Bravo! I’ve been searching for alternative approaches when it comes to dealing with the natural monopolies of electric utilities.
As I digest the dense information from this podcast, I am wondering about a few things:
1. The financial impact PBRs have on IOUs - Most IOUs are public companies that offer stock on a stock exchange and provide a dividend. These IOUs are attractive investments for those who are looking for low risk investments. I am wondering if the impact of PBRs changes the financial performance behavior of IOUs. And if it does, what are the ripple effects?
2. It was noted in the beginning, PBRs are associated with IOUs. IOUs are not the only entity providing electricity to customers. I am wondering what is behind the rate design of publicly owned utilities and coops. Is a variant of PBRs the basis of the rate designs of publicly owned utilities and coops?
3. IOUs, by the very nature of their natural monopoly position and their regulation-based business environment for such a long time, have an instilled culture that when it needs to change, it does so in a slow manner. After all, it has an obligation to assess risk against being able to deliver electricity in a safe and reliable manner.
To alter the culture, so that it deals with risk in different ways that opens the door to change and innovation, it must have the people who can think differently. I wonder if the leadership of IOUs are those people who can think differently.
The utility industry has high propensity for capital due to ongoing load growth and replacement and refurbishment of existing generation, transmission, and distribution (GTD) infrastructure. Even with aggressive energy, efficiency, demand response, and distributed energy resources, the nature of the business is, and will in large part remain, the production and delivery of electricity by means of capital- intensive facilities.
Command over capital as a means of corporate survival and growth is not just desirable, but an utter necessity for electric utilities. To attract capital, investor-owned utilities must have an overarching corporate objective to increase shareholder value (SV), largely a function of rate base (RB) , rate of return (ROR), and kilowatt hour sales, and the level of the return on equity (ROE) relative to the utility’s cost of capital. If the ROE is higher, then the utility’s SV will be higher than if ROE is lower, all else being equal.
Regulators are supposed to set the authorized ROE at a level equal to the cost of equity capital. While the cost of equity capital is not directly measurable, there are many indications, both quantitative and anecdotal, suggesting that the cost of equity in the economy, (particularly for an investment such as a utility company that is generally of lower risk than the market as a whole), is lower than currently authorized utility ROE levels.
If the ROE is higher than the cost of capital, the result is that the investor owned utility (IOUs) obtain even more benefits from increasing RB through new steel-in-the-ground investments, particularly when the IOUs’ stock is selling above book value
Decoupling mechanisms do not change the underlying basis of the IOUs’ business model. Decoupling mechanisms addresses the short run (between rate case) requirement that revenues from electricity sales be sufficient to recover, but not exceed, the regulatory allowed cost of current capital investments
The cost of new “steel in the ground” projects are included in periodic rate case filings where increases in allowed revenues are accompanied by upward adjustments to historic sales data. Decoupling mechanisms do not dissolve the underlying truth that sales growth - be it kilowatt hours or widgets - is what makes the world go ‘round for the capitalist business model.
In fact, by reducing the utility’s overall business risk, decoupling mechanism reduces the utility’s cost of capital. If the utility’s rate of return is not reduced to reflect the lower risk (commensurate with the reduction in the cost of capital), decoupling mechanisms may have far different short-term and long-term impacts. Giving a utility decoupling protection without reducing the return on equity to reflect the reduced risk would skew utility shareholder incentives toward growth in capital investments by not recognizing the risk reduction. Thus, where the rate of return is above the cost of capital to begin with, it ends up even farther above the cost of capital adjusted for the reduced risk than if decoupling did not exist.
Thus, decoupling mechanisms may actually provide long-term incentives to reduce energy efficiency, demand response, and distributed energy resources effectiveness (particularly in peak demand periods) to promote capital spending. The most fundamental way to motivate utilities to procure energy efficiency, demand response, and distributed energy resources is to stop making supply-side investments so attractive.
The utility industry has high propensity for capital due to ongoing load growth and replacement and refurbishment of existing generation, transmission, and distribution (GTD) infrastructure. Even with aggressive energy, efficiency, demand response, and distributed energy resources, the nature of the business is, and will in large part remain, the production and delivery of electricity by means of capital- intensive facilities.
