Are utilities making too much money?

[Music] Greetings. Everyone, this is Voltz for February 11, 2026. Are utilities making too much money? I am your host, David Roberts. Democratic politics these days is hyper-focused on affordability, specifically energy affordability. This has prompted a great deal of policy discussion about how to bring energy prices down. One proposal recently outlined in the Atlantic by previous Voltz guest, Leah Stokes, is to cut back on the amount of money utilities are allowed to make through their capital spending on new infrastructure. What's known in the biz as their return on equity or ROE. Matt Eglaceus responded to this proposal by characterizing it as a kind of backdoor degrowth move from the dastardly green groups, as though they just don't want the utilities building anything because they hate energy and prosperity. That is a borderline deranged, but I fear perhaps somewhat common misunderstanding. Ironically, Stokes' proposal is a quite mild form of what can be a much more radical critique. Long-time energy analyst and expert Mark Ellis released a paper last year arguing that utility rates of return are dramatically, systemically too high and should be pegged to the utility's cost of capital. While somewhat complicated to explain, this reform would dramatically slash utility profits. So what's the deal here? Who determines these rates of return and how do they do it? Are those rates, in fact, too high? Who might actually lower them and what would happen if they did? Is this all a devious degrowth plot by the Greens? To talk through all of this, I have with me today Joe Daniel, a long-time veteran in this space, once a fixture on energy Twitter, RIP, who helps run carbon-free electricity work for RMI? He and his colleagues recently released a paper on rebalancing ROE, so I thought he would be a good guide through what can be a dauntingly complex topic. We are going to walk through it piece by piece so that ordinary people, even political pundits, can understand the real motivations and stakes involved. With no further ado, Joe Daniel, welcome to Vultz. Thank you for coming. Thank you for having me. It's been a long time, Joe. I was certain that you had been on before and I googled and I guess this is the first. Yeah, though, this is the first time I've been able to be on the pod, but I'm excited about being here. I'll tell you what, though. I'm not sure I'm excited about the emails that we're going to get after this body. That's really wonderful. That's pod life. This is a spicy topic in our communities. Yeah, it's pretty funny. It's spicy in our community and utterly impenetrable from outside our community. I mean, there are lots of issues like that, but this, I think, even more than, I once wrote that utilities and utility regulators are protected by a force field of tedium. I still stand by that. We're going to penetrate that force field today because this really does. It's very obscure and technical, but it really matters now. All of a sudden. We're going to catch people up. Ordinary people, as I said, can understand it. It's not really that complicated. Once you understand what the terms mean, I got a slight preamble to set you up here. People have listened to Vultz for a long time. We've done a lot of pods on utilities, the utility regulatory setup, etc. But I just want to quickly run people through the logic that has led us to this point, and then I'll hand it off to you. When you're creating a electricity system, you discover pretty quickly that you don't want multiple companies building wires all over your city. You figure out, well, this seems like a monopoly. This seems like a natural monopoly. We're just going to assign a particular territory to a utility, and that utility will be the monopoly provider of electricity in that territory. But for obvious reasons, with the railroad, the railroad mess, fresh on our minds, let's not let the monopoly sell the product they have a monopoly over. That would be crazy. That would invite corruption. They could just set the price however they wanted, etc. So they have to sell electricity at cost. They have to sell it to ratepayers for whatever it costs them to produce it. So then you have a question, well, how do they make money? If you want to attract private capital into this sector, if you don't want the government to have to pay the whole freight to electrify the country, if you want private capital coming, how do you give them returns? How do you attract private capital? And the answer to this question was, okay, what we'll do is we won't let them profit on the sale of electricity, but we will let them get a rate of return on investments into electricity infrastructure, basically. So that is how utilities make their money. So then what is that rate of return on their investments? Normal businesses operating in markets, right? That is determined by the market. But this is not a market. This is a monopolies. So how much they get on their investment, the rate of return they get on their investments is established by regulation, by public utility commissions. That I think is in as compact form as humanly possible, the background we need to understand why you've got these public utility commissions setting the rates of profit, basically, for utilities. That's why we have the situation. Now, having set that up, maybe you can tell us in a little more detail what it looks like for a PUC to do this. Like the utility comes to the PUC with a case. The PUC hears it. Tell us a little bit about how this actually works in practice. Sure. So it's called a rate case. You said that they come in for a case. We call it a rate case because it's ultimate goal is to go through the rate-making process that results in the rate sheet being determined. How the utility is allowed to calculate our bill. The first step in that process is a calculation of revenue requirements. And as you well know, and I think most of your listeners know, every state, every utility jurisdiction is slightly different. And so in some states, they use a historical