Electricity Regulation In The US: A Guide
Electricity RegulationIn the US:A Guide
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ElectricityRegulationin the US:A GuideMarch 2011The Regulatory Assistance ProjectHome Office50 State Street, Suite 3Montpelier, Vermont 05602phone: 802-223-8199fax:802-223-8172www.raponline.org
Electricity Regulation in the US: A GuideContents1About This Guide To Utility Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12The Purpose of Utility Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32.1 Utilities are Natural Monopolies2.1 The Public Interest is Important2.2 Regulation Replaces Competition as the Determinant of Prices2.3 The So-Called Regulatory Compact2.4 All Regulation is Incentive Regulation3A Brief History of Regulation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73.1 Grain Terminals and Warehouses, and Transportation3.2 Utility Regulation3.3 Restructuring and Deregulation4Industry Structure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94.1 Overview4.1.1 Investor-Owned Utilities (IOUs)4.1.2 Public Power: Municipal Utilities,Utility Districts, Cooperatives, and Others4.2 Vertically Integrated Utilities4.3 Distribution-Only Utilities4.4 Federal vs. State Jurisdiction4.4.1 Power Supply4.5 Power Supply Structure and Ownership4.5.1 Federal Power Marketing Agencies4.5.2 Regulation of Wholesale Power Suppliers/Marketers/Brokers4.5.3 Non-Utility Generators4.5.4 Consumer-Owned Utilities (COUs)4.5.5 Retail Non-Utility Suppliers of Power4.5.6 Transmission4.6 Managing Power Flows Over the Transmission Network4.6.1 RTOs, ISOs and Control Areas4.7 Natural Gas Utilities5The Regulatory Commission . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205.1 Commission Structure and Organization5.2 Appointed vs. Elected5.3 Limited Powers5.4 Consumer Advocates5.5 COU Regulationii
Electricity Regulation in the US: A Guide6What Does The Regulator Actually Regulate?. . . . . . . . . . . . . . . . . . . . . . . . . . 246.1 The Revenue Requirement and Rates6.2 Resource Acquisition6.3 Securities Issuance6.4 Affiliated Interests6.5 Service Standards and Quality6.6 Utility Regulation and the Environment7Participation in the Rulemaking Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297.1 Rulemaking7.2 Intervention in Regulatory Proceedings7.3 Stakeholder Collaboratives7.4 Public Hearings7.5 Proceedings of Other Agencies Affecting Utilities8Procedural Elements of US Tariff Proceedings . . . . . . . . . . . . . . . . . . . . . . . . 318.1 Filing Rules8.2 Parties and Intervention8.3 Discovery8.4 Evidence8.5 The Hearing Process8.5.1 Expert Testimony8.5.2 Public Testimony8.6 Settlement Negotiations8.7 Briefs and Closing Arguments8.8 Orders and Effective Dates8.9 Appeal9The Fundamentals of Rate Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369.1 Functional and Jurisdictional Cost Allocation9.1.1 Interstate System Allocation9.1.2 Regulated vs Non-Regulated Services9.1.3 Gas vs. Electric9.2 Determining the Revenue Requirement9.2.1 The “Test Year” Concept9.2.1.1 Historical vs. Future Test Years9.2.1.2 Average vs. End-of-Period9.2.2 Rate Base9.2.3 Rate of Return9.2.3.1 Capital Structure9.2.3.2 A Generic Rate of Return Calculation9.2.3.3 Cost of Common Equity9.2.3.4 Cost of Debt9.2.4 Operating Expenses9.2.4.1 Labor, Fuel, Materials and Outside Services9.2.4.2 Taxesiii
Electricity Regulation in the US: A Guide9.2.4.3 Depreciation9.2.5 Summary: The Revenue Requirement9.3 Allocation of Costs to Customer Classes9.3.1 Embedded vs. Marginal Cost of Service Studies9.3.2 Customer, Demand and Energy Classification9.3.3 “Vintaging” of Costs9.3.4 Non-Cost Considerations9.4 Rate Design Within Customer Classes9.4.1 Residential Rate Design9.4.2 General Service Consumers9.5 Bundled vs. Unbundled Service9.6 Advanced Metering and Pricing9.7 Service Policies and Standards9.8 Issue-Specific Filings9.9 Generic Investigations9.10 Summary: The Fundamentals of Regulation10 Drawbacks of Traditional Regulation and Some Fixes . . . . . . . . . . . . . . . . . . 5910.1 Problems10.1.1 Cost-Plus Regulation10.1.2 The “Throughput” Incentive10.1.3 Regulatory Lag10.2 Responses10.2.1 Decoupling, or “Revenue-Cap” Regulation10.2.2 Performance-based, or “Price-Cap” Regulation10.2.3 Incentives For Energy Efficiency or other Preferred Actions10.2.4 Competitive Power Supply Contracting10.2.5 Restructuring10.2.6 Prudence and Used-and-Useful Reviews10.2.7 Integrated Resource Planning11 Transmission and Transmission Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . 6411.1 Transmission System Basics11.2 Transmission Ownership and Siting11.3 Transmission Regulation12 Tariff Adjustment Clauses, Riders, and Deferrals . . . . . . . . . . . . . . . . . . . . . . 6912.1 Gas Utility-Purchased Gas Adjustment Mechanisms12.2 Electric Utility Fuel Adjustment Mechanisms12.3 System Benefit Charges for Energy Efficiency and Clean Energy12.4 Infrastructure and Other “Trackers”12.5 Weather-Only Normalization12.6 Deferred Accounting and Accounting Ordersiv
