Low-Energy Fridays: The Electric Rates are Too Damn High
If there’s one thing everyone agrees on these days, it’s that electric bills are too damn high. Since 2019, average residential electric rates have gone up by 33 percent. People are understandably upset about this and have proposed ways to lower electric bills ranging from more competition to state ownership of the means of power production. But is the amount of money utilities make the real problem? Would reining in power company profits actually help lower electric bills? That’s the current debate across the country.
Among the more creative proposals for lowering bills are plans to reduce the rate of profit that monopoly utilities can make off their captive ratepayers. In around two-thirds of the country, electric consumers lack choice when it comes to their electric provider. The local electric utility in their area has the sole authority to provide power, often owning and managing all parts of the grid—from power plants to transmission to distribution systems delivering power to end users. Without competition, utilities have no incentive to lower customers’ monthly bills.
To prevent these utilities from using their monopoly position to gouge their customers, state regulators must generally approve the rates they charge. These rates are determined according to a specific formula that includes utility spending, the cost of debt service, and, importantly, an added percentage of these costs known as a “return on equity” (ROE), or the profit rate. Most utilities in the United States receive an ROE of around 10 percent, plus or minus one point.
Some amount of ROE is needed for utilities to attract investment and financing to build and maintain their expensive infrastructure. But people are increasingly questioning whether the standard rates of ROE are higher than necessary. After all, non-monopolies routinely invest large amounts of capital with an expected profit rate significantly below 10 percent. The long-term equity returns forecast for major investment firms in the United States is only 6.7 percent, and investors are willing to put forward capital even though their investments are subject to greater risk than those made by a monopoly utility with a captive customer base.
The combination of rising electric bills with growing skepticism about utility practices has spurred a number of legislative efforts to rein in utility ROE. For instance, U.S. Rep. Greg Casar of Texas has introduced HR 8568, which would require the Federal Energy Regulatory Commission (FERC) to set an ROE rate that accounts for the lower risk monopoly utilities face. Casar claims the legislation could reduce the average household electric bill by $500 annually.
Some state proposals go even further. In Pennsylvania, HB 2224 would cap utility ROE at 2 percentage points above the 10-year U.S. Treasuries yield, which would currently work out to between 6.5 and 7 percent. Bills in New York and Rhode Island would cap ROE at 4 percent.
Of course, profit isn’t (or shouldn’t be) a dirty word. In a competitive system, the pursuit of profit can lead to innovation, which results in major benefits for customers and society. The ideal way to address excessive utility profits would be to open the sector up to competition so that any profit earned by energy companies would come from delivering benefit to consumers rather than from their monopoly. As R Street has detailed, there are ways to introduce competitive pressures that could help keep costs in check, even in a monopoly system.
Historically, utilities have been the main opponents of increased electricity competition. But even if competitive reforms are mostly off the table, public consternation over high electricity bills will lead to other policies to control costs—many of which utilities might find equally unpalatable. Efforts to reduce utility ROE are a good example of this, even if it primarily targets monopolies. As long as electric rates continue to increase, support for such measures will rise as well.