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

February 26, 2014
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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.•

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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.
 

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  1. I have been on this program while on parole from 2011-2013. No person should be forced mentally to share private details of their personal life with total strangers. Also giving permission for a mental therapist to report to your parole agent that your not participating in group therapy because you don't have the financial mean to be in the group therapy. I was personally singled out and sent back three times for not having money and also sent back within the six month when you aren't to be sent according to state law. I will work to het this INSOMM's removed from this state. I also had twelve or thirteen parole agents with a fifteen month period. Thanks for your time.

  2. Our nation produces very few jurists of the caliber of Justice DOUGLAS and his peers these days. Here is that great civil libertarian, who recognized government as both a blessing and, when corrupted by ideological interests, a curse: "Once the investigator has only the conscience of government as a guide, the conscience can become ‘ravenous,’ as Cromwell, bent on destroying Thomas More, said in Bolt, A Man For All Seasons (1960), p. 120. The First Amendment mirrors many episodes where men, harried and harassed by government, sought refuge in their conscience, as these lines of Thomas More show: ‘MORE: And when we stand before God, and you are sent to Paradise for doing according to your conscience, *575 and I am damned for not doing according to mine, will you come with me, for fellowship? ‘CRANMER: So those of us whose names are there are damned, Sir Thomas? ‘MORE: I don't know, Your Grace. I have no window to look into another man's conscience. I condemn no one. ‘CRANMER: Then the matter is capable of question? ‘MORE: Certainly. ‘CRANMER: But that you owe obedience to your King is not capable of question. So weigh a doubt against a certainty—and sign. ‘MORE: Some men think the Earth is round, others think it flat; it is a matter capable of question. But if it is flat, will the King's command make it round? And if it is round, will the King's command flatten it? No, I will not sign.’ Id., pp. 132—133. DOUGLAS THEN WROTE: Where government is the Big Brother,11 privacy gives way to surveillance. **909 But our commitment is otherwise. *576 By the First Amendment we have staked our security on freedom to promote a multiplicity of ideas, to associate at will with kindred spirits, and to defy governmental intrusion into these precincts" Gibson v. Florida Legislative Investigation Comm., 372 U.S. 539, 574-76, 83 S. Ct. 889, 908-09, 9 L. Ed. 2d 929 (1963) Mr. Justice DOUGLAS, concurring. I write: Happy Memorial Day to all -- God please bless our fallen who lived and died to preserve constitutional governance in our wonderful series of Republics. And God open the eyes of those government officials who denounce the constitutions of these Republics by arbitrary actions arising out capricious motives.

  3. From back in the day before secularism got a stranglehold on Hoosier jurists comes this great excerpt via Indiana federal court judge Allan Sharp, dedicated to those many Indiana government attorneys (with whom I have dealt) who count the law as a mere tool, an optional tool that is not to be used when political correctness compels a more acceptable result than merely following the path that the law directs: ALLEN SHARP, District Judge. I. In a scene following a visit by Henry VIII to the home of Sir Thomas More, playwriter Robert Bolt puts the following words into the mouths of his characters: Margaret: Father, that man's bad. MORE: There is no law against that. ROPER: There is! God's law! MORE: Then God can arrest him. ROPER: Sophistication upon sophistication! MORE: No, sheer simplicity. The law, Roper, the law. I know what's legal not what's right. And I'll stick to what's legal. ROPER: Then you set man's law above God's! MORE: No, far below; but let me draw your attention to a fact I'm not God. The currents and eddies of right and wrong, which you find such plain sailing, I can't navigate. I'm no voyager. But in the thickets of law, oh, there I'm a forester. I doubt if there's a man alive who could follow me there, thank God... ALICE: (Exasperated, pointing after Rich) While you talk, he's gone! MORE: And go he should, if he was the Devil himself, until he broke the law! ROPER: So now you'd give the Devil benefit of law! MORE: Yes. What would you do? Cut a great road through the law to get after the Devil? ROPER: I'd cut down every law in England to do that! MORE: (Roused and excited) Oh? (Advances on Roper) And when the last law was down, and the Devil turned round on you where would you hide, Roper, the laws being flat? (He leaves *1257 him) This country's planted thick with laws from coast to coast man's laws, not God's and if you cut them down and you're just the man to do it d'you really think you would stand upright in the winds that would blow then? (Quietly) Yes, I'd give the Devil benefit of law, for my own safety's sake. ROPER: I have long suspected this; this is the golden calf; the law's your god. MORE: (Wearily) Oh, Roper, you're a fool, God's my god... (Rather bitterly) But I find him rather too (Very bitterly) subtle... I don't know where he is nor what he wants. ROPER: My God wants service, to the end and unremitting; nothing else! MORE: (Dryly) Are you sure that's God! He sounds like Moloch. But indeed it may be God And whoever hunts for me, Roper, God or Devil, will find me hiding in the thickets of the law! And I'll hide my daughter with me! Not hoist her up the mainmast of your seagoing principles! They put about too nimbly! (Exit More. They all look after him). Pgs. 65-67, A MAN FOR ALL SEASONS A Play in Two Acts, Robert Bolt, Random House, New York, 1960. Linley E. Pearson, Atty. Gen. of Indiana, Indianapolis, for defendants. Childs v. Duckworth, 509 F. Supp. 1254, 1256 (N.D. Ind. 1981) aff'd, 705 F.2d 915 (7th Cir. 1983)

  4. "Meanwhile small- and mid-size firms are getting squeezed and likely will not survive unless they become a boutique firm." I've been a business attorney in small, and now mid-size firm for over 30 years, and for over 30 years legal consultants have been preaching this exact same mantra of impending doom for small and mid-sized firms -- verbatim. This claim apparently helps them gin up merger opportunities from smaller firms who become convinced that they need to become larger overnight. The claim that large corporations are interested in cost-saving and efficiency has likewise been preached for decades, and is likewise bunk. If large corporations had any real interest in saving money they wouldn't use large law firms whose rates are substantially higher than those of high-quality mid-sized firms.

  5. The family is the foundation of all human government. That is the Grand Design. Modern governments throw off this Design and make bureaucratic war against the family, as does Hollywood and cultural elitists such as third wave feminists. Since WWII we have been on a ship of fools that way, with both the elite and government and their social engineering hacks relentlessly attacking the very foundation of social order. And their success? See it in the streets of Fergusson, on the food stamp doles (mostly broken families)and in the above article. Reject the Grand Design for true social function, enter the Glorious State to manage social dysfunction. Our Brave New World will be a prison camp, and we will welcome it as the only way to manage given the anarchy without it.

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