Electricity Regulation in the US: A Guide13 Integrated Resource Planning/Least-Cost Planning . . . . . . . . . . . . . . . . . . . . 7313.1 What is an IRP?13.2 How Does an IRP Guide the Utility and the Regulator?13.3 Participating in IRP Processes13.4 Energy Portfolio Standards and Renewable Portfolio Standards .13.5 How an IRP Can Make a Difference14 Energy Efficiency Progams . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7714.1 Why Are Utility Commissions Involved?14.2 Utility vs. Third-Party Providers14.3 Range and Scope of Programs14.4 Cost Causation and Cost Recovery14.5 Total Resource Cost, Utility Cost, and Rate Impact Tests14.6 Codes, Standards, and Market Transformation15 Aligning Regulatory Incentives With Least-Cost Principles . . . . . . . . . . . . . 8515.1 Effect of Sales on Profits15.2 Techniques for Aligning Incentives15.2.1 Decoupling15.2.2 Lost Margin Recovery15.2.3 Frequent Rate Cases15.2.4 Future Test Years15.2.5 Straight Fixed-Variable Pricing (SFV)15.2.6 Incentive/Penalty Mechanisms16 Regulatory Treatment of Emission Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9116.1 Currently Regulated Emissions16.2 Anticipated Regulation16.3 Commission Treatment of Emissions Management Costs17 Low-Income Assistance Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9417.1 Rate Discounts17.2 Energy Efficiency Funding17.3 Bill Assistance17.4 Payment Programs17.5 Deposits17.6 Provision for Uncollectible Accounts17.7 Disconnection/Reconnection18 Service Quality Assurance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9819 Smart Grid. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10020 Summary: Regulation in the Public Interest . . . . . . . . . . . . . . . . . . . . . . . . . . 104Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105v
Electricity Regulation in the US: A Guidevi
Electricity Regulation in the US: A Guide1. About This Guide toUtility Regulation1Over the past 140 years, society has undergone a fundamentaltransformation. The invention of the incandescent light bulbin the 1870s introduced lighting as one of the first practicallyavailable uses of electrical power. Electric utilities began to springup in major cities during the 1890s, and by the 1900s they were spreadingrapidly across the U.S. The National Academy of Engineering designatedelectrification as the 20th century’s greatest engineering achievement, beatingthe automobile, computers, and spacecraft.This conclusion is hardly surprising when one considers the intricate webof wires that connects every light switch in the U.S. to massive power plants,individual rooftop solar panels, and every source of electricity generationin between. Add to this the layer of pipes that run underground to feedstovetops, power stations, and factories with natural gas, and you havethe foundation on which modern society has been built. The utility gridcontinues to grow as the U.S. population expands and demand for energyincreases. In 2009, the U.S. consumption of energy was 95 quadrillionBtus; this energy powers industry, transportation, residential homes, andcommercial establishments throughout the country. Regulation of the utilitysystem has also evolved over the past 140 years to ensure that the system isreliable, safe, and fairly administered. This guide will focus on electric andnatural gas utility regulation in the U.S., and is meant to provide a basicunderstanding of the procedures used and the issues involved.The purpose of this guide is to provide a broad perspective on the universeof utility regulation. The intended audience includes anyone involved in theregulatory process, from regulators to industry to advocates and consumers.The following pages first address why utilities are regulated, then provide1 Material from two federally produced handbooks to the utility sector are used and referencedliberally throughout these pages, as are many historical works. This guide was writtenprimarily by RAP Senior Advisor Jim Lazar, an economist with over 30 years’ experience inutility regulation. The RAP review team included Rick Weston, Rich Sedano, Riley Allen,David Farnsworth, Christopher James, Edith Pike-Biegunska, Wayne Shirley, and CamilleKadoch. Editorial and publication assistance was provided by Thad Curtz and Diane Derby.1
