Boosting Consumer Control with Better Utility Governance — Episode 237 of Local Energy Rules

Josh Macey:
Problem number one is we often just pay too much for electricity as utilities overinvest in big capital expenses they don’t need.

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John Farrell:
Why shouldn’t monopoly utilities be organized to serve shareholder interests? Because the folks that really benefit from — or pay the price of — utility decisions are the captive utility customers. Four decades of corporate law has encouraged businesses in competitive markets to focus on their shareholders, but it’s a model that ignores how having a monopoly gives utility shareholders little incentive to reduce costs, avoid pollution, or improve reliability — all things we want from this essential public service. Josh Macey joined me in April 2025 to discuss how to reform utility governance and market structure. He’s an associate professor at Yale Law school who studies energy and environmental law, and the co-author of a piece published by Bloomberg last fall that sums up the issue: “Utilities Are America’s Real Monopoly Problem and Need Scrutiny.”

I’m John Farrell, director of the Energy Democracy Initiative at the Institute for Local Self-Reliance and this is Local Energy Rules, a podcast about monopoly power, energy democracy, and how communities can take charge to transform the energy system.

Josh, thank you so much for joining me on local Energy Rules.

Josh Macey:
Thanks, John. I’m really delighted to be here.

John Farrell:
So I love to ask this question of all my guests, which is to explain a little bit about how they got to where they are. And I think of this sometimes from the perspective of myself 20 years ago looking for a job and trying to ask, answer this question of how do I find my way to what I want to do? But I’m also thinking it from the perspective of I just think it’s interesting to understand how people’s life experiences all of a sudden lead them to these really interesting careers. So how did you get into environmental and energy law?

Josh Macey:
So in some ways just a series of accidents, like many people who end up studying climate change, I always loved and cared about the environment and the outdoors, but I didn’t study any environmental engineering or anything in college. Basically three things happened. One is I worked at an investment bank and so developed sort of some experience in finance that turns out to be quite useful for understanding electricity markets. I didn’t really like that. So I went to law school like many people, and the two things that happened in law school are one I turned out to be better at writing than I was at actually doing anything that a practicing attorney does. And two, one of my closest friends in law school had spent his life thinking, I want to study electricity market. So we ended up doing a reading group together, writing a couple papers that turned into articles. My experience in finance turned out to be quite useful in electricity market design, and then I just found it incredibly interesting and important and have been here ever since.

John Farrell:
Thank you so much. I just love hearing how people come to these issues. I still remember back for my experience with ILSR, I was doing an informational interview with ILSR and they asked me to actually interview for this open job. And so I didn’t really get to learn what ILSR was about for two years after I was on the job and then came around to that. So I love that you just had a friend in law school who was interested in this and all of a sudden realized that that was a common interest. So the motivation for inviting you on the show was this piece that you co-authored in Bloomberg in September, 2024. You and Kent Chandler made the bold claim that, “utilities are America’s real monopoly problem and need scrutiny,” which obviously caught my attention as someone who has come around to this over many, many years of working on energy policy. So could you just start by explaining what are the costs to us, to consumers, to society of this lack of attention that we’ve had to monopoly energy utilities?

Josh Macey:
Yeah, I think it’s maybe a little bit helpful just to understand how utilities work and then sort of how I think the two ways they use their monopoly power in ways that are bad for society. So the first thing is public utilities have a legal right to a monopoly in a particular geographic franchise that we often think of as their service territory. And for about a century, we thought of every part of electricity production — generation, transmission, distribution — as a natural monopoly or at least as something that should be given a monopoly franchise. And if you give someone a monopoly franchise, especially something as important as electricity production, the classic regulatory solution is to closely scrutinize their investments and essentially price regulate so that captive customers like you and me are supposed to pay a not exorbitant amount for this essential service. And so the first problem is that when you give someone a right to a monopoly, there are many, many ways they can just overcharge you.
So problem number one is we often just pay too much for electricity as utilities overinvest in big capital expenses they don’t need, they’re highly reluctant to invest in assets that would cause a regulator to say, Hey, we don’t need to authorize recovery for something you’ve already invested in. They’re worried about stranding assets they’ve already invested in. And so problem number one is just we have this thing that is a monopoly franchise and if we’re not carefully regulating it, we pay too much. The second problem, which is what Kent and I were focusing on in the op-ed is for many years, but at least since the 1970s and really picking up in the 1990s, we took certain parts of the electricity sector and said, we’re going to introduce competition here. We decided for example, that generation was not a natural monopoly and so generators should compete with each other.
And one thing that is becoming increasingly clear is that because many of the utilities that have a franchise in one part of electricity production, say transmission or distribution, use that special privilege that they have to give themselves an enormous advantage in the competitive segment. So even though generators owned by a monopoly utility are supposed to compete with generators owned by independent power producers, the public utility has many ways to give its own assets an enormous advantage and act in anti-competitive ways. So to just give a couple quick examples, one is something you’ve spoken and written about which is control over the interconnection queue. In order to access the grid, you need to connect to the transmission system and the monopoly transmission utility often sort of runs what we call the interconnection queue. It determines the order in which resources connect to the market and how much they pay to interconnect to the extent that grid upgrades are needed.
And many transmission owners have enormously slow interconnection queues to the tune of five years. And there are many immediate reasons, this is an extremely complicated issue, but one concern they have if they also own generation is that they don’t want to connect a competitor that would cause its own generation to make less money. And so I think of this as just a vertical integration problem. Vertical integration is when you own both the transmission assets as well as the generation assets. They’re two part and the parent company owns both. And the concern that Kent and I were writing about in that op-ed is the many different ways that usually the transmission owner blocks access to the grid in order to keep the price of electricity high. And this is a problem both in terms of price and in terms of climate. The core problem is that transmission owners when they own generation don’t want to take steps that will reduce the amount of revenues their generators earn and they don’t want to take steps that will force some of their generators to retire. And so if they don’t connect to other independent power producers, that can cause the price of energy to pay more. So that’s just the cost issue. The second issue, which is also very important is that we need to dramatically expand the transmission system in order to decarbonize. Low cost wind and solar is typically located far from parts of the country that consume large amounts of electric energy. And so if you are reluctant to build a bunch of transmission for anti-competitive reasons, it makes decarbonization much more difficult.

