Cost of Service Regulation

Question 1

Describe the economic basis for regulating utilities

Answer 1

1. Natural Monopoly
2. Any kind of profits (even miscalculated) based on price above market price represents a deadweight loss to society
3. At the same quantity, the increased price represents decrease in consumer surplus

Question 2

Describe the legal basis for regulating utilities

Answer 2

1. Public utility
2. CL historical root - price fixing for businesses with a public interest (king’s charter) is basis for regulatory compact

Question 3

Describe the constitutional basis for regulating utilities

Answer 3

1. Munn (1876) - Takings 14A does not require a private biz, in which the public has a significant interest to be compensated for losses incurred due to govt regulation (not confiscatory)
2. Nebbia (1934) - Substantive DPC does not prevent states from enacting economic policies (price fixing) so long as they are not unreasonable or arbitrary (rational basis test) –> SC will NOT scrutinize economic regulation (did not address takings issue)
   
   • Like Hope Natural Gas (end result test)

Question 4

Describe the fundamental asymmetry in the Takings issue in ratemaking

Answer 4

1. Takings issue only arises when price is too low as to effectively “take” investors’ ROI
2. But, monopolistic behavior that occurs when price is too high is a policy problem, not a takings problem

Point - regulatory compact does not always do away with the takings issue

Question 5

What is the ratemaking in theory?

Answer 5

Regulatory Compact - Balance consumer’s interested in reasonable rates free from monopolistic profits with investor’s interest in earning reasonable ROI
1. Set prices to replicate what a competitive marketplace would produce even if there is no comparable markets for electricity prices
2. Critique - circular reasoning bc no market actually exists

Question 6

5 Goals of Ratemaking

Answer 6

1. Capital attraction - debt or equity financing
2. Reasonably priced energy
3. Efficiency - utility is competitive as other firms w/ similar risks
4. Demand control & consumer rationing = rate design
   
   • Declining block rate (less P & high Q)
   • Inverted block rate (high P & less Q)
5. Income transfer & profit control - consumers to utility investors

Question 7

Ratemaking Formula

Answer 7

R = O +B(r)
* R = Revenue Requirement - what a utility is entitled to collect
* O = Operating cost (fuel, labor - varies w/ quantity) (maybe advertising and charitable donations?)
* B = Rate Base (debt + equity financing) (most litigated)
* assessed by depreciating the asset over a period of time, but depreciated expense is added to O
* r = Rate of ROI (higher than market rate) (constitutionalization of corporate finance) (litigated)

R is assessed every year?

Question 8

What body of law places limits on rates?

Answer 8

4 bodies of law
1. State & federal statutes - just and reasonable; nondiscriminatory
2. State & federal constitution - fair value test?

Question 9

Describe the development of constitutional limits on rates

Answer 9

1. Smyth v. Ames - Fair Value (more intrusive judicial test)
2. Brandeis - critiqye of fair value test
3. Hope Natural Gas - End Results Test

Question 10

What is the fair value test and what are its critiques

Answer 10

1. Forward-looking calculation of its net present value
2. Factors - original cost of cosntruction, investment in permanent improvements, market value of stocks & bonds
3. Actual legitimate cost - what you already paid
4. book cost - estimated production cost
5. Critique circular! Fair value is not the starting point but the end product of the regulatory calcuation

Question 11

What is the End Result Test?

Answer 11

• So far as the end result is “fair balance between consumer interest and investor interest” the judicial inquiry is at an end
• Judicial review follows administrative process, and court will not scrutinize the method that FERC or PUC uses to calculate the rate
• Open question - financial viability of the utility is part of the ratecase, but can a utility be allowed to fail?

Question 12

What is the Filed Rate Doctrine?

Answer 12

1. Forbids a regulated entity to charge rates for its service other than those properly filed w/ appropriate federal regulatoyr authority
2. Purpose - assure effective FERC oversight, prevent sweetheart deals or exclusion of competitors

Question 13

What are the limits to Filed Rate Doctrine?

Answer 13

1. FERC must honor rates & cannot revise through rulemaking procedure
2. Cannot normally set rates retroactively
3. Neither fraud nor misrepresentation claims invalidate filed rate

Question 14

What happened in the City of Girard?

