Original Posting
Costello, K. W. (2019). The consequences of escalated politicization in the US regulatory process. Competition and Regulation in Network Industries, 20(3), 207–217. https://doi.org/10.1177/1783591719836874
(https://journals.sagepub.com/doi/full/10.1177/1783591719836874)
Abstract
To some observers, public utility regulation has expanded its domain far beyond its original mandate and what is socially optimal. Their view is that regulators should stick to setting just and reasonable rates and taking other actions that improve the long-term welfare of utility consumers. After all the raison d’etre for public utility regulation is to protect consumers from “monopoly” utilities. Utilities provide essential services to both individuals and society. When left unregulated, these services would presumably be excessively priced with no guarantee of availability for those who want it and willing to pay for it. Diverting from this focus—driven by escalating politics—risks regulators’ ability to achieve their core objective of protecting consumers. One positive aspect of politicization is that it allows regulators to have access to more diversified information from stakeholders that could result in better decisions. One criticism of regulation is that it tends to stay with its policies and practices too long in spite of changing market and technological conditions. Additional stakeholders in the regulatory process could push regulators toward changes that are in the public interest but would not pursue on their own.
Politicization—that is, using government to gain favors or to divide up total wealth in one’s favor—means a lot of things: (1) more special-interest influence with additional stakeholders that have the potential to jeopardize the public interest, (2) increased emphasis on short-term (or myopic) effects, (3) more difficult execution of the “balancing act” with additional interests and social objectives, (4) departure from traditional objectives of serving the long-term interest of utility customers, (5) higher rent-seeking costs (labeled later in this article as “fighting costs”), and (6) the increased likelihood of subsidies and the socialization of costs for new investments. Politicization per se does not mean a negative outcome, but it often results in one interest group unduly influencing governmental decisions that harm the public good.
One positive aspect of politicization is that it allows regulators to have access to more diversified information from stakeholders that could result in better decisions. One criticism of regulation is that it tends to stay with its policies and practices too long in spite of changing market and technological conditions. Additional stakeholders in the regulatory process could push regulators toward changes that are in the public interest but would not pursue on their own.
Public utility regulators are vulnerable to rent-seeking efforts by advocates to achieve self-serving outcomes at the expense of the general public. The electric industry in particular has several features making it highly visible and susceptible to politics and interest-group lobbying. They include a substantial environmental footprint, a large user of energy, an essential service, and high social cost from service interruptions. But utilities themselves may be promoters of broadening their social responsibility for the purpose of goodwill/public relations that would lead to favorable treatment by regulators and other governmental entities. I have seen that happening increasingly with utilities advocating subsidization of energy efficiency and clean energy technologies.
One interpretation of recent events occurring across the United States is that they resemble a contest by an increasing number of special interests to persuade regulators often with biased evidence, that their favored agenda is compatible with the public interest. This agenda has focused on the major money items, like ratemaking and utility investments.
No single view of the public interest
While the public interest is subject to different interpretation and ambiguity, most US regulators over the course of decades have defined it in terms of just and reasonable rates. State utility regulators generally associate such rates to satisfy the following five conditions: (1) compatible with the costs of an efficient and prudent utility, (2) reflective of the cost of serving different customers and providing different services, (3) avoidance of undue price discrimination, (4) fairness among customer groups, and between utility shareholders and customers, and (5) reasonable opportunity for a prudent utility to receive sufficient revenues to cover its cost of capital so as to attract new capital and maintain good financial health.
A different perception of the public interest is the composite indicator of the public well-being (a metric if you will) that “adds up” the individual effects of a regulatory decision on stakeholders and other societal interests. It is closely related to the concept social welfare. A third perception relates the public interest to the stakeholders’ collective consent to a regulatory action.
The central premise in any definition of the public interest is that the aggregate interest of society overrides the well-being of special interest groups. Major obstacles in regulatory decisions are making the multiple regulatory objectives comparable (e.g. measured in dollars) and scaling up individual objectives to arrive at a “public interest” metric. Because of this impracticability, the ultimate decision of whether one action or policy advances the public interest more than another action comes down to qualitative factors or judgment.
