Regulating Public Utility PerformanceThe Law of Market Structure, Pricing and Jurisdiction
Scott Hempling
Regulatory Law:
Purposes, Power,Rights and
Responsibilities
Purposes ofregulation
Purposes ofregulatory
law
Subjects andsources ofregulatory
law
Market Structure:
From Monopolies toCompetition—Who
Can Sell What toWhom?
TheTraditional
UtilityMonopoly
Exclusiveretail
franchise
Obligation toserve
Consent toregulation
Quality ofservice
Eminentdomain
Limit onnegligence
liability
AuthorizingCompetition
Historicalsummary
Eliminatingthe legal
monopoly atretail
Constitutionalquestions
MakingCompetition
Effective
EffectiveCompetition:
Definitions, goalsand metrics
Unbundling:Reducing theincumbent'scontrol of"essentialfacilities"
Reducingnon-facility
entry barriers
MonitoringCompetition
for Anti-competitiveBehaviors
Anti-competitive
pricing
Tying
Marketmanipulation
Rethinkingseparation
Pricing:
How Much CanSellers Charge—and
Who Decides?
"Just andReasonable"
Prices in Non-Competitive
Markets: Cost-Based Rates Set
by theRegulator
The rate-setting
equations
What does "justand
reasonable"mean?
Imprudent Actionsand inactions:Who bears the
costs ofinefficiency and
waste?
Prudent actionsbut uneconomic
outcomes:Who bears the cost
of bad luck?
Variations oncost bases
Departuresfrom cost
bases
"Just andReasonable"
Prices in"Competitive"
Markets:Market-BasedRates Set by
the Seller
Seller-set pricescan be "just andreasonable"—if
seller lacks marketpower
The courts speak:To prevent marketpower, regulatorsmust screen and
monitor
The agencies act:Techniques andprocedures forscreening and
monitoring
Are scarcityprices just
andreasonable?
The future ofmarket-based
rates
Discrimination:When Is
Favoritism"Undue"?
Unduediscrimination
Duediscrimination
Cost allocationwithin holding
company systems
Filed RateDoctrine:
The "Rate onFile" Is the
Only LawfulRate
Filed rates:Purposes and
principles
Commissiondecisionsconstrain
courts
Federalcommission
decisionsconstrain statecommissions
Commissionmust respectits own rates
Applicationto market-based rates
Applicationto antitrust
law
Applicationto non-rateterms andconditions
Fraud doesnot block the
filed ratedefense
RetroactiveRatemaking:
TheProhibition
and theExceptions
Three bases
FourIllustrations
Sevenexceptions
Mobile-SierraDoctrine:
When DoesContract
"Sanctity"Give Way toGovernment-
OrderedAmendments?
Principle: Thecommission
cannot let partiesout of theircontracts
The "publicinterest"
exception
One standard—with a
rebuttablepresumption
Three ways topreserve theregulator's
role
Escape from thepresumption:Fraud, duress,
illegality
Specialapplications
Jurisdiction:
State, Federal andFuture
The Federal–State
Relationship
Limits onfederalaction
Limits onstate action
Regulating withinthe limits: Six
models of federal-state interaction
Jurisdiction'sFuture
MarketStructure
Pricing
Federal-statejurisdictionalrelationships
Corporatestructure andchanges in
control
1
Regulatory Law:Purposes, Power, Rights and
Responsibilities
Purposes of regulation
Economists:
Exploit economies of scale,address market imperfections
Residential customers:
Protect us from abuse
Industrial customers:
Set rates so we can competeglobally
Shareholders:
Give us a chance for a fair return
Lenders:
Ensure cash flow sufficient topay off debt
Competitors:
Lower entry barriers, give us ashot
Environmentalists:
Limit environmental damage
Purposes of regulatory law
Powers
Responsibilities
Rights
Procedures
Subjects and sources ofregulatory law
Subjects
Sources
2
The Traditional Utility Monopoly
Exclusiveretail
franchise
Exclusivityexpress in statute
Sevenvariations onexclusivity
New serviceoffered by non-
incumbent
Customer self-service
Group self-service
Adjacentmonopolies as
rivals: Locationaland fringe
competition
Exclusivefranchise for aspecific service
Competition forthe exclusive
franchise
No statutoryexclusivity
Franchiserevocation
Revocationauthority
Revocationjustifications
Regulatoryoptions forfranchise
accountability
Obligation toserve
The anti-discrimination
