Power to the People is a column by D. Maurice Kreis, New Hampshire’s Consumer Advocate. Kreis and his staff of four represent the interests of residential utility customers before the NH Public Utilities Commission and elsewhere.
DONALD M. KREIS, Power to the People
If there is a fundamental truth that applies to ratepayer advocacy, it is this: The customer has the only wallet in the room.
Yes, we rely on investor-owned companies like Eversource, Liberty, and Unitil to provide our electric grid, our natural gas, and sometimes our water. Yes, investors pony up quite a pile of capital, which saves us ratepayers the trouble of doing so.
(Though query whether customers who rely on publicly owned utilities, like municipal electric departments or the New Hampshire Electric Cooperative, aren’t doing just fine. There is something to be said for a democracy-based paradigm in which the investors and the customers are the same people.)
Here’s the thing about those utility investors, though. The customers always make the investors whole eventually; it is all but guaranteed.
In regulatory parlance, utility shareholders are entitled to both a return on their investment and a return of their investment. Both are the subject of intense argument during rate cases at the Public Utilities Commission (PUC).
Determining the return on investment involves figuring out a reasonable ROE – return on equity – to plug into the formula for calculating utility rates. ROE is supposed to be tied to how risky the investment is. That makes intuitive sense; you’d expect to earn more on your investment in a high-flying pharmaceutical firm than on your federally insured account at your credit union.
Surprise, surprise: utilities are always whining to the PUC about how risky they are. They sing a different tune during their quarterly calls with investment analysts, when the idea is to make the utility stock look more attractive by showing what a sure bet it is.
Early in my career in utility regulation, I learned to savor a good ROE fight. Lately I am growing more obsessed with the matter of return on investment. The problem is that, unless you’re careful, utilities figure out how to squeeze some extra cash out of this aspect of rate-setting.
Return of shareholder investment comes via one of the operating expenses that utilities get to recover via their rates: depreciation. A simple example will (hopefully) make this clear.
Let’s say that thanks to $500 million in shareholder equity and $500 million in borrowed funds, a utility has $1 billion in capital assets providing service to its customers. And let’s make this super-oversimplified by assuming that those assets have a ten-year useful life – that is, after a decade in service they will be completely worn out and in need of replacement.
Under this scenario, the utility would be entitled to recover $100 million a year in depreciation expenses. That way, at the end of the ten-year useful life, the utility will have its $1 billion back – which allows it to pay back lenders, purchase new assets, and even return investment capital to shareholders if desired.
In the real world, it’s much more complicated because utilities are constantly replacing existing infrastructure and building new facilities, and not all assets have the same useful life. That creates mischief potential.
Mischief potential multiplies when the PUC approves so-called “step adjustments.” Basically, over the years, lots of utilities have convinced the Commission to avoid rate cases (which are expensive and complicated) by allowing automatic rate increases as new facilities are placed into service. Typically, the PUC allows a utility either two or three of these automatic annual adjustments.
Our new director of finance at the Office of the Consumer Advocate, Al-Azad Iqbal, recently pointed out that it’s unfair to allow such automatic recovery on new assets without taking into account the depreciation of existing assets.
Returning to the above example, each year the company recovers $100 million in depreciation expenses, the “book” value of those assets decreases by $100 million. So, at the end of Year 1, the utility should only be earning a return on a $900 million investment.
So, if you wrap up a rate case when the utility has $1 billion in assets, and you give them an automatic “step” adjustment 12 months later because they’ll be making $200 million in new investments, it’s unfair to ratepayers if you calculate that adjustment so as to allow for a return on, and a return of, a $1.2 billion investment. The more accurate number would be $1.1 billion – a $100 million difference.
What’s that worth to the owners of the only wallet in the room, the ratepayers? Well, these days, a good rule of thumb is that ratepayers pay about a seven percent return (to cover interest to lenders and ROE to shareholders). That means that, in our simplified example, the utility would be extracting $7 million a year in free money from its customers.
As the guardians of the only wallet in the room when the PUC is hearing a rate case, rest assured that we hate giving utilities free money. So, in future rate cases in which utilities seek step adjustments, we’ll be coming for that $7 million.
If there are any utility shareholders or executives among my readers, they might point out that other aspects of the rate-setting process at the PUC work to the advantage of ratepayers. A prime example is the phenomenon of “regulatory lag” – the fact that inflation takes its toll on utility costs between rate cases whereas rate increases lag behind this reality.
Step increases go a long way toward addressing regulatory lag. Ultimately, the cure for this problem is changing the way we set rates altogether. Instead of basing them on a backward-looking focus on utility costs, why not make future rate adjustments based on actual utility performance?
Utilities are always bragging about how much more reliable, innovative, and customer-empowering they are getting. We should consider using the process of setting rates to hold them accountable for accomplishing these things.