With the entry of more stakeholders in the regulatory process, noncore objectives have taken on a higher status with regulators. I have observed that regulators are willing to trade-off some core objectives (namely, protecting consumers against monopoly power) to advance noncore ones; for example, advancing energy efficiency or renewable energy with subsidies funded by general ratepayers, higher than cost-based rates, or worsening of a utility’s financial position. Net energy metering1 is a prime example: Some regulators have fostered the development of rooftop solar photovoltaic systems at the cost of higher rates to general ratepayers.
Challenges for state utility regulators
In the United States, many state utility regulators face increasing demands—for example, from state legislatures and stakeholders—and shrinking resources or growth in resources falling short of the demands. We are talking here about a death-spiral-type condition that jeopardizes the capability of regulators to protect the public interest.
To wit, increasingly state utility regulators have had to undertake more tasks with the same or even less money, akin to untiying the Gordian knot that can spiral into a situation where regulators are unable to adequately address the issues brought before them. One factor is more stakeholder participation, making rate cases and other proceedings more complex and expensive. This spiral may only grow over time as regulation becomes less effective in executing its mission in an increasingly politicized world. I should note that legislative actions that set the framework for regulation may restrict the ability of regulators to serve the public interest. Politics typically drive those actions, with special interests unduly influencing the legislation that may fail to have the public interest in mind.
Regulators need to elevate their game in dealing with nontraditional issues brought before them because of increased politicization. We have seen the rise in complex issues facing the electric industry, like net energy metering, growing competition to utility services, demand charges, integration of renewable energy, demand response, cloud services, and so forth that regulators will have to address. These issues involve technological, economic, and political (e.g. socialization/subsidization) factors that require new and special skills by regulatory personnel.
One prime example is the evaluation of new capital projects on the basis of their attributes that go beyond cost. With enhanced politicization, environmental, job creation, economic development, and other factors are increasingly being considered. It then becomes more difficult for regulators to make the inevitable trade-offs that best advance the public interest.
Three features of good regulation
Balancing legitimate interests
As its fundamental duty, regulation should make well-informed decisions driven toward the public interest. It strives for balance and justice. Specifically, good regulation weighs legitimate interests and makes decisions based on facts. Its decisions should not unduly favor any one interest group over the public interest. They should coincide with the law and the evidentiary record.
This means that good regulation should avoid excessive politicization2 and influence by any one interest group,3 which erode regulation as an institution and instrument of public policy. Politically expedient decisions tend to undermine the agency’s commitment to promoting the long-term interest of both utility consumers and society as a whole.
Each stakeholder group, as one would expect, promotes positions and makes arguments that it considers economically or otherwise beneficial to itself. The regulator’s job is to sift these arguments in identifying those that arise only from self-interest and in discerning those arguments that arise from self-interest but promote the public interest.4 For example, any regulatory assessment on rate mechanisms is complex, requiring a combination of analytics, unbiased information, and judgment by regulators to make decisions that are best for the public good.5
In today’s environment, balancing involves the recognition of (1) utility competitors wanting a “level playing field”; (2) many consumers no longer wanting just plain vanilla service (e.g. reasonable prices and reliable service) but wanting such things as more control over their utility bill, the ability to self-generate and real-time information from their utility; (3) utilities wanting rates that allow them to be financially healthy; (4) third parties wanting access to the utility distribution network; (5) consumer advocates wanting affordable utility service for low-income households; and (6) environmentalists and other groups wanting clean energy and energy efficiency. As one illustration, utilities face increased competition from third parties. Regulators must set rules and policies that provide neither third parties nor utilities with an unfair advantage or unduly handicap one of them to compete with the other. I have seen too many times where regulators have formed an agreement with utilities to address the challenges posed by increased competition by suppressing it. At the other extreme, I have also viewed regulators handicapping utilities in a way that results in uneconomic outcomes.
