How Strongly Do Regulations Impact the Utilities Sector?

The majority of all American consumers receive their utilities services from private companies that are regulated at the state level by public service commissions. According to survey data from the American Public Power Association, privately owned utility companies served 66.9% of electricity customers across the country in 2021. Larger federal or state power utilities are run directly by the government, as are many rural and municipal utilities.

Utility companies often hold "natural monopolies" over a certain service even when they are privately owned. To compensate for this, government regulations heavily superintend public utilities to protect consumers against undesirable monopolistic practices. Government agencies can regulate the prices utility companies charge their customers, their budgetary process, their ability to construct new facilities, the services they are allowed to offer, and their energy efficiency programs.

This article will review two of the most common and heavily regulated utility subsectors: water and electricity.

Water Regulations

Of all the regulated utilities, the water subsector seems to generate the most controversy. This is particularly true when drought conditions persist, which is common in California, for example, the most populous state in the country. The government-run Los Angeles Department of Water and Power, serving one of the largest cities in the state, is one of the biggest utilities in America.

As with all historically monopolized utilities, the water industry benefits substantially from economies of scale and massive sunk infrastructure costs. Water is not particularly easy to move around the city in a pressurized, safe, and ecologically healthy way.

Water has seen dramatic changes in the amount of regulation to which it is subject over the past century or so. In the 19th century, water had limited municipal oversight. By the mid-20th century, it was widely municipally owned. In the 1970s and 1980s, as happened with other utility industries, water was privatized, and the oversight was once again limited, in a similar way to how it was in the late 19th century. Water authorities today restrict production, prices, and distribution.

Electric Regulations

In the delivery of electricity, economists from the World Bank have argued that evidence falls on both sides of the private versus public question. Ultimately, according to its analysis of the global market, privatization is more common in higher-income economies in general, but there is relatively little difference in the outcomes for users.

Electric companies weren’t always overseen by the government and, in America, electric regulations have followed a cyclical development. The early pioneers of economic electricity included famous private entrepreneurs such as Thomas Edison, J.P. Morgan, and Nikola Tesla, all of whom were subject to very little oversight.

In the early 20th century, state commissions in the U.S. had established regulations over the electricity industry, also establishing monopolistic grants to single-utility providers. This created an atmosphere with different regulations from jurisdiction to jurisdiction, especially for federally operated electric utilities, which are often exempt from state and local regulations.

Typically, however, to compensate for the monopoly, state commissions set the rates for service, which are calculated from the price plus what the commission deems a reasonable return on investment, and they reserve the authority to make the company enact some service improvements. The companies are required to offer the service to those living in their territory.

Federal Energy Regulatory Commission (FERC)

The Department of Energy Organization Act of 1977 established the Federal Energy Regulatory Commission (FERC) as an independent agency regulating the interstate transmission of electricity, oil, and natural gas. This act, along with the Energy Policy Act of 2005, has given FERC a whole slew of regulatory functions in the utility sector, including the power to:

• Oversee hydroelectric dam licensing and safety
• Establish oil pipeline transportation rates and services
• Review certain electric company mergers and acquisitions
• Approve plans for new interstate natural gas pipelines
• License and inspect private, municipal, and state hydroelectric projects

The overall stated mission of FERC is to use its regulatory control to “assist consumers in obtaining economically efficient, safe, reliable, and secure energy services at a reasonable cost through appropriate regulatory and market means, and collaborative efforts.”

Power Purchase Agreement (PPA)

A power purchase agreement (PPA) is a contract between a private utility company and a government agency. Through a PPA, the private utility produces power for the government agency for an extended time, often between 10 and 20 years. In essence, the government becomes the sole client of the private utility company.

FERC regulates PPAs, wielding enormous influence in the utility sector. FERC can award contracts, establish pricing, and instigate or delay lawsuits against power companies.

Environmental Regulations

All utilities are heavily influenced by regulations on coal, oil, nuclear power, and natural gas. Eighty percent of the electricity in the U.S. came from these sources as of 2020, with renewables (wind, hydro, solar, biomass, and geothermal) accounting for the remaining 20%.

FERC is responsible for overseeing environmental matters related to a utility company’s projects in natural gas and hydroelectricity. FERC will issue environmental impact statements reporting potential effects on the environment by proposed natural gas or electricity-generating projects. PPA contracts might include stipulations regarding the environment by which the PPA partner must abide in order to maintain its contracts.

Criticisms of the Utilities Model

Some critics argue that public utility regulations are a “plodding, expensive, and often corrupt model.” They say that these regulations trade efficiency and competition for a model that slows down innovation, particularly in sectors that benefit from technological innovation. Defenders of the public utilities model argue that it is better designed to fit community needs.

The critics seem to have made some headway. Regulations for public utilities have decreased since the late 1970s because of the belief that competition leads to better outcomes than regulations. Some economists have argued that public utility regulations are cyclical, with ideology playing a role in the disinterest in regulations, which now mirror regulations from the late 19th century.