year to determine revenue requirements. In some states, they use a future test year to determine revenue requirements. But however they do it, they essentially say, all right, we think that in order to operate the electric grid, it's going to cost this amount of money. And included in that is the operating costs of, let's say you're in a vertically integrated jurisdiction where the utility owns the generation, the transmission and the distribution. It might include the fuel costs to run the power plants. It might include the purchased power prices to trade electricity across borders. And it will include the remaining plant balance, the remaining value of that power plant that will eventually be depreciated over time, which represents a former capital expenditure. And it includes essentially interest on that because in order to raise money to finance that power plant or the transmission line or the distribution lines, the utility had to raise money. And embedded that is the interest rate. And you can think of return on equity. This is, again, we're going to try to keep this simple. And so for the other experts out there, this is a simplified analogy here. We're doing the 101 version. Yeah, this is just a lot of folks. So it's the interest rate that the utility gets to earn or their investors more accurately, get to earn and get baked into the revenue requirements. Those revenue requirements then get allocated through cost allocation to different customer classes, residential, commercial, industrial. And then the utility says, all right, we'll be expecting those customer classes to use this much amount of electricity. And so we want to charge them this number of dollars per kilowatt hour. So baked into that rate is implicit a certain amount of costs, including profits. Right. So what the utility is saying to the utility board is, here's the amount of money we need to A, run the system and B, have a little bit of profit, enough profit to attract the capital we we need to do this basically. Like our revenue. requirements plus a little bit of return. Yeah. I want to take this moment to dispel one common mistake about when we're talking about ROE is that some people think of it as a profit margin. That this is the utility's profit margin that they tack this on to your electric rate. But it's not quite that because a profit margin is essentially profit divided by total costs. So if you sell a widget for $100, and it only costs $90 to make, that's a 10% profit margin. But a 10% ROE does not translate into a 10% profit margin. This is where the confusing math of that revenue requirement comes into play because a 10% ROE translates into a 16% profit margin. Why is that? I'm glad you asked. So let's go back to that analogy of the interest rate on a loan. If you were to take a loan for $10,000 on a 10-year payback period with a 10% interest rate, you would be paying over the lifetime of that loan 36% of the costs would be going to interest. And so you're not paying $1,000 over 10 years. You're paying almost $4,000. And the same thing happens in the revenue requirement calculation where essentially the utility is investing every year in new capital and depreciating that capital and recovering on interest. And so a 10% profit margin on the return on equity-- and that's the other thing that we can dig into. It's just the equity portion of the investment. So it's a-- you've operating costs and capital costs. And the capital costs are-- the funds are raised through debt and equity. So it's a portion of a portion of a portion of the costs that you get a return on. And still, it represents a higher portion of the bill than the number itself. I see. I think an important distinction here that we should get out of the way is the distinction between return on equity. So as you say, they have operational costs and they have capital costs. And we're only talking about capital costs. And we're only talking about the capital that they raise through equity, not through debt. We're talking about the return on equity. What sort of rate of return do they get on that? There's also another term, cost of equity. And it turns out that the distinction between cost of equity and return on equity is crucial here. And this is like technical and a little wonky. But this is, I think, a load bearing distinction here that we have to keep in our mind. Absolutely. Yeah, this is really, really important. I think it's, again, if ROE is not profit margin as the first myth we're going to bust today, the difference between ROE and COE has to be the next myth that we bust. Right. Let me run my crude understanding by you and see if it's roughly. When we say return on equity is a number you can see on paper. It is how much money you're getting back from the equity. Cost on equity is not a specific objective number. It is the amount of return that will be required to attract the capital, I think, because as I understood it, when we talk about the regulatory compact, maybe people have heard of the regulatory compact. Don't let Ari Pasco here use that. I know. I know I hear Ari in my head. It's to be clear, the regulatory compact is not a legal document. It's not written down anywhere. Nobody is legally bound by it. It's just sort of a descriptive account of the logic of utility regulation here. But the idea is, as I said, you don't want utilities to profit off electricity, but you want to attract capital. So you need to offer a return that attracts enough capital. But I think also implicit in that is anything you offer beyond that is just draining rate payer money into investor pockets, basically. Is useless, is just pure, piratic profit for the investors. I think the part of the regulatory compact is you're supposed to offer a rate of return that attracts capital, but no more than that. Is that right? Is that a fair account of the implicit contract here? Because what we're coming back to, I think, kind of what the whole pod ends up revolving around is that the cost of equity that would be required to attract capital, utilities are getting more than