objective
The citizenaccess objective
The economicdevelopment
objective
Limits on theobligation to
serve
Contracts thatundermine the
obligation
Consent toregulation
Quality ofservice
Statutory bases
Components ofquality:
Traditional andnew
Regulatoryrequirements
Legal sources:Rules, statutes
and orders
Types ofregulatory
requirements:Inputs andoutcomes
Remedies:Financial
penalties anddirected actions
The“managementprerogative”
constraint
Eminentdomain
Power,purposes and
limits
Public–privateoverlap
Federal roles
Limit onnegligence
liability
Generallimitation and
its justifications
Parties anddefenses
Exceptions tothe general rule
No immunity:Gross
negligence
Federal–staterelations
3
Authorizing Competition
Historicalsummary
Electricity
Gas
Telecommunications
Threevariables
Eliminating thelegal monopoly at
retail
Exclusivefranchise
Obligation toserve
Consent toregulation
Quality ofservice
Power ofeminentdomain
Type of seller
Type oftechnology
Limitedliability fornegligence
Constitutionalquestions
Definitions:“Sunk costs”and “future
profits”
Shareholderexpectations
of futureprofits
Contractprecluding
competition
No contractprecluding
competition
Shareholderexpectation of
sunk costrecovery
TakingsClause Case law Policy
outcomes
Electricitysales at
wholesale
Electric salesat retail
Natural gaspipelines
Telecom
ContractClause
Concludingconstitutional
thoughts
4
Making Competition Effective
Effective Competition:Definitions, goals and
metrics
Definitionsof
competition
Goals ofcompetition
Effectivecompetition:
Meanings andmeasurements
Unbundling: Reducingthe incumbent's controlof "essential facilities"
Unbundlingdefined
The antitrustfoundation
Monopolistsmay not
monopolize
Essentialfacilitiesdoctrine:Origins
Essentialfacility
examples
Incumbent’srefusal to
share:Business
justifications
Antitrust'srole in utility
regulation
Statutoryfoundation:
The prohibitionagainst "undue
preference"
Gas andelectricity at
wholesale
Gas andelectricity at
retail
Telecommunications
Limits onincumbent’sobligation to
sharefacilities
Unbundledrates for
competitiveneutrality
Costunbundling
Total elementlong-run
incrementalcost
Separation toreduce
temptation
Functionalunbundling
Corporateunbundling
Codes ofconduct
Transfer ofcontrol to
independententity
Divestiture
Unbundling'seffects onvertical
economies
Electricity'sancillary
services andefficiency
losses
Gasmarketing
data
Telecommunications: From
alienattachments to
broadband
Newbottlenecks
and newtensions
Broadband
Smart grid
Reducing non-facilityentry barrier
Entrybarriersdefined
Productpromotionadvantages
Entrenchedcustomer
preferences
Long-termcontracts
Entry barriersin regulated
utility markets
Changingsuppliers
Monthlybilling
Knowledgeof the
customerbase
Incumbent'sname
5
-
MonitoringCompetition forAnti-competitive
Behaviors
Anti-competitive pricing
Price squeeze
Predatory pricing
Tying
Definition and examples
"Technology tying" in utilityindustries
Market manipulation Rethinking separation
Sufficient
competition scenario
Insufficient
competition scenario
6
"Just and Reasonable" Prices inNon-competitive Markets:
Cost-Based Rates Set by theRegulator
The rate-setting
equations
What does"just and
reasonable"mean?
Statutorypurpose: Seller
and buyerinterests
Constitutionalconstraint: TheTakings Clause
Regulator'sduty: Honorshareholders'
legitimateexpectations
Substantiveexpectation:
Opportunity toearn fair return
Proceduralexpectation:Opportunityfor hearing
Limits onshareholders'
legitimateexpectations
Regulatorydiscretion under
the "just andreasonable"
standard
Roles oflegislature,commission
and court
Imprudentactions andinactions:
Who bears thecosts of
inefficiencyand waste?
Prudenceprinciples
Imprudentactions
Poorperformancerelative toobjectiveindices
Failure to usereasonable
managementpractices
Failure tooversee
contractors andemployees
Failure tosecure
remediesagainst erring
supplier
Failure to heedofficial
criticisms
Imprudentinaction
The imputationsolution
Imputationanalogy: Whogets the gainon sold-offcapacity?
