Utility regulators operate under a mandate to act in the public interest, yet they cannot agree on how to define, measure, or fulfill that duty. The late economist and regulator Alfred Kahn defined this interest as promoting economic efficiency, protecting consumers from discriminatory and insufficient access to utility service, and emulating competitive market outcomes in sectors where competition is not possible. Over decades of practice, regulators have tried to balance protecting customers from excessive rates and discriminatory practices against the need to attract capital for safe, reliable service.
The balancing act
Regulators typically weigh three factors: legal constraints requiring reasonable financial viability and just rates, their own perception of fairness, and the collective interests of stakeholders. This balancing act serves as a standard for weighing the pros and cons of decisions, though it carries a risk. In attempting this balance, regulators may end up serving their own interests—such as avoiding political backlash—instead of the public interest.
Defining the collective interest of society is a matter of value judgment. Even if everyone agrees on broad goals like fairness or a pollution-free environment, they disagree on their relative priority. One regulator might rank cost-effectiveness as most important, while another prioritizes mitigating climate change or ensuring fairness. Consequently, members of the same agency can favor different decisions while arguing they are in the public interest.
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Statutes give regulators wide discretion to establish “just and reasonable” rates and assure universal service, though they cannot confiscate property or allow excessive price discrimination. The reality is that the statutes set only boundary conditions. In today’s world, the list of demands has grown. Competitors seek a level playing field, many customers want more control over their bills and self-generation options, providers want financially healthy rates, and environmentalists demand clean energy. These new demands complicate the lives of regulators trying to make decisions commensurate with the public interest.
Measuring the outcome
A significant challenge is weighing and prioritizing these objectives. Assigning weights requires judgment, while examining effects demands unbiased data. If a regulator prioritizes economic efficiency, they may favor rate mechanisms based on marginal-cost principles and strong incentives for productivity. However, switching to such systems can have a large negative effect on certain customers, illustrating the trade-offs regulators must make.
Even with the same information, regulators can disagree because they assign different weights to objectives or disagree on which objectives are relevant. For example, one might believe affordability is a legislative issue, while another believes it falls within the agency’s purview. Cost trackers provide a concrete example of this tradeoff. These mechanisms allow utilities to recover certain costs, such as fuel costs exceeding the test-year level, without a full rate review, lowering financial risk and preventing returns below authorized levels. However, trackers can create incentive problems if regulators fail to adequately scrutinize the costs or if utilities raise costs in one area while ignoring decreases elsewhere.
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Given that each regulator has a different definition of the public interest, unbiased analysis cannot declare which is correct. Regulatory decisions that cause discernibly bad outcomes, like massive cost overruns or service outages, breach the public interest, but such outcomes are uncommon. What seems more relevant is achieving tolerable outcomes. If society is content with utilities keeping the lights on, the marginal benefits of doing better may not matter that much. Regulators face two major obstacles: the benefits of individual objectives are sometimes impossible to quantify, and there is no consensus on the specification of the proper public-interest curve.
The road ahead
Regulators face two major obstacles in advancing the public interest. The benefits of individual regulatory objectives toward the public interest are sometimes impossible to quantify. Second, there is no consensus on the specification of the proper public-interest curve, what parameters to include, as well as its shape. How much does a more financially healthy utility promote the public interest?
Does lowering a utility’s financial risk transfer risks to its customers, thereby triggering a fairness or moral hazard problem? Do utility regulators’ demands that utilities achieve clean-air standards beyond those set by environmental agencies serve the public interest? In addition to core objectives such as non-discriminatory access to utility service, fairness, and just and reasonable rates, what other objectives should regulators consider in their decisions?
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Where does this all lead us? The most regulators can do is to deal with trade-offs and make subjective judgments, since they are unable to measure the public interest or even agree on what it is. All in all, the verdict is that regulators enjoy much freedom to do what they want and can rationalize their decisions to be in the public interest, a disheartening thought that leads to the obvious question: What are the social benefits of utility regulations? Are they necessarily positive?
Cost Trackers and Incentives
Cost trackers allow utilities to adjust rates to collect costs without a formal review. These mechanisms enable faster recovery of costs that deviate from the test-year level, such as fuel costs, while lowering financial risk. One rationale for trackers is to prevent utilities from earning a rate of return intolerably below what the regulator authorized in the last general rate case.
Historically, utility regulators have frowned upon utilities passing on costs to consumers through mechanisms outside a general rate case-even when subject to prudence review-unless “extraordinary circumstances” exist. Regulators consider the possible downside consequences, such as utilities earning an excessive rate of return between rate cases.
