Power Outages, Utility Regulation, and New Utility Holding Company Structures

Reliability under "Performance-Based Regulation"
Recent long duration electric power outages in hot weather and slow recovery after storms have raised concerns about reliability, the level of utility investment in infrastructure, and commitment of staff and resources to preventive maintenance. These concerns may be related to the trend of state utility regulation, which has been to set "delivery" rates for several years using a "macro" approach that does not specifically review details of utility spending plans. Utilities are given great flexibility to allocate resources, cut costs and keep any savings during the term of the rate plan as profit. When the rate plan expires, another multi year plan is typically approved.

The New York PSC created statistical performance "metrics" and standards so that, ostensibly, utilities will not slash costs in areas that eventually affect service quality and reliability. The intent was to focus on "performance" and results, while reducing regulatory scrutiny of inputs, such as infrastructure investment, maintenance, and staffing levels, and giving utilities what they wanted, which was increased "flexibility." In its enthusiasm to allow utilities broad latitude to cut costs where they choose without regulatory "micromanagement" while delivery rates are frozen during long term rate plans, regular five-year detailed audits of utility plans, performance and operations - outside the ratesetting cases - apparently were abandoned by the PSC, even though they are statutorily mandated. See Con Ed Monitor a Sleeping Watchdog, indicating that the PSC has not conducted such audits of Con Edison for at least 15 years.

Under this lightened regulation, have utilities reduced maintenance, such as tree-trimming and replacement of old power poles, with a result that greater damage occurs when large storms hit? Is it now economic for a utility to risk failing the PSC performance metrics if the cost of meeting the standard is greater than the cost of failing it, or if the cost of meeting the standard would reduce earnings? In 2004, the New York PSC reviewed the advent of performance regulation, and suggested that public safety may have been compromised under the regulatory policies that rely more on utility choices in an order regarding the investigation of an electrocuted pedestrian in New York City:

"Over the past 10 to 15 years, we and other regulatory commissions across the nation have moved from traditional one-year litigated rate cases to multi-year performance-based rate plans. The purpose of these plans is to allow for rate stability while allowing the utilities greater flexibility in managing their operations. Staff’s investigation into this matter suggests that the utilities may not have been placing enough attention and emphasis on safety matters."

A 2004 PULP report indicates that for several years, Con Edison had set a lower budget each year for certain preventive maintenance programs, and then each year underspent the budget. For example, maintenance budgets and expenses significantly declined from 1999 - 2003 in the Brooklyn-Queens division, which includes the areas that experienced lengthy outages in the summer of 2006.

Negative rate adjustments when a utility fails to meet performance standards have not been swiftly implemented by the PSC when the performance standards are not met. Instead of a prompt downward adjustment or refund to customers, rate reductions have been "deferred," to be taken into account in a future rate case when calculating rates for future years.

For example, Con Edison failed to meet reliability standards in 2002. A 2003 PSC order said the company was "directed to defer $7.5 million in shareholder funds on its books for the benefit of ratepayers, use of such deferral to be determined at a later date."

Ultimately, this credit for ratepayers was amortized, along with others, over three years beginning in 2005. The impact of the delayed reliability performance adjustment for 2002, now being amortized from 2005 - 2008, is insignificant in the context of the 2005-2008 rate plan, where sums much larger than the deferred rate adjustments for poor reliability performance were compromised in the final joint proposal for settlement of the case.

Why would the PSC allow the financial impact of performance failures be so disconnected from the time of failure, delayed, and then diffused over years in the next rate case?

Some utilities have argued that the PSC cannot impose performance based rate reductions without hearings and without following statutory procedures for the imposition of penalties under Section 25 of the Public Service Law. Section 25, which was enacted before modern administrative law and procedure was developed, requires court proceedings for the PSC to impose financial penalties for failure to obey a law, rule, or PSC order. It is unclear whether the PSC could require a set of reliability performance criteria and impose adverse financial consequences for failure to satisfy them without following the antiquated and cumbersome procedures of Section 25.

This lack of legislative clarity may be a factor in the rather weak reliability performance plans, all of which have been agreed to by utilities in the context of their rate case settlements. A lack of real teeth in the form of prompt and significant financial consequences for a utility failure to provide safe, reliable and adequate service is not unsurprising. Ultimately, the sanctions for poor performance in the rate case settlements have all been acceptable to the utilities.

There should be a full investigation whether reliability has been impaired as a result of the relaxed PSC oversight, whether the PSC "performance metrics" actually and accurately measure the right things to assure reliability and adequacy of service, whether economic consequences to utilities of not attaining existing performance targets set by the PSC are really sufficient, and whether the power of the PSC to impose prompt, meaningful rate refunds or reductions in response to objectively measured failure to provide reliable service needs to be clarified or bolstered by the legislature.

Have New Holding Company Structures Affected Utility Infrastructure Investment Decisions?
Apart from "performance regulation," another factor influencing utility investment in infrastructure is their new corporate structure. Previously, financial choices were rather limited for local utilities: profits basically were paid out as dividends to shareholders or reinvested into the utility infrastructure. Money raised by the sale of stock or issuance of bonds generally had to be invested in the utility operations.

New holding company structures were encouraged by lax SEC enforcement of the federal public utility holding company act (PUHCA), which eventually was repealed in 2005, and by the New York PSC, when it attempted to "restructure" New York's electric industry in 1996-97. Now New York utilities send their profits to their holding company parents, and the proceeds of new stock and bonds issued by the holding company parent, even though primarily based on the assets and operations of the state regulated utility, can be spend on activities of other ventures withing the holding company structure.

For example, the holding company parent corporation may buy utilities in other areas, states or countries, as National Grid has done, or may enter into new lines of business through less regulated subsidiaries, as Enron did and as Con Edison has done.

As a result, the holding company parents now can allocate the capital earned from New York regulated utility to investments, or raised by issuing new stock and bonds, in other areas and activities where they believe greater returns for shareholders can be realized. Some states are now considering enactment of their own utility holding company laws to refocus utilities on the provision of reliable local service at reasonable rates.