands driven by political forces. An expansive role for utilities could place upward pressure on electricity prices and potentially conflict with traditional regulatory objectives, like cost-based rates, consumer protection, least-cost utility operations, and adequate service reliability.
Ironically, utilities themselves may be promoters of broadening their social responsibility for the purpose of goodwill/public relations that would lead to favorable treatment by regulators and other governmental entities. I have seen that happening increasingly with utilities being strong proponents of subsidized energy efficiency and clean energy technologies.
The Bad Side of Politics Infiltrating Regulation
More politics in public utility regulation reflects various efforts by stakeholders to gain favors from government. This has negative repercussions for regulation. First, it means more special-interest influence with additional stakeholders that have the potential to jeopardize the public interest. Second, emphasis shifts to short-term (or myopic) effects. Third, it makes more difficult execution of the long-standing “balancing act” with additional interests and social objectives. Fourth, it tends to cause regulators to depart from traditional objectives of serving the long-term interest of utility customers. Fifth, it inevitably results in wasteful rent-seeking costs. Sixth, it increases the likelihood of subsidies and the socialization of costs for new investments.
The third point derives from the increase in interest groups that complicates the regulator’s task to arrive at a balanced outcome. How do regulators sum and weigh those interests to advance the public good? After all, one can define the public interest as the composite indicator of the public well-being (a metric if you will) that “adds up” the individual effects of a regulatory decision on special interests. The public interest takes on more obscure interpretation when special interests become more diverse and larger in number: It is harder to define and to know when it improves.
One prime example of the fourth point is the evaluation of new capital projects on the basis of their non-cost attributes. With enhanced politicization, regulators have increasingly considered the effects on the environment, job creation, economic development and other outcomes. This heightens the difficulty for regulators to make the inevitable trade-offs that best advance the public interest. It also likely results in less concern for utility-customer welfare, as other objectives become integral to regulators’ decisions.
Regarding the fifth point, public utility regulators are vulnerable to rent-seeking efforts by advocates of special interests to achieve self-serving outcomes at the expense of the general public. The electric industry in particular has several features making it highly visible and susceptible to politics and interest-group lobbying. Prominent ones are a substantial environmental footprint, a large user of energy, an essential service, and high social cost from service interruptions.
The sixth point is especially harmful, as subsidies — often the result of increased politicization — can be (1) unfair to funding parties (namely, ratepayers), (2) economically inefficient, and (3) unfair to competing energy sources. One common bizarre practice is for electric utilities to subsidize their customers to use less of their service via energy efficiency initiatives; and to subsidize their competitors behind the meter via net metering and underrecovery of grid costs from distributed generation customers. Overall, subsidies almost always fail a cost-benefit test from an aggregate economic-welfare (i.e., public interest) perspective.
One illustration of politicization is the question of how much competition to allow in traditionally monopolistic markets. I have observed how regulators have often formed an agreement with utilities to address the challenges posed by increased competition by suppressing it. At the other spectrum, I have also seen regulators, pressured by third-party providers, handicapping utilities in an uneconomical way. Incidentally, some critics of regulation have alleged that regulation itself is a major source of utility monopoly power because of its mandate to limit entry even when economic, technological and markets conditions would support opening up the market to competition.
To be fair, it may not be regulators themselves who are at fault for the extreme politicization that is diminishing the interests of utility customers. Legislative actions set the framework for regulation that may restrict the ability of regulators to serve the public interest. Politics typically drive those actions, with special interests unduly influencing the legislation. We have seen utilities, environmentalists and other special interests going to state legislatures for favors that they are unable to get from regulators. Their intent is to promote their agenda, not what is in society’s interest.
An Evaluation of Recent Trends in Regulation
Has regulation improved over time to better serve society? It has taken on issues that are marginal to its core mission and, given limited regulators’ resources, diverted attention away from its primary function to protect consumers from monopolists.
Have regulatory failures and capture become more pronounced? Historically, capture referred to undue influence by utilities at the expense of their customers and the public interest. More recently, capture has encompassed other stakeholders with the same effect of harming utility customers and the public interest. This modern-day capture has sprung from the advancement of certain interests with no or little financial effect on utilities. We are seeing utility customers being “taxed” with surcharges and supposingly “innovative rate mechanisms” to recover utility investments that intend to accrue benefits to society, rather than to utility customers.
Often overlooked, regulators should ask themselves whether utilities’ core customers are on the short end of the straw. Are customers funding the advancement of social objectives through inflated rates without compensatory benefits? The term “turkey stuffing” correctly describes the situation where utilities keep attaching surcharges to a typical customer’s bill to fund investments and other activities whose benefits may largely accrue to others.
Regulatory failure refers to the outcome of regulatory practices and policies that make matters worse than if regulation was non-existent. A serious problem is that regulation has expanded to address social issues that are best dealt with by other governmental entities or the marketplace. Because of this, it has lost sight of its basic duty to serve the long-term interests of utility customers. To me, from the perspective of utility customers that has been a serious failure of state public utility regulation.