Electricity Regulation in the US: A Guidean overview of the actors, procedures, and issues involved in regulation ofthe electricity and gas sectors. The guide assumes that the reader has nobackground in the regulatory arena, and serves as a primer for new entrants.It also provides a birds-eye view of the regulatory landscape, includingcurrent developments, and can therefore serve as a review tool and point ofreference for those who are more experienced.These chapters will briefly touch on most topics that affect utilityregulation, but will not go into depth on each topic as we have tried to keepthe discussion short and understandable. For more in-depth analysis ofparticular topics, please refer to the list of reference materials at the end ofeach section. RAP Issuesletters, which provide a more comprehensive reviewof many topics in this guide, are available online at www.raponline.org. Also,a lengthy glossary appears at the end of this guide to explain utility-sectorterms.2
Electricity Regulation in the US: A Guide2. The Purpose ofUtility RegulationElectric and natural gas utilities that deliver retail service toconsumers are regulated by state, federal, and local agencies.These agencies govern the prices they charge, the terms of theirservice to consumers, their budgets and construction plans, andtheir programs for energy efficiency and other services. Utility impactson air, water, land use, and land disposal are typically regulated by othergovernment agencies. Environmental regulation is generally beyond thescope of this guide, but the pages that follow do identify ways in whichutility regulation can be reformed so as to achieve, or at least not undermine,environmental policy objectives.Two broad, fundamental principles justify governmental oversight of theutility sector. First, since a utility provides essential services for the wellbeing of society — both individuals and businesses — it is an industry“affected with the public interest.” The technological and economic featuresof the industry are also such that a single provider is often able to serve theoverall demand at a lower total cost than any combination of smaller entitiescould. Competition cannot thrive under these conditions; eventually, allfirms but one will exit the market or fail. The entities that survive are callednatural monopolies — and, like other monopolies, they have the power torestrict output and set prices at levels higher than are economically justified.Given these two conditions, economic regulation is the explicit public orgovernmental intervention into a market that is necessary to achieve publicbenefits that the market fails to achieve on its own.This section covers the overall context in which utility regulation operates,as a preface to discussing the structure of the current industry and theregulatory framework that has evolved with it.2.1. Utilities are “Natural Monopolies”In 1848, John Stewart Mill published an analysis of natural monopolies,noting that, “(a) Gas and water service in London could be supplied at lowercost if the duplication of facilities by competitive firms were avoided; and3
Electricity Regulation in the US: A Guidethat (b) in such circumstances, competition was unstable and inevitably wasreplaced by monopoly.”2 The natural monopoly concept still applies to at leastthe network components of utility service (that is, to their fixed transportand delivery facilities). However, even where there is sufficient competitionamong the providers of energy supply and/or retail billing service, the utilitysector’s critical role in the infrastructure of modern, technological societyjustifies its careful oversight.2.2. The Public Interest Is ImportantRegulation is intended to protect the “public interest,” which comprises avariety of elements.Utilities are expected to offer (and in the United States, provide) service toanyone who requests it and can pay for it at the regulator’s (or government’s)approved prices. In this sense, service is “universal.” A connection chargemay be imposed if providing service involves a significant expenditure by theutility, but even that is subject to regulation and, in many cases, is subsidizedin some manner by other customers or taxpayers.3While some public services, like fire and police protection, are providedby government without many direct charges to users, utilities (evenwhen government-owned) are almost always operated as self-supportingenterprises, with regulations dictating the terms of service and prices.Utilities must also adhere to strict government safety standards, becausetheir infrastructure runs throughout our communities and the publicwould be affected by sagging wires, ruptured pipes, and other problems.The production and distribution of electricity and natural gas also haveenvironmental and public health impacts — by the emission of pollutants,on scenic views and land uses, and even from noise — that can adverselyaffect the public. Generating