The Descent of Utility Regulation

State utility regulation has departed from its primary role of protecting customers from the monopoly power of utilities. For example, we have seen regulators approving higher utility rates, as well as compromising utility reliability, to advance the agendas of politically influential interest groups such as social-justice and clean-energy activists. Many regulators have become advocates of the environmental, social and governance (ESG) movement that has infiltrated the corporate and political worlds at the expense of utility customers. 

My main advice for utility regulators is that they should stick to their knitting: setting just and reasonable rates and taking other actions that improve the long-term welfare of utility customers. After all, the raison d’être for utility regulation (although often done poorly over time) is to protect customers from “monopoly” utilities. Pursuing other purposes only diminishes regulators’ ability to achieve this long-standing central objective. 

To be fair to utility regulators, legislatures have become more immersed in utility matters by demanding that regulators take particular actions (endorsed by special interests) that go far beyond merely giving their traditional policy guidance. The executive branch as well has compelled regulators to act in line with its political interests. Both of these developments have eroded the independence of utility regulation and its core mission to foster the interest of utility customers.

Independence Obstructed by Politics

Independence is essential for allowing a regulatory agency to protect the general public in the face of strong economic and political pressures. Jeopardy of a regulatory agency’s independence can originate from different parties: Utilities, the executive branch of state or the federal government, the legislature, special interest groups, and the judicial branch. One real-world condition for independence is the inability of the governor or legislature to remove a regulator unless she is guilty of gross inefficiency, neglecting her duties, or violating the law. The independence of utility regulators has diminished in recent years as the regulatory process has become more political. 

Independence is constrained, however, partly by law and because a regulatory agency must be responsible to the public for its actions. Good government requires that an agency be held accountable when it makes decisions that affect the general public. 

Good regulation is compatible with a public-interest objective, and it avoids excessive politicization and influence by any one interest group, actions which diminish regulation as an institution and instrument of public policy. While individual interests have legitimacy, the regulator must consider all the interests collectively to make decisions that advance the public good. Politically expedient decisions tend to undermine the agency’s commitment to promoting the long-term interests of utility customers and other stakeholders. Of course, regulation cannot totally remove itself from politics, as its decisions touch the well-being of different groups, including the different groups of consumers, utility shareholders and other stakeholders. 

Politicization of utility regulation—that is, using regulators to gain favors—means many things, mostly bad: more special-interest influence with the potential to jeopardize the public interest by (1) placing added emphasis on myopic effects, (2) parting from the charge of regulation to serve the long-term interest of utility customers, (3) escalating rent-seeking costs and increasing the likelihood of subsidies and mandates, and (4) spreading the cost and risk for uneconomical, politically-driven investments onto utility customers. For most of its history, public utility regulation has struggled with balancing utility interest against consumer interest; more recently, consumer interest against environmental, social justice, and other peripheral interests. 

Politicization typically ends up with one interest group unduly affecting governmental actions that harm the public good. Good regulation tries to avoid excessive politicization. Politically expedient decisions tend to disrupt the agency’s commitment to fostering the welfare of society as a whole. 

Long-term utility customer welfare, in fact, is one of the least represented interests in the regulatory and political arena. Utilities look out for their financial interest, consumer advocates lean toward a short-term view, and other stakeholders have their own agenda (e.g., the advancement of clean energy). A gap in adequate representation for the long-term interest of customers becomes evident. Regulators’ main duty should be to fill that void, notwithstanding the intense pressure they face to mollify individual stakeholders with the most clout, even when it results in higher rates and lower service reliability. 

A New Utility Business Model

It is hard to avoid the fact that much of what we see today that passes for the public good is actually rent-seeking, which benefits a distinct minority at a cost to the majority. The electricity industry in particular has special features that make it highly visible and prone to politics and interest-group lobbying. The major ones are a substantial environmental footprint, a large user of energy (e.g., fossil fuels), provision of a critical service, and high social cost from service interruptions.

We know from past experience that politics rationalizes its actions as morally unobjectionable when, in fact, it bestows handouts to a narrow group at the expense of the public good. Because the public interest is diffused and not well-organized, regulators should act as its proxy.

