Utility regulation

Utility regulation basics

There’s no doubt that electricity is considered a vital service,

essential in today’s world. It is also part of a complex

industry, one all the more perplexing with the energy crisis

of 2000-2001 and aftermath.

Pacific Power is a regulated, investor-owned, loadserving electric utility. What does that mean, and how does

it benefit customers?

Regulated

U.S. electric utility companies such as Pacific Power are

subject to regulatory oversight at both the state and federal

levels. Utility operations within each state are under the

jurisdiction of state agencies known as Public Utility

Commissions or Public Service Commissions, while interstate

operations – primarily related to transmission and 

wholesale power transactions – are regulated by the

Federal Energy Regulatory Commission (FERC) and others.

State commissions are made up of appointed or elected

officials, assisted by a staff of utility experts. All of the

states served by Pacific Power have appointed commissions.

Commissions are charged with reviewing all utility 

expenditures before they can be passed on to customers in

the form of rates. They also serve as watchdogs to ensure 

that utilities are responsive to customers’ needs, and that

service is adequate and reliable. Issues within state 

jurisdiction include:

• Prices charged to retail customers – what utility costs can

be recovered through rates

• Services the utility can offer, such as pole attachment for

cable and phone companies and the process to be

charged for such services

• Standards to ensure utility safety and reliability

• Maximum return on equity that shareholders can earn

• Service area boundaries

• Bookkeeping methods

• Matters relating to financial reorganization

• Proposed purchases, sales or change in status of property

• Company mergers

Regulation evolved to balance the potential pitfalls of a

natural monopoly business with strong consumer protection

safeguards. In exchange for a franchised, monopoly service

area, utilities accept an obligation to serve – meaning there

must be adequate supply to meet customers’ needs 

regardless of the cost. While there are no guarantees, 

utilities also are given the opportunity to recover their

costs and earn a “fair and reasonable” return on their

investments. Price changes take place only after extensive,

public multi-month processes, called rate cases, where 

utility costs and operations are fully scrutinized. Only 

cost that pass regulatory muster are allowed into rates.

One size doesn’t fit all

Not all utilities are subject to state regulation.

Government-owned utilities, including peoples’ and

public utility districts and municipal power systems, are

not under the jurisdiction of state utility commissions.

They typically are self-regulated, with local boards 

setting their prices and service standards. Cooperatively

owned utilities, including rural electrical authorities

(REAs), are also self-regulating.

Investor-owned

The main distinction between an investor-owned utility

(IOU) and a publicly-owned utility is how they are

funded. IOUs are funded by a combination of bonded

debt (mortgages) and the owners, or shareholders, who

invest money by buying stock in an IOU. In exchange,

the investors expect (but are not guaranteed) some

return on that investment in the form of dividends 

paid and/or growth in share value. Public entities also

must go to others for funding, but they go to the bond

market, paying interest for the use of that money.

While debt (purchasing bonds) often has a lower 

cost than equities (stock), interest on debt must be paid

regardless of the business situation. That is not the case

with stocks, where the dividend can be lowered or cut

altogether if necessary. Shareholders carefully watch 

the financial performance of their companies, however,

and there is a strong incentive for IOUs to operate as

efficiently as possible to maintain the balance between

competitive prices to customers and stable to increasing

returns for their shareholders.

IOUs share in risk

When things don’t go well, such as what happened in

2000-2001 when wholesale energy prices skyrocketed,

shareholders absorb much of the risk for investor-owned

utilities. If state commissions don’t allow IOUs full return

of those increased costs in customer rates, shareholders

must absorb excess costs. Public power entities don’t

have that cushion and must pass all increased costs

directly through to customers.

The energy crisis provides a solid example of what an

investor-owned utility must endure. During the crisis,

Pacific Power and sister company Rocky Mountain Power

together incurred excess net power costs of $1 billion in

order to serve customers. The utility was only able to

recover around $300 million of these costs, with 

shareholders absorbing around $700 million, with only a

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Utility regulation

slim chance at best of any additional recovery. Public entities, with no shareholders to help shoulder the burden,

passed their increased costs along to ratepayers in full.

Seattle City Light had a 55 percent increase, Snohomish

PUD had a 53 percent rate increase and Clark PUD had a

45 percent increase following the energy crisis.

Investor-owned utilities are tax-paying businesses that

directly employ nearly 400,000 people in the U.S., thus

enhancing the economic health of thousands of communities,

and in some cases, acting as a primary place of employment.

They are also a source of revenue and employment for

other businesses in the community, as they depend on 

private companies for goods and services ranging from office

supplies to complex generating equipment. IOUs serve

nearly 74 percent of American consumers.

Load-serving

A load-serving utility such as Pacific Power is one that 

provides electric service to a retail customer base through

its own distribution system. While still the norm, as the

U.S. electric power industry has evolved, new “competitive”

or “direct access” rules have been established in many states

under which the “poles and wires” utility is eventually 

to be replaced as the power commodity supplier by new

competitive players. The utility’s obligation in these 

situations changes from supplying power to simply 

delivering it from an alternative supplier to the customer.

Today’s more open, competitive electricity market suppliers

include non-utility producers and suppliers such as 

cogenerators, independent power producers, merchant

generators and power marketers or traders.

As markets evolve and public policy changes, these

entities may play an increasing role in generating and

transferring electricity within the United States. Pacific

Power supplements power supplies from its own fleet of 

generation stations with purchases from the entire range 

of independent power suppliers as well as from other 

traditional utilities. The company continues to consider

options from these suppliers as it looks for the most

cost-effective, reliable and environmentally sensitive

way to meet its customers’ needs into the future. As 

of now, Pacific Power continues to have its full, 

traditional obligation to provide its customers with safe,

reliable economic service and the company’s core 

dedication is first and foremost to meeting that 

obligation.

Benefits

Despite the obvious differences between investor-owned

and publicly owned utilities, the debate continues as 

to which is better, more efficient, and ultimately, of the

greatest benefit to the customers it serves. There is no

doubt that public utility districts have their positive

attributes, but it is clear that the IOUs also provide 

customers with great stability, reliability and value.

Being regulated allows an IOU like Pacific Power to

maintain some of the lowest rates in the West and in the

country, to provide quality and reliable service and, unlike

the PUDs, to be the bearer and manager of risk. An IOU

also brings to the table social and technological leadership

and the capability to maintain the stability of and

expand the electrical grid and build new generation as

needed. Even more, IOUs contribute to the communities in

which they serve though employing hundreds, 

sometimes thousands, of people, through the payment 

of taxes and fees, through shareholder-financed foundation

grants for charities and community programs, through

support with volunteerism and contributions and in

leading the way in low-income assistance and 

environmentally sensitive investments and programs.

Even when the benefits have been weighed and the

differences highlighted, investor-owned utilities and

publicly owned or government-owned utilities share one

common concern: continuing to provide the critical service

of electricity to consumers and businesses into the future

through sustainable, low-cost and reliable means.

12/08