power often produces pollution; transmissionlines have both visual and physical impacts on land use; and the availabilityof natural gas creates opportunities to use less-polluting fuels than oil or coal.2 John Stewart Mill, cited in Garfield and Lovejoy, Public Utility Economics, 1964, P. 153 Strictly speaking, a subsidy exists when a good or service is provided at a price that is belowits long-run marginal cost — i.e., the value of the resources required to produce any moreof it. While some market theorists argue for pricing based on short-run marginal cost, thatissue here is, in our view, an accident of history. In general equilibrium — where the marketis operating as efficiently as it can and total costs are minimized — long-run and short-runmarginal costs are the same, because the cost of generating one more unit from an existingpower plant is the same as the cost of building and operating a new, more efficient powerplant. Certainly, the long run —that period of time in which all factors of production (capitaland labor) are variable — is the sensible context in which to consider the public-policyconsequences of utility matters, since investments in utility infrastructure are, for the mostpart, extremely long-lived.4
Electricity Regulation in the US: A GuideRegulators may therefore impose environmental responsibilities on utilities toprotect these public interests.Because most utility consumers cannot “shop around” between multipleproviders as a result of the natural utility monopoly, regulation serves thefunction of ensuring that service is adequate, that companies are responsiveto consumer needs, and that things like new service orders and billingquestions are handled responsively. In addition, the utility is often a conduit— through the billing envelope or other communications — for informationthat regulators consider essential for consumers to receive.Finally, given utilities’ crucial role in the economy and in society’s generalwelfare, service reliability standards are often imposed as well.2.3. Regulation Replaces Competition as theDeterminant of PricesFor most businesses, the prices of goods or services that are sold aredetermined by what the customer or market will bear. In economic terms,markets will “clear” at the point where marginal costs equal the value thatconsumers, in the aggregate, set for the good or service; that is at the pointwhere supply intersects with demand. A different approach to price-settingis required for utilities, since competition and free entry into markets doesnot exist in natural monopolies. Regulators use a cost of service approachto determine a fair price for electric service, by which the aggregate costs(including a reasonable return of, and on, investment) for providing eachclass of service (residential, commercial, and industrial) are determined.Prices are set to recover those costs, based on the sales volumes for each class.2.4. The So-Called Regulatory CompactIt is occasionally argued that regulation constitutes an agreement betweena utility and the government: the utility accepts an obligation to serve inreturn for the government’s promise to set rates that will compensate it fullyfor the costs it incurs to meet that obligation. This agreement is sometimescalled the regulatory compact.Although this phrase is often heard, there is in fact no binding agreementbetween a utility and the government.4 Regulation is an exercise of thepolice power of the state, over an industry that is “affected with the publicinterest.” Its need arises primarily from the monopoly characteristics of the4 This is true in the United States. In other parts of the world, however, regulation by contractis quite common.5
Electricity Regulation in the US: A Guideindustry, and its general objective is to ensure the provision of safe, adequate,and reliable service at prices (or revenues) that are sufficient, but no morethan sufficient, to compensate the regulated firm for the costs (includingreturns on investment) that it incurs to fulfill its obligation to serve. The legalobligations of regulators and utilities have evolved through a long series ofcourt decisions, several of which are discussed in this guide.52.5. All Regulation is Incentive RegulationSome analysts use the term incentive regulation to describe a system inwhich the regulator rewards utilities for taking actions to
4.1.1 Investor-Owned Utilities (IOUs) 4.1.2 Public Power: Municipal Utilities, Utility Districts, Cooperatives, and Others 4.2 Vertically Integrated Utilities 4.3 Distribution-Only Utilities 4.4 Federal vs. State Jurisdiction 4.4.1 Power Supply 4.5 Power Supply Structure and Ownership 4.5.1 Federal Power Marketing Agencies
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