Command over capital as a means of corporate survival and growth is not just desirable, but an utter necessity for electric utilities. To attract capital, investor-owned utilities must have an overarching corporate objective to increase shareholder value (SV), largely a function of rate base (RB) , rate of return (ROR), and kilowatt hour sales, and the level of the return on equity (ROE) relative to the utility’s cost of capital. If the ROE is higher, then the utility’s SV will be higher than if ROE is lower, all else being equal.
Regulators are supposed to set the authorized ROE at a level equal to the cost of equity capital. While the cost of equity capital is not directly measurable, there are many indications, both quantitative and anecdotal, suggesting that the cost of equity in the economy, (particularly for an investment such as a utility company that is generally of lower risk than the market as a whole), is lower than currently authorized utility ROE levels.
If the ROE is higher than the cost of capital, the result is that the investor owned utility (IOUs) obtain even more benefits from increasing RB through new steel-in-the-ground investments, particularly when the IOUs’ stock is selling above book value
Decoupling mechanisms do not change the underlying basis of the IOUs’ business model. Decoupling mechanisms addresses the short run (between rate case) requirement that revenues from electricity sales be sufficient to recover, but not exceed, the regulatory allowed cost of current capital investments
The cost of new “steel in the ground” projects are included in periodic rate case filings where increases in allowed revenues are accompanied by upward adjustments to historic sales data. Decoupling mechanisms do not dissolve the underlying truth that sales growth - be it kilowatt hours or widgets - is what makes the world go ‘round for the capitalist business model.
In fact, by reducing the utility’s overall business risk, decoupling mechanism reduces the utility’s cost of capital. If the utility’s rate of return is not reduced to reflect the lower risk (commensurate with the reduction in the cost of capital), decoupling mechanisms may have far different short-term and long-term impacts. Giving a utility decoupling protection without reducing the return on equity to reflect the reduced risk would skew utility shareholder incentives toward growth in capital investments by not recognizing the risk reduction. Thus, where the rate of return is above the cost of capital to begin with, it ends up even farther above the cost of capital adjusted for the reduced risk than if decoupling did not exist.
Thus, decoupling mechanisms may actually provide long-term incentives to reduce energy efficiency, demand response, and distributed energy resources effectiveness (particularly in peak demand periods) to promote capital spending. The most fundamental way to motivate utilities to procure energy efficiency, demand response, and distributed energy resources is to stop making supply-side investments so attractive.
I'm a community organizer, fought the local electric muni over a solar fixed fee (standby service rider) on new solar. Something like 165 IOUs and 2000 munis across the US. I would love to see a discussion around regulating the unregulated "public power" muni monopoly where rates/energy policy are solely decided by a city council (i.e. no state PRC oversight and exempt from state energy transition plans). Here in oil/gas/coal country (Northwest New Mexico) their IRPs/COSSs (by a selected pro-utility consultant) are always gas generation weighted (No VOS/LCOE) with lip service to installing solar. Folks have told me to get out the vote to elect a pro-renewable council. Not realistic here given politics and the historic boom/bust fossil dependence. Thoughts?
Regarding the idea of making utilities publicly owned: California has partially done this, by authorizing Community Choice Aggregators (CCAs) to purchase power from various producers for their local customers, while transmission grids continue to be owned & maintained by the 3 big state sanctioned utility monopolies. The CCAs are regulated by the state, but also have to answer to the local county governments they serve. Customers can opt out of their local CCA & purchase power from the utility if they like, but the CCAs have better rates for power. But the utilities actually administer customer billing & charge customers for transmission.
Bravo! I’ve been searching for alternative approaches when it comes to dealing with the natural monopolies of electric utilities.
As I digest the dense information from this podcast, I am wondering about a few things:
1. The financial impact PBRs have on IOUs - Most IOUs are public companies that offer stock on a stock exchange and provide a dividend. These IOUs are attractive investments for those who are looking for low risk investments. I am wondering if the impact of PBRs changes the financial performance behavior of IOUs. And if it does, what are the ripple effects?