Trying to accommodate varied and somewhat conflicting objectives poses a daunting challenge for regulators—certainly much more than in the past when fewer stakeholders appeared before regulators in contested proceedings. Through their history, regulators have emphasized—at least on paper if not always in practice—the longer term consequences of their actions, rather than trying to appease the immediate demands of stakeholders and others.
What also cannot be ignored is the reality that the regulators’ self-interest may not equate with the public interest. It seems implausible that society could effectively steer regulators’ actions toward the latter—which means a lack of social control of regulation itself.
Trust and independence
A respectable regulatory agency will earn the trust of the general public and the various interest groups that come before it. As perhaps their biggest challenge, regulatory agencies have the obligation to make decisions on behalf of the public interest, notwithstanding the decisions’ unpopularity and political opposition, even decisions at odds with expressed public preferences.
Independence is essential for allowing an agency to protect the general public in the face of strong economic and political pressures. Jeopardy of a regulator’s independence can originate from different entities: utilities, the executive branch of state government, the state legislature, special interest groups, and the judicial branch.6
Independence has bounds, however, partly by law and because a regulatory agency must be held responsible to the public for its actions. Specifically, good government requires that an agency is held accountable when it makes decisions that affect the general public.
Adaptability to new conditions
State legislatures have allowed utility regulators broad authority to achieve the principal goals of “public convenience and necessity,” “public interest,” and “just and reasonable rates.”7 In most states, the legislature’s role is to provide broad guidance to regulators, who then establish specific rules, policies, and procedures to achieve the legislature’s broad objectives. A regulator can then adapt its practices to fulfill its obligations in a dynamic world of changing utility industries, economics, and public policy.8
Any successful institution in challenging times must be open to new ideas and new practices. Otherwise, besides being anachronistic, the institution loses the ability to achieve its goals, which for regulatory agencies is to serve the public interest.
Escalated politicization with additional stakeholders could actually helped in this regard: The inherent inertia of utilities, regulators, and some consumer groups may collectively endorse the status quo when changes in regulatory policies and utility practices would be socially beneficial.9 Other stakeholders, like environmentalists, third-party vendors, and utility competitors, could propel regulators to support reforms that are responsive to industry and public-policy developments.
The badness of politicization
As pressures intensify for more new social investments, driven largely by politics, utility regulators have had to grapple more with the adverse effects of cost socialization and subsidies.10 These effects include passing on excessive risks to consumers and providing utilities with weak incentives to invest and manage their operations efficiently.
As an illustration, one path is for regulators to encourage distributed generation (DG), electric vehicles, and other new technologies, but not to give away the store. Cost subsidization can be unfair to some consumers (i.e. those who do not receive compensatory benefits) as well as to competing third-party providers. Regretfully, the evidence confirms that some states has been on the forefront of bad policies that have inflicted a regressive-tax-type wound on lower income folks.
The domain of electric utilities responsibilities has expanded beyond the provision of reliable service at “just and reasonable” prices. According to most state statutes, regulators must assure the public that utility rates are “just and reasonable” and not unduly discriminatory. These requirements mean that consumers are charged no more than necessary to give a utility a reasonable opportunity to recover efficiently incurred costs, including a fair return on their investments.
Increasingly, policymakers require utilities to extend their sphere beyond a for-profit commercial enterprise by assisting low-income households, accommodating, facilitating, and even subsidizing their competitors (e.g. distribution generation) and renewable energy, adopting nonprofitable new technologies, promoting energy efficiency, achieving clean-air targets beyond federal and local mandates, and empowering their customers to make more economical decisions. These demands on utilities have often jeopardized their ability to operate as profitable entities providing basic services reliably and economically.
