PRIVATE (UTILITY) REGULATORS.

• Author: Payne, Heather

1. INTRODUCTION 1001 II. THE REGULATORY COMPACT 1009 III. EVIDENCE THE REGULATORY COMPACT IS NOT BEING UPHELD, AND THAT REGULATORS ARE INEFFECTIVE 1014 A. Comparisons Using the CPI 1016 B. Utility Capital Spend and Allowed Return on Equity 1019 1. Utility Capital Spend 1020 2. Allowed ROE 1023 3. The Impact from Capital Spend and Allowed ROE 1025 C. Customer Engagement 1028 C. Customer Choice 1029 2. Consumer Involvement 1031 IV. INFORMATION ASYMMETRY 1033 V. HOW OTHERS RESPONDS TO SIMILAR CHALLENGES - AND WHAT REGULATORS COULD LEARN 1036 A. Zero-Based Planning 1039 B. Utility Data Transparency and Confidentiality 1043 C. Other Lessons--Customer Engagement and Innovation 1047 VI. WHAT IMPLEMENTING ZBP, TRANSPARENCY, AND INNOVATION WOULD LOOK LIKE IN PRACTICE 1049 VII. CONCLUSION 1052 I. INTRODUCTION

   The concept of the regulatory compact has long underpinned regulation of electric utilities. (3) Electric utilities typically enjoy monopolies in their service territory, and governments allow those monopolies on the condition the utility companies submit to government oversight. (4) Rather than try to prevent monopolies, the government allows them but then tries to mitigate anti-competitive behavior through regulation. (5) With the basic premise that regulators make the monopoly as efficient as competition, the regulator is supposed to ensure that the public pays a fair price for service. (6)

   The tools traditionally used by regulators to ensure our regulated monopolies were efficient might have been sufficient when we had a simple grid: one where the vertically integrated, regulated utility produced all the power in large centralized plants from fossil fuels, controlled the transmission and distribution lines, owned the relationship with a captive ratepayer, and dealt only with one-way electricity flows from the utility to the customer. (7) But that is not the way our electricity grid operates today. (8) The transition away from coal and toward natural gas for electricity generation, (9) new requirements for regional transmission planning and cost allocation, (10) increasing amounts of customer-sited solar generation, (11) the ability of distributed energy resources to bid into wholesale markets, (12) and the rise of storage (13) have all brought the role of incumbent regulated utilities--and the costs which customers incur due to incumbent utility action or inaction--into sharper focus. While the regulatory compact was always questionable in terms of ensuring efficiency and fair prices, it has become even more difficult with recent changes.

   Grid infrastructure accounts for much of regulated utilities' expenditures today, (14) and parts of the physical grid are very old. (15) But regulators must decide if the amount they spend on grid infrastructure is necessary (16) or if utilities are using capital spending for another purpose--namely, to increase profits. At least some regulators have found that planned utility investments either provide insufficient customer value (17) or that investments heing made now are locking in the current way of doing business, which may or may not be in the public interest. (18)

   The acknowledgement that vertically integrated regulated utilities may not be efficient--or be operating in the captive customers' best interests--started a regulatory transition more than twenty years ago. (19) As part of that transition, the regulated utility landscape has essentially fractured into two main models in the United States. The first is in states that maintain vertically integrated utilities such that a single company owns generation plants, controls the transmission and distribution poles and wires within its service territory, and acts as the only point of contact for a captive customer base. (20) So, for example, if you live in Chapel Hill, North Carolina, Duke Energy Carolinas generates, transmits, and sells you electricity--no other company is involved in providing your electricity, and Duke Energy Carolinas has a complete monopoly over all aspects of the market. (21) With a typical vertically integrated utility, a residential customer bill only has one line, which lists the amount of power used (in kilowatt hours (kWh)), the rate per kWh, and then the total due determined by multiplying those two numbers together. (22)

