To reform our energy system, we must travel back in time — over 100 years ago in fact — to understand the (unofficial) “compact” made between utilities and policymakers. Sometimes referred to in regulatory and legal proceedings, the Utility Regulatory Compact has no legal weight but is often used as an informal framework for negotiation between utilities — which desire to grow and profit — and policymakers for whom low energy prices, reliable service, and societal benefits are priorities.
As we covered in the introduction of this series, our energy system is facing new threats, and the Utility Regulatory Compact that has treated us (mostly) well over the last century is in dire need of reform. But to do this, we must understand its history. Any attempt to change our energy system for the sake of clean energy goals, climate change, or national security relies upon understanding why the Utility Regulatory Compact was created, how it came into being, what it looks like, and the incentive structure that supports it all.
In this series, Sealed president and founder Andy Frank explains the vision for a new Utility Regulatory Compact. We’ll dive deeper into why it needs to be updated, the key challenges to be solved, and the specific solutions that can be embraced by utilities and policymakers across the U.S.
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The Utility Regulatory Compact was created by the unlikeliest of alliances
Let’s dial the clocks back to the early 20th century, when utilities looked very different than they do today. There were multiple utilities — electric, gas, and phone companies — providing competing services in the same place. Most energy utilities built power plants and delivered electricity or gas. Some also provided electrical appliances and other services.
To operate, utilities had to obtain a (non-exclusive) license, which was typically issued at the municipal level for five to ten years at a time. As you can imagine, back then “political machines” often maintained hold on basic city services and so there was significant corruption when it came to who got a license and who didn’t.
This dynamic played out, for example, in Chicago, where a corrupt clique of city aldermen called the Gray Wolves accepted bribes in exchange for awarding franchises. In some cases, the aldermen established their own competing franchises in order to extract even bigger bribes from existing utility companies.
In the midst of this chaotic corruption, Samuel Insull, the father of the modern utility industry, saw an opportunity for a better regulated business model. Insull, president of the Chicago Edison Company (the precursor to Commonwealth Edison) and protege of Thomas Edison, believed the utility industry was plagued by wasteful competition. Given the high capital costs to build power plants, and establish distribution systems, it was difficult to make money amid utility price wars.
Insull flipped the script on business as usual when he squared off against these corrupt cronies, who figured Chicago Edison would pay up big to avoid the Gray Wolves from forming a competing company. They were surprised, however, when Insull refused to pay. In turn, the Gray Wolves were forced to actually form a competing company, but were shocked to find that Insull had made it nearly impossible for them to operate. That’s because Insull had made strategic agreements with almost every electrical manufacturer that produced critical equipment.
Insull then was able to buy the Gray Wolves’ 50-year franchise (much longer than any previous license) for $50,000, a fraction of the price of what the Grey Wolves had initially tried to sell it for. Insull then went on to use this franchise to “build the first giant, integrated utility serving a large metropolitan area”.
Progressive leaders of the time, seeing all of this play out, believed this growing industry should be regulated. Men like Louis Brandeis (who later became a Supreme Court justice) had seen the power of unregulated monopolies and trusts in the rail, oil, and steel industries. He and others feared that electricity, a rapidly growing industry, could be dominated by large, national corporations with almost unlimited pricing power.
The progressive instinct was to first focus exclusively on public ownership of utilities. Between 1896 and 1906, the number of municipally owned electric plants grew in number from 300 to 1,250. Many utilities, in fact, are still owned by municipalities or are organized as co-ops. But following the Great Panic of 1907, momentum slowed on public ownership, as it became harder for cities to get the money needed to purchase plants.
Voracious capitalists and trust-busting progressives came together on common ground
Insull thought that utilities could raise the capital necessary to expand their systems and keep prices low, as long as they were granted monopolies. The problem: The industry was run largely by free-market conservatives who laughed him off stage in 1898, during the annual convention of the National Electric Light Association, when he proposed the regulation idea. Insull persisted, however, and eventually persuaded most of these energy capitalists to buy into a regulated future.
The idea of regulated capitalism was also an appealing proposition to progressives like Brandeis, who wanted to protect consumers by regulating private utilities. Eventually the two sides came together through the National Civic Federation (NCF).
The NCF was an early 20th-century version of a think tank that sought “rational solution[s] to the most pressing problems of the day,” with a board equally represented by business, labor leaders, and progressive politicians (including Insull and Brandeis). Not long after its founding, the NCF commissioned a two-year study of public power that outlined what became the Utility Regulatory Compact. (The early design of the compact was heavily influenced by a parallel study led by Insull and the National Electric Light Association.)
In 1907, the NCF published its report. Its first recommendation was that “[p]ublic utilities, whether in public or private hands, are best conducted under a system of legalized and regulated monopoly.” That same year, Wisconsin became the first state to adopt the Utility Regulatory Compact with its 1907 Public Utilities Law. Shortly thereafter New York and Massachusetts adopted similar laws. By 1914, 43 states had established regulations for electric utilities.
The Utility Regulatory Compact made monopolies respectable
While progressives and businesses agreed on the need for a monopoly in order to serve the public interest in the utilities sector, the NCF made clear that these monopolies needed to be held accountable by making them revocable and subject to transparent reporting. The NCF report states: “Private companies operating public utilities should be subject to public regulation and examination under a system of uniform records and accounts of full publicity.”
The NCF also supported the cost-of-service model that allowed utilities to earn a fair return on their capital investments. “Rates should be fair, reasonable, and sufficient to yield a fair return upon the fair value of the property used in the public service,” read the NCF’s report.
The (sometimes tawdry) dealmaking that led to the formation of what is often referred to as the Utility Regulatory Compact is the foundation of the energy system that powers our lives. Under this compact, utilities hold a geographic monopoly that is regulated by public utilities commissions elected by the people or appointed by state governors. And utilities earn profits based on investments (usually capital) approved by regulators at a capped rate of return.
Insull summarized well the case for private, regulated monopolies with a cost-of-service model:
“The more certain this protection is made, the lower the rate of interest and the lower the total cost of operation will be, and, consequently, the lower the price of the service to public and private users. If the conditions of our particular branch of public service are studied in places where there is a definite control, whether by commission or otherwise, it will be found that the industry is in an extremely healthy condition, and that users and taxpayers are correspondingly well served.”
These foundational principles agreed upon by unapologetic capitalists and crusading progressives are woven into the fabric of our energy economy. Every state now has a public utility commission (or equivalent) that regulates one or more parts of the electric and gas system according to the principles of the Utility Regulatory Compact. For decades, the arrangement has worked well enough to power our prosperity: From 1900 to 2000, as more and more Americans gained access to power in their homes and increased their energy usage in response to increased prosperity, the electric industry’s revenue grew from less than $200 million to over $230 billion annually.
But as we enter a new era of clean energy, climate change, and challenges to growth, cracks are appearing in many of the assumptions that drove the formation of the Utility Regulatory Compact. The next piece in the series will look at how our energy system and needs have changed over time, and how the Utility Regulatory Compact is no longer working for many of the stakeholders that made it possible.
Over the course of this series, we will explore the vision for a new Utility Regulatory Compact. We’ll dive deeper into why it needs to be updated, the key challenges to be solved, and the specific solutions that can be embraced by utilities and policymakers across the U.S.
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