Although difficult to quantify, one can reasonably speculate that politics has had an overall negative influence on regulatory decisions. Regulation is in a disequilibrium state: It is struggling with finding the “right” actions on major issues, like ratemaking, investment planning and relative weights to place on different objectives. This has stemmed partially from the increased politicization that has penetrated public utility regulation.
Prospects for the Future
We can expect continued increased politicization, making it more difficult for regulators to balance the interests of different stakeholders so as to advance the public good.
The trend in public utility regulation has been a decreased emphasis on consumer protection and more attention paid to social benefits that ultimately may harm consumers. This is a troublesome development.
Regulators will need to elevate their game if they are to deal with non-traditional issues brought before them because of increased politicization. We have seen the rise in complex issues facing the electric industry, like net energy metering, transforming utility distribution systems into a platform, utility business models, growing competition to utility services, demand charges, integration of renewable energy, demand response, cloud services and so forth that regulators will have to address. These issues involve technological, economic, and political (e.g. socialization/subsidization) factors that require unprecedented skills for regulatory personnel.
We should see technology lessening the role of regulators in influencing the performance of utilities and the welfare of consumers. This is a good thing, as market forces become more dominant and responsive to consumer needs. An increased political environment may delay this development, as entrenched interest groups may suffer harm that they will try to forestall by pressuring regulators to stay with the status quo.
Increasingly state utility regulators have had to undertake more tasks with the same or even less money, akin to untieing the Gordian knot that can spiral out of control from regulators unable to adequately address the issues brought before them. One factor is greater stakeholder participation, making rate cases and other proceedings more complex and expensive. It is likely that this spiral will only grow in the future as regulation becomes less effective in executing its duties in an increasingly politicized world.
Ending on a pessimistic note, we cannot ignore the reality that regulators’ self-interest may deviate from the public interest, irrespective of the political environment. It seems implausible that society can effectively steer regulators’ actions toward the latter pursuit — which means a lack of social control of regulation itself. While regulators hold utilities accountable for their actions, who is able to hold the regulators accountable? —-
[1] For a different view, under which legal contracts between organized buyers and utilities would substitute for the regulatory covenant, see Robert Bradley, “The Distortions and Dynamics of Gas Regulation,” in Jerry Ellig and Joe Kalt, eds., New Horizons in Natural Gas Deregulation, (Praeger: 1996); and Bradley, “The Origins of Political Electricity: Market Failure or Political Opportunism?” Energy Law Journal, May 1996.
Kenneth W. Costello, formerly Principal Researcher, National Regulatory Research Institute, is a noted regulatory economist specializing in energy. He received his B.S. from Marquette University in Mathematics (1970); an M.A. from Marquette in Economics (1974), and studied in the doctoral economics program at the University of Chicago (1976-1978).
The role of the regulator is one that is critical in the regulatory paradigm. It is not a matter of crunching numbers to recover costs, rather which costs to include and how to recover them. There might not be anything as important to effective regulation as rate design that provides efficient price signals. Antiquated concepts of recovering fixed costs through fixed charges, even suggestions I have proposed, need to be scrapped and replaced with providing the best price signals, whether time of use or demand charges or critical peak pricing and then using the customer charge to true-up revenue requirements. The customer charge is the least elastic item on the bill, so it can deviate form cost causality the most without causing inefficiencies.
Now what costs are recovered through these rate designs? Do we stop with internal costs or do we look at external costs such as environmental costs that sometimes are or are not included? Looking at cost considerations should have us look at resource decision making processes and what solutions yield acceptable results rather than the phantom of least costs.
Finally, the seemingly efficient solution might not be the best solution when we look at economic disruptions; so one-off solutions are still in the mix. Effective regulation is hard. Unless we put more effort into pricing and the external costs and secondary effects, we as regulators will fail.
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Kenneth Costello: Thank you for your commentary. Your points have touched on some of the difficulties encountered by adverse intervenor Californians for Green Nuclear Power, Inc. (CGNP) before the California Public Utilities Commission in proceeding A.16-08-006. In September, 2016, CGNP began opposing PG&E’s harmful plan to voluntarily close Diablo Canyon Power Plant in 2025, six decades before the end of the well-maintained plant’s useful life. One of our big problems is the interests advocating for the extremely large amount of intermittent solar generation and intermittent wind generation fit your description of “rent seekers” – to the detriment of California’s ratepayers, its environment, and public safety. Would MasterRescource be interested in this breaking story?
[…] Kenneth W. Costello, formerly Principal Researcher, National Regulatory Research Institute, is a noted regulatory economist specializing in energy. His previous post at Master Resource was Rent-Seeking under Public Utility Regulation: Who Protects Ratepayers? […]