Utility Regulation Demystified – Part 1, Origins and Basic Principles

Posted on January 25, 2014

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Despite a wave of deregulation which came into vogue in the early 1980’s, many important services and systems we all rely upon are overseen by regulatory agencies and tribunals who set the prices for services, determine minimum service standards, and approve major contracts, projects and capital investments.  Here in British Columbia, for example, our electricity and gas utilities are supervised by the BC Utilities Commission, as is the mandatory coverage program of the provincial government’s monopoly automobile insurance provider, the Insurance Corporation of British Columbia.  Our provincial coastal ferry fleet is overseen by the Ferry Commission.

Our telecommunication and broadcasting systems are regulated by the federal Canadian Radio-Television and Telecommunications Commission (CRTC), and our energy infrastructures which come under federal jurisdiction are subject to the National Energy Board.

These tribunals operate under a system of legal rules and procedures full of obscure jargon which can be baffling to outsiders.  This system evolved over many years and has historical roots going back many centuries.

In mediaeval times, English law imposed restrictions on “common carriers.”  Halsbury’s Laws of England defines a common carrier as “one who exercises the public profession of carrying the goods of all persons wishing to use his services or of carrying passengers whoever they may be.”  This could include the operator of a ferry service, a barge service, or a coach, offering service to the public at large.  They had a legal duty to provide service to all comers, without discrimination – that is, at fair prices which would apply equally to all customers.  A similar set of rules evolved for various “common callings” like the operators of inns.

It is not difficult to see how these laws provided the historical basis for our modern human rights laws.  Section 8(1) of BC’s Human Rights Code (very typical of such statutes) shows its origins in the law of common carriers, with specific prohibitions on discrimination based on race, gender, or other stipulated grounds:

8  (1) A person must not, without a bona fide and reasonable justification,
(a) deny to a person or class of persons any accommodation, service or facility customarily available to the public, or
(b) discriminate against a person or class of persons regarding any accommodation, service or facility customarily available to the public
because of the race, colour, ancestry, place of origin, religion, marital status, family status, physical or mental disability, sex, sexual orientation or age of that person or class of persons

Utility regulation shares the same lineage.  Oddly enough, the BC Utilities Commission and Human Rights Tribunal are first cousins.

natural gasModern North American utility regulation emerged with the development of railways, which are obviously latter-day common carriers.  The same principles were adapted to the regulation of telephone systems and energy utilities.  The problem was that vital services to the public were provided by monopolies – “natural monopolies” because it would make no sense to install two or more sets of telephone cables or natural gas pipes through a community, or to lay two or more sets of train tracks along the same route.  Monopoly ownership of an essential service created the risk that the company would impose unreasonable prices, and would have little incentive to maintain the system in a safe and reliable state.  Because they faced no competitors, they could reap super-profits by over-charging and under-investing.

The answer was  for governments to establish tribunals to enforce what became known as the “regulatory compact.”  The regulator would set rates and terms of service to ensure prices were non-discriminatory and reasonable and services were reliable, and in return those rates would be sufficient to ensure that the provider could earn a reasonable profit on its operations.

Some of the basic elements of classic utility regulation are as follows:

1.  Revenue Requirement

The utility discloses all of its costs of providing service and all of its capital assets, and the regulator sets rates which cover those costs and provide a return for shareholders.  (Utilities do not profit from their service delivery activity, as such, but rather from their return on capital investments – pipes in the ground, wires hanging on poles, hydro dams, compressors, switches, computer systems, buildings, vehicles.  The sum total of these capital assets is known as the utility’s “rate base.”)  The total amount of money the utility will collect from all of its customers is its “revenue requirement” which is usually adjusted annually.

2.  Rate Design

The regulator sub-divides the utility’s customers into service classes, each with its own shared cost and service characteristics.  For energy utilities, the three largest customer classes are households (residential customers), commercial customers, and large industries.  The regulator sets rules and rate structures (“tariffs”) tailored for each of the classes, dividing up the entire revenue requirement of the utility among the classes.

3.  Approval of Investments

Because the monopoly service provider is entitled to receive a return on all of its capital assets from its customers, its capital investments and projects must be approved by the regulator before they can be included in its rate base.  Regulatory law is full of strange and obscure names for things, and one of those is the order approving a major capital addition to the utility’s system: the “Certificate of Public Convenience and Necessity” or CPCN.

We live in an era of complexification.  The issues and needs which must be addressed in the operation of our energy systems, for example, are far more diverse then they used to be, and often pull in inconsistent directions.  Regulators are struggling to find new guiding principles and processes to meet the demands of our times.

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