that. They're getting return on equity that is substantially exceeding the cost of equity, and that is the problem here. So let me just tell me, is that a fair account of what cost of equity means? Well, sort of with the caveat, because you had a fantastic podcast on performance-based regulation with my colleague, Cara. I am. If you haven't heard that podcast, I mean, David, you've heard it. For your listeners, we haven't heard it. They should go back and listen to it, because there are situations where we do want to create the incentive for utilities to earn a little extra to go above and beyond, right? To do the right thing. But not just for doing the normal thing. But that caveat aside, I think your explanation is better than many that I've heard. I was reading a testimony in a proceeding, and it's not the first time, and I hope it, I wish it was the last, it won't be, where experts, supposed experts in this field have said, "I'm going to use ROE and COE interchangeable." And as you've correctly identified, that is fairly flawed. Yeah, the delta between them is the whole substance of this critique. But I think this is implied in what I said about COE, but just to draw it out, like how much return is required to attract investor money is not a, just to repeat myself, not an objective factual number that you can just look up. There's a little bit of. Yeah, it's an opportunity. Psychology to it. There's some estimation to it. Yeah, well, I think the way to think about cost of equity is as the opportunity costs for investors who would be investing in some other similar risk profile, similar investment. So, it's the stock returns investors for go, is the way to think about it. And I think the other thing that we need to unpack in what you just said is that there are actually two ROEs we're talking about. There's the authorized ROE and the realized ROE, and those two things are not the same. The authorized ROE is set administratively by a regulator. And the realized ROE is what appears on the utility accounting statements at the end of the year and is what the utility actually earns. So, like the PUC can't dictate what it actually earns because there's markets involved in uncertainty and et cetera. Yeah. And this goes back to. I mean, this is going to be, I guess, the theme of today is called "Mithbusting ROE." Because a lot of folks, and I don't want to trigger too many people, but a lot of folks talk about the guaranteed profit or guaranteed ROE. Yeah. And that is strictly speaking not true. And I think it's important to bring a little data to that conversation because I think it informs that breakdown that you had earlier, which is the exact way that I think about it. Like, authorized ROE, realized ROE, and then the delta between that and cost of equity. Quickly tell us what happens. So, the PUC, the utility comes to the public utility commission, makes its case, public utility commission says, fine, you get a ROE of 10%. And then they go out to do whatever they do in the market. And for whatever reason, there's an uptick in the market or something. And they end up earning, I don't know, 11%, or 12%. What does the PUC do? Is there any. What happens? Well, first, I love to. Because I went up and I pulled up the RMI has utility transition hub, which is an amazing database made possible through the amazing work of catalyst cooperative and one of our analyst named John Ray. And it's actually what we've done in one of those many data sets is collect every utility's authorized earnings and their actual earnings. Can I guess before you reveal, are the realized earnings reliably higher than the authorized earnings? They are not. What? I know. I was surprised by this too. And the first cut of the data that I looked at, I was like, okay, well, maybe I'm just looking at it incorrectly. And so I cut it a lot of different ways. And the only thing I can say is I have never felt or personally experienced the phrase lies, damn lies, and statistics. More. Wait, is it reliably lower or is it just more or less random? So I think there's two stats that I'll bring out to kind of give you a sense, because there's a lot of different ways you could cut it. The first is number of utilities that over a 15 year period, in fact, it holds true whether you look at it over a 15 year period or 10 year period, it remains true whether you remove the outliers or not. But you know, basically on average, about 60% of the utilities are over earning and 40% of the utilities are under earning. But in aggregate, as an industry, the utility industry earns about 95% of what they're allowed ROEs would imply. Okay. And what is the lesson that we should take from that? What is the implication? Well, to circle back to what you said earlier, if the allowed ROE average in the industry is about 10% of the utilities, then we're going to have to do that. What it is, it's about 10% right now, a little bit higher actually. We can infer that the industry average realized ROE is 9.5. And so we could say, oh, the utilities are earning less than they're authorized. But if cost of equity is 7.5, they are actually still over earning by 2%. Right, assuming you accept the premise that the return on equity should be roughly equal to the cost on equity, and we're going to, I guess, discuss that more directly later. But so we can say, if you look at it, realized ROE versus authorized ROE, they're under earning slightly. But if you compare earnings to COE, to the cost of equity, to what would be required to induce their investment in the first place, they're over earning substantially. You know, before we talk about the implications, like why it matters, let's just make sure we establish, because the main case here is that ROE's are systematically too high. And so let's just talk about a little bit of the evidence base that supports this. And when we say too high, just to be clear, what we mean is an ROE that exceeds COE, a return on equity that exceeds cost of equity. Is that what you mean by too high? What I mean is that the ROE could be lower, and the utility would