The governors of New Jersey and Maryland have embarked on a crusade that could topple competitive energy markets in their states—and perhaps beyond. Glen R. Thomas, former chairman of the...
fair rate of return or that lengthen the time between rate cases. There are at least three potential ways to reduce rate of return contention.
Unbundling and deregulation. The airline industry, trucking industry, gas production and transport, and electricity generation capacity once fell under comprehensive rate of return regulation but were subsequently deregulated either partially or fully.
Unbundling and deregulation reduces rate of return battles because they reduce the size of the asset base subject to rate regulation. In other words, with a smaller pie, there should be less incentive to fight. For example, in what I called the "contractualization" of the U.S. interstate gas transport industry, the determination of the fair rate of return has become increasingly less important as contractual obligations between gas transporters and distributors replace traditionally regulated rates. And if rate regulation ends completely, then the reason for the fight over rate of return vanishes.
Reduce the number of contested issues. Permitting cost pass-throughs like fuel adjustment clauses, weather adjustments, revenue decoupling mechanisms, and other techniques that remove attrition, 4 reduces the need for filing frequent rate cases because it eliminates factors outside of management's control.
Institutionalized price cap regulation. Price cap regulation, or performance-based regulation (PBR), allows prices to be indexed to both the general price level and durable industrywide productivity trends. As such, it has reduced the frequency of contested price-setting cases where rate of return is an issue. However, PBR regulation does not prevent rate of return from arising as an issue when it does appear.
In conclusion, contention over the fair rate of return is an unavoidable component of utility regulatory oversight, even under alternative frameworks. Efforts to make the process objective and mechanical are futile as an administrative and practical matter. The only realistic way to reduce rate of return contention over the long term is to unbundle and deregulate utility functions (like gas transmission), and lengthen the time between rate cases by instituting PBR or other progressive regulatory programs.
For the rate of return contention that does exist, it is hard to foresee abandoning the DCF as the gold standard relied upon so heavily by U.S. commissions and utilities for the past couple of decades. From the perspective of dispute-resolution techniques and simple efficiency, the DCF-despite its difficulties-retains attributes that other rate of return methods just cannot match.
- Justice Robertson, Mississippi Supreme Court, State of Mississippi et al, v. Mississippi Public Service Commission and Mississippi Power Company, Jan. 4, 1989.
- In reality, this issue has, alas, never gone away entirely.
- Regulatory commissions outside the United States do not have the luxury of either such deep capital markets (with many publicly traded companies in the same industry) or the associated vast array of stock analysts. As a result, they use other methods, but with less robust results and often more extensive contention.
- Attrition occurs when earnings are depressed over time because the marginal cost of new plant and equipment exceeds average costs and average prices.
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