The issue
The Regulatory Compact is the traditional mode of
regulation for the electric utility industry, also known as
cost-of-service regulation. In this regulatory
environment, the utility is recognized as a natural
monopoly and is obligated to provide service to all
consumers within its authorized footprint. It is regulated
by a state utility commission.
In return for its obligation to serve, the utility is
given the opportunity to receive not only its investment
and cost of providing service, but an opportunity to earn
a fair return on its investment.
How we got to this point
The Regulatory Compact evolved in the early years
of the electric industry, largely after passage of the
Public Utility Holding Company Act (1935).
In earlier eras, consumer load was growing almost
faster than utilities could keep up with. New
infrastructure was a way of life. But the era of Ozzie and
Harriet was simpler in many ways. Environmental
constraints were minimal. Technology was inexpensive
and land was even cheaper.
Utilities would foot the bill for whatever new
construction was needed and could quickly verify to their
commissions that costs incurred were prudent and
therefore recoverable. They then could begin recovering
those costs (with a return) from ratepayers, and they
could do so in a manageable timeframe.
AEP position
While AEP embraces the history of the Regulatory
Compact, the time has come for alternative mechanisms
within the traditional regulatory framework to help
eliminate the regulatory lag and uncertainty that have
become a way of life for many utilities.
Flexibility will be key going forward. While the
Regulatory Compact is still beneficial to both utilities and
customers, we must remain open to innovations to
streamline the ratemaking process.
What the industry says
In the mid-late 1990s, states began a stampede toward
industry restructuring and competitive retail markets. That
stampede came to a grinding halt after the California crisis
in 2000 and 2001, and by 2005, states were reversing their
decisions and returning to the more stable environment
provided by traditional regulation.
Regulatory frameworks in the US electric utility industry: 2001-2010
Source: EIA
Source: EIA
In the wake of the stampede, many state commissions
instituted rate freezes and price caps to control prices as
consumers adjusted to the changes. In some cases, those
protections may have shielded consumers from realities
that now seem larger because they are unexpected.
Many states now are considering alternative regulatory
models within the Regulatory Compact framework –
pricing tools and mechanisms to address specific issues
without upending the entire architecture.
What the stakes are
While the Regulatory Compact has been around for
over 75 years, it has begun an evolution from a static
environment that breeds regulatory lag and uncertainty to a
more dynamic framework that embraces alternative
regulatory mechanisms such at formula rates, preapprovals,
and rate adjustment mechanisms. Because lag
and uncertainty increases risk for utilities, impacts Wall
Street ratings, and increases the cost of capital; both
utilities and state regulators are more open than ever to
alternative mechanisms within traditional ratemaking that
mitigate old shortcomings and avoid potential impacts on
customer rates and delays in needed infrastructure.
