Check out this article from Energy Central. A workshop in Topeka, Kansas has been trying to figure out how to incentivize Kansas utilities to embrace conservation. The local regulated utility summarizes the problem:
"We are totally committed to energy efficiency," said Chris Giles of Kansas City Power and Light, "as long as we can have the same level of return we would earn and prohibit the loss of profit margins."
Step one in the 12-step process is, after all, admitting that you have a problem, so I take this admission as a necessary (if not a sufficient) step in the right direction.
The sexy way du jour to address this is via decoupling, which -- through some mathematical rate manipulation -- enables utility revenues to be maintained even when their kWh sales fall. Needless to say, the Kansas hearings are investigating that, but as they do so, they're exposing some rather interesting problems with the theory. For instance:
... David Springe, director of the Citizens' Utility Ratepayer Board ... noted that utilities already have succeeded in moving much of their risk -- fuel costs, transmission costs, environmental costs -- onto consumers. Now utilities are asking that even more risk be assumed by the consumer.
"We've moved just about everything that is volatile to the customer," Springe said. "We have removed all of the risk. All that's left is, how do we give them more money?"
This idea was echoed later:
John Perkins, a consumer advocate from Iowa, said the idea that utilities' profits ought to be protected at all costs is wrong.
"It doesn't matter why our revenues are down," he said, offering a paraphrase of utilities' position. "Just give them back to us."
These are pretty compelling arguments, and ones that go to the heart of the so-called "regulatory compact." The state granted a monopoly and in return expects the utility to manage the grid and bear a certain (albeit limited) degree of risk. Consistently shifting that risk off of the utility and onto the customer ultimately breaks the compact or at least compels us to ask whether we ought to revisit our base assumptions.
At which point things get interesting.
Utility regulators have an obligation to ensure that utilities earn profits on their capital investments that are high enough to attract capital to their business, but not so high as to earn unfair profits for the utilities on the backs of their captive customers. Defining this magic return is hard, but it is guided by a general principle as follows:
A public utility is entitled to such rates as will permit it to earn a return equal to that generally being made at the same time and in the same general part of the country on investments in other business undertakings which are attended by corresponding risks and uncertainties.
In other words, the utility regulator needs to figure out how risky the utility investment is, find other folks making comparably risky investments (and attracting capital) and then give the utility a comparable return. In theory, that's easy. In practice, it's really hard -- for the simple reason that there are no unregulated businesses that face the same level of de minimus risk faced by a regulated monopoly. The difficulty of that calculation however, doesn't diminish the fundamental link between risk and return. Since decoupling lowers the risk faced by utility investments, logic suggests that it ought to also be coupled to a reduced rate of return. In non-utility speak, that means that decoupling should lead to lower electricity rates.
No utility is likely to remind their regulator of this linkage. But it has come up in this case, again from the Citizen's Utility Ratepayer Board:
[Springe] said that the justification for guaranteeing profits is that utilities assume risk when they make their investments, and thus deserve to be rewarded.
"Return on equity compensates them for risk," he said. "We have to have a substantial return on equity reduction."
Legally, he's spot on. Politically, that is of course a hard fight, but it's sure to be an interesting one.
Making buildings more efficient: rationalizing retrofit markets
Making buildings more efficient: looking beyond price
Comments
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JMG Posted 5:26 am
28 Aug 2008
There's a guy who works for the Wisconsin PUC (if the utilities haven't taken a contract out on him yet) who gives a great presentation on why we've been overly generous to utilities for decades.
In a nutshell, PUCs have been granting utilities exorbitant rates of return based on the assumption that the rates needed to attract capital are those paid to someone who holds only that single investment --- but, of course, nobody only invests in a single stock. Utilities are held by huge funds that invest in a whole portfolio of stocks and the utility stocks have the great virtue of being countercyclical to a bunch of other things (driven more by weather than most other things), which means that the overall risk of the portfolio goes down, justifying lower ROI rates.
Bottom line--as we make the risk of utilities go down towards that of savings bonds, the ROIs should approach that of savings bonds. Right now most IOUs are getting 11-12% or even more, which is a huge scam on ratepayers and a huge unearned windfall for shareholders.
The 5% Project
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Sean Casten Posted 5:43 am
28 Aug 2008
(I find this more compelling because if I understand your argument correctly, that would affect the utility's cost of equity - in the form of the value of their stock price - but not their return on invested capital as set in a rate case. I certainly buy the logic that cheap equity capital has bearing, but that gets even more academic, since it would - if pushed to the natural extreme - suggest that rate-set utility returns should be increased whenever the price of the publicly traded stock falls, which doesn't make much sense.)
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JMG Posted 6:35 am
28 Aug 2008
The 5% Project
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Pangolin Posted 6:44 am
28 Aug 2008
Seize the utilities by eminent domain and you to can have lower power costs through programs of conservation and resource management like SMUD in Sacramento CA does.