A major topic in the policy debate is the extent to which utilities should broaden their functions to address society’s demands driven by political forces. An expansive role for utilities could place upward pressure on electricity prices and potentially conflict with traditional regulatory objectives, like cost-based rates, consumer protection, least-cost utility operations, and adequate service reliability.
Tensions in achieving broad objectives
There is an inherent conflict between regulators obligating electric utilities to advance a growing number of social objectives while at the same time expecting investor-owned utilities to (1) carry out their fiduciary responsibilities to shareholders and (2) manage their costs to keep rates down to the lowest possible level consistent with reliable and safe service. Perhaps more than any other private entities, society expects electric utilities to integrate social goals into their decision-making process.
Regulators themselves face the difficulty of balancing the objectives of keeping prudent utilities financially healthy while fostering a broadened social agenda. One can rightly ask whether electric utilities more resemble public agencies than private entities driven to serving only their shareholders and customers. One can also question whether funding social mandates through utility rates best serves electricity consumers. Regulators as well as other policymakers should stand back and do a thorough reality check when contemplating the proper roles for electric utilities.
Increased difficulty in achieving balanced decisions
State utility regulators have consistently subscribed, over the years, to what regulatory observers call the “balancing act” of regulation. They attempt to balance the rights of utilities and their customers by considering three major factors: (1) legal constraints—for example, utilities have a right to be given a reasonable opportunity to be financially viable and customers have a right to just and reasonable prices; (2) the regulator’s perception of fairness; and (3) compatibility with a broader interest. Regulators try to balance the interests of the multiple diverse stakeholders with the overall objective of promoting the general good. At least, that is the premise behind the public interest theory of regulation.
On a personal note, having worked for a state utility regulator for almost 10 years and working with regulators across the country for over 28 years, balancing is difficult to achieve. One must first thoroughly understand the issue at hand and then be able to evaluate disparate positions in terms of advancing the public interest. As I have stated several times in public and in previous writings, what to do in these situations is not immediately obvious, as many complex issues lie in a “gray area” where regulators struggle to make the right decision. The increased politicization that we have seen over the past several years only aggravates this problem. One certainty is that regulators cannot avoid making trade-offs among an increasing number of objectives, some of which are conflicting. One recent example is promoting DG that may impose a burden on full requirements customers or utilities.
The hidden costs of politicization
When a stakeholder seeks a regulatory action that benefits itself at the expense of the utility or other stakeholders, the costs incurred by all stakeholders to persuade the regulator to counter the proposal or advance their position, or both, can be quite high. I define these costs as “fighting costs.” Theoretically, the maximum “fighting” costs that stakeholders would be willing to incur to preserve the status quo (e.g. consumer groups wanting to maintain volumetric rates11) or to propose a new practice (e.g. an electric utility advocating a new rate design) depends on the following: Since a stakeholder’s chances of getting the regulator to accept its position or oppose the positions of other stakeholders are uncertain (i.e. the probability is less than one), it would expend only some portion of its ex ante economic benefits from winning. For customer groups, the benefit would coincide with an increase in consumer surplus; for utilities, the benefit would be higher profits or the avoidance of lower profits.
Whether all fighting costs are wasteful (i.e. represent social costs) is part of the ongoing debate over the merits of the status quo; for example, the sum of costs expended by solar advocates (utilities) to maintain (oppose) net energy metering may actually improve both economic efficiency and equity. If the regulator decides on maintaining the status quo, nothing has changed. It then seems that the fighting costs were wasteful. On the other hand, by avoiding a proposed change that would have been socially harmful, the fighting costs incurred by the proponents of no-change were justified.
Illustration: The contentious debate over volumetric rates and net energy metering
Residential customers, solar advocates, and conservationists have lobbied hard against scraping volumetric rates.12 They view an alternative rate structure with a higher fixed charge as having four major negative effects: (1) driving up bills for low-usage customers, some of whom may be low-income households; (2) reducing incentive for price-induced energy efficiency; (3) diminishing the economics of distributed energy resources; and (4) widening the gap between marginal price for customers and full marginal social cost. Because of uncertainty and the free-rider problem, what they are willing to spend to maintain volumetric rates would be less than their ex ante benefits.13
As we also observe, electric utilities are willing to spend a lot of money on eliminating or diluting volumetric rates. They see volumetric rates as hurting their finances when customers shift to distributed energy resources or conserve on their use of electricity.
