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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. No second amendment, pro life, pro traditional marriage, reagan or trump tshirts will be sold either. And you cannot draw Mohammed even in your own notebook. And you must wear a helmet at all times while at the fair. And no lawyer jokes can be told except in the designated protest area. And next year no crucifixes, since they are uber offensive to all but Catholics. Have a nice bland day here in the Lego movie. Remember ... Everything is awesome comrades.

  2. Thank you for this post . I just bought a LG External DVD It came with Cyber pwr 2 go . It would not play on Lenovo Idea pad w/8.1 . Your recommended free VLC worked great .

  3. All these sites putting up all the crap they do making Brent Look like A Monster like he's not a good person . First off th fight actually started not because of Brent but because of one of his friends then when the fight popped off his friend ran like a coward which left Brent to fend for himself .It IS NOT a crime to defend yourself 3 of them and 1 of him . just so happened he was a better fighter. I'm Brent s wife so I know him personally and up close . He's a very caring kind loving man . He's not abusive in any way . He is a loving father and really shouldn't be where he is not for self defense . Now because of one of his stupid friends trying to show off and turning out to be nothing but a coward and leaving Brent to be jumped by 3 men not only is Brent suffering but Me his wife , his kids abd step kidshis mom and brother his family is left to live without him abd suffering in more ways then one . that man was and still is my smile ....he's the one real thing I've ever had in my life .....f@#@ You Lafayette court system . Learn to do your jobs right he maybe should have gotten that year for misdemeanor battery but that s it . not one person can stand to me and tell me if u we're in a fight facing 3 men and u just by yourself u wouldn't fight back that you wouldn't do everything u could to walk away to ur family ur kids That's what Brent is guilty of trying to defend himself against 3 men he wanted to go home tohisfamily worse then they did he just happened to be a better fighter and he got the best of th others . what would you do ? Stand there lay there and be stomped and beaten or would u give it everything u got and fight back ? I'd of done the same only I'm so smallid of probably shot or stabbed or picked up something to use as a weapon . if it was me or them I'd do everything I could to make sure I was going to live that I would make it hone to see my kids and husband . I Love You Brent Anthony Forever & Always .....Soul 1 baby

  4. Good points, although this man did have a dog in the legal fight as that it was his mother on trial ... and he a dependent. As for parking spaces, handicap spots for pregnant women sure makes sense to me ... er, I mean pregnant men or women. (Please, I meant to include pregnant men the first time, not Room 101 again, please not Room 101 again. I love BB)

  5. I have no doubt that the ADA and related laws provide that many disabilities must be addressed. The question, however, is "by whom?" Many people get dealt bad cards by life. Some are deaf. Some are blind. Some are crippled. Why is it the business of the state to "collectivize" these problems and to force those who are NOT so afflicted to pay for those who are? The fact that this litigant was a mere spectator and not a party is chilling. What happens when somebody who speaks only East Bazurkistanish wants a translator so that he can "understand" the proceedings in a case in which he has NO interest? Do I and all other taxpayers have to cough up? It would seem so. ADA should be amended to provide a simple rule: "Your handicap, YOUR problem". This would apply particularly to handicapped parking spaces, where it seems that if the "handicap" is an ingrown toenail, the government comes rushing in to assist the poor downtrodden victim. I would grant wounded vets (IED victims come to mind in particular) a pass on this.. but others? Nope.

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