John Farrell:
One of the things I thought was so interesting about the piece that you wrote was that you had a particular example of an antitrust situation in North Carolina where Duke Energy, the incumbent monopoly, was found to have behaved in anti-competitive ways. I was hoping you could explain how Duke was able to leverage its publicly granted monopoly to impede a competitor In that case.

Josh Macey:
Sorry in advance that the details of this are a little bit complicated, but it was a pretty exciting case because antitrust regulators have long been reluctant to bring enforcement actions against public utilities. And you can see why it’s both the doctrine is messy. If you give a company a legal right to a monopoly, it’s hard to bring a Sherman antitrust claim against the company. The doctrine is quite clear that the public utility has protection against antitrust enforcement in the parts of the business that have a legal right to a monopoly, but not in the parts that should participate in competitive markets. So there shouldn’t be doctrinal barriers to it, but there are still some amount of messiness in bringing in antitrust action. The Department of Justice has also just been quite worried about how technical and complicated electricity markets are. And this is a little bit funny since 13 years ago, actually one public utility, Entergy, joins an RTO in order to get out of a Department of Justice antitrust Enforcement action, which shows that we have been comfortable doing this, but the Department of Justice has been reluctant to bring antitrust claims for at least a decade, but the Sherman Act allows competitors to bring suits to enforce the antitrust laws.
And so what happened in this case that Kent and I wrote about is an independent power producer is trying to connect to the Duke system so that it can enter into a contract with municipality to sell energy. And Duke does two allegedly anti-competitive things that made it difficult and arguably impossible for the independent power producer to sell energy to the municipality. The first thing it did is Duke just slow walked and appears or allegedly tried to say the independent power producer reached its contract so we don’t have to interconnect. And you can think of this as using this interconnection process I was talking about a second ago, to keep your competitor off of the system. So Duke owns most of the transmission system in parts of North and South Carolina, but it also owns an enormous amount of the generation. And so it has a legal obligation to connect to independent power producers, but it slow walks that system or seems to slow walk the interconnection process, arguably making it virtually impossible for the independent power producer to sell electric energy.
The second thing it does is I think really interesting, and I want to try to explain this as simply as possible because it’s kind of complicated, but Duke is both a buyer and seller to this municipality. The municipality owned a small generator and when the generator had excess power, Duke’s transmission affiliates purchased the excess power from the municipality. When the municipality needed more power, it purchased from Duke generators and the municipality was being offered a much cheaper contract from the independent power producer. And so it said, okay, we’re going to buy from the independent power producer. And Duke I think thought this was a real threat to its generation business. If the independent power producer is cheaper, it’ll take a bunch of business from Duke’s generation. And so Duke says, we’ll enter into a contract where maybe we’ll offer to reduce the price we’re selling electric energy to you. But what we’ll really do is when you’re selling us excess power, you don’t need all the power your generators are using, we’ll pay a huge premium, a big markup. And so basically Duke said, we will pay more to buy energy than we were before, such that this looks like a very, very sweet deal. At least that’s the allegation in the complaint. And the reason this was I think quite anti-competitive is Duke, because it’s a regulated monopoly in the transmission market, is able to automatically pass those costs onto its captive customers. So what this means is ordinarily we think a company doesn’t want to increase the amount it’s spending to buy a good or service because it will make less money, or a competitor will be able to outperform it. But because captive customers like you and me are automatically on the hook for the price Duke spends in buying electric energy, Duke is kind of indifferent to the fact that it’s now spending more.
And so it’s complicated, but it’s a really stark example of how public utilities are able to, because they can pass certain costs onto customers who have no choice but to purchase energy from Duke, we’re captive customers, Duke has a legal right to a monopoly to sell us energy, Duke is able to offer a very, very sweetheart deal that makes it impossible for the independent power producer to compete with Duke. And it does so not because Duke in fact offers cheaper or more reliable service, but simply because it has the ability to get ordinary customers, people paying their monthly electricity bill, to pay for the cost of allegedly anti-competitive conduct.

John Farrell:
I mean, I think it makes perfect sense to me. And we have a situation in which utilities are often put into a position where they’re both in a competitive market and not in a competitive market. There are some pieces like interconnection and management of the distribution system that in every single state universally the distribution system is monopolized by the incumbent utility company and they are going to manage that interconnection process to get onto the grid. And so that is a hugely powerful tool for them because if there are any ways in which they are exposed to competition, whether it’s through generation or transmission construction or anything, that ability that they have, that control that they have over that interconnection process. And then the other way I think that you’ve outlined really clearly is that these captive customers, right, where they have that monopoly, the customers don’t have choices about who they’re receiving service from, which isn’t just about who I get my electricity from and who sends me the bill for that, but it’s also about the fact that I am now stuck in some cases paying for things automatically that the monopoly decides to do. And that may be sort of subsidizing their behavior in a competitive market, which is they’re not supposed to do obviously, but is the risk of having that ability to pass those costs along. Did I get that pretty close?

Josh Macey:
Yeah, I think there are two things that were allegedly anti-competitive that Duke did in this case. The first is that Duke controls the critical infrastructure, the transmission system. And if you’re a generator, you cannot sell to anyone if you can’t access the grid. And so if you slow walk or just prevent competitors from interconnecting, you can protect your monopoly. The second thing is Duke has a legal right to a monopoly which gives it a captive customer base. When Duke spends money on things, it is able to automatically recover the costs virtually all of the time by passing those costs onto captive customers who pay their monthly electricity bills. So Duke offers a sweetheart deal to someone who’s thinking of buying cheaper power from one of Duke’s competitors In the competitive market, Duke is not able to operate its generation more efficiently. What it’s able to do is pass the costs on from the sweetheart deal to captive customers. And when Duke, because it’s the company with a legal right to a monopoly is in a position to do that, it makes it essentially impossible for any competitor to enter the market even when it does in fact offer cheaper service or more reliable service.

