ILNews

Pashos: Is cost-of-service regulation relevant in today's world?

February 26, 2014
Back to TopCommentsE-mailPrintBookmark and Share
Indiana Lawyer Focus

“No task more profoundly tests the capacity of our government ... than its share in securing for society those essential services which are furnished by public utilities. Our whole social structure presupposes ... dependence upon private economic enterprise. To think of contemporary America without the intricate and pervasive systems which furnish light, heat, power, transportation, and communication is to conjure up another world.” (Felix Frankfurter)

For over a century, Indiana’s public utility rates have been established by governmental agencies, acting as a replacement for a competitive marketplace. The “regulatory compact” under which such regulation takes place holds that public utilities should be given exclusive territories in which to provide these important services so as to avoid a duplication of facilities; in return, public utilities should provide adequate and reliable service to all customers in such territories, at reasonable rates determined by the government. Under this regulatory compact, public utilities submit to regulation and give up the potential upside of substantial profits that other competitive enterprises seek, and customers give up the ability to choose their utility providers.

pashos Pashos

The linchpin of regulated ratemaking has been “cost of service” – rates set based on an estimate of the utility’s reasonable and prudent costs of providing utility services to customers going forward, plus a fair return for investors who supply the utility with needed capital. Cost-of-service regulation provides utilities with an opportunity, but not a guarantee, that they will recover their actual costs of providing service along with a fair return for their investors.

The traditional cost-of-service ratemaking model seeks to ensure that investors continue to provide needed capital and customers continue to receive near universal service at reasonable rates. As the U.S. Supreme Court stated, “the rate-making process ... i.e., the fixing of just and reasonable rates, involves a balancing of the investor and the consumer interest.” Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591 (1944).

Today, public utilities are experiencing significant cost increases, due to issues such as federal environmental and other mandates, and the need to upgrade decades-old infrastructure. These cost pressures, combined with fast-paced technology, market changes and other states’ experimentation with retail deregulation, are causing policymakers and others to ask whether cost-of-service regulation remains relevant or whether deregulation might be a preferable alternative.

Given the very recent history of relatively low and stable natural gas and wholesale power prices, deregulation may appear to be an attractive replacement for cost-of-service regulation. But a more in-depth analysis of other states’ retail deregulation experiences indicates that retail deregulation may present more risk than reward.

A principal motivation behind retail deregulation has been the theory that competition would produce lower prices for consumers. A historical comparison of the electricity prices and price changes in regulated and deregulated states, however, indicates that retail deregulation does not impact electricity prices in any significant way. Rather, the price of electricity is determined by numerous other factors upon which deregulation has little to no impact (for example, fuel proximity and prices, wholesale power prices, construction costs, and government renewable policy requirements). Moreover, the distinct possibility exists that retail deregulation is unlikely to produce price reductions except possibly during periods of low natural gas prices, low wholesale power prices, and generating capacity surpluses. Deregulated Electricity in Texas, supra at 63. Retail Electric Rates in Deregulated and Regulated States: 2012 Update, American Public Power Association, April 2013, available at http://www.publicpower.org/files/PDFs/RKW_Final_-_2012_update.pdf. Kenneth Rose, State Retail Electricity Markets: How Are They Performing So Far?, ElectricityPolicy.com (June 2012). Mathew J. Morey and Laurence D. Kirsch, Retail Rate Impacts of State and Federal Electric Utility Policies, Christensen Associates, The Electricity Journal. Vol. 26, Issue 3 (April 2013).

Even if the price benefits were long term and persuasive, there are risks associated with deregulation that must be considered. These risks include price volatility, reliability of supply, complexity of deregulation, and loss of state jurisdiction.

Electricity is considered to be the most volatile commodity in the world, and natural gas is a volatile commodity, as well. Under regulation, utility customers are largely protected from this price volatility because the utility has “iron in the ground” assets and contracts to hedge against spot market price changes. But in deregulated environments, customers bear more price volatility themselves.

The construction of new-generation assets to ensure the availability of electricity and adequate reserves is a very real issue in deregulated markets. Deregulated markets have struggled to effectively incentivize sufficient construction of new generation, as is illustrated by brownouts and blackouts that have occurred in deregulated markets in Texas and California. Deregulated Electricity in Texas: A History of Retail Competition, Texas Coalition for Affordable Power, December 2012, available at http://tcaptx.com/wp-content/uploads/2013/03/SB7-Report-2012.pdf. The Western Energy Crisis, the Enron Bankruptcy, and FERC’s Response, available at http://www.ferc.gov/industries/electric/indus-act/wec/chron/chronology.pdf.

Retail deregulation legislation must necessarily address numerous complicated issues, many of which can produce unintended consequences (such as the California energy crisis in the early 2000s). As just a few examples of such issues: How will deregulation take place? Will incumbent utilities be required to divest their generating assets? How will “stranded costs” be calculated? How will stranded costs be recovered from customers? Should incumbent utilities be required to act as a “provider of last resort?” How should incumbent utilities be compensated for acting as a provider of last resort?

