The American utility market is based on a social contract. The government sanctions private, for-profit monopolies to provide approximately 70% of electricity and 95% of natural gas deliveries in the United States. In return, these private monopolies, called investor-owned utilities (IOUs), agree to provide universal service and to be subject to cost-of-service regulation (COSR) of their customer rates, usually by state utility commissions. The other 30% of electricity and 5% of gas are provided by publicly or mutually owned utilities.

IOUs are granted regional franchises not subject to competition under the rationale that they are “natural monopolies”: their service can be most efficiently provided by a single entity. In principle, utility rates must be “just and reasonable”: sufficient to recover only the actual and prudent costs incurred in providing service to their captive customers.

There is an inherent tension in the cost of service–based utility regulatory model. As investor-owned businesses, IOUs seek to maximize their profits, which often runs headlong into regulators’ goal of achieving just and reasonable rates. Moreover, IOUs too often have the upper hand in their interactions with regulators, to the detriment of their customers. Over the last three years, IOU residential electricity rates have increased 49% more than inflation. In contrast, their publicly owned counterparts have increased 44% less than inflation. In some states, the contrast is even more stark. Investor-owned San Diego Gas & Electric’s residential rate increased by 78%, to over 45 cents per kilowatt-hour (kWh) between 2020 and 2023. Similarly sized Sacramento Municipal Utility District’s average residential rate rose less than inflation and, at less than 17 cents/kWh, is barely one-third of SDG&E’s. As a result of IOU price hikes, their residential customers’ average monthly electric bills hit $137, 15% higher than public utility residential customers’, compared to just 3% higher in 2020. As of September 2024, nearly one-quarter of US households were unable to fully pay their energy utility bills in at least one month in the past year.

This policy brief explains a root cause of this problem: excessive utility rates of return allowed by utility commissions in setting customer prices. Rate of return (ROR) is the time-value-of-money compensation to investors for assuming the risk of providing capital to the utility. After an overview of utility rate-making principles, this brief covers how excessive utility rates of return contribute to the divergence between investor and public interests, and how IOUs have been able to outfox their regulators to convince them to award excess rates of return. It concludes with common-sense recommendations to realign utility investor incentives with the public interest, particularly codifying in legislation the long-standing regulatory standard setting the rate of return equal to the market-based cost of capital, improved coordination in the utility consumer advocate community, leveling the regulatory litigation playing field, and fostering regulatory responsibility.