John Farrell:
I think it’s sometimes helpful too to point out to folks that there are some parallels, at least loosely with some of the ways that tech platforms operate. When you think about like Apple devices, there’s only one app store that you can go through that Apple Controls sort of similar to the interconnection process, the utility controls. If Apple deems that your product, your app is competing in some way with one of their native apps, they may not approve it to be sold on the app store. And in fact that has happened in some cases or they may make it more difficult for you in order to do that to get something on the app store. So anyway, just noting that this is not a problem unique to utilities, it comes up in other places. Of course we have that unique layer here of the fact that we have used the law to grant monopoly status to these utilities. But we’re going to get more into that too. As we talk about this. Let me ask you to talk a little bit more about what role federal antitrust regulators could play here because it’s a story from North Carolina is so interesting in part because antitrust cases against utilities are so rare because their competitors are reluctant to bring cases against an opponent that often has the keys to their access to the grid. As you just outlined, Duke was controlling the interconnection access for this independent power producer. So it not only needs to have the money to hire the lawyers to fight, but it also is now probably going to get a black market internally in Duke energy. And unfortunately there are examples where utilities have said, well, I didn’t like how that one company operated or treated us and we’re in a position of power. So how can federal antitrust regulators help fill the gap here where maybe private parties are reluctant to publicly go up against the utility that controls their access to their market?

Josh Macey:
I think that there are two parts of your question. One is why don’t we see more antitrust enforcement? And the other is what can antitrust do to fix this? I think that there are three reasons that antitrust is hard, but it also should be a tool that is used to address some of these problems. The reasons antitrust is hard is first utilities are just incredibly well-resourced. So if you’re the Department of Justice or a competitor and you’re thinking of bringing a lawsuit against a utility, you know that you’re going to be dragged through years and years of litigation and that seems to deter enforcement by both the Department of Justice and by competitors. The second reason is what you were alluding to, which is competitors rely on utilities to connect to the grid. And so even if you know could win an antitrust case, you may be reluctant to anger a company that you’re going to be relying on for years and years and years.
And then the third reason is that there are utility specific legal doctrines that make antitrust enforcement somewhat hard. And I’ll just briefly talk about two and why they should not be a barrier. So the first is something called the state action doctrine Under the state action doctrine, if a state gives a utility, a legal right to a monopoly and actively supervises to make sure the utility is not abusing the monopoly, you are not subject to antitrust laws. So the first question in bringing an antitrust claim is, Has a state given the utility legal right to a monopoly and is it supervising? There are sort of some funny examples where arguably the states are not supervising. For example, Alabama hasn’t had a rate case in over 30 years. One could say that when public utility commissions have just dropped the ball, we should consider antitrust. But the bigger argument is most of the time the state has a policy granting a utility of monopoly.
So you’d ask reasonably, how the hell can you bring an antitrust claim? And I think that that is actually not a barrier. And the reason is that the decision to grant a monopoly in one part of the industry — distribution or transmission — does not provide state action protection in the generation segment. So we have to be careful and I think antitrust regulators should be aware of the fact that yes, the state action doctrine means you can’t say a utility doesn’t have a legal right to a monopoly over distribution, but you can say you can’t use your monopoly over distribution to give yourself a monopoly over generation. And that’s the kind of conduct I’m usually worrying about. The second doctrine is an enormously arcane people who study other legal subjects, don’t even believe it exists, but it’s called the filed rate doctrine. And the filed rate doctrine says that if the relevant regulator, typically FERC has accepted a tariff, the utility, you can’t have a collateral attack on the tariff.
And so the filed rate doctrine actually says if FERC has reviewed the practice, you have some protection against enforcement by the Department of Justice. And this has been presented as a large barrier for antitrust enforcement, but it’s incorrect to think of it as a big barrier. And the reason is that utility tariffs say things like, You have to actually interconnect with competitors. And so when a utility ignores the thing that FERC has done, which is typically how it acts anti-competitively, the filed rate doctrine should not be a barrier to antitrust enforcement. So this brings us to the, I think second part of your question, which is how could antitrust be useful? And so the Sherman Act is written in really broad terms, it prohibits monopolization in extremely broad terms, but I think what’s really important about the Sherman Act is that the remedies available are one, a court can issue an injunction so it can actually force a utility to do certain behavior, to interconnect with competitors, and things like that.
But the second thing that I think is maybe the most important, it’s rare that this tool is used, but when the Department of Justice is able to show certain types of antitrust harms and the need for certain types of remedies, it can force a company to divest or sell off certain assets. And so I think in very, very egregious cases of anti-competitive conduct, it is possible for the Department of Justice to go in and force a transmission owner to sell its generation assets. And to the extent that one of the concerns we were talking about earlier is that the transmission owner is trying to protect its generation assets and engaging in pretty dramatic anti-competitive action to prevent competitors from accessing the grid, forcing the transmission owner to sell its generation would immediately get rid of that anti-competitive incentive.

John Farrell:
I have a couple follow up questions. One is from the perspective of I am not a lawyer but have done some reading about the state action doctrine and I have to give credit to somebody else whose name is now alluding me. He’s a Stanford professor and he wrote a piece in 2017 about this

Josh Macey:
Michael Wara.

John Farrell:
That’s the one. Thank you. Michael Wara,

Josh Macey:
Small world.

