In fall 2004, Navigant Consulting conducted a comprehensive survey1 to solicit the insights of utility leaders into the key challenges surrounding regulatory uncertainty, and the implications on the rate-case and ratemaking activities of gas and electric distribution utilities. The message, heard loud and clear, was that regulatory uncertainty is real and remains one of the most critical issues in the North American energy industry. It must be better managed.
For this year's survey, cognizant that state and provincial utility regulators keenly are aware of industry concerns surrounding regulatory uncertainty and have important perspectives to share on various issues, Navigant Consulting solicited perspectives from both utility executives and state or provincial regulators who oversee the operations of these utilities.2 Our objective was to compare and contrast the perspectives, priorities, and actions of utility executives and regulators in an effort to promote a better understanding of regulatory uncertainty between both groups, and to provide an issues-oriented platform to identify possible industry-wide solutions to minimize future regulatory uncertainty.
Survey respondents were asked to identify: (1) the major causes of regulatory uncertainty; (2) the key regulatory objectives that utilities and regulators desire to achieve; (3) the challenges to the regulatory process and the various actions that, if taken, could enhance the process; and (4) the challenges to the rate-case process and the various actions that can enhance the process.
Utility leaders and regulators exhibited their divergent views as to the major causes of regulatory uncertainty as shown in Figure 1. Interestingly, 80 percent of utility leaders indicated that the most important cause was "the potential for cost disallowances in after-the-fact prudence reviews," while regulators overwhelmingly (100 percent) stated that it was the "changing perspectives of regulators over time in addressing customer and shareholder issues." Despite their differences in ranking the causes of regulatory uncertainty, both groups agreed in other causal areas, most notably "not knowing the longer-term direction and progression of regulatory decisions" and "not being able to secure from regulators pre-approval of major infrastructure investments."
Approximately 90 percent of survey respondents either "strongly agreed" or "agreed" with the proposition that regulatory uncertainty is caused by "changing regulatory standards and expectations for the operational and financial performance of utilities." This may be indicative of the recent experiences of utilities, regulators, and other stakeholders related to the pronounced increase in rate-case activity during the last 12 months.
Survey respondents also provided their own comments regarding the causes of regulatory uncertainty, such as "failure of federal legislators and regulators to anticipate the unintended consequences of actions" and "erratic and/or dramatic changes in direction and policy at the federal and state levels."
Survey respondents were asked their opinions as to what specific actions the regulator or utility must undertake to address each cause that most contributed to regulatory uncertainty. Not surprisingly, the utility respondents focused on the after-the-fact prudence review topic. Typical of the comments received from utility respondents were the following actions:
The regulators also weighed in with their own actions to address regulatory uncertainty. Their comments included the following actions:
From these results, it is encouraging to see both utilities and regulators offering these types of constructive actions to address the challenge of managing regulatory uncertainty. Nevertheless, the real challenge will be how to undertake such actions within the context of the current regulatory environment. To accomplish some of these objectives, each group must take the initiative to begin the process of change, and each must believe that the other party will commit to do the same. Other parts of this survey will provide further insights into how challenging this goal might be to achieve in light of the various comments provided by survey respondents related to "best practice" principles associated with the regulatory process, the building of trust, and their perceptions of the rate-case process.
In an effort to better understand how regulatory uncertainty affects the distribution utility segment of the energy industry, survey respondents were asked to identify the most important regulatory objectives for a distribution utility to achieve, and the most important objectives for a utility regulator to achieve. Interestingly, as Tables 1 and 2 indicate, there was a fairly strong consensus among utility leaders and regulators as to the most important objectives for utilities and regulators. This is a desirable outcome, but the resulting actions that utilities and regulators actually take, and the related processes that they adopt in an effort to achieve these objectives, can be an entirely different story.
The perceptions of one group concerning the actions of the other group in addressing and achieving these objectives over a period of time can lead to disagreements concerning approach or style, and result in differences of opinion that cloud the original intent of each group's worthy efforts. Recognizing the age-old adage, "actions speak louder than words," it is thought that much of the strained relations that exist today between utility leaders and regulators is the byproduct of misperceptions created by past actions or styles inconsistent with the original business and regulatory objectives stated by these groups.
