dukehike

To the Representatives of the North Carolina General Assembly,

After Duke Energy referenced Virginia’s experience with extended rate reviews as a rationale to support similar policy in North Carolina, I was asked by the North Carolina Sustainable Energy Association to offer my perspective as a former Attorney General of Virginia on the real-world impact of extended rate reviews as well as the ‘banding’ around returns on equity (ROE).

I should note that unlike North Carolina, in Virginia, the Attorney General is charged with representing consumers in electricity rate cases before our public utility commission – called the State Corporation Commission in Virginia.  Thus, I was deeply involved in not just electricity regulation, but in the rate cases that resulted in the setting of Virginia’s electricity rates for our two largest utilities – Dominion and Apco (a subsidiary of AEP).

I was surprised to learn that there are some in North Carolina arguing in support of longer rate review periods and banding around ROE who are referencing Virginia’s recent experience as a positive example. While more extended rate reviews have been a boon for Virginia’s two monopoly utilities, particularly when combined with the use of ROE banding, it has been economically destructive for the millions of families and businesses who are their customers.

The Virginia experience with the extension of rate reviews out to every three years has been a boon for the utilities because it has allowed them to lock-in over-earning of hundreds of millions of dollars every year. A tax increase of this size would be vehemently attacked (correctly) as destructive to our economy, but when the legislature gives more power to raise rates to the politically powerful utilities, we used to hear very little in response.  Now that the impacts have become so large, more businesses and ordinary citizens have begun to strenuously object to the transfer of wealth from most families and businesses in Virginia to our two dominant monopoly utilities.

I can only conclude that the use of Virginia as an example is in the hopes that no one in North Carolina will figure out just how bad Virginia’s experience has been for ratepayers – particularly since 2015.

Virginia’s public utility commission has taken the highly unusual step of reporting on the utilities’ windfall profits in its orders. During the last several years commissioners have gone to the trouble of calculating the utilities’ locked-in over-earnings, which by the end of this year is on track to total over $1 billion since 2015, when this scheme was begun, possibly as high as $1.5 billion.

As a conservative, I do not usually use the phrase “windfall profits;” however, when companies have a government-mandated monopoly, and the government passes legislation that arranges the regulatory scheme in such a way that the monopolies will nearly-certainly get more money from the citizen-ratepayers for no additional service, then in my experience “windfall profits” accurately describes the arrangement.

As supporters no doubt claim, multi-year rates are a tool that regulators can use to minimize the amount of time and cost of annual rate cases. And while that is true, the challenge is that the utilities use them as a tool to maintain elevated rates and avoid true-ups that would otherwise result in lowering customer bills. The most significant example of how this routinely harms customers is after long-term rates are raised and locked in, then the utility over-earns. In this (common) circumstance, if an annual rate case structure was in place, the utility would be required to true-up their books and customers would get money back the next year. With multi-year rates, the utility gets to keep such over-earnings to themselves.

If Duke’s unadjusted over-earning and under-earning each happened with equal frequency, perhaps we could view Duke’s support for extending rate reviews neutrally. But that is not what actually happens. Like in Virginia, Duke virtually always over-earns.  In fact, it is my understanding that the last time that Duke under-earned was in the 2007-08 recession. It’s easy to see why this aspect of multi-year rates is so appealing to the utility and why customers should be concerned.  If your public utility commission was able to predict Duke’s performance nearly as accurately as Duke can, then one would expect approximately equal error around the ROE, i.e., under-earning would occur with a frequency similar to over-earning.  Instead, for over 10 straight years Duke has never under-earned.

In the year-to-year management of a capital-intensive electric utility, it is easy to shift costs between years.  E.g., take a big expenditure in year three instead of year two, thereby driving down earnings and profits in year three.  If year three is the base year for a utility’s next rate case, one can easily understand why the costs would be shifted into year three – to make the company look poorer relative to its then-current rates at the moment in time when its next three years’ worth of rates (or more) are to be set.

It will always be the case that the utilities in a regulated monopoly environment will have better control over the course of costs and spending and the information related to those expenditures than any other entity, as the utility itself knows its day-to-day needs and opportunities better than any other entity ever can.  Given that reality, the longer the period of rate reviews, the greater will be the over-earning errors, and the more economic harm will occur to the businesses and families of North Carolina, just as we have seen in Virginia.

When you consider the addition of an earnings band around the return on equity (ROE), it adds an additional element of gamesmanship in the year-to-year management of costs and profits.  If your law allows any earnings “within the band” of, e.g., 80 basis points (8/10ths of 1%, or 0.8%) of the ROE to be treated as neither over- or under-earning for rate purposes, then this feature of the system will be ‘managed’ by the utility.  If your NCUC sets a utility’s ROE at 10.0% and you have a band of 80 basis points, then the utility’s earnings goal will be to hit exactly 10.79% ROE, as this will be the amount of over-earning they can have without being accountable for it as over-earning per se.

Not surprisingly, ratepayers want the benefits of innovation, fuel choice and control of their own energy destiny. But the monopoly utility model does not accommodate market competition and free choice. Multi-year rates represent an expansion of government-mandated monopoly control of electricity that Virginia’s experience indicates exacerbates the economically unfair aspects of monopolies.

Sincerely,

Hon. Kenneth T. “Ken” Cuccinelli, II
46^th Attorney General of Virginia
B.S.M.E., UVa.
J.D., Antonin Scalia Law School at GMU
M.A., International Transactions, GMU