John Farrell:
Yeah, it is really a small world at this point. It’s hilarious. His contention about the state action doctrine that I thought was very interesting, and as somebody who has participated in many state regulatory proceedings, I can say with a lot of confidence that I don’t often see state utility commissioners considering the competitive impacts of utility proposals, whether that’s we want to build something, we want to invest in this thing, we want to change our interconnection, tariff, et cetera. Most of the time there is not a lot of discussion about the impact on competitors in those conversations. And so I’m just curious about the degree to which the active supervision component of the state action doctrine that gives that shield to monopoly companies, to what degree does that rely on that regulator having actually considered and in many cases then have a public record in their proceedings, these anti-competitive impacts, or is that one place where there would be a soft point potentially to say, yes, this action you took was approved, but there’s no record that the commission ever considered the anti-competitive impacts of it. They just looked at a cost benefit analysis of like, is this cheaper than doing X or Y? And said, okay.

Josh Macey:
This is exactly right, but I want to be very clear about the state action doctrine should pose no barrier to antitrust enforcement, but you can understand why we think it does. And so the state action doctrine says if a state has a policy approving or endorsing monopoly and actively supervises the monopolist, then the company is not vulnerable to antitrust enforcement. And so the example you gave is one in which it would be fairly easy to show that the state does not in fact have a policy approving monopoly. The state, you can’t just say this policy resulted in monopoly, you have to have tangible evidence that the state wants to give a company a monopoly in a certain matter. And so to the extent that a state approves something, that is not evidence that it has a policy endorsing monopoly unless it actively considers the anti-competitive effects of the thing it approves.
The second way to attack a state action doctrine defense is to say that the state is not actively supervising the anti-competitive effect. The fact that a state approves of a contract doesn’t mean it is actively supervising the monopoly abuse and many public utility commissions simply lack the resources to review all of the details of a utility tariff. And many simply don’t, in fact review crucial investments, which I think is a way of attacking the second part of the state action doctrine. There’s no act of supervision, but what you said, I actually think ignores the strongest reason that the state action doctrine is not a defense here. The reason for that is that the Federal Power Act creates a delicate balance between the parts of the electricity industry that states have jurisdiction to regulate and the parts of the electricity industry that FERC the Federal Energy Regulatory Commission has jurisdiction to regulate.
And so states can regulate retail sales, but they do not get to regulate the wholesale market. And the wholesale market means the sales from generation to the load serving entities that sell energy to you and me, that is exclusively the jurisdiction of FERC. Similarly, the price we pay for transmission is exclusively the jurisdiction of FERC. And so even if a state wants to give a company a monopoly in the wholesale market or over transmission sales, it can’t do so because it simply doesn’t have authority to regulate that matter because Congress has given authority in that jurisdictional sphere to FERC’s exclusive sovereign authority.

John Farrell:
It sounds like it would not be the case though if we’re talking about distribution level interconnection that that would be potentially a different story. So a lot of the work that I do is focused on community solar or rooftop solar. We have evidence, in fact, there was a case, an antitrust case in Arizona against, in this case it was a pseudo public utility salt river project around there creating a unique fee on customers that had rooftop solar that went through some litigation. It was eventually settled. So we don’t really know whether or not the legal arguments would’ve stood up or not. I guess I’m just kind of curious when we talk about the distribution grid and distributed resources, is there a more challenging case to bring an antitrust action against a utility because of that than if you were talking about the wholesale market where there is more clear federal jurisdiction?

Josh Macey:
So that case is really interesting and we can go into details about it, but the Ninth Circuit actually says they’re complicated things because it’s basically a state owned enterprise, but it gets more into the filed rate doctrine stuff I was talking about before, and the ninth Circuit doesn’t think that’s a real defense here. And it also doesn’t touch much on state action doctrine. And the reasons are you’re absolutely right, a state can give a utility a monopoly over distribution, but the jurisdictional argument is still, I think pretty important because it’s going to depend on the market that the CCA wants to participate in the community choice aggregator to the extent it wants to participate in a wholesale market, which many of community choice aggregators will want to do when they sell excess electric energy, the state lacks jurisdiction to give a monopoly there. So I think you’re completely right that states do have more state action doctrine authority over the distribution system, but if what we’re talking about is some company or entity or cooperative or municipality or community choice aggregator trying to sell electric energy in a wholesale market, the fact that they have to connect to the distribution system rather than transmission system is not a complete barrier.
Let me try to phrase this accurately. The particular way that you’re interconnecting will definitely affect how much authority states have under the state action doctrine to shield utilities from antitrust enforcement. And it is definitely the case that states have more authority to regulate interconnection of the distribution system than the transmission system. That said, to my knowledge, no state when reviewing an interconnection process is considering the anti-competitive effects in terms of how that will affect things like community choice aggregators. And so I don’t view that as evidence of a policy favoring monopoly here. And so I think that is still a limitation to the state action doctrine. In addition, depending on how the community choice aggregator is set up, some of the times, even if they’re connecting through the distribution system, they’re going to want to sell excess supply in the wholesale market. And no matter what the state does, it cannot undermine FERC regulations promoting competition in the wholesale market, even if it wants to grant a monopoly in the distribution system.

John Farrell:
Great. That is helpful in terms of understanding these jurisdictional barriers. While we’re on the subject of states, we’ve talked a little bit about the DOJ and the role that it has in enforcing the Sherman Antitrust Act and taking actions. Do you think there are things that states could do to help to reign in utility monopoly power?

Josh Macey:
Yeah, so I think, one, states have quite a bit of authority over generation assets and they also regulate the public utilities that sell to customers. And when FERC and states oversaw restructuring, which is just the term I use for competitive wholesale markets for selling electric energy, it was often states that ordered utilities to sell their generation assets. So the first and easiest thing states could do is order what energy wonks call full corporate unbundling — that if you own transmission, you should not be allowed to own generation. And that’s a structural separation that I think would dramatically reduce these kinds of incentives. You should just quarantine the utility so that if you own transmission or distribution, you don’t own things that participate in competitive markets. The second thing is a lot of states have state antitrust laws and states could, especially to the extent that rate regulated, utilities want to act anti-competitively with things like electric charging stations, rooftop solar… states can enforce the antitrust laws that they have authority that apply within their own states.
And then there are other ways that states can get involved. They can push for utilities to enter into regional transmission organizations where operational control over the transmission system is run by a nonprofit entity. Also, another problem for antitrust enforcement by both federal regulators and competitors is a lack of information and states. I think it would be very helpful to do much more in terms of disclosure about the utilities operations and how it’s acting, how it’s voting if it participates in a regional transmission organization, just so that we know what it’s thinking about and what’s going on.