2. It was noted in the beginning, PBRs are associated with IOUs. IOUs are not the only entity providing electricity to customers. I am wondering what is behind the rate design of publicly owned utilities and coops. Is a variant of PBRs the basis of the rate designs of publicly owned utilities and coops?
3. IOUs, by the very nature of their natural monopoly position and their regulation-based business environment for such a long time, have an instilled culture that when it needs to change, it does so in a slow manner. After all, it has an obligation to assess risk against being able to deliver electricity in a safe and reliable manner.
To alter the culture, so that it deals with risk in different ways that opens the door to change and innovation, it must have the people who can think differently. I wonder if the leadership of IOUs are those people who can think differently.
Hoping to make some progress along these lines in MA with a new climate bill: https://www.wbur.org/news/2024/11/04/2024-massachusetts-clean-energy-bill-solar-wind-batteries-permitting-reform
Thanks for this.
The utility industry has high propensity for capital due to ongoing load growth and replacement and refurbishment of existing generation, transmission, and distribution (GTD) infrastructure. Even with aggressive energy, efficiency, demand response, and distributed energy resources, the nature of the business is, and will in large part remain, the production and delivery of electricity by means of capital- intensive facilities.
Command over capital as a means of corporate survival and growth is not just desirable, but an utter necessity for electric utilities. To attract capital, investor-owned utilities must have an overarching corporate objective to increase shareholder value (SV), largely a function of rate base (RB) , rate of return (ROR), and kilowatt hour sales, and the level of the return on equity (ROE) relative to the utility’s cost of capital. If the ROE is higher, then the utility’s SV will be higher than if ROE is lower, all else being equal.
Regulators are supposed to set the authorized ROE at a level equal to the cost of equity capital. While the cost of equity capital is not directly measurable, there are many indications, both quantitative and anecdotal, suggesting that the cost of equity in the economy, (particularly for an investment such as a utility company that is generally of lower risk than the market as a whole), is lower than currently authorized utility ROE levels.
If the ROE is higher than the cost of capital, the result is that the investor owned utility (IOUs) obtain even more benefits from increasing RB through new steel-in-the-ground investments, particularly when the IOUs’ stock is selling above book value
Decoupling mechanisms do not change the underlying basis of the IOUs’ business model. Decoupling mechanisms addresses the short run (between rate case) requirement that revenues from electricity sales be sufficient to recover, but not exceed, the regulatory allowed cost of current capital investments
The cost of new “steel in the ground” projects are included in periodic rate case filings where increases in allowed revenues are accompanied by upward adjustments to historic sales data. Decoupling mechanisms do not dissolve the underlying truth that sales growth - be it kilowatt hours or widgets - is what makes the world go ‘round for the capitalist business model.
In fact, by reducing the utility’s overall business risk, decoupling mechanism reduces the utility’s cost of capital. If the utility’s rate of return is not reduced to reflect the lower risk (commensurate with the reduction in the cost of capital), decoupling mechanisms may have far different short-term and long-term impacts. Giving a utility decoupling protection without reducing the return on equity to reflect the reduced risk would skew utility shareholder incentives toward growth in capital investments by not recognizing the risk reduction. Thus, where the rate of return is above the cost of capital to begin with, it ends up even farther above the cost of capital adjusted for the reduced risk than if decoupling did not exist.
Thus, decoupling mechanisms may actually provide long-term incentives to reduce energy efficiency, demand response, and distributed energy resources effectiveness (particularly in peak demand periods) to promote capital spending. The most fundamental way to motivate utilities to procure energy efficiency, demand response, and distributed energy resources is to stop making supply-side investments so attractive.
I saw an article about a new direct air capture material, I wanted to get it to you right away, 5 minute read
https://www.latimes.com/environment/story/2024-10-23/this-powder-can-remove-as-much-co2-from-the-air-as-a-tree
The utility industry has high propensity for capital due to ongoing load growth and replacement and refurbishment of existing generation, transmission, and distribution (GTD) infrastructure. Even with aggressive energy, efficiency, demand response, and distributed energy resources, the nature of the business is, and will in large part remain, the production and delivery of electricity by means of capital- intensive facilities.
