Game Over: Regulatory Capture, Negotiation, and Utility Rate Cases in an Age of Disruption
40 Pages Posted: 28 Aug 2017 Last revised: 15 May 2018
Date Written: July 6, 2017
Utility ratemaking proceedings at public utility commissions across the country are becoming the new battleground in the transition to clean energy. While technology has made alternative energy sources and strategies like demand response cheaper and more readily available, utility operating and revenue models – and the legal and regulatory frameworks that govern them – have not kept pace. Despite the emergence of performance-based regulatory models that incent the deployment of private capital vs. rate based assets (potentially disrupting the entire monopoly construct), current regulatory structures continue to maintain the status quo of increasing revenues and profits for incumbent utilities based on the traditional monopoly model. Even the NY REV proceeding, which is arguably the most progressive performance-based model currently under consideration in the U.S., specifically allows for the continued protection of incumbent utility revenues and profits in the name of maintaining financial outlooks, credit ratings and access to the capital necessary to build the capabilities required to enable the transition.
One way utilities have been attempting to ensure continued revenue and profits into the future is by increasing capital investment. Rate-based capital deployed by regulated utilities has doubled in the last decade. This spending is then recouped from ratepayers through ratemaking proceedings.
An examination of both historical and recent rate cases demonstrates that utilities, public staff and utility commissions continue to play a game in which each party is able to demonstrate that they are meeting their own objectives and that utility investments and the rates necessary to support them are prudent. One way this occurs is through settlements that transpire between public staff and utilities during ratemaking proceedings: the utility asks for a rather large increase; public staff says that the request is too high and would be too expensive for the public; the utility and public staff negotiate to somewhere around half of what the utility requested and present this to the commission; and the commission approves the new utility rate case. This way, the utilities get an increase in profits, public staff can claim they are working for the public interest, commissioners claim they are doing their jobs, and the ratepayers continue to pay more.
This paper begins with a discussion of regulatory capture – necessary for the “game” – and a structure of how prudent investment theory, regulated vs. restructured markets, and ratemaking continue to enable this capture. In order to quantify this “game” between regulated utilities and regulators, this paper presents an empirical study of investor-owned utility rate cases, specifically looking at the increases (percentage-wise) that utilities requested, and what they were finally granted by PUCs. For a subset of the data set where public staff recommendations are publicly available, a comparison between what public staff recommended, what was requested, and what was approved by the PUC is also presented. After reviewing the empirical findings, the article poses a specific question: should normal negotiation tactics – where the solution is to meet in the middle – apply to regulated monopolies? I posit the answer is no, and discuss potential changes to the current regulatory framework to stop this “game” by examining the process and outcomes through regulatory negotiation theory. Market solutions certainly could be one potential solution; additional judicial oversight is another. Competitive markets are being tried in states like New York and California. However, absent prompting from regulators, it is unlikely that utilities and the financial markets that support them will readily accept any change that leads to lower returns without adequate protections. However, to transition to a low-carbon future, it will become imperative to change utility – and regulator – behavior.
Keywords: Regulation, Regulatory Capture, Ratemaking
JEL Classification: K20, K23, Q4, Q48
Suggested Citation: Suggested Citation