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John Farrell:
We’re going to take a short break. When we come back, I ask Josh about any examples of state antitrust action, we talk about his recommended reforms for utility governance, and I ask for his top two recommendations to reduce utility anticompetitive behavior. You’re listening to a Local Energy Rules podcast with Josh Macey, an associate professor at Yale Law school who studies energy and environmental law.

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John Farrell:
That’s super helpful. Do you know of any state that has pursued any kind of enforcement action using state antitrust law against an electric utility?

Josh Macey:
So an extremely important case about jurisdiction is called ONEOK versus Learjet, and it went to the US Supreme Court, and the question was whether the Federal Power Act preempts state antitrust enforcement and the Supreme Court says it does not. The case was about anti-competitive conduct of pipelines and the Supreme Court said that the state antitrust law could be used to sue, essentially, pipelines that were arguably manipulating data used about price indices. And the reason I hesitated, and I haven’t figured this out yet, is I don’t remember if the state brought the case or the competitor did, and I was just trying to look that up. But the point is, in some ways it doesn’t matter because it A, that state antitrust laws have been used and have been directly affirmed by the US Supreme Court and whether it’s a competitor or a state that brings it, they are still I think an option that could be used, could be and should be used, and that’s a gas case, but it’s the exact same jurisdictional sphere and a similar utility story.

John Farrell:
So I wanted to ask you about another piece that you’ve written along with Aneil Kovvali. You talk about a governance problem with monopoly utilities, and this is probably going to go way down into the weeds, but I love it and I think it’s kind of an important issue that you raise here. So I want to quote one part of the piece that you wrote, which is, “corporate governance mechanisms ensure that public utility companies are managed for the benefit of shareholders, but it is rate payers who internalize the consequences of utilities decisions.” And I guess I should say the sort of broader arc of the piece is an argument that in fact, because these utilities are monopolies and it is rate payers that bear the burden, they really ought to be responsive to the benefits of rate payers, not shareholders. But I was hoping you talk a little bit about what’s an example or two of the impacts of that governance model for electricity consumers in terms of the behavior of the utility.

Josh Macey:
Corporate governance in the United States is organized around giving control rights to shareholders, the people who invest in a company, and this is based on a few conceptual arguments made primarily by Frank Easterbrook and Dan Fishel who were University of Chicago law professors in the eighties and Frank Easterbrook is now a judge and it’s a pretty brilliant insight and it’s used to justify why corporations should be run by and for the interest of shareholders. And the core argument is that shareholders are known are thought of as residual claimants. And what that means is that if Apple makes an iPhone, it takes a risk and it’s rewarded for that risk because people buy iPhones and Apple makes a gazillion dollars. And so we think that there is alignment between society’s interest and shareholder interest because the fact that a successful investment or project is immensely profitable for shareholders, gives shareholders a unique incentive to pursue socially valuable projects.
Creditors, unlike shareholders, their profits are capped at the interest rate on the debt. If you have a bond and you have a 6% interest rate, even if Apple makes a trillion dollars, you’re not going to get paid more than the interest rate on the bond, but shareholders get that residual value. So because they’re paid last but they get whatever is left over, they’re the only investors that have this incentive to pursue highly profitable projects. So the core insight that Easterbrook and Fischel made is that these residual claimants want to pursue socially valuable projects. And what Anil and I wrote in this paper is that rate regulation, especially a rate regulated monopoly, doesn’t look at all like the classic corporate governance paradigm. If you have a regulatory, if a regulator sets a cap on the profit that shareholders can make, the utility doesn’t have an incentive to pursue socially valuable projects.
The way we put it is that rate regulation converts shareholders from residual claimants to fixed claimants. They look exactly like creditors. The utility shareholders really do not want to pursue cost reductions beyond any kind of marginal incentive incorporated into their rate because all of those benefits go to rate payers, not shareholders, they don’t want to pursue more reliable investments because they already have a regulatorily set return on equity and investing and spending more on reliability is not going to improve their profits. They don’t want to invest in emissions reductions beyond what the regulator has authorized because again, that will cause their cost to go up, but it doesn’t lead to, but customers can’t say, Oh, we really like that this causes less pollution, so we’re going to pay you more. In other words, it is this, whatever the return on equity authorized by the regulator is what the utility will be able to recover.
And this seems to lead to really perverse investment incentives from the perspective of the utility. So if you are a utility, one of your biggest fears is that you will have made an investment and the regulator will not authorize recovery for all of the costs you’ve spent. So let’s say you’re a utility, you’ve just built a really expensive gas fired power plant, and then tomorrow we realize, hey, we could have provided cheaper and more reliable service with battery storage. The utility will not invest in the storage unless it gets regulatory approval to A, recover the cost of the storage and B, not take a loss on the gas. And if the utility goes to its regulator and says, just kidding, we didn’t need to spend a billion dollars on a one gigawatt combined cycle gas plant, the regulator is very likely to say, well then why should we let you recover for an investment that’s not useful to us?
And so the thing that the utility wants is basically not it not to do things that will increase the odds that it doesn’t get to recover what it thought it would be able to recover for the investments it’s made. And it also wants to make sure whenever it makes an investment, it knows it’s absolutely going to be assured that it will be able to recover. And so the fact that utilities can’t make a gazillion dollars by inventing into an iPhone, it makes them risk averse, but it also means that shareholders actually don’t have the incentives. And what Anil and I wrote is that the people who seem to have the right incentives are rate payers. If a utility invests in reliability beyond what it was told, it could recover on rate payers benefit by more reliable service if the utility reduces costs, ratepayers pay less. And so rate payers are much more excited about that. They benefit directly from lower costs, but shareholders don’t receive those benefits. And similarly, if the utility decarbonize or improves its environmental performance rate, payers also benefit. And so our argument is that if you take the Easterbrook and Fischel argument seriously, it is actually the ratepayers who under the kind of core Chicago law and economics approach to corporate governance should have control rights of public utilities.