The total “fighting cost” between the supporters and opponents of volumetric rates have escalated over the past several years. I would guess that tens of millions of dollars have been expended by these groups in regulatory proceedings to advocate their positions.
Whether these costs are wasteful depends on who wins and the benefits from the regulatory decision. If one believes that volumetric rates are socially bad, then successful efforts to replace them would have a benefit.14 If the pro-volumetric rates group prevail, then nothing really changes other than substantial amount of money was spent on fighting. Of course, if one believes that volumetric rates are preferred to alternate rate structures, then efforts to counteract the utility’s position would have a benefit.
In the debate over net energy metering,15 the maximum fighting costs equal the combined costs incurred by solar advocates to lobby for continuation of net energy metering and by electric utilities to replace net energy metering with some other pricing method.16 If these costs produce no change in pricing method (i.e. maintain net energy metering), they represent a social cost of continuing with net energy metering.
With ratemaking becoming more politicized, it is no surprise that stakeholders in the regulatory process are willing to spend more money and time on either proposing changes in ratemaking or countering proposals by other stakeholders. One can readily see the fighting costs proliferating in recent years. The stakes are high, justifying substantial fighting costs from the perspective of the special interests.
Politicization of gas-pipeline certification
The recent development of gas pipeline certification by the Federal Energy Regulatory Commission (FERC) exemplifies increased politicization in the regulatory process at the federal level. The agency is under pressure from environmentalists to consider the climate-change effect of new pipelines. While one can sensibly argue that FERC should ignore greenhouse gas (GHG) emissions, the courts so far have agreed with climate advocates. But here is the problem: Even if FERC has the obligation to consider the environmental consequences of major pipeline projects, assessing their effects on climate change, let alone measuring them, overstretches its capability as an economic regulator. This should in no way imply that we should refrain from mitigating climate change. Arguably, this task should fall under the responsibilities of environmental agencies and other governmental entities with more capability than FERC to address climate change.
Even if FERC has an accurate measurement of net changes in GHG emissions—which is a big if—and a reasonable estimate of their effect on climate change, it is unclear how it would apply that information for decision-making. There is enormous uncertainty over how an increase in GHG emissions would affect the economy (in dollar terms) and other aspects of society. This would require FERC, among other things, to measure with tolerable accuracy how a new pipeline would trigger nuclear retirements and shrink renewable energy. Is it reasonable to imagine that FERC possesses such clairvoyant powers?
From a public-policy perspective, it seems far-fetched to think that FERC, as an economic regulator, should engage itself in the highly contentious climate-change controversy. FERC should have limited responsibility over climate change and consideration of other so-called social benefits inherently difficult to quantify, let alone substantiate.
But what seems even more nonsensical is that the opposition to new pipelines on environmental grounds could hinder the use of natural gas to replace coal-fired facilities and as an economical back-up for intermittent renewable energy. This is an example of where politicization could actually hurt the interest of the winning party in a regulatory decision. This would be not the first time that an unintended consequence (in this instance, an increase in GHG emissions) has occurred in public utility regulation.
Overall, by making gas pipeline certification more politicized, pipelines have had to spend additional money to defend their position, courts have become more burdened, and environmentalists have spent large sums of money protesting new pipelines. Although not by themselves socially harmful, these costs would seem to overwhelm any benefits: Demanding that FERC considers climate change is destined for failure in the sense that the consequence derives from first-degree, ill-informed decision-making with the likelihood of a net cost to society. This is a classic case of what academics call “regulatory failure.”
Does society expect too much from utilities?
