Investor-Owned Utilities’ Excess Rates of Return with Mark Ellis
Mar 10, 2025
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Mark Ellis, a Senior Fellow at the American Economic Liberties Project, brings three decades of energy industry experience to the table. He discusses his paper on the excess returns of investor-owned utilities, revealing how their profit models strayed from initial designs. Ellis critiques regulatory practices and highlights the need for reforms to enhance transparency. He emphasizes the role of competition in utility regulation and explores innovative financing strategies that could align energy costs with sustainability goals, all while addressing the impact on American households.
Utilities exploit regulatory mechanisms to set profit margins above their cost of capital, harming consumer pricing and service efficiency.
The need for reform is underscored by the historical principle that a utility's rate of return should equal its actual cost of capital.
Proposed solutions include requiring utilities to seek equity financing from the market, promoting fair competition and reducing costs for consumers.
Deep dives
Understanding Utility Regulation and Monopoly Practices
The conversation highlights the complexities surrounding utility regulation, emphasizing that utilities operate as de jure monopolies which are routinely granted the ability to negotiate profit margins with regulators. This leads to an environment where the utilities often set their rate of return above their actual cost of capital, exploiting regulatory mechanisms to enhance profitability unfairly. As the speaker illustrates, this is evident as utilities maintain higher returns even as interest rates decline, which indicates a systemic issue where utilities' lobbying efforts and accounting practices can skew regulatory outcomes. Consequently, these practices harm consumers, as the utilities prioritize shareholder profits over fair pricing and efficient service.
The Cost of Capital and Rate of Return Discrepancies
A central theme discussed is the long-standing principle that a utility's rate of return should equate to its cost of capital, a benchmark established over a century ago. Multiple regulatory economists have historically confirmed that if the rate of return significantly exceeds the cost of capital, it suggests inefficiencies or exploitation within the regulatory framework. This discrepancy is illustrated through historical data showing price-to-book ratios consistently above one, suggesting that utilities are often making profits significantly higher than justified. The interview points out that the utilities' ability to manipulate this system ultimately results in increased costs for consumers, highlighting the need for reform in regulatory policies.
Impacts of Regulatory Capture and Competition
The risk of regulatory capture is a significant concern, as utilities often influence or co-opt both regulators and the experts who testify on their behalf. This creates an uneven playing field where the utilities’ position is favored, leading to insufficient scrutiny of their practices and accounting methods. The conversation suggests that regulators may lack the necessary resources or willpower to challenge utilities, often accepting their narratives uncritically. In contrast, a call for increased transparency and competitive procurement of capital funding could harness market forces to set fair rates that accurately reflect the cost of capital.
Proposed Solutions for Utility Regulation Reform
Proposed solutions to address the discrepancies within utility regulation include legislating that the rate of return must align with the actual cost of capital and enshrining these standards in law to prevent utilities from gaming the system. One innovative suggestion includes requiring utilities to seek equity financing directly from the market, similar to how they currently approach debt financing. This competition for equity could lower costs and incentivize fair investment practices, benefiting consumers by potentially reducing their rates. Additionally, a broader array of stakeholders, such as pension funds and retirement asset managers, could engage in direct investment opportunities, fostering innovation and sustainable practices within utility operations.
The Role of Consumer Advocacy in Utility Regulation
The discussion underscores the growing recognition among consumer advocacy groups of the critical need to reform utility regulation—not merely for environmental concerns but to ensure fair pricing for consumers. The current dialogue suggests that while environmental initiatives are vital, they must be balanced with affordability and real consumer impacts. Some environmental organizations have begun to shift their focus toward aligning their goals with consumer interests, acknowledging that a fairer pricing structure can facilitate broader adoption of green technologies. Engaging the public more effectively in these discussions could pave the way for collaborative efforts that advocate for both environmental sustainability and economic fairness in utility services.
Mark Ellis, an American Economic Liberties Project Senior Fellow, discusses his recent paper “Rate of Return Equals Cost of Capital.” In this episode of Second Request, he examines how and why investor-owned utility profit models diverted from their initial design, as well as how much excess returns cost American households.
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