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