Effective Regulation of Public Utilities

          Washington State, that is.  The Washington Utilities and Transportation Commission has rejected the proposed acquisition of Avista (formerly Washington Water Power) by Hydro One, the government-controlled utility serving in Ontario, Canada.  The Commission’s December 2018 Order emphasized two problems:  (1) risks to Avista from political interference by Hydro One's 47% owner, the Province of Ontario; and (2) benefit-lopsidedness, with Avista’s shareholders getting 6-12 times what its ratepayers would get.  The Commission has produced a fact-filled, logically reasoned model for analyzing corporate structure risks and benefit-cost mismatch.

          But the Order has one odd aspect:  It attributes Avista’s risks entirely to Hydro One's government ownership.  (The opinion often associates the noun "interference" with the adjective "political.")  Interference is interference, whether the utility's holding company owner is controlled by a government entity or a for-profit entity.  In the last 30 years, dozens of U.S. state commissions have allowed for-profit, risk-taking holding companies to take control of their states’ local utilities.  With these approvals, commissions have diminished their influence over the utility and its decisionmakers, while subjecting their utilities to unavoidable conflict—between the holding company's pecuniary aims and the utility's public service obligations.¹   Had these other commissions applied the Washington Commission's reasoning (minus its implication that for-profit interference is somehow less harmful than political interference), today's electric industry would be less concentrated, more diverse, less risky, safer for customers and conservative investors, and less labor-intensive for regulators.

Parent-utility conflict

          Hydro One's controlling shareholder was Ontario, so Ontario called the shots.  (Hydro One has other shareholders, but under Hydro One's charter no other person can own more than 10%.)  Due to state commission approvals, most U.S. utilities also have a controlling shareholder—a holding company—so the holding company calls the shots.  The utility must obey its owner's instructions.  The central instruction:  Maximize earnings, then (1) use those earnings to finance utility capital expenditures that produce more earnings; or (2) dividend the earnings to the holding company, which then can either invest them in its other businesses or pay them out to its ultimate shareholders.

          A utility’s duty to its customers sits uncomfortably with its duty to the holding company.  The utility must spend as necessary, and no more than necessary, to serve customers reliably and cost-effectively.  But the holding company has no customer service obligation.  So it is free to use the utility’s earnings to support its other investments, rather than use its earnings to support the utility’s responsibilities.  That legal freedom puts the utility at risk, because the typical U.S. holding company, as the 100% owner of the utility's equity, is the utility's sole source of equity.

          Of course, the holding company is not a lawless landlord, bleeding its properties while the residents suffer.  The holding company wants its utility healthy.  But the utility fills just one place in its owner's portfolio. Duty-bound to its ultimate shareholders, the holding company aims to maximize the total value of the portfolio, not the health of any one part of that portfolio.  And so we have conflict—between the utility's specific obligation to its customers, and the holding company's general obligation to its ultimate shareholders.  That conflict leads to the multiple problems discussed next—problems Washington's order exposed; problems most other commissions endure.

Interference with the utility's independence

          Hydro One had promised not to interfere with Avista’s operations.  But the Commission found that Ontario's political players undermined that promise "more or less completely."  Even as the Avista application was pending, those players (1) forced the resignations of Hydro One's entire board and CEO; and (2) committed electorally to reducing Hydro One’s rates, without considering effects on safety, reliability, and finance . . .