Does the “Compact” Between Regulators and Utilities Really Exist?

Utility lawyer Scott Hempling always has something well informed and original to say about electricity in the US.  This month’s essay is no exception:

I recently came across this quote:

There is … a long-standing, but unwritten, rule that governs cost recovery and lies at the heart of establishing regulated prices. This rule is known as the regulatory compact. Under the regulatory compact, the regulator grants the company a protected monopoly, essentially a franchise, for the sale and distribution of electricity or natural gas to customers in its defined service territory. In return, the company commits to supply the full quantities demanded by those customers at a price calculated to cover all operating costs plus a “reasonable” return on the capital invested in the enterprise.1

This is the formula fed to regulatory newcomers:  smooth, sweet and easily digested.  But it lacks the essential nutrients. As commonly misused, the phrase “regulatory compact” refers to the regulatory treatment of shareholder investment under the statutory “just and reasonable” standard and the Fifth Amendment’s Takings Clause in the U.S. Constitution.2 There is a legal relationship between utility and regulator, and between utility investment and regulator-set rates.  But that legal relationship is not “long-standing,” it is not “unwritten,” and it is not a “rule.”  To call a “compact” what the Supreme Court has described as “essentially … ad hoc and factual” is artificially narrow, incumbent-protective, and legally wrong.

Mr. Hempling takes apart the “ad hoc and factual” relationship between electric companies and regulators, masquerading as some kind of regulated utility compact, and blows away much of what we are taught about electric utility monopolies.

The next paragraph is particularly relevant to AEP’s and FirstEnergy’s grab to control the regulation process in HB2201:

Those who cite the “regulatory compact” talk only of an exchange of service for money.  The real relationship is richer.  It requires the utility to satisfy the regulator’s standards for performance at “lowest feasible cost,”3 to use “all available cost savings opportunities”4; and to pursue its customers’ legitimate interests free of conflicting business objectives.  In return, the regulator must establish compensation that is commensurate with the utility’s performance.  But there is more.  To set standards for performance and ensure compliance, the regulator must have the resources, expertise and political support that is at least the equal of the utility’s.  And for this relationship to work to each party’s benefit, it must include a mutual commitment not to use the political process to undermine either the utility’s or the regulator’s ability to do their jobs.  Those who talk of a “regulatory compact” leave most of these factors out. [emphasis mine]


Utilities often cite the “compact” self-referentially, as if it is their compact, created solely to support their specific revenue needs and their specific business success.  (As in, “Utility of the Future” rather than “Customer Needs of the Future.”)  But the legal relationship just described transcends any particular utility.  Its foundation is a franchise, of which the incumbent utility is but a temporary grantee, one whose rights depend on performance.  The utility has no lifetime lock on the franchise (see “Regulatory Capture I:  Is It Real?“); nor is it like a New York City taxi medallion—bought from government, resold  for profit.  The franchise is a right to be earned, not demanded.

This describes perfectly the entitled attitude of both AEP and FirstEnergy in West Virginia, as well as that of our supposed regulators, the supine WV PSC.

Read Mr. Hempling’s entire piece.  It will open your eyes about what utility regulation really is.

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