Defense againstdisallowance:
The"managementprerogative"
Burdens ofproof on
prudence andimprudence
General rule:Rebuttable
presumption ofprudence
Deference toutility expertise
Financialconsequences
of costdisallowance
Prudentactions butuneconomicoutcomes:
Who bears thecost of bad
luck?
Prudence doesnot guaranteecost recovery
Three points onthe risk-
assignmentspectrum
Four limits onregulatory
actions
Variations oncost bases
Area rates
Price caps
Alternativeform of
regulation
Departuresfrom cost
bases
Is the departurenecessary tocarry out astatutorypurpose?
How does therate compare to
cost?
Loosening theconnection
between rateand result
7
"Just and Reasonable" Prices in"Competitive" Markets:
Market-Based Rates Set by theSeller
Seller-set pricescan be "just andreasonable"—if
seller lacks marketpower
Paths to regulatorywithdrawal
Wholesaleelectricity: Seller-by-seller review
The courts speak:To prevent marketpower, regulatorsmust screen and
monitor
The obligation toscreen
The obligation tomonitor
The agencies act:Techniques andprocedures forscreening and
monitoring
Screening sellers
Market powerscreens: Horizontal
and vertical
Horizontal marketpower
Vertical marketpower
Other entrybarriers
Affiliatetransactions
Monitoring sellersand punishing
violators
Are scarcity pricesjust and
reasonable?
The future ofmarket-based
rates
8
Discrimination:When Is Favoritism "Undue"?
Undue discrimination
Rate differences notjustified by cost
differences
Rate differences withanti-competitive effect
Due discrimination
Different customerprofiles
Different settlementstrategies and contract
histories
Price discounting toretain customers
Product differences
Cost allocation withinholding company
systems
Systems that plan andoperate utility assets
centrally
Systems that mix utilityand non-utility
businesses
9
Filed Rate Doctrine:The "Filed Rate" Is the Only
Lawful Rate
Filed rates:Purposes and
principles
Commissiondecisionsconstrain
courts
Federal courts
State courts
Federalcommission
decisionsconstrain statecommissions
Commissionmust respectits own rates
Application tomarket-based
rates
Antitrust and contractdamages unavailable
"Retroactivity"allowed if seller has
violated a market ratecondition
Application toantitrust law
Application tonon-rate
terms andconditions
Fraud doesnot block the
filed ratedefense
10
Retroactive Ratemaking:The Prohibition and the
Exceptions
Three bases
Statutory basis
Constitutionalbasis
Policy basis
Four illustrations
Tax paymentslower thanestimates
Tax depreciationdifferences
"Direct billing"of gas production
costs
Someone else'scost
Seven exceptions
Regulatory"notice"
Utility "deferral"of expenses
Affiliatetransactions
Hard-to-predictcosts
Commission self-correction
Judicial reversalof commissionrate decisions
Disgorgement ofillegal gains
11
Mobile-Sierra Doctrine:When Does Contract "Sanctity"
Give Way to Government-Ordered Amendments?
Principle: Thecommission cannot
let parties out oftheir contracts
The "publicinterest" exception
One standard—with a rebuttable
presumption
Three ways topreserve the
regulator's role
Escape from thepresumption:Fraud, duress,
illegality
Specialapplications
Market-basedcontracts
Non-signatories
Application totariffs
12
The Federal–State Relationship
Limits
on federal action
CommerceClause
WithinCongress'sCommerce
power
OutsideCongress'sCommerce
power
TenthAmendment
Agencystatutoryauthority
Limits
on state action
DormantCommerce
Clause
Discrimination
Burden
SupremacyClause
Expresspreemption
Occupation ofthe field
preemption
Conflictpreemption
In general
State review ofretail utilitypurchases
under FERC-jurisdictional
contracts
Thepresumption
againstpreemption
Regulating within thelimits: Six models of
federal–stateinteraction
Bright linedivisions
Interstate–intrastate
Retail–wholesale
Bundled–unbundled
Localdistribution
and bulk powersystem
Federalenlists state
State enlistsfederal Joint boards Regional
compactsOverlappingjurisdiction
13
Jurisdiction's Future
Market structure
Evaluating alternativearrangements
Defining obligatoryservice
Universal service
Other features
PricingFederal–statejurisdictionalrelationships
Interdependencies
Obligation to serve
Infrastructure readiness
Corporate structureand changes in control