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
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.
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
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.