PG&E went bankrupt when the "free market" in legislators resulted in the looting of the state of California as well as all of the people who invested in it's stock. Deregulation at it's finest.
Some things are too important to be left up to markets and capitalists.
Put the Carbon Back
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Delay And Deny Posted 6:48 am
28 Aug 2008
Wind energy bumps into power grid's limits
http://news.cnet.com/Wind-energy-bumps-into-power-grids-l ...
The dirty secret of clean energy is that while generating it is getting easier, moving it to market is not.
The grid today, according to experts, is a system conceived 100 years ago to let utilities prop each other up, reducing blackouts and sharing power in small regions. It resembles a network of streets, avenues, and country roads.
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Sean Casten Posted 8:16 am
28 Aug 2008
PG&E and the other CA regulated utilities thus got caught in a squeeze when wholesale power prices exceeded retail and they were legally prohibited from raising rates to compensate. Thus, they not only lost money on every kWh they sold, but were also required to keep selling them.
There is a school of thought - and it is one to which I subscribe - that says that one of the risks faced by any business is the change in the regulatory environment, and therefore even though PG&E went bankrupt on account of gov't regs, that doesn't necessarily mean that the gov't has an obligation to cure. (Indeed, as a regulated utility, one can also argue that they had a more intimate knowledge of the changing CA regulations than any other market participant - hardly babes-in-a-wood, caught completely off-guard by the fact that retail price caps were coming, or that wholesale prices were not capped.)
That said, this school of thought is certainly not universal, and even those of us who subscribe to it still have some sympathy to PG&E's argument that since the gov't drove them bankrupt, they (or, more accurately, the government's underwriters... California taxpayers) should bail them out. Which of course, is what they did.
But in any event, note that this was hardly a case where markets and capitalists brought about the collapse of PG&E and subsequent tax-payer financed bailout. Quite the contrary: it was a really shoddy piece of regulation that was, at core, anti-market.
Moreover, while there were no shortage of shenanigans committed by unregulated market participants which were responsible for some of the wholesale power price spike, even that end of the equation is really not properly blamed on the market. The awkward truth is that much of what Enron and their ilk did in CA was not technically illegal. Amoral yes, but not illegal.
Because as much as the state failed to let markets into the distribution side of the business that remained under obligation to serve and retail price caps, they equally let wild-west capitalism into the wholesale market, without imposing any kind of market oversight to make sure that abuses didn't take place. Markets still require regulatory vigilance to make sure they are not manipulated, which is why we have anti-trust protections and all sorts of other rules in the markets we think of as being fully deregulated. CA didn't do this - they got rid of the rate-setting sheriff who had previously overseen the monopolies but failed to replace her with an anti-trust sheriff to oversee the capitalists. Thus again, the fault was the way the regulations were re-written, not the market forces per se.
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Wolverine Posted 9:04 am
28 Aug 2008
Privately owned utilities have absolutely no incentive to provide cleaner energy. Their overriding concern is to turn a profit for their shareholders, which is almost always contrary to environmental concerns.
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Sean Casten Posted 10:43 am
28 Aug 2008
Let's be a bit more nuanced, Wolverine.
If a utility is too intimately tied to the public good to allowed to compete (and hence, to fail), then it ought to be government owned. That is, after all, the role of government. On the other hand, if a utility is better incentivized by having a profit, competition and the fear of failure, then deregualate them completely and don't step in to bail them out when times get rough.
The regulated monopoly model we have today is the worst of both worlds - it lacks the fiscal discipline of a competitive business but lacks the customer-first mandate of a government entity. The worst thing we can do is maintain that mess.
But complete nationalization of utilities is hardly a cure-all, as the many socialist failures will attest (and indeed, as many gov't utilities will attest. The really big gov't utilities, a la TVA and BPA are hardly paragons of energy efficiency and PV, after all). Competition works on the generation side, given sufficient gov't oversight against anti-trust abuses. The high-voltage transmission system also has the potential to be competitive, at least for some parts. The low voltage distribution system, on the other hand really is a natural monopoly. (This is the wire running down your street. It doesn't make sense to run 5 wires down the same street to compete with one another, and so this does have certain natural monopoly characteristics.)
That suggests that the distribution system ought to be nationalized (or municipalized, as you wish). Get rid of the profit that serves only as a tax on the price and the facade of a competitive business. But the rest of the system is quite amenable to competition.
The PG&E case I cited was not at all because I'm in favor of protecting my poor regulated brethren. (After all, last time I checked, $300 billion/year in steady revenues doesn't quite qualify as "poor"!) It's because it highlights the failures of our regulatory model that consistently insists that half-pregnant is a viable alternative.
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