When Just Saying No Is Bad For Your Health

Utility rate increases are rarely if ever popular, but more than ever we need reliable electricity.

No one likes paying a higher utility bill. So regulators and politicians who just say no to rate increases are likely to score points with voters. That is, provided they don’t stay in the position long enough for the consequences to show up.

Earlier in this century, I was interviewed on a Washington D.C. television station on the subject of why the local utility’s service record was so abysmal, particularly during storms. For me, the answer was simple.

Mainly, the root of the problem was the badly frayed relationship between the company and local regulators.

Year after year, the worse relations became, the less the utility was willing to invest in its system, for fear of regulators forcing them to take a big write off. Not investing meant deteriorating equipment, which became more vulnerable to weather events. More frequent and longer outages made the company increasingly unpopular with the public, which made regulators even less willing to grant rate increases needed to fund the investment. And the financial markets noticed, raising the utility’s cost of capital and thereby making it even more difficult to invest.

This conundrum had no winners—just losers. Consumers and businesses struggled with increasingly unreliable service, even as electrification and digitization of the economy made the cost of even short power outages prohibitive. Regulators were under increasing pressure to punish the utility, which would have further discouraged system investment.

The company’s stagnated and its dividend was not increased once from early March until Exelon Corp (NYSE: EXC) acquired it in 2015. Over that time, the stock was a chronic underperformer, meaning the utility paid a much higher price to fund investment than its peers. And the result was—you guessed it—underinvestment that wound up further undermining reliability, leading to more and longer storm outages and so on.

Ironically, the happy ending to the story was the merger of the company—the old Potomac Electric—with Exelon. Being part of a larger utility with far more resources has quantitatively improved electric service in D.C. And the bad old days of residents reflexively reaching for their flashlights when dark clouds appeared are decidedly in the past. But the merger itself could hardly have been more controversial, taking more than two years to close. And arguably only the persistence of D.C.’s mayor got it over the finish line.

The story of Pepco was in stark contrast to that of Dominion Energy’s (NYSE: D) Virginia Power. Operating just on the other side of the Potomac River, the utility was subject to essentially the same weather. But as I pointed out in that long ago interview, the company enjoyed a generally good reputation with its customers. Its reliability record was far superior to Pepco’s. And its electricity rates were appreciably lower as well.

The difference maker: Dominion/Virginia Power had a cooperative relationship with Virginia regulators for decades, whereas pre-Exelon merger Pepco had evolved a fundamentally adversarial one with officials in D.C. and to a large extent Maryland as well.

It’s been nearly nine years since the Exelon/Pepco merger. And almost all US utilities now pursue stakeholder settlement agreements when it comes to investment plans and customer rates. That means getting input from regulators, politicians, consumer advocates, large industrial customers, municipalities, environmental advocates and everyone else in between when changes are proposed.

The final results are almost never everything the utility initially wants. But the settlements do tend to produce more lasting and stable outcomes. And that in turns builds confidence of investors, which means a lower cost of capital for companies and thereby a lower cost of making needed upgrades to systems to improve reliability.

Barely five years ago, many doubted California utilities could survive in an era where the state’s wildfires were worsening every year—and with Inverse Condemnation doctrine putting them on the hook for damages even when companies have followed best practices. But since then, Edison International (NYSE: EIX) has cut its wildfire damage risk by more than 85 percent. And PG&E (NYSE: PCG) has cut roughly the same amount, despite being forced to declare bankruptcy at one time due to damage lawsuits.

It was cooperation between California regulators and politicians—including the governor—that made this outcome possible. Weather in the state has if anything become more violent. But danger to vital power systems continues to diminish. And the state avoided what would have been years of litigation and perhaps hundreds of billions of taxpayer-funded expenses in the process.

Hawaii is still early in its recovery from the deadly Maui wildfire. But there are already signs that state/utility cooperation is speeding restoration efforts, and potentially will get disaster funds to victims far sooner than would be possible with multi-year litigation. It’s also still early days for Xcel Energy (NYSE: XEL) in Texas regards it role in igniting Texas’ Smokehouse Fire. But that should be the kind of solution emerging there as well.

There is, of course, the chance that events in both cases could follow the pre-Exelon merger Pepco example. If that happens, publicly aired acrimony will increasingly replace evidence of cooperation. Lawsuits will mount while the utilities dig in. Xcel could even put its Texas unit into bankruptcy to short-circuit claims against it. And the court battles would drag on, at the cost of tens of millions of dollars that would not be spent on restoration and restitution.

At this point, such an outcome seems highly unlikely. In fact, more intrepid investors will rightly see an opportunity to bet on amicable results.

The key—as it always is with the utility industry—is how well utilities and regulators get along to come up with mutually acceptable solutions to challenges. And the example over the past century plus is some states and localities will do a better job of than others, with the best results for consumers, businesses and investors alike.