New Research Report Examines Downward Trend of Utility ROEs Impacting Electricity Bills

The Downward Trend of Utility Return on Equities: What It Means for Electricity Costs

Recent research conducted by the Alliance for Innovation and Infrastructure (Aii) has unveiled significant findings regarding the return on equity (ROE) of electric utilities. This report, titled "Ratemaking for a Reliable Grid: Return on Equity, Capital Attraction, and Customer Costs in a Changing Electric System," highlights a noticeable downward trend in both requested and authorized ROEs over the past two decades. This contradicts the prevailing notion that these returns significantly drive the rising costs of electricity for consumers.

Understanding ROE and Its Implications

The return on equity is a critical component of the financial metrics used in utility ratemaking. It is designed to ensure that electric companies can maintain financial health while providing reliable service. The latest report has concluded that, contrary to common belief, utilities have not continuously increased their ROEs; instead, they have been on a steady decline. This contradicts frequent accusations that utilities overcharge consumers in pursuit of profit.

Benjamin Dierker, Executive Director of Aii and co-author of the report, emphasized the complexity of ratemaking, noting, "ROE is one component of ratemaking, not the whole bill. Policymakers should focus on facts, incentives, constraints, and long-term outcomes rather than blunt reforms that may appear attractive in the short term but weaken the system over time."

Key Findings of the Report

The report presents several enlightening statistics:
1. Long-Term Decline: A review of utility data reveals that both requested and authorized ROEs have experienced a downward trend over the past twenty years, defying the expectations of systematic increases.
2. Current Rate Cases: Among the 69 electric utility rate cases studied since 2020, only 20 cases (about 29 percent) showed an increase in authorized ROE, further supporting the notion of stagnation in utility profits.
3. Understanding Capital Structure: It's crucial to note that ROE applies only to the equity portion of the utilities’ capital structure. The debt component is treated separately, which further complicates the understanding of utility financing and rate-setting.
4. Opportunity, Not Guarantee: The report clarifies that authorized ROE does not equate to guaranteed profit. Instead, utilities are given a chance to earn a regulated return, distinguishing between requested, authorized, and actual (earned) ROEs.
5. The Risks of Blunt ROE Caps: The report warns that proposals designed to cap ROE could lead to financial instability for utilities, ultimately resulting in risks for consumers due to potential lack of investment in necessary infrastructure.
6. Impact on Investment and Reliability: Higher borrowing costs or lesser financing flexibility can hinder the reliability and pace of needed infrastructure investments, which are critical for an effective electricity grid.
7. Customer Protection Needs: As demand for electricity surges, particularly from large-scale data centers, policies must effectively allocate costs to ensure ordinary customers are not burdened by infrastructure built for industrial needs.

Practical Implications of the Findings

This report serves as a cautionary note for policymakers engaged in ratemaking reforms. The experiences in Pennsylvania and Connecticut, referenced within the report, illustrate how proposed reforms could have unintended consequences on cash flow and investment capacity. The strategic balance between consumer protection and financial sustainability needs careful consideration to avoid damaging the regulatory environment that supports electric service reliability.

As Owen Rogers, a policy analyst at Aii, notes, "Customers deserve to be protected, especially in this high-demand infrastructure environment. But customer protection depends on prudent policy that balances real-world needs for consumers today and well into the future."

Ultimately, the Aii report underscores the importance of maintaining a careful and informed approach to utility regulation. Its recommendations encourage reforms focused on enhancing transparency, cost allocation, and long-term infrastructure planning, avoiding superficial fixes that might appear beneficial in the short term but could actually jeopardize the stability and reliability of electric service.

For full details on the study, you can access the complete report here.