   The second model is in states that have restructured such that the incumbent regulated utility does not actually own the generation plants. (23) Regulators in these states have determined that the actual generation of electricity (as opposed to the transmission of electricity) is not a natural monopoly (24)--and that customers can benefit from having generation-related competition set the price that is paid for the actual electricity. However, even in restructured states, the transmission and distribution--the poles and wires--remain controlled by a regulated monopoly. (25) If you live in Manhattan, for example, the electricity you use may be generated by all sorts of merchant generating units, all of whom are free to set rates at what they think the market will bear. (26) However, the transmission and distribution lines are provided by the Consolidated Edison Company of New York (CECONY)--and CECONY, as a regulated monopoly, remains heavily regulated by the state. (27) Your monthly electricity bill reflects this additional complexity. The amount of electricity used is still listed, and the generation cost is still charged at a per kWh rate. (28) But the customer will also see a separate charge for transmission and distribution service (the monopoly service), plus a service charge for the costs associated with servicing their account (generating and sending a bill, processing payment). (29) The customer, in a restructured market, therefore has additional transparency that the customer in a vertically integrated state does not: the consumer can determine what portion of their bill pays for the actual electrons that power their homes and what portion goes toward getting those electrons to them.

   When a regulated utility--either a vertically integrated one or one in a restructured market that provides monopoly service--wants to change the rates it charges to its captive ratepayers, it must go before the state regulatory commission in a proceeding called a rate case. (30) Rate case proceedings--in addition to legislative mandates and other regulatory decisions (31)--determine the amount that customers pay in their monthly bills. (32) In vertically integrated states, the rate proceedings wholly determine what customers pay, whereas in restructured states, rate proceedings determine what customers pay for the monopoly part of their service with the market determining the cost of the actual electrons.

   As regulators make decisions in rate cases and other proceedings, both in vertically integrated or restructured markets, they are supposed to ensure that the regulated utilities act efficiently and in the public interest. (33) This is a critical question as a "public purpose was the rationale for granting utilities the right to provide uncontested electric service in the first place." (34) The monopoly structure should only persist if regulators can ensure actions taken are in the public interest and that monopoly regulated utilities are as efficient as they would be if they operated within a competitive market.

   Nevertheless, as this Article will demonstrate, there is evidence that the regulatory compact--the fundamental basis for allowing monopoly control of parts of our electricity system--is not working, and regulators are ineffective in ensuring the regulatory compact is fully upheld. (35) That conclusion draws support from three major pieces of evidence--each of which indicate that regulated monopolies are not operating as efficiently as their non-monopolistic counterparts. (36) First, the evidence includes an electricity consumer price index that is rising faster than the consumer price index for all items. Second, consumers are asked to pay for record rates of capital spend. Third, the allowed return on equity rates utilities receive have not varied with underlying debt costs. (37)

   Inefficiencies within the regulation of electric monopoly utilities are especially problematic given electricity's centrality to modern life. (38) Electricity usage tends to stay constant, regardless of price, and its high inelasticity means users cannot easily reduce consumption when regulators allow rates to increase. (39) Making matters worse, as noted by Justice Stephen Breyer before he joined the Supreme Court, is the fact that a "monopolist, if unregulated, curtails production in order to raise prices." (40) In other words, "[h]igher prices mean less demand, but the monopolist willingly forgoes sales--to the extent that he can more than compensate for the lost revenue (from fewer sales) by gaining revenue through increased price on the units that are still sold." (41) With ineffective regulation of a necessity of modern life, electric monopolies are actually getting an even better deal: more demand and higher prices. Structural changes, technological changes, and our increased dependency on electricity all demand regulatory changes.

   While innovations from the private sector have been utilized within other regulatory spheres, monopoly utility regulation has, to date, remained relatively uninformed by the activities and initiatives of private actors. (42) Regulators should, therefore, look elsewhere for tools to help with effective implementation of the regulatory compact. In order to do so, however, they must first come to terms with the sources of their regulatory ineffectiveness: they need to understand, in other words, why they have thus far struggled to ensure efficiency. This Article posits that the fundamental issue is information asymmetry: simply put, fully regulated, monopolistic cost-of-service utilities are not providing enough information to enable meaningful...