Have investor-owned electric utilities outlived their usefulness? Many in the public power sector have long answered a rousing “Yes,” but the idea has long been anathema outside the world of munis and co-ops.
Now two veteran economic analysts who have long studied the electric system are suggesting that private-sector electric companies may be large, clumsy, and inefficient ways to serve society’s purposes. In a recent article in Oilprice.com, Leonard Hyman and William Tilles provocatively ask “why do we still have investor-owned utilities, which charge higher prices, for identical services, while using public money to lobby for further rate increases? Maybe governments at various levels should simply finance the big-ticket items of electricity decarbonization themselves and reap the savings.”
Hyman and Tilles, co-authors of the venerable book “Electric Utilities Past, Present, and Future,” now in its ninth edition, are agnostic about private versus public ownership of crucial infrastructure industries. In their article, they compare the U.S. electric system, dominated by the IOUs to U.S. water utilities, dominated by publicly-owned systems.
They note, “The electricity and water utility industries are mirror images in a way. Government agencies service roughly 85% of water consumers and investor-owned companies the rest. Investor-owned utilities serve roughly 85% of the electricity market and government agencies serve the balance. Government agencies provide both essential commodities at a lower cost in both markets.”
Over the past 10 years, investors in private electric companies have out-earned corporate bonds’ average 3-4% yield, “the risk-free return upon which investors build their expectations.” They have generally earned double that and “should have been satisfied with total returns (meaning current income plus price appreciation) of 6-8% for low-risk utility investments. But investors did far better.”
Hyman and Tilles write that corporate bonds are now yielding 5% and electric company investors should be happy with 8-9% returns. “Regulators will, no doubt, continue to set much higher numbers for allowed utility equity returns. Whether this is due to regulatory capture or other forms of undue corporate influence we have no idea but the ongoing pattern is suggestive.”
Going forward, they predict that the IOUs “will lose major customers because they will be unable or unwilling to furnish the quality of service these customers require. And customers will have the ability to contract out for a ‘premier’ utility service or own and operate the assets themselves. As a result, the legacy franchise-owning electric companies may lose revenue.”
At the same time, the electric companies will need to “raise huge sums in the capital markets to upgrade and expand plant and equipment, replace aging assets, and decarbonize and upgrade the grid. Financing that program will require a steady stream of rate hikes for customers, some of which may drive away business dependent on low energy costs or adversely impact the neediest customers.” [Readers of The Quad Report may think of California as they read that last sentence—Ed.]
How will utility regulators respond? They will cut back on rate increases, trimming the fat returns to which the investors have become accustomed, shrinking returns as capital expenses increase. They note pointedly, “We don’t see the water companies running out of capital, do we?”
The proper question then becomes whether the higher cost to the utility in order to serve the equity investor is worthwhile for society. “The investor-owned utilities do not seem better run, but all the extra taxes and higher capital costs probably add 5-10% to the customer’s utility bill. The bulk of the nation’s water consumers get the benefit of lower capital costs and taxes via public or municipally owned entities while the bulk of the nation’s electricity users do not.”
Hyman was a senior advisor to investment bankers at Salomon, Smith Barney and head of utility research at Merrill Lynch. Tilles headed utility equity research at two major brokerage houses and then became a portfolio manager investing in long/short global utility equities. He has taught political science. Both are frequent contributors to Oilprice.com.
Calif. CPUC blinks on income-tax electric rates
The California Public Utilities Commission has backed away from a plan to add a graduated income-based fixed charge to its volumetric electric rates for the states three investor-owned utilities. The income tax plan was designed to lower the impact of the state’s enormous electric rates on low-income consumers.
The plan had recently come under intense fire from Democratic legislators and the state’s renewable energy interests, charging that it would undermine the incentives of customers to reduce use and utilities to switch to solar, wind, and storage.
Instead of the income tax, the CPUC on Wednesday (Mar. 27) adopted something of a hybrid. New rates will include a fixed charge for all customers to recover costs that are not related to electric usage – for items such as fire controls, upgraded transmission, energy efficiency programs, and the like. This is designed to reduce impact of these costs when they are folded into the volumetric rates. For most customers, the charge would amount to $24.15 per month. For some low-income customers, the fixed fee would be $6/month.
According to the commission, “The proposal cuts the usage rate by 5 to 7 cents per kilowatt-hour, making electricity cheaper for all customers and cheaper to electrify homes and vehicles. The usage rate will continue to vary throughout the day just like how rates operate today to encourage conservation.”
The commission is taking comments on the new proposed rate structure. If approved, the new electric prices will go into effect for San Diego Gas & Electric and Southern California Edison in 2025 and Pacific Gas & Electric in 2026.
–Kennedy Maize