The Utilities That Will Need To Carry Out Electrification: Governance Issues

The Utilities That Will Need To Carry Out Electrification: Governance Issues

The Utilities That Will Need To Carry Out Electrification: Governance Issues

The “electrification” agenda is the idea that the move away from fossil fuels and carbon emissions can happen via electricity: that is, generate carbon-free electricity and then use it to replace fossil fuels.

But in-between the massive increase in electricity generation that would be needed and the uses of that electricity in homes, cars, and businesses, there will also need to be a dramatic expansion (maybe a tripling or quadrupling) in electricity lines to distribute that electricity where needed. In the US electrical grid, almost all of the distribution of electricity is done by regulated public utilities. These companies are owned by shareholders–that is, you can buy stock in them. But their pricing and investment plans are regulated by the government. And these companies are the ones that will ultimately be making the decisions about whether and in what ways to expand the electrical grid.

Aneil Kovvali and Joshua C. Macey discuss the issues in “The Corporate Governance of Public Utilities” (Yale Journal on Regulation, 40:2, 2023, pp. 569-619). From the abstract:

Rate-regulated public utilities own and operate one-third of U.S generators and nearly all the transmission and distribution systems. These firms receive special regulatory treatment because they are protected from competition and subject to rate caps. In the past decade, they also have been at the center of high-profile corporate scandals. They have bribed regulators to secure subsidies for coal-fired generators and nuclear reactors. They have caused wildfires and coal-ash spills that resulted in hundreds of deaths and billions of dollars in liability. Their failure to maintain reliable electric service has contributed to catastrophic blackouts. Perhaps most consequentially, they have emerged as powerful opponents of state and federal climate action. This Article describes the unique corporate governance challenges public utilities face and argues that these governance challenges contribute to the pervasive inefficiencies and the frequency of corporate misconduct that characterize utility industries.

As the authors point out, the shareholders that own rate-regulated public utilities are different from shareholders in other companies. Because of the regulations, the shareholders are never going to get a super-high rate of return, but because the regulators don't want the electric company to go out of business, shareholders are also somewhat protected from losing money. If the company performs quite well–providing reliable and green energy at low cost–it’s the users of that electricity, the ratepayers, who will actually reap the greatest benefit. Conversely, if the company performs badly, the shareholders are likely to be somewhat protected by the regulators, but those depending on the electricity supply will suffer.

In a meaningful sense, the shareholders of this kind of company are more like creditors, getting a steady return unless there is a bankruptcy. The ratepayers are more like shareholders, because they are the residual claimants who experience most of the benefit or harm when the company performs well or badly.

The proposed solutions of the authors to this situation are only mildly persuasive, in my view. For example, they want “ratepayers” to have a place on the board of directors of these regulated public utilities, which I suspect would have little effect on the underlying incentives.

Kovvali and Macey are focused on the overall governance problem for these companies, not really on the need to have a dramatic expansion of the electrical grid. But as they point out, existing public utilities that both generate and transmit electricity may have mixed incentives about building additional transmission lines. After all, additional transmission is likely to mean more outside competition from electricity produced elsewhere–which can be a good thing for rate-payers, but harder to justify to shareholders. In general, shareholders of publicly-regulated utilities are not likely to lobby the company or the regulators for a dramatic expansion of transmission lines, because such a step would involve taking on a lot of debt and probably (given regulated prices) will not improve shareholder returns. But unless regulators provide them with incentives to do so, public utilities aren’t likely to expand transmission lines. Along with the various practical hands-on issues of dealing with the costs and permissions needed to expand transmission lines, these institutional constraints are likely to be another complicating issue.

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Timothy Taylor

Global Economy Expert

Timothy Taylor is an American economist. He is managing editor of the Journal of Economic Perspectives, a quarterly academic journal produced at Macalester College and published by the American Economic Association. Taylor received his Bachelor of Arts degree from Haverford College and a master's degree in economics from Stanford University. At Stanford, he was winner of the award for excellent teaching in a large class (more than 30 students) given by the Associated Students of Stanford University. At Minnesota, he was named a Distinguished Lecturer by the Department of Economics and voted Teacher of the Year by the master's degree students at the Hubert H. Humphrey Institute of Public Affairs. Taylor has been a guest speaker for groups of teachers of high school economics, visiting diplomats from eastern Europe, talk-radio shows, and community groups. From 1989 to 1997, Professor Taylor wrote an economics opinion column for the San Jose Mercury-News. He has published multiple lectures on economics through The Teaching Company. With Rudolph Penner and Isabel Sawhill, he is co-author of Updating America's Social Contract (2000), whose first chapter provided an early radical centrist perspective, "An Agenda for the Radical Middle". Taylor is also the author of The Instant Economist: Everything You Need to Know About How the Economy Works, published by the Penguin Group in 2012. The fourth edition of Taylor's Principles of Economics textbook was published by Textbook Media in 2017.

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