That leads to the question of whether society requires too much from electric utilities. We expect utilities to maintain financial viability, make electricity affordable to all customers, adopt, and accommodate new technologies that compete with their core business, decarbonize their generation portfolio, promote less usage of electricity by their customers, and increase consumer empowerment. No other private business comes to mind in which society expects firms to address such a wide range of social issues. This is the result of increased politicization of public utility regulation.
Often overlooked, regulators should ask themselves whether utilities’ core customers are on the short end of the straw. Are customers funding the advancement of social objectives through inflated rates without compensatory benefits?17 The term “turkey stuffing” accurately describes the situation where utilities keep attaching surcharges to a typical customer’s bill to fund investments and other activities whose benefits may largely accrue to others.
The dynamics work something like this: Politics and interest groups are driving change toward, say, a clean energy/high energy efficiency future; utilities are not necessarily opposed but want changes in ratemaking and regulatory rules to protect their financial interest.18 Regulators, pressured by both utilities and advocates of clean energy, seem to acquiesce in and even exhibit enthusiasm about this development. They generally pass through costs increases and revenue losses to core utility customers. Utilities favor more cost allocation to DG customers but DG advocates fear that this would stifle DG growth. DG advocates adamantly oppose what they consider any “unfair” action that would suppress the prospects for DG growth, including their unwillingness to surrender any subsidies or favoritism that they presently enjoy. Utilities, in their self-interest, see DG as a competitor. But to make their case more cogent to regulators argue that giving “away the store” to DG customers harm the vast majority of customers who depend entirely on the utility for their electricity.
Policymakers should look hard at what they are doing in appeasing different interest groups. Do they understand the accumulated effect of additional demands on utilities that increase their rates and compromise the long-term interest of utility customers? Are they taking us down the right path or down the primrose path to a deep hole with inefficient and unreliable utility service and excessive electricity prices? Have hype and ideology overridden the fundamentals of engineering, economics, risk management, and good public policy in mapping out our electricity future? Do we need to reevaluate the role of electric utilities in society in view of the new political forces? An inevitable tension exists between a for-profit entity trying to achieve several and conflicting social goals. If regulators satisfy utility shareholders and the utility is fulfilling its prescribed social goals, everyone seems to be happy, except for those utility customers picking up the tab.
Conclusion
Much of what we observe today that passes for the public good is actually rent-seeking, which benefits a distinct minority at a cost to the majority. We know from past experience politics rationalizes its actions as morally unobjectionable when in fact it bestows gifts upon a narrow group at the expense of the public good. Because the public interest is diffused and not well-organized, regulators should act as its advocate.
One glaring observation stands out: Much of the activity toward change in the utility industries derives from what economists called rent-seeking, suggesting that special interest groups are the true impetus behind change. Either for ideological or monetary reasons, these groups want to shape the future, and the sooner the better. Their self-interest motive encompasses only themselves—not the broader public interest. Their vision of the future would fill up their pockets or satisfy their followed agenda. The difficult job of regulators in this environment is to balance the interests of different groups to best serve the public good.
We previously noted that ratemaking is an example where the regulators’ job has become more complicated in recent years because of expanded public policy objectives and the appearance of more stakeholders in the regulatory process. When regulators account for affordability, the bolstering of renewable energy, and the environment, they must often compromise core objectives; namely, the long-term interest of utility customers and a financially healthy utility, objectives for which they historically held dear.
One ultimate question is: Would bad policies originating from self-interested politics always prevail, regardless of the public good? An optimist would say the “good” will win out. This presumes that regulators will act on unbiased information to balance the interests of different stakeholders for the public interest. Yet such optimism may be akin to believing in the tooth fairy: We observe myriad governmental policies with adverse consequences for the public interest. We may be going down that same road for public utility regulation.
Declaration of Conflicting Interests
The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.
Funding
The author(s) received no financial support for the research, authorship, and/or publication of this article.
ORCID iD
Kenneth William Costello https://orcid.org/0000-0003-0835-798X