John Farrell:
I will get to the point where I ask you what does this mean for how we change governance of utilities? But I just want to emphasize just because this is worth repeating every time we encounter it, and you touched on this earlier as well in the conversation, right? Utilities right now almost universally their biggest incentive for action is the fact that they recover that nearly guaranteed rate of return on capital expenditures. So if capital expenditures overlap with benefits to consumers, we will see socially useful behavior. And if they don’t, then we’ll just see the utility making capital expenditures because it will earn its rate of return and they’ll do better their best to justify. I thought your example was particularly good here of you also have a situation where utility is not likely to admit it made a bad choice because one of the sort of linchpins of getting their money back is this notion, this term, which is a term of our prudence and has some legal force, if that expenditure was prudent, then they get their money back. And if it’s not, then they don’t. So if they build that gigawatt gas plant and then they say, actually, we think we could do this cheaper, there’s no incentive for them to admit fault to admit it made a bad choice because like you said, the regulator’s obligation really ought to be to say, well, you shouldn’t get that money back then that was a bad management decision, and yet the utility has no incentive to own up to it. So you do create this fascinating system in which the utilities incentives are really very much divorced from the interests of the consumers. So how would we fix that? How can we change governance of utilities that make sure that consumers are actually having some control over the decisions that utilities make? And maybe I’ll just say listeners to this podcast have heard me talk a lot and with a lot of people about public power. So we know very much you could change the entire ownership structure, but there are things short of that that you talk about that in ways that we could reform corporate governance of utilities that would at least elevate the role of consumers and maybe get better outcomes for consumers.

Josh Macey:
So in some ways, my proposals sound like they run in totally opposite directions because essentially I think one solution is more competition, have utilities face a real threat that somebody can do it instead of them. And the other solutions are let the utilities shareholders have much less discretion to make decisions. And that looks like public power, it looks like cooperatives or it looks like much more regulatory oversight where the regulator is making decisions. And I think one is we should do more within the government and the other is we should do less within the government. But I think that that kind of emphasizes the extent to which the rate regulated utility model is a weird compromise where it looks like a lot of government control, but in a kind of weird, let’s give enormous handouts to capital that don’t align with theory. And so I do think an easy thing is we do not need to make sure that every future investment is made by the company that happens to have done it for the last a hundred years.
And so when making new investments, I think it is useful to say, let’s have a competitive solicitation and see if we can do this at a lower cost. The other set of things that I think would be very, very useful are a set of reforms to make sure that a wider set of stakeholders is in the driver’s seat in terms of directing utility incentives. And this can be dramatic intervention. We should have public power municipalities or something like the Tennessee Valley Authority should do things, or it could be a set of softer reforms. Let’s just have board representation look very different. Let’s tie things like executive compensation to performance that’s tied not just to shareholder returns, but how the utility performs for its customers. So in financial markets, for example, if a high level bank executive is running a bank and is complicit in triggering a recession, their compensation will be affected. That’s not really the shareholder control model, but it recognizes the fact that there’s a distortion of incentives and we should have regulators think about that. So I think things like tying executive compensation to performance that actually affects rate payers is helpful.

John Farrell:
I should just interrupt for a second to say that in a prior podcast episode, which I have recorded but hasn’t been published yet, but will be by the time this one comes out, I talk to Travis Gibrael from Reclaim Our Power and about Senate Bill 332 in California, which actually does that, it ties executive compensation to reliability measures or it would if it passes.

Josh Macey:
And I believe Katie Sieben is the chair of your commission. Is that right?

John Farrell:
That’s correct, yep.

Josh Macey:
I think she limited Xcel executive compensation two years ago or something. It was complicated because Xcel operates outside of Minnesota, so they still made a great deal of money, but it’s still quite interesting.

John Farrell:
Sorry, you were continuing with a couple other examples of ways that we can do the reform.

Josh Macey:
Also things like fiduciary duties. So corporate managers owe duties to shareholders, and if a corporation engages in enormous waste, you can bring a suit against corporate managers. And it seems to me that if a utility engages in enormous waste, the people who are harmed are rate payers. It will often be the case that the shareholders will not be harmed because even though, so there are pretty dramatic examples, the various nuclear investments in the south are often cited. So the Vogtle plant in Georgia was supposed to cost $8 billion. We’re now around 34 or 35 billion. One might say that’s an example of just shocking corporate waste, but it hasn’t harmed shareholders because the Georgia Commission continues to authorize rate increases. And so that’s a situation where suing the managers directly on behalf of rate payers would also be quite helpful. And thinking about whether fiduciary duties should be reformed, that might have to happen through reform to Delaware law, but it is actually possible that a state could create a cause of action that would allow suits for waste in such circumstances.

John Farrell:
One of the other suggestions in the paper was about banning lobbying of elected officials and regulators, which of course matters a lot in this case because you’re talking about decision makers who really hold within their hands the ability to affect utility profits, right? They approve the regulated rate of return, they might approve environmental regulations or other mandates that significantly affect the utilities business. And I’ve been very curious about this. You’ve got some states have been saying, well, if you lobby, you at least can’t charge consumers for the lobbying because the lobbying is really on behalf of shareholders. I’m kind of curious here, what are the legal grounds that you could use to say to a utility company you actually can’t lobby at all if that’s what we were saying in that suggestion.

