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Restoring Financial Balance

With looming mandates and aging infrastructure, utilities need regulatory support.

Fortnightly Magazine - November 2011

How can you tell if your utility regulator has gone too far in imposing costly mandates or denying adequate recovery of legitimate costs? What are the proper bounds for protecting the interests of a privately owned enterprise alongside those of the public if the relationship has become too one-sided? How can you restore the right balance?

The ongoing interactions between utility interests, the regulators and the public are guided in the broadest sense by a combination of legislative mandates, commission rulemakings and legal precedents. Some analysts have developed a short-form set of principles that summarize the scope of regulation by articulating a “regulatory compact” of quid pro quo exchanges that underlie the regulatory process. The concept dates back to the beginnings of utility regulation. The government determined that utilities, as natural monopolies, needed to be regulated lest they exercise monopoly market power. To prevent monopoly abuse, while maintaining access to capital in a highly capital-intensive industry, utilities were insulated from most competitive risks—but had to accept lower rates of return on their investments.

Some idealists might believe that the regulatory compact represents a well-established, balanced working arrangement that guides regulators’ actions in what is often an adversarial process. Some might even say that the process has remained fairly stable over time. The reality, however, is that the balancing of stakeholder interests has shifted considerably over the past few decades toward the consumer and special interests who seek to advance a particular agenda through utility regulation. The shift undoubtedly reflects the economic, political, and social sentiments du jour . There’s evidence of this trend in numerous areas of the utility regulatory process. The relevant question is whether a more sustainable balance can be found, because without that balance, utility service quality and consumer interests ultimately might suffer.

Compact History

To understand the need for a sustainable balance between utilities’ needs and the perceived public interest, we must begin with the regulatory compact itself. The foundation of this agreement is the system of rights and obligations that emanate from the legislative and judicial processes (See Figure 1) .

Both the rights and obligations are often constrained by the regulatory process itself. Thus, there is no unlimited obligation to serve, but rather an obligation constrained by a variety of legislative and regulatory policies related to payment, service continuation, and line extension rules, for example. Similarly, the utility’s right to a reasonable rate of return is constrained to a return on assets that are used and useful, whose costs have been prudently incurred.

Those involved in the regulatory process might appreciate that the construction of the regulatory compact reflects a long legislative and judicial history dating back to the 1800s in the United States, and further back in other parts of the world. One need only to open the cost-of-capital testimony submitted in a rate proceeding to find reference to the U.S. Supreme Court Hope