Disclosure: I had help writing parts of this article with ChatGPT. I think it’s nontheless an interesting and quick read.
Up until the early 20th century, the electric grid was largely unregulated, with companies jockeying for control and market share. Drawing comparisons to the railroad industry, the public was worried that utilities would soon charge exorbitant prices. In response to these concerns, many cities began establishing their own electric companies, with the aim of returning any excess profits to their citizens. However, the prevailing attitude at the time was against granting too much power to the government, due to fears of corruption and the erosion of traditional American values.
It was in this context that the Wisconsin Governor introduced a new regulatory model in 1905. He created a railroad commission with full jurisdiction over the state’s transportation companies. This commission’s authority was extended to electric companies in 1907. New York had done a similar thing the month prior. By 1914, 43 states had adopted Wisconsin and New York’s approach, establishing regulatory commissions to oversee their electric utilities.
Despite these efforts, holding companies that owned multiple utility companies were not regulated, allowing them to generate huge profits despite the fact that the utilities themselves were subject to oversight. President Roosevelt campaigned on stifling these holding companies, and ultimately passed the Public Utility Holding Company Act (PUHCA) of 1935. This more or less fixed the problem. Kinda cool.
This system remained remarkably stable until the 1970s energy crisis, during which energy prices soared. To reduce these costs, focus was put on fostering competition and limiting monopolies in the energy sector. The first main step was to The Public Utility Regulatory Policies Act (PURPA) of 1978. This required that utility companies buy energy from independent energy generators at the utility’s “avoided cost” rate, which is the cost the utility would have incurred to generate the power itself or purchase it from another source.
There were a few more key laws that intended to drive energy security, decreasing prices, environmental concerns, and technological advancements:
- The National Energy Policy Act, passed in 1992, established the Federal Energy Regulatory Commission (FERC), granting it the power to regulate state electric industries.
- FERC issued Order 888 in 1996, requiring transmission companies to provide energy generators with equal access to the grid. This order aimed to establish a truly competitive market for power generation, recognizing that it did not necessarily need to be monopolized.
- Order 2000, issued in 1999, advanced energy deregulation by creating Regional Transmission Organizations (RTOs, which are essentially the same as ISOs). These nonprofit entities facilitated the buying and selling of electricity across regions, making it easier for market participants to trade energy. RTOs replaced state operation and control over the transmission grid, streamlining the process and increasing efficiency.
- In 2005, President Bush signed the Energy Policy Act, which transferred the regulation of utilities from the Securities and Exchange Commission to FERC. This transfer further consolidated FERC’s role in overseeing the evolving electric grid and its transition towards a more competitive marketplace. This also repealed and replace the PUHCA of 1935.
The “deregulation” term is somewhat confusing because there’s still lots of regulation. The largest component of this arc is that power plant companies are now separate entities that have lots of flexibility in how they spend their money and how they charge customers. The generation and transmission segments are still tightly regulated, and can’t even spend their own money without agreement from the government. But there are other forms of reducing regulation, like allowing companies to own utilities in multiple states.
I find knowing the vocabulary of a field can be really illuminating as to the inner workings of the field. The utility industry can be broadly divided into three primary segments, each which owns particular infrastructure:
Generation: This segment involves the production of electricity using various energy sources such as coal, natural gas, nuclear, hydroelectric, solar, wind, and other renewable sources.
Transmission: The transmission segment is responsible for the high-voltage transfer of electricity over long distances. It’s the bridge between the generation and distribution segments of the market. This is largely regulated by FERC, and ISO/RTOs typically operate these, but don’t own or maintain them. That’s the job of the regulated utility. Kinda interesting.
Distribution: The distribution segment involves the delivery of electricity from substations to residential, commercial, and industrial customers. Distribution networks consist of lower-voltage power lines. Distribution utilities are typically regulated by state public utility commissions
- ISO/RTOs: Nonprofits, ensure the reliable and efficient delivery of electricity across the grid by managing the flow of power, maintaining grid stability, and overseeing the day-to-day operation of the electric power system. They largely run the wholesale market and also operate the transmission lines, which necessarily need to go hand in hand, because the market decides where energy should flow.
- Wholesale Market: The wholesale market refers to the buying and selling of electricity between generators, utilities, and other market participants before it is delivered to end-users. This is typically managed by ISOs or RTOs to ensure fair competition, grid reliability, and efficient market operations.
- Public/State Utility Commissions: PUCs are state-level regulatory bodies that oversee the operations of utility companies.
- Energy Supplier: An energy supplier is a company that generates and/or purchases energy to sell to consumers. In deregulated markets, customers can choose an energy supplier based on factors such as price, contract length, and renewable energy content. Interestingly, energy suppliers may simply be middlemen - they buy from power plants, and sell to customers, without owning their own infrastructure.
Incentives of Regulated Utilities
In the regulated electric utility industry, companies are subject to a capped profit margin based on a percentage of their total expenditures. This system, known as the “rate of return” regulation, is designed to ensure that utilities can recover their costs and earn a fair return on their investments without overcharging consumers.
For example, if a utility company spends $1 billion on infrastructure and operations, and the profit cap is set at 10%, the company is allowed to recuperate up to $1.1 billion from its customers. The utility can adjust its rates to reach this revenue target, and as such, it is incentivized to spend as much as possible. The more the utility spends, the more it can earn, up to the point where consumers reduce their electricity usage in response to higher prices.
To counteract this potential for overspending, state/public utility commissions (PUCs) maintain oversight and approval authority over utility projects. PUCs ensure that the investments made by utilities are necessary, cost-effective, and in the best interest of the public.
The negotiation process between the PUC and utility companies is referred to as the “rate case.” It’s a confusing term - “rate” meaning the price consumers are will pay, and “case” meaning an argument, like in a court of law. During this process, the utility presents its argument for adjusting consumer rates, based on its projected costs and investments. The PUC then reviews the proposal and comes to an agreement on the reasonable areas in which to spend money. To see a Rate Case example, search for “capital forecast” or “budget book”, or “improvement plan” in any of these NY State links.
Appendix / Sources
- Samuel Insull is an absolutely fascinating character who was the main exploiter of creating holding companies. He started out as an immigrant and Thomas Edison’s secretary, and soon grew an empire of which he was “president of 11 companies, on the boards of 65; his utilities network had 6,000 units in 37 states and Canada, and employed 75,000 persons.” That all but collapsed in 1932, I believe due to the nature of his high leverage and the stock market crash, in tandem. That same year, he wrote a will stating saying that his full estate of $2MM would be put in a trust for his debts of $14MM (not inflation adjusted). The wikipedia page is excellent.
- Thanks Jake Jurewicz for inspiring me to do some of this reading