The typical scheme for electric utilities places customers in one of two bins: investor-owned or city-owned. There is a perennial debate over utility ownership. Should we rely on investor-owned utility companies or should cities manage their own utilities? The answer is simple: neither. Both are fundamentally flawed. Investor-Owned Utilities (IOUs) are inefficient and today’s Public-Owned Utilities (POUs) suffer from paralysis. The state of California would be better served by a reformed POU system centralized under one agency.
The debate around public and private ownership largely revolves around transmission and distribution of electricity. Depending on where a customer lives, they are either served by an IOU or a POU.
The vast majority of Californians are served by Investor-Owned Utility companies| Image Source: California Energy Commission
IOUs, like Southern California Edison or PG&E, are private entities that provide electricity to customers to generate profit. POUs, like the Los Angeles Department of Water and Power, are nonprofit entities owned and operated by local governments. In either case, both IOUs and POUs have structural inadequacies that demand a centralized alternative. Consumers in this market are poorly served by the for-profit model due to the nature of electricity as a commodity, the incentive to misuse funds, poor private financing options, and the necessity to charge a premium in the first place. While the public-owned model solves many of these issues, it is held back by its management by local governments.
Investor-Owned Utilities: A Warped Simulacrum of a Market
Because IOUs need to operate at a profit, their rates will necessarily be higher than an equivalent nonprofit entity. The profit that any given IOU is allowed to make is directly governed by the California Public Utilities Commission (CPUC). The CPUC limits the maximum rate of return of equity (ROE) that a company may earn, usually between 10 and 12 percent.
Using ROE to derive shareholder returns gives the state leverage over POUs’ investment strategy state, but also encourages inefficient spending. By raising the limit on a company’s ROE, the state can incentivize companies to invest in new infrastructure and upgrade the existing grid. However, it also permits companies to artificially inflate their equity by “goldplating” capital investments. In other words, purposefully wasting money to increase shareholder returns. The ROE limit cannot be set too low either, otherwise there is no incentive to invest in new developments. This tightrope that the state has to walk leads to millions of dollars being unnecessarily spent at the customer’s expense, as companies often increase their rates to pay for these goldplated developments.
IOUs are further limited by the immense capital costs of simply existing in the market. Budgets can easily swell into the billions of dollars, which is raised by selling private equity and taking on debt. This is the dominant financing model for private for-profit entities, but it simply cannot compete with the municipal bond market. IOUs typically have to pay back debt and equity amounts at interest rates over 7 percent. Meanwhile, municipal bonds typically only have an interest rate of 4-5 percent. For an industry that regularly operates in the billions of dollars, this difference in interest becomes an immense burden on ratepayers once costs are passed on.
Across California, IOUs typically charge much higher rates than POUs| Image Source: Energy Institute at Haas
The profit incentive to overspend and their competitive disadvantage in sourcing to source cheap capital are clear downsides to private-owned utility companies. Some would argue that these typical downsides of private enterprise are acceptable given the benefit of competition. What makes these issues especially pernicious though, is that customers don’t receive the benefits of market competition that might be seen elsewhere.
The immense capital costs of building power lines, transformers, and substations prohibits easy entry into the market. Further, if multiple companies did want to compete for customers they would need to build duplicate infrastructure to do so. After all, a customer cannot purchase electricity unless it is shipped directly to them. This makes electrical transmission more analogous to transportation and roads than any discrete consumer good. Because the market is most efficient when there is one producer, electricity is a textbook example of a natural monopoly.
Since this market is a natural monopoly, free market principles are not enough to justify the existence of IOUs.
Public-Owned Utilities: Affordable but Ineffective
So if not IOUs, why not switch wholesale to local POUs? POUs avoid many of the detrimental effects of private ownership. Since they are nonprofit entities, POUs are not able to raise rates on a whim. In fact, Proposition 26 classified the rates charged by POUs as taxes, requiring voter approval for any rate hikes. There is a caveat though. As of Citizens for Fair REU Rates v. City of Redding (2018), if the raise in rates can be deemed necessary to cover the costs of the service, it doesn’t require approval. This allows POUs to save customers as much as possible while also maintaining their operations.
As government agencies, POUs can raise funds by issuing bonds that have returns as low as 5 percent. Having less expensive financing options allows POUs to complete capital investment projects at a lower overall cost, saving ratepayers money in the long-run.
Furthermore, as government agencies they are not required to pay taxes on their revenue, although some jurisdictions require Payments in Lieu of Taxes (PILOTs).
The major drawback of POUs is that they are owned and operated by local governments. California gives many of its cities a great deal of autonomy which extends to utility companies. Where the CPUC enforces strict requirements for IOUs to meet renewable energy goals, POUs operate under much more relaxed standards from the California Energy Commission (CEC).
This allows POUs to act independently, but it also permits them to fall out of compliance. This has manifested in the failure of some POUs to meet standards for clean energy set by the CEC. In an effort to keep the bills low for ratepayers, POUs may neglect to modernize their infrastructure, an incredibly expensive endeavor. While the CPUC can intervene directly, the CEC is defanged. The only recourse for the CEC is to provide recommendations and refer the offending utility to the California Air Resources Board. Whether a city is acting slowly to save customers money or for parochial opposition to the state’s goals, it is nonetheless an inefficiency that cannot be allowed.
A Centralized Public-Owned Utility: Planning for the Future
With these aspects of IOUs and POUs in mind, what would a system that combined the positives but cut out the negatives look like? To cost-effectively modernize the electrical grid, California must transition to a Centralized Public-Owned Utility (CPOU). A CPOU would leverage the advantages of a conventional POU – a nonprofit structure, low-cost debt through bonds, and tax-free operations – under a centralized planning agency that retains the expertise present in the private market.
The CPUC is arguably the most effective part of the IOU model, providing goals, restrictions, and guidelines that would be carried over to the new system. At the same time, replacing the laissez-faire enforcement of the CEC with a refitted CPUC would inoculate against the political obstructionism of local POUs. A CPOU would force local governments to comply strictly with state requirements and allow the State Legislature to step in to regulate distribution and rates when conflicts arise.
However, there is a far greater benefit to the CPOU that neither IOU nor POU possesses: access to the state’s tax base. With sufficient political will, many of the CPOU’s operations could be wholly subsidized through taxes, laying the groundwork for a universal electricity system. Cost inequities in rural areas and deprivation in low-income communities would be resolved by transitioning away from the ratepayer model to a single-payer model. Like roads, it is essential that this infrastructure be made accessible to everyone. While this would come at the cost of increased taxes, some IOUs already socialize their costs among their customers.
Solar power energy metering exemplifies a similar existing framework. As it stands, many have installed solar panels and receive a credit on their electricity bills. Because of this adverse selection effect, IOUs have had to look elsewhere to fund their existing infrastructure. This led to AB-205 (2021-2022), which allowed IOUs to charge an income-graduated fixed rate charge. This is effectively a progressive tax enacted by a private entity.
Much of the apparatus for a CPOU already exists. Our decentralized POUs suffer from an inability to act and the for-profit nature of IOUs don’t offer a competitive market advantage. If California wants to step into the future with a world-class economy, the state needs to control its most valuable commodity.
Featured Image Source: Wikimedia Commons