Finally, when states embark upon retail deregulation, they cede a significant amount of jurisdiction over generation and generation pricing to the federal government. Once a state deregulates, the construction of generating facilities and the pricing of electricity generation will, for the most part, take place at the federal, wholesale level, leaving states without much ability to oversee the adequacy of generation supply or the pricing of such supply to retail customers, as experienced in Maryland and New Jersey.

While Indiana may want to explore deregulation as an alternative to cost-of-service-based regulation, the complexity and risks associated with deregulation should not be ignored or underestimated. Similarly, Indiana should not ignore or underestimate the continued usefulness and possible beneficial evolution of cost-of-service regulation.•

__________

Kay Pashos is a partner in the Indianapolis office of Ice Miller LLP. She practices in the area of energy and utilities law, advising and representing energy and utility companies before state and federal regulatory agencies in a variety of cases. The opinions expressed are those of the author.
 

ADVERTISEMENT

Post a comment to this story

COMMENTS POLICY
We reserve the right to remove any post that we feel is obscene, profane, vulgar, racist, sexually explicit, abusive, or hateful.
 
You are legally responsible for what you post and your anonymity is not guaranteed.
 
Posts that insult, defame, threaten, harass or abuse other readers or people mentioned in Indiana Lawyer editorial content are also subject to removal. Please respect the privacy of individuals and refrain from posting personal information.
 
No solicitations, spamming or advertisements are allowed. Readers may post links to other informational websites that are relevant to the topic at hand, but please do not link to objectionable material.
 
We may remove messages that are unrelated to the topic, encourage illegal activity, use all capital letters or are unreadable.
 

Messages that are flagged by readers as objectionable will be reviewed and may or may not be removed. Please do not flag a post simply because you disagree with it.

Sponsored by

facebook - twitter on Facebook & Twitter

Indiana State Bar Association

Indianapolis Bar Association

Evansville Bar Association

Allen County Bar Association

Indiana Lawyer on Facebook

facebook
ADVERTISEMENT
Subscribe to Indiana Lawyer
  1. All the lawyers involved in this don't add up to a hill of beans; mostly yes-men punching their tickets for future advancement. REMF types. Window dressing. Who in this mess was a real hero? the whistleblower that let the public know about the torture, whom the US sent to Jail. John Kyriakou. http://www.nytimes.com/2013/01/26/us/ex-officer-for-cia-is-sentenced-in-leak-case.html?_r=0 Now, considering that Torture is Illegal, considering that during Vietnam a soldier was court-martialed and imprisoned for waterboarding, why has the whistleblower gone to jail but none of the torturers have been held to account? It's amazing that Uncle Sam's sunk lower than Vietnam. But that's where we're at. An even more unjust and pointless war conducted in an even more bogus manner. this from npr: "On Jan. 21, 1968, The Washington Post ran a front-page photo of a U.S. soldier supervising the waterboarding of a captured North Vietnamese soldier. The caption said the technique induced "a flooding sense of suffocation and drowning, meant to make him talk." The picture led to an Army investigation and, two months later, the court martial of the soldier." Today, the US itself has become lawless.

  2. "Brain Damage" alright.... The lunatic is on the grass/ The lunatic is on the grass/ Remembering games and daisy chains and laughs/ Got to keep the loonies on the path.... The lunatic is in the hall/ The lunatics are in my hall/ The paper holds their folded faces to the floor/ And every day the paper boy brings more/ And if the dam breaks open many years too soon/ And if there is no room upon the hill/ And if your head explodes with dark forbodings too/ I'll see you on the dark side of the moon!!!

  3. It is amazing how selectively courts can read cases and how two very similar factpatterns can result in quite different renderings. I cited this very same argument in Brown v. Bowman, lost. I guess it is panel, panel, panel when one is on appeal. Sad thing is, I had Sykes. Same argument, she went the opposite. Her Rooker-Feldman jurisprudence is now decidedly unintelligible.

  4. November, 2014, I was charged with OWI/Endangering a person. I was not given a Breathalyzer test and the arresting officer did not believe that alcohol was in any way involved. I was self-overmedicated with prescription medications. I was taken to local hospital for blood draw to be sent to State Tox Lab. My attorney gave me a cookie-cutter plea which amounts to an ALCOHOL-related charge. Totally unacceptable!! HOW can I get my TOX report from the state lab???

  5. My mother got temporary guardianship of my children in 2012. my husband and I got divorced 2015 the judge ordered me to have full custody of all my children. Does this mean the temporary guardianship is over? I'm confused because my divorce papers say I have custody and he gets visits and i get to claim the kids every year on my taxes. So just wondered since I have in black and white that I have custody if I can go get my kids from my moms and not go to jail?

ADVERTISEMENT