still attract reasonably priced capital. And therefore could still make the investments it needs to. And if that's true, then all that extra money is just pure profit. It's just pure skimming profit for the investors. It's not serving any purpose. Well, it's certainly driving up costs for customers. I definitely want to talk about the implications of that. But I also want to double click on an important part of this, because we talked about, we could have just said, "Oh, COE is this ephemeral market-based opportunity cost." But it's driven by market conditions, right? And it's really intuitive that cost of equity and return on equity can't be the exact same. Like you can't use ROE to set COE. This is why the word equals always gives me a little bit of anxiety. Because in mathematics, if A equals B, then B equals A. And that's not the case for ROE and COE. Because if the cost of equity increases, if the cost to attract capital increases, you would expect stock prices to lower. But if the return on equity rises, you would expect stock prices to increase. So, I don't know. When I hear somebody say ROE and COE are the same thing, it's sort of like saying pressing the accelerator and the brake at the same time will move a card forward. It doesn't make intuitive sense. So that is a really important element of this discussion. Well, it certainly makes no sense to take it as a premise, right? Like it might be that you could show that in practice, they are coming out the same, but conceptually, they're not the same. Like empirically, they're going to vary. And the whole point of this is that you can show that ROE's are higher than COE, maybe not across the board, but very frequently. So what is the evidence for that? What is it? Like what type of studies would show that and what have they shown? There's been a lot. You'd mentioned Mark Ellis' paper. He documents it a little bit in his paper. We do as well in hours to studies that I'm really familiar with. One came out of UC Berkeley. In fact, it was just updated last year that looked at the risk premium, which is essentially the difference of the weighted average return on equity that utilities are granted and other similar low-risk benchmarks. And what it found was in the 1980s, the utility returns and a 30-year T-Bill or 10-year T-Bill roughly moved lock and step. But then in the late '80s and in the '90s, the Treasury Bill returns went way down. The yields went down a lot. ROE's went down a little bit. They went from 15% to 13%, but they weren't reduced nearly astramatically as some of these historical benchmarks. This study was essentially replicated. I actually don't know which study came out first. Carnegie Mellon University also had a study. They came out roughly the same time. The UC Berkeley one was updated. We've seen even entities like S&P Global track the risk premium. And they had a big story last year about this that showed that that risk premium peaked in 2020. So at the height of the pandemic, that premium that utilities were earning was at an all-time high. I think it's worth noting that generally speaking, the way academics talk about this is utilities are not zero risk. It's not a true guaranteed rate of return. So it would make sense for there to be some delta between a 30-year Treasury Bill and utilities are we? Yes, but, and this gets to a question I kind of wanted to ask. It's not zero risk, but it's pretty low. It's about as low as you can find for investors. It's hard to think of big investments that are more reliable, lower risk. Then this is a little crazy to me that they're getting rates of return that exceed what people get in actual markets. Yeah. Where there is way more risk. Yeah, I mean, I think the academic papers that I've seen tend to say three to three and a half percent is the economic equilibrium that they would expect. RMI is going to be releasing. I hate to scoop myself, but we've been working on my colleague, Christian Fong, who has really been leading a lot of our analytical work on ROE and cost of capital and cost of equity. You know, all of these things. He's working with a ROE expert from Wisconsin CUB. He's a guy named Steve Kym. We're about to release a report on cost of equity and the myths of cost of equity. In that report, we come up with a range of what we think the industry's real cost of equity is. I think it's going to be in line with that. Treasury bills right now are at about 4.2 percent. 3.3, 3.8, 3.5. Those all numbers all make sense. Those numbers are very different. Yes. 10 percent. Considerably lower than 10.5 or 11. Less than half one might even say. Let me just summarize this because we've got a bunch of stuff we need to move on to. Just to summarize this, the cost of equity, as we say, is not an objective factual number. There's a little bit of estimation to it, but there are market indicators you can look at to estimate it. Basically, any which way you estimate it, it comes out substantially lower than the return on equity that utilities are actually making. There's a substantial body of empirical evidence and analytical evidence and studies and everything that say that utility ROEs are too high in the sense that their ROE is substantially exceeding the cost of equity. The money they're getting back is more than they need to get back to induce the investment. That, I think, is well established. empirically well established. Both academia and by practitioners. Also, importantly, it wasn't always that case. There was a time when these things were much closer. You could see over time as they drift out of. Let's talk briefly about why that's happened. If it is possible to roughly estimate COE and the logic of regulation is that you're setting ROE roughly at COE, why have they been drifting up beyond COEs steadily for 20 to 30 years? Now, why is that happening? Well, it's what I like to call the utility home court advantage. In most states, the utilities, again, I have to keep on caveating not every state because some states have requirements that the utility has to come in for a race every two years. But