The Problem
When state regulators determine how much utilities can charge customers, their responsibility is to approve “just and reasonable” rates. According to a long-standing, court-validated standard, a just and reasonable rate is what is needed for utilities to cover their cost of capital (COC) — that is, to provide an investor return sufficient to attract equity financing in capital markets. For example, if an investor is willing to buy utility stock that will yield a 7 percent return, a just and reasonable rate should allow utilities to cover their operating and fixed costs, plus a rate of return (ROR) of 7 percent.
An ROR above COC is not “just and reasonable.” It is an excessive money transfer from consumers’ pockets to investors. But utilities have captured the regulatory system and pushed ROR far beyond COC. By one measure, the ratio of returns to capital costs has exceeded 1.0 for 30 years, and reached 2.0 over the last 15 years. That means regulators have been approving rates that have massively enriched utility shareholders at the expense of ratepayers.
Changing this system to ensure monopoly utilities limit rates of return to their cost of capital could immediately reduce rates by 10 percent or more.
The Solution
State legislators should codify in law the long-standing regulatory standard that the rate of return for monopoly utilities be equal to the market-based cost of capital. This standard has a long history, dating back to a concurring opinion penned by Supreme Court Justice Brandeis in 1922 and formally adopted by the full Court in the 1944 Hope Natural Gas decision.
In addition to allowing for the reduction of rates, such a change would enable regulators to prioritize other needs, rewarding utilities for investing smartly, as opposed to for simply investing, period. Other countries, such as the UK, Australia, and Canada, keep rates of return equal to the cost of capital and experience better outcomes. For more see, “Rate of Return Equals Cost of Capital: A Simple, Fair Formula to Stop Investor-Owned Utilities From Overcharging the Public,” as well as New York Senate Bill S6557A (2023-2024).