California Public Utilities Commission

Forums on Governance, Management, and Safety Culture

Apr. 26, 2019

President Picker and Commissioners, thank you for your
invitation today to address the topic of how the State of California may align
the corporate governance of PG&E with the interests of consumers and the
public at large.

There are two modes of utility regulation in which the
Commission might engage. It can either become deeply involved in management of
the company’s safety program and organizational structure, or it can
economically regulate the company and incentivize the accomplishment of safety
objectives. This is not necessarily a dichotomy. The Commission could do both.
However, in my view, it is a more productive use of your time to focus on
rewards and penalties for safety performance.

In a perfect world, the Commission would establish financial
consequences for PG&E’s safety performance, and utility officials would
execute the changes and improvements necessary to obtain rewards and avoid
negative financial consequences. It remains unclear why, for PG&E, this has
not seemed to work. PG&E has seemed impervious even to the very large fines
assessed against it for safety conduct in the past. Moreover, a firm typically
faces a strong incentive to avoid bankruptcy—and yet that is what has happened
to PG&E.

It is important to note that, in more modest circumstances,
the Commission has defined safety performance metrics for utilities—and the
utilities have performed. In 1999,
the Commission established performance-based regulation for San Diego Gas &
Electric’s electric operating company. As part of that program, the Commission
established targets for employee safety, tying a relatively modest potential
reward, $3 million, to achievement of a predefined metric. Ultimately,
SDG&E beat the target and earned a bonus return.[i]

The stakes here are obviously higher, but the same principle
could be applied to PG&E and other California utilities’ performance in the
face of wildfires and other public-safety risks. Metrics could measure the negative
outcomes of utility-caused fires and explosions: How many people were killed,
injured or dispossessed of their worldly possessions in a particular reporting
period? How much property damage occurred as a result of the utility property’s
failure? Macabre though it may seem, these are ultimately the safety outputs in
question. On the other hand, safety inputs
are difficult to measure directly, and measurements of this kind risk reducing
safety to a checklist undertaking: the very type of thing one might want to

What amount of money should be on the line for performance
of this nature? California’s electric utilities have proposed substantial
premia in pending return on equity applications. They, in other words, have
already come up with their estimation of the money that is or should be on the
line. To my mind, however, it is somewhat odd that the risk/reward dynamic of
wildfire risk would tie back to a return on invested capital. After all, as the
Commission and its consultant NorthStar have recognized, it is primarily the
corporation’s actions in relation to capital
assets that have caused safety problems. Spending on vegetation management,
more frequent inspections, situational awareness, safety trainings: None of
this attracts any return in the
current utility business model, much less a premium. Indeed, these items would
each diminish corporate earnings if their cost increased between rate cases.

Put another way: If safety improvements were obtainable
primarily through increased capital spending, it would be reasonable to persist
with the status quo, in which a utility’s profit is a function of its “used and
useful” capital investment. The existing regulatory model, which rewards a
utility’s equity investment, whether at 10 percent or 17 percent, ensures that.
But if safety improvements will result primarily from operational improvements,
then the cost-of-service, rate-of-return regulatory model appears misaligned to
it. This would seem to be a powerful argument for tying a potentially
substantial amount of the corporation’s existing or incremental profit
opportunity to safety performance.

Finally, the Commission has asked how the utility’s senior
management and board members might be properly incentivized. Usually, commissions
regulate firms—not the people who work at those firms. One would expect
corporate earnings to drive the behavior of the firm’s principals and, in turn,
their senior managers and employees. But investment and profit can occur in a
manner that becomes unmoored from the earnings model that utility regulation
creates, and which pivots instead toward speculation about California
policymaking and bankruptcy court rulings. In these circumstances, it may be
appropriate to ask whether financial incentives that exclusively face the firm
are sufficient to induce performance.

While the typical mode of public utility regulation is the
regulation of the firm, there are notable exceptions. The Federal Power Act
requires officers of public utilities to obtain preapproval from the FERC
before they enter into a number of arrangements referred to as interlocking
directorates.[ii] This
is intended to safeguard the public from self-dealing and monopolization in the
industry. When utility regulators require the submission of certain reports,
they sometimes require a named individual to attest to the veracity of the
information submitted. And in utility commissions’ adjudicatory proceedings,
testimony is sworn under oath: a corporate but also a personal obligation for
truthfulness. So it would not be profoundly out of the ordinary if the
Commission here, in these grave circumstances, caused PG&E’s directors and
management to have compensation tied to safety outcomes. This would surely
underscore the matter in the board’s policymaking, and would create board
members as an ally to safety regulation’s objectives.

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