Josh Macey:
So I think states can and should essentially ban lobbying. Now you can say there are two pots of money. There’s money from rate payers and money from shareholders. And there’ve been large controversies about utilities using rate payer funds to lobby directly or indirectly. Some things include things like hiring actors to go and say, we support this pro utility law, and so customers are being forced to pay for things that seem to keep rates high for customers. And that seems transparently bad, but some of the money is fungible and we say that there’s money that belongs to shareholders and money belongs to rate payers, but to the extent that the utility has a better credit rating or is in a better financial position that causes its cost of capital to go down, these are all things that affect both rate payers and shareholders. And so I think it is hard in practice to say we are able to distinguish between when the money is coming from rate payers and when it is coming from shareholders.
And so given that much of the utility business model, much more than most industries depends on decisions being made by regulators to authorize cost recovery, I think we should insist on much more strict firewalls that make it difficult for utilities to convince regulators to authorize recovery for things that often don’t end up benefiting rate payers. So this is maybe silly an anecdote, but I thought I studied and understood utility regulation from reading all these dockets and laws and whatnot. And then I went to NARUC for the first time, and NARUC is the National Association of Regulatory Utility Commissioners. And I was having lunch with a couple of state commissioners and I thought I was with these celebrities because all these people kept going up to them and offering to pay for their drinks and saying, if you ever leave, we want to talk about employment opportunities.
And it turned out that these were the people who were either the lobbyists or were the consulting firms that testified about utility rates. And it was sort of shocking how hard they worked to cozy up to the regulators. And it makes sense. Their entire livelihood is based on the decision that these regulators make. But given that I think it is pretty important to maintain strict ethical standards such that the regulators responding to the actual economic implications of their decisions and not to the fact that there’s been political pressure or relationships have been built over time, I think given how it is very, very, very hard, if you are an ordinary customer of a public utility to intervene in a rate case or an integrated resource plan, we end up relying entirely on regulatory decisions. And so my position is those decisions should be based on the merits of the case and not on the fact that utilities gain political points by aggressively using rate payer funds or even any funds to affect the regulator’s decision.

John Farrell:
I love it. I think it is really, it’s fascinating what you said about NARUC because I think it is really important for people to understand how this works and how loose a lot of the ethical rules are. I mean, there are a lot of junkets and trips and things that utility regulators can take on the utility dime to very lovely places that all of us would like to go for vacation and are expensive among other things and ways that they spend our money. There was one other thing that you mentioned in this paper about governance reform that I thought was particularly interesting given the history. So you talked about breaking up utility holding companies. So we’ve talked about Xcel Energy, I think, or Duke. Most of these companies are actually holding companies that have several state-based utilities. So the history here was that the Public Utility Holding Companies Act was passed in the 1930s and it intentionally broke up these kinds of multi-state holding companies to say, actually utilities should just be focused on their service territories, which should be geographically contiguous because that’s where all the economies of scale come from and the operational benefits.
And yet now you have companies like Xcel Energy, which I know deeply because I’m based in Minnesota and have done regulatory intervention. So they have a Minnesota arm that is somewhat contiguous with some North Dakota and Wisconsin, but then they’ve got a Colorado company and then they have a New Mexico company and there’s thousands of miles between these different companies. So I’m curious about the Public Utilities Holding Company Act was repealed in 2005, and we’ve seen a wave of utility mergers over the past 20 years recreating the system that led to significant financial problems in the 1920s. Tell me about what you’re thinking about the opportunity to break up these holding companies again and what purpose it might serve in terms of improving outcomes for consumers.

Josh Macey:
When you spend too much time reading 1920s and 1930s utility regulatory proceedings, you’re kind of amazing how we’re encountering the exact same problems we did in the 1920s and 1930s. So FDR’s campaign in 1932, a central platform he ran on was that large holding companies had just really, really harmed consumers that they were impossible to regulate, that they became excessively leveraged, and that they ended up paying enormous profits to shareholders that they were never expected to do so, given that they had this kind of agreement that they would be given a return, but they would provide safe and reliable service, and then their failures had contributed to the Great Depression. And so he passes the Public Utility Holding Companies Act largely to address many of those problems. And PUHCA, as it’s known, does a couple of things, but two of the really important things are, one, it says that public utilities must have a contiguous geographic service territory.
We should have a single system that we’re looking at and it should be plausible for a regulator to look at it. So things like Xcel, having unconnected service territories in Colorado and Minnesota would’ve been prohibited. And the second thing it does is it gives, initially the SEC when PUHCA was mostly repealed in 2005, this authority is actually not repealed, but it goes to FERC in section 203 of the Federal Power Act, and it gives special merger review authority to a regulator on the idea that utility mergers are especially dangerous and we need to consider a broader array of things when utilities are merging. And I mean, some of PUHCA’s authorities are incredibly dramatic. The SEC could affirmatively break up holding companies if it understood that they were exposing customers to excessive harms. But throughout the deregulatory wave of the 1970s through nineties, there was a great deal of pressure to roll back PUHCA.
And so we basically repealed the whole thing in 2005. And I’m working on a paper on this now called PUHCA 2.0, which is hoping to outline what a modern PUHCA would look like. And I think there are two things that would be crucial, maybe more, but one is what you got at, which is that we should ensure that public utilities have jurisdiction in a manner such that it is plausible for an actual regulator to supervise the utility’s activities. So a utility that has service territories in multiple states can often shop around for state regulators to get favorable decisions and leave state regulators that are less sympathetic to their decisions in a very difficult position. So a kind of dramatic example is Rocky Mountain Power, which has service territories in Utah, but also Washington and Oregon, and it actually has the same, it doesn’t have separate subsidiaries, it’s the same entity.
And a big problem it’s facing right now is wildfire risk. And Utah, which has less wildfire risk than Washington or Oregon, is completely vulnerable to catastrophic wildfire liability from Washington or Oregon. And so to the extent that Washington or Oregon is worried about wildfire risk, it actually has an incentive to under regulate because it knows that Utah customers will be on the hook for their liability suffered. It’s the same set of shareholders. And so I think dealing with jurisdictional shopping is one thing that a modern PUHCA should do. But the second thing that I think is arguably more important is that a modern PUHCA, so many of the problems we’ve talked about are how utilities cause rate payers to subsidize behavior in competitive markets. And so PUHCA actually allowed vertical integration. Transmission owners could also own generation. But now that we think generation should participate in a competitive market, I think that a modern PUHCA should be used to separate the rate regulated entity and the non rate regulated entity.
And to the extent that the core idea behind PUHCA was we should carefully understand what business activities the utility is engaged in. A modern PUHCA would be very, very useful in saying there’s basically no reason to allow transmission owners to own generation. The economies of scale we understood to exist in the 1920s and thirties no longer exist in the context of generation. We understand that we can have large markets and balancing authorities that manage competitive wholesale markets for generation without having a transmission owner own that entire portfolio of generation. We no longer need to have all of those activities under the same corporate parent. And so I think it would be really, really exciting if there’s any interest in folks pushing for PUHCA to be used to force utilities to divest themselves at their generation assets.