One way to define the regulatory process is in terms of the various roles and responsibilities of utility regulators. We asked survey respondents to indicate their views as to the relative importance of these roles. The results, provided in Figure 2, underscore the different business and market outlooks taken by utilities and regulators on the utility distribution segment of the energy industry. These two groups find consensus in the fundamental roles and responsibilities of regulators-regulation of natural monopolies and advising the government-but there is little agreement when it comes to regulatory roles and responsibilities dealing with performance issues for both utilities and the markets in which they operate. Presumably, utilities believe that the establishment of quality and performance standards is less important as part of the regulatory process. Utilities claim they already embrace these standards by having to respond to customer needs, market pressures and competitive threats, and specific management initiatives. Many utilities also believe the market is self-policing and that if the "rules of the road" are properly set, regulatory monitoring of market behavior and performance is unnecessary. The survey results suggest that regulators believe the establishment of quality and performance standards, and the monitoring of market behavior, are both important aspects of their jobs, and that utilities cannot, or are not willing to, adopt these concepts without specific regulatory directives and oversight.
Survey participants also were asked to think about the "best practices" principles that can guide the specific activities of a particular regulatory body, and to indicate the relative degree of effectiveness of the regulatory body for which survey respondents worked, or under whose jurisdiction they operated ().
In summarizing these rankings, Table 3 contrasts the views between regulators and utility survey respondents in the five areas that the majority of regulator survey respondents saw themselves as "Most Effective/More Effective." We observed the greatest difference of opinion for the following three best practice principles: independence, predictability, and flexibility.
We also asked utility leaders and regulators to identify specific actions that could improve a regulatory body's overall effectiveness. Both groups provided many suggested actions, some of which are shown below.
The building of trust between the utility and the regulator greatly can enhance the effectiveness and efficiency of the regulatory process. With this premise, we asked survey respondents about the strength of their opinions as to the actions a utility and regulator each could take to build the greatest amount of trust between them. Table 4 shows how each group weighted these actions, with some carrying equal weight within each respondent group.
While ranking the effectiveness of these actions, survey respondents remained cognizant of the nature and the prospect for success in implementing such actions, commenting, "You can never 'fully disclose' to another party's complete satisfaction"; "[Parties should] not be bound by traditional thinking, or by an 'us/them' mentality"; "Better dialogue consistent with rigorous and ethical standards"; "Focus on goals, performance rather than micro-managing the process."
Based on recent rate-case experience, survey respondents identified actions that would make the rate-case process less adversarial and controversial, but more predictable and effective. Comments from utilities and regulators reflect a mutual awareness, and in some cases, agreement as to the positive steps that each party can bring to the regulatory process. A sampling follows.
Finally, we asked survey respondents to indicate the single most important change to the rate-case process that would improve stakeholder response to the utility's rate increase request and related proposals. The types of changes they identified focused on areas dealing with the need for better and more open communications, more transparency in the process, greater education, more efficient and understandable rate-case processing procedures, the need for an expedited regulatory decision schedule, reduced and more focused filing requirements, and fostering a better understanding of why the utility's rate increase is necessary.
After cutting through all the perspectives and suggested actions provided by survey respondents, we believe the single biggest obstacle that must be overcome to manage regulatory uncertainty is the lack of trust between utility leaders and regulators. The trust issue affects virtually all of the roles, responsibilities, and best-practice principles of regulators, and it greatly influences their interaction with the utilities they regulate.
In response to the ongoing transformation of the energy industry, it is well understood that the role of regulation-its focus, processes, and resources-must change. However, the correct solution and path to change often lies in the eyes of the beholder and varies considerably among utilities and regulators. Therefore, it is absolutely critical and incumbent upon utility leaders and regulators to ensure their intentions are well known to the other through open, honest communication and complete disclosure of the facts, and that this approach permeate throughout their respective organizations so that interactions at all levels are sensitized. Most important, it must occur at both the commissioner and staff levels. Although the process undoubtedly will be a continuous one, eventually the building of trust should instill a belief that each group will "do the right thing," which should over time enable utility leaders and regulators to focus on performance rather than simply on "one-off" rate case outcomes. The actions of utility leaders and regulators must be compatible so that utilities can continue to provide safe, reliable, and cost-effective services in a financially responsible manner and meet tomorrow's industry challenges.