From my perspective, over time utility regulation has done a worse job in this regard. It has taken on social issues that are marginal to its core mission and, as a result, diverted attention away from its primary job of protecting consumers from monopolists.  

A current regulatory issue in the US and other countries centers on utilities’ business models, including how much they should broaden their activities to satisfy society-wide political demands. There is an inherent discordance between treating utilities as both a for-profit business and a purveyor of public goods. These demands on utilities, which are costly and eventually passed through to customers in the form of higher rates, have complicated their ability to operate in their proper role as profitable entities providing basic services reliably and economically. 

This development exemplifies what analysts refer to as mission creep, where government entities tend to expand their mission and goals beyond their original scope. Electric utilities in particular, with the approval of and often coerced by utility regulators, have drifted from serving utility customers to obliging other interests.

Utilities as Social Agencies

This misguided development originated with the politicians and bureaucrats who conceive utilities as social agencies by extending their domain beyond a for-profit commercial enterprise. Utilities have had to offer special rates and other concessions to low-income households, accommodate, facilitate and even subsidize their competitors (e.g., via net metering, where the local utility buys back power from a rooftop solar customer at an inflated price) and renewable energy, invest in uneconomic new technologies where cost is subordinate to other factors (e.g., the effect on carbon emissions), subsidize energy efficiency, and achieve clean-air targets beyond federal and local mandates. 

That naturally leads to the question of whether society demands too much from electric utilities. We expect utilities to maintain financial viability, provide reliable and resilient service, make electricity affordable to all customers, adopt and accommodate new technologies that compete with their core business, decarbonize their generation portfolio, and promote less usage of electricity by their customers. No other private business comes to mind in which society believes that firms tackle such a wide range of social issues. 

As a side note, many economists argue that state and federal legislatures can best address the “affordability” problem either by supplementing the income of poor households—via cash subsidies with no strings attached—or providing in-kind assistance funded through general revenues, for example, in the form of “energy stamps”. Specifically, they contend that these actions are more effective and efficient than subsidizing the poor through utility rates. While their argument has sound economic merit, the reality is that political pressures and legislative mandates have led to electric and gas utilities’ initiatives to insulate low-income households from unaffordable utility bills. Another reality is that these actions, labelled pejoratively but accurately by some as “taxation by regulation,” have necessitated higher rates for the majority of customers to pay for subsidies targeted at a distinct minority.

Trying to appease different interests complicates regulatory efforts to achieve a political equilibrium (i.e., a consensus) and retain the traditional objective of utility regulation to assure “just and reasonable” prices and reliable service for households, businesses, and other users of utility services. Added objectives in recent years have clashed with the traditional objectives.

One example involves regulators facing intense pressure to favor clean energy sources. Consequently, they have had to grapple more with the economic inefficiencies of cost socialization and subsidies. One path is for regulators to encourage distributed generation, electric vehicles, and other new technologies—for example, by removing socially harmful regulatory barriers—but not to give away the store (e.g., setting a target for the share of electricity produced by renewable energy by 2030). Cost subsidization can be unfair to some customers as well as to competing third-party providers. Regretfully, we have evidence confirming that some jurisdictions have been at the forefront of bad policies that have inflicted a regressive tax-type wound on lower-income utility customers.

Regulatory Failure

Over the past several years, utility regulators have placed higher weights on non-traditional objectives like affordability, advancement of energy efficiency, renewable energy and other forms of clean energy. This has come at the cost of economic efficiency and equity. The latter outcome results from subsidies offered to certain technologies (e.g., energy-efficiency hardware, rooftop solar), paid for by utility customers with an average income below that of the beneficiaries. In other words, these subsidies have a regressive effect that skews in favor of higher-income customers.    

Regulatory failure, a term sometimes used by economists, is the sum of actions that lead to an undesirable outcome or performance that falls short of what the general public expects. As of today, it is unclear to what extent utility regulation has fallen short in this regard. However, I believe that the recent trend in utility regulation has drifted in the wrong direction.