John Farrell:
Well, you’ve hung with me for a long conversation here, Josh, which I really appreciate. I had lots and lots of questions for you about this issue of governance of our utility sector. So I’m curious, if you had to pick one thing, it could be a federal action, could be a state action, it could be adopting PUHCA 2.0 as you’re writing about, but what would be that one first step you think should be taken to help get some progress on this issue of utilities and anti-competitive use of their market power?

Josh Macey:
I’ll do a cop out and I’ll say two,

John Farrell:
I’ll accept that.

Josh Macey:
But one is I think that state and or federal regulators should take whatever actions they can to structurally separate generation and transmission, and also just simply to quarantine the monopoly utility in economics and law literatures, there’s a lot of debate about when vertical integration makes sense, but there are so many abuses that utilities can engage in when they have a captive customer base that ends up distorting the competitive market. That I think forcing that structural separation would be quite valuable. And that could happen through antitrust enforcement, it could happen through a modern PUHCA, it could happen through an aggressive FERC, and it could happen through state legislation. But the first thing would be quarantining the rate regulated monopoly.
The second thing is I think much more appetite and support for public planning and public options as an alternative to investor owned utility service would also provide a yardstick for understanding are we actually getting good service or not? So that could be, let’s have public power that has real state support and accountability. So the Tennessee Valley Authority and Bonneville right now are quite disappointing, but 70 years ago, they were sort of core agencies that were used not only to support rural electrification, but also to understand whether the investor owned utility was acting diligently or if TVA could do things more efficiently. That was evidence that our utilities were not acting in the public interest. And so it could look like public power, but it could also look like having the federal government or maybe groups of states create parallel processes for building and planning grid infrastructure. So to the extent that utilities don’t want to invest in transmission, if the Department of Energy says, we know we have congestion here, we’ve identified congestion and we know a high voltage line would reduce that congestion, let’s solicit bids to make sure that someone will build a line that will get rid of that congestion. And that’s a way of creating public planning that operates in parallel to the utility led planning that I also think would increase the accountability of the rate regulated utilities.

John Farrell:
I love that. I did get to talk to Shelly Welton, her paper for the Hamilton Project talked about that public planning idea. So folks are interested and encourage them to check out that interview. I also just wanted to say about the kind of yardstick, Mark Ellis with the American Economic Liberties Project recently wrote a piece for the San Francisco Chronicle because he’s been really hot on this issue of utility rate of return. And he pointed out that in the last three years in the United States broadly, so this is across the whole country, that investor owned utility rates have been rising 50% faster than inflation, and public power rates have beening 50% lower than inflation. So when we talk about yardsticks, I think we have a pretty good yardstick already that we have a problem, at least in the near term. And having more of those, I think seems like a great idea. So I really appreciate that suggestion, Josh.

Josh Macey:
Yeah, it’s funny. Yeah, Shelly is a beloved co-author, and I’m talking, my next meeting is with Mark, so it’s very small world.

John Farrell:
Well, Josh, thank you again for joining me for this conversation. Thanks for the writing and the work that you’re doing. I can’t wait to read about PUHCA 2.0. I’m probably one of a few dozen people who could say that honestly, that they’re excited to see this coming, but I just really appreciate your thoughtfulness around this idea of how do we properly manage these big entities that are providing this essential public service. So thank you for your continued work and thanks for joining me today.

Josh Macey:
No, thanks so much for having me on. I really enjoyed speaking with you.

*****

John Farrell:
Thank you so much for listening to this episode of Local Energy Rules with Josh Macey, an associate professor at Yale Law school who studies energy and environmental law.

On the show page, look for a link to the piece Josh co-authored with Kent Chandler called Utilities Are America’s Real Monopoly Problem and Need Scrutiny, as well as his report on The Corporate Governance of Public Utilities with Aneil Kovvali. We’ll also have links to several related podcasts, including episode 109 with Scott Hempling on whether utilities are still natural monopolies, episode 149 with Ari Peskoe about what he describes as the utility transmission syndicate, the interview I mentioned with Shelley Welton (episode 219) that discusses public grid planning, and a recent episode (#233) with Claire Wayner about the regulatory gap. We’ll also have my discussion with Lynne Kiesling about quarantining the utility monopoly, episode 195.

Local Energy Rules is produced by myself and Ingrid Behrsin, with editing provided by audio engineer Drew Birschbach.

Tune back into Local Energy Rules every two weeks to hear how we can take on concentrated power to transform the energy system.

Until next time, keep your energy local, and thanks for listening.

Transcript – LER 237 – Josh Macey.txt
Displaying Transcript – LER 237 – Josh Macey.txt.