Answer 14

1. City of Girard’s power plant failed & entered into long term contract w/ utility, which was filed (check)
2. Point - Both the utility and the customer are both bound by the terms of the Filed Rate until regulatory authority approves a change

Question 15

What is the Mobile-Sierra Doctrine?

Answer 15

1. Permits modification of rates charged by a utility only if that modification is in the public interest because the rate is found to be unjust, unreasonable, or unduly discriminatory
2. Only for long-term contracts
3. High standard to meet

Question 16

What happened in Potomac Electric?

Answer 16

1. Facts - fill in
2. Point - A mere disparity or benefit to utility or customers does not suffice to satisfy Mobile-Sierra’s public interest standard

Question 17

FPA Sec. 205

Answer 17

(a) Rates and things that effect rates shall be just and reasonable, and if they are not, they are unlawful.
(b) Non-discrimination provision
(c) Must file publicly, rate schedule & contracts that effect or relate to rates & “classifications, practices, and regulation.”
(d) Notice is required

Question 18

FPA Sec. 206

Answer 18

(a) Unjust or preferential rates – complaint or motion from the commission may cause an investigation, and if rate is unfair, then the commission may set the appropriate rate
(b) Refund Effective Date – if rate is found unreasonable, FERC may set new rate and offer refunds
- Section 206 allows FERC to amend rates that are unjust, unreasonable, unduly discriminatory or preferential.

Question 19

What are the two main ways that PUCs deal with failed investments?

Answer 19

1. Used & Useful Test
2. Prudent Investment Test

Question 20

What is the Used & Useful Test?

Answer 20

1. Ratepayers are only responsible for the costs that resulted in the electricity generated they used
2. Thus, half-finished projects do not go into B, but only in O
3. But it may not even go into O (rare) - Duquesne

Question 21

What happened in Duquesne?

Answer 21

1. Fact - Failed project investment not inlucded in B or O
2. Point - It is not a taking to disallow recovery of capital investments to a failed project
3. Affirms Hope Natural Gas - total embrace of total effects (if fair and responable, inquiry ends)

Question 22

What is the Prudent Investment test?

Answer 22

1. If an investment was made prudently, then it can be factored into B
2. Pro-investment but encourages overinvestment

Question 23

What happened in Jersey Central?

Answer 23

1. Facts - A utility is at the brink of financial viability. Court is more concerned with the price being confiscatory
2. Point - Rates set by FERC are just and reasonabel only if the results constitute a reasonable balancing of (1) investors’ financial interests and (2) consumer interest in being charged fair rates

Question 24

Describe the three prevailing ways that courts answer the question of whether utilities are allowed to fail

Answer 24

1. Bork (maj): If these allegations (unable to pay dividends) were true, then this would be taking. Can’t allow that.
2. Starr (con): CWIP already undermines the used and useful test. Prudent investment is also not great. Neither test, strictly applied, is balanced.
3. Mikva (dis): Rates are not unreasonable or confiscatory simply because investors would lose money. We are not near a taking, utilities should be allowed to fail.

Jersey Central

Review this

Question 25

Tell me the long story of regulation & deregulation of utilities

Answer 25

1. At first, there was no regulation of utilities
2. Early 1900s - State-level regulation began with the antitrust movement when utilities became monopolistic. PUCs set prices through rate case
3. Attleboro Gap - Dormant CC prevents PUCs from approving rates for interstate transactions. Attle
4. 1935 - FPA created FPC/FERC to set prices for interstate wholesale transactions & transmissions, creating a “bundled rate”???
5. Everyone is happy until 1970
6. Chicago School of Economics - can do better!
   
   • Macro - capture theory + sus about corruption
   • Micro - generation can be more competitive, power pools are already happening
7. Order 888 - FERC creates RTOs to run wholesale and transmission markets. For rates to be approved, must join the RTO. FERC has discrimination duty, and coudl argue that state utilities were discriminating against more efficient prices

Question 26

Tell me the short story of regulation

Answer 26

Utilities were unregulated, then heavily regulated, to now slowly deregulated

Question 27

What is rate trapping?

Answer 27

???

Question 28

What federalism issue arises in Cost of Service Regulation?

Answer 28

fill in