Regulatory Compact

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
Regulatory frameworks in the US electric utility industry: 2001-2010
Source: EIA

Restructing Status
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.

Issues In Electricity

Issues In Electricity

Regulatory Compact