Command over capital as a means of corporate survival and growth is not just desirable, but an utter necessity for electric utilities. To attract capital, investor-owned utilities must have an overarching corporate objective to increase shareholder value (SV), largely a function of rate base (RB) , rate of return (ROR), and kilowatt hour sales, and the level of the return on equity (ROE) relative to the utility’s cost of capital. If the ROE is higher, then the utility’s SV will be higher than if ROE is lower, all else being equal.
Regulators are supposed to set the authorized ROE at a level equal to the cost of equity capital. While the cost of equity capital is not directly measurable, there are many indications, both quantitative and anecdotal, suggesting that the cost of equity in the economy, (particularly for an investment such as a utility company that is generally of lower risk than the market as a whole), is lower than currently authorized utility ROE levels.
If the ROE is higher than the cost of capital, the result is that the investor owned utility (IOUs) obtain even more benefits from increasing RB through new steel-in-the-ground investments, particularly when the IOUs’ stock is selling above book value
Decoupling mechanisms do not change the underlying basis of the IOUs’ business model. Decoupling mechanisms addresses the short run (between rate case) requirement that revenues from electricity sales be sufficient to recover, but not exceed, the regulatory allowed cost of current capital investments
The cost of new “steel in the ground” projects are included in periodic rate case filings where increases in allowed revenues are accompanied by upward adjustments to historic sales data. Decoupling mechanisms do not dissolve the underlying truth that sales growth - be it kilowatt hours or widgets - is what makes the world go ‘round for the capitalist business model.
In fact, by reducing the utility’s overall business risk, decoupling mechanism reduces the utility’s cost of capital. If the utility’s rate of return is not reduced to reflect the lower risk (commensurate with the reduction in the cost of capital), decoupling mechanisms may have far different short-term and long-term impacts. Giving a utility decoupling protection without reducing the return on equity to reflect the reduced risk would skew utility shareholder incentives toward growth in capital investments by not recognizing the risk reduction. Thus, where the rate of return is above the cost of capital to begin with, it ends up even farther above the cost of capital adjusted for the reduced risk than if decoupling did not exist.
Thus, decoupling mechanisms may actually provide long-term incentives to reduce energy efficiency, demand response, and distributed energy resources effectiveness (particularly in peak demand periods) to promote capital spending. The most fundamental way to motivate utilities to procure energy efficiency, demand response, and distributed energy resources is to stop making supply-side investments so attractive.
Thanks so much for this podcast. Very useful to have this clear explanation of PBR.
I'm a community organizer, fought the local electric muni over a solar fixed fee (standby service rider) on new solar. Something like 165 IOUs and 2000 munis across the US. I would love to see a discussion around regulating the unregulated "public power" muni monopoly where rates/energy policy are solely decided by a city council (i.e. no state PRC oversight and exempt from state energy transition plans). Here in oil/gas/coal country (Northwest New Mexico) their IRPs/COSSs (by a selected pro-utility consultant) are always gas generation weighted (No VOS/LCOE) with lip service to installing solar. Folks have told me to get out the vote to elect a pro-renewable council. Not realistic here given politics and the historic boom/bust fossil dependence. Thoughts?
Regarding the idea of making utilities publicly owned: California has partially done this, by authorizing Community Choice Aggregators (CCAs) to purchase power from various producers for their local customers, while transmission grids continue to be owned & maintained by the 3 big state sanctioned utility monopolies. The CCAs are regulated by the state, but also have to answer to the local county governments they serve. Customers can opt out of their local CCA & purchase power from the utility if they like, but the CCAs have better rates for power. But the utilities actually administer customer billing & charge customers for transmission.
This is a great idea. Next step---- Get alegislator to sponsor a bill proposing this change . Try Angelique Ashby---our local State Senator.
I think that 50 cents per kWh in California is outrageous. How has the CPUC approved this. It is 5 times what some other utilities charge nationwide.
I don't know how California expects people to choose to decarbonize (switch to EVs, heatpumps, etc) when electricity is just not competitively priced.
I thought the Shift Key podcast had a couple of episodes in June 2024 that were helpful.
"How California Broke Its Electricity Bills" and "How to Fix Electricity Bills in America"