As Judy Endejan reported on October 21, the Washington State Clean Energy Leadership Plan Report identified regulatory influences and challenges as a key factor influencing clean energy job development in Washington. One of those challenges is the uncertainty utilities face in cost recovery because regulated utilities do not know whether they will be allowed to recover the cost of investment in new power sources, much less earn a return on that investment, until the investment has been “blessed” by the Washington Utilities and Transportation Commission (UTC) as being a “prudent” investment.

Utility regulation grew out of the late-19th Century struggle to regulate railroads, followed by the early-20th Century effort to regulate electric utilities. Because both were natural monopolies they started by charging excessive rates to small customers who had no market power to negotiate with them, and no choice but to pay what was charged or go without service. From that grew the concept that rates should be set by a regulatory body, and that those rates should be “fair, just, reasonable and sufficient.” That meant that they should be fair to both the utility and the consumer, should offer the utility a fair profit, including a reasonable return on its investment, and should be sufficient to allow the utility to attract capital necessary for it to continue to meet the demands of its customer base.

But along with that principle of fairness to both the utility’s investors and its customers, utility rate making has included another concept – which is that utility stockholders, not customers, should be the ones at risk if the utility’s management makes bad business decisions. In the heyday of the railroads, competing railroads built parallel tracks and extended tracks into areas without enough business to ever repay the investment. They spent extravagantly where they should have been more cautious. From that experience came the concept that utility commissions should determine that an investment was “prudent” before utility customers are asked to pay for it, or reward the utility with a profit on the investment. If the utility’s management makes bad decisions, that should be the stockholders’ risk, because the stockholders have the ability to throw management out, and stockholders receive the profits when management makes good decisions.

That “prudence” review normally occurs as part of a general rate making proceeding, after the investment has been made and the source of supply is on-line and functioning. The Legislature has created both a staff to the UTC, and a Public Counsel, who represents individuals and small commercial utility customers, and who are vigilant in requiring utilities to actually prove the prudence of any investment that the utility wants to have included in the asset base from which its rates are calculated. That means that a utility does not know for sure when it makes the investment in new equipment or generation plant that it will be allowed to earn a return on that investment.

All businesses have their challenges, and in the ordinary course of things, that might be viewed as just a risk of doing business as a public utility. After decades of prudence reviews, the utilities certainly have a frame of reference for what they are going to have to show when the prudence of their investments comes before the UTC. But things arguably change when we begin to ask utilities to invest in new, and sometimes unproven, technologies that may reduce the utility’s carbon emissions and reduce greenhouse gas production. With no track record of UTC approval of such investments, utilities have a considerable disincentive to make the investments today, and only find out many months later whether they can earn a return on the investment.

Graham & Dunn would propose that the Washington utility regulation statutes be amended to remove that disincentive to investments that would reduce utility greenhouse gas emissions. Three changes in the current utility statues would be useful. First, the statutes should explicitly authorize a pre-investment “prudence” determination by the UTC. Regulated companies should not be expected to make decisions about investments in leading edge technology that will reduce their carbon emissions without knowing whether or not the regulators will approve those investments. Second, prudence determinations should be expedited. A typical general rate case can result in a ten-month delay in getting a decision. For a stand-alone prudence determination occurring prior to an investment, that period should be shortened to 60 to 90 days. Third, the Legislature may also want to say something about how the UTC should consider the inherently greater risk in evaluating an investment before the new facilities are completed and on-line than in the traditional prudence review when the investment has been completed and is functioning. Staff and public counsel can be expected to express greater skepticism about a prudence determination at the point where cost overruns and performance problems could yet be in the future than when the total cost of new equipment is established. The difficulty with that sort of risk aversion is that consumers and rate payers are also facing another risk – which is that utilities will not convert their current power generation and delivery infrastructure until it is too late to make the conversion without unacceptable costs in terms of climate change, carbon price shocks, and damage to the environment from the greater challenges in retrieving remaining fossil fuels. The Legislature may want to direct the UTC to consider that risk of not making green investments in balancing the risk associated with leading-edge technology investments. The point would not be to eliminate consideration of risk, but only to have the UTC recognize that the risk of not acting cannot be ignored and must be balanced against the risk of approving utility investment in leading-edge technologies.