Why Are Electric Utilities Regulated?

In the late 1800s and early 1900s anyone could build the facilities necessary to serve one customer, a few customers or a large community of customers. Most of these initial supply arrangements consisted of a small generator located at or near the point of usage.

But it soon became clear that economies of scale could best be achieved by using one or more generating plants interconnected to many customers by a network of transmission and distribution lines. Suppliers who had the financial capability to build the required network of plants and delivery facilities could undercut the prices of smaller providers. Those smaller providers either went out of business or merged with a larger provider. 

Eventually, most communities had only a single monopoly supplier. Advocates for consumers were concerned that a single investor-owned utility would try to maximize its profits by charging excessive rates for its service.  

And the investor owned utilities had their own concerns. They were worried that municipalities might create a public owned utility or that another privately owned supplier might come to town and start a price war. Privately owned utilities were willing to give up their ability to fully capitalize on their monopoly position in exchange for some guaranty that they could retain that monopoly position. 

Policy makers of the time arrived at something called the “Regulatory Compact”.  The Regulatory Compact is basically an agreement between the utility and the government.  Under that agreement the utility promises to invest in facilities necessary to provide service to customers within its service territory and to charge rates for those services that are set by the government. In exchange, the government promises to protect the monopoly status of the utility within a defined service territory and to authorize rates that permit the utility to recover its operating costs plus a reasonable return on its investment. 

Virtually every state has now incorporated a form of the Regulatory Compact in its state Public Utility Act. Those Public Utility Acts empower a three or five member regulatory agency (know as a Public Service Commission or a Public Utility Commission) to establish franchise service territories for each utility and to set “Just and Reasonable” rates for the services provided by the utility.  

In 1935, with passage of Title II of the Federal Power Act, Congress gave to the Federal Power Commission (now named the Federal Energy Regulatory Commission) authority to set Just and Reasonable rates for interstate wholesale sales between utilities (a transaction that had previously been held by the US Supreme Court to be beyond the authority of the state regulatory agencies).

David Rosenstein worked as an attorney and consulting engineer in the electric utility industry for 40 years. When he retired he wrote a book entitled Electrifying America: From Thomas Edison to Climate Changewhich describes the evolution of the electric industry from the time Edison invented the light bulb until today. Each of his posts in this Blog describe a different aspect of electricity, the electric industry or the issues currently faced by the electric industry. 

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