in most states, the utilities get to pick and choose when they come in for a race case. So it would only make sense for them to come in for a race when those favorable conditions. Right. I see. So they choose the timing of their recases too to maximize this? I mean, Ed, you can't fault them. Of course they would. I know. Well, this is what I want to impress on people. Is like, if you think of a business as what it does to make money, then the utility business, like what you need to be good at to make money as a utility is sweet talking PUCs. That's the business skill you need to rise above in the utility world. I don't know how much sweet talking does, but I know that being able to go into that case when you want to and getting as much prep time as you want to build huge information asymmetry too. You have all the information you have all the money. And they get to choose, there's a couple of different models that are used to estimate COE and to estimate what a good, allowed ROE should be. And they get to go in and they get to make their case. And then you respond to their case, right? And they had however much time they needed. They had their internal staff and external experts build this case. And lobbyists and legislators on their side and just like the power to bully you. Like PUCs are rarely particularly powerful or well-staffed or well-paid or well, you know what I mean? Like the utilities have more power basically. And once that case is filed, if you are the consumer advocate, you've got a clock. You've got, you know, in some states it's like 60 to 90 days to file your discovery. And then 30 days after that, you have to file your direct testimony and then 30 days after. So you're on a clock immediately. And most states only have, you know, they have a consumer advocate office with a relatively underfunded understaffed. If they have it at all. And you might be dealing with three or four rate cases at a time. And also this is another thing I want to mention, which was the most jaw dropping thing in Mark Ellis's paper, which is that the PUCs are using this procedure to set R O E's that basically takes for its raw data what other PUCs are granting to other utilities. So like you can easily see why this all rises together. If they're all just referencing each other, you know, if you're only reference for an R O E is what are the other guys giving us an R O E. You see how R O E's at all the PUCs just sort of drift, slowly drift over time. Is that like the way Ellis describes that is so jaw dropping that I had trouble believing it? Is that genuinely true that PUCs are doing this? Are setting R O E based on what other PUCs are offering? Not all states, but it is one of the methods that is sometimes used. That is just insane. And if you like think back to the example earlier, the situation earlier where in the late 80s, Treasury bill yields were declining. The first utility to go on for a rate case, you know, the commission might have said, well, Treasury bills were declining. Why shouldn't we reduce your R O E? And they said, you can, you can lower R O E, but like look at our appears, you know, so you can't lower it that much. You can't make us so much lower than our peers. And so it kind of like creates a cushion. So that, you know, there's a little bit of first after disadvantage there, but they might have needed to go in for a rate case so they could, you know, if they had a big capital plan or whatever it was, but you get insulated by the other utilities. And then which utilities are you going to pick? You know, surprisingly, most utilities that I've seen use pure metrics, don't pick the five highest R O E utilities. They try to pick, you know, three or four that are above and one or two that are below. So it makes me trying to make, make this absurd model appear more reasonable than it is. But if that's your model, you pick your own R O E by the comparison set, right? That you pick. This is why in our paper, wholeheartedly agree with this, this idea that the, you know, anything that relies on pure metrics or referencing to peer utility groups, probably shouldn't be the basis for setting an R O E. If utility wants to compare themselves to other utilities, I have no objection to that in principle, but using it to set their returns just does not hold water. I mean, maybe one thing to draw out about this is kind of the, I guess what you call the socio-political dynamic, which is, do you want to be the PUC who says to utility? Yes, it's true that all the other PUCs are offering their utilities to high rates of return. But we're not going to do that. We're going to be the one PUC did not do that. Any PUC that does that is like inviting a world of pain. I disagree with this because, oh, really? Yeah, because here's the thing is utility commissions did that for years. Utility R O E used to be 15%. They're now 10%. We've been able to reduce utility R O E's in the past. Yeah. And the industry didn't clap. It's still here. It's still chugging along. The central thing I think that people need to understand about this. Why are we talking about this? Why does it matter? Why does it matter that all these utilities are getting rates of return that are substantially in excess of their cost of equity? Because I think, you know, this gets back to Matt Eglaceus and his reaction to this piece. I think there's an intuition that might say the higher of a rate of return, you give them the more they're going to want to build. And right now we're in a time in the utility sector, in the electricity sector, where we need a lot of building, where we desperately need a lot of building. So what's the problem if we give them excess incentive to build? We need them to build a lot. What is the problem with return on equity being too high? Well, I guess from my vantage point, if this idea that the higher the ROE, the more the utility is going to just invest in whatever cap X spending, there is some evidence that there is a correlation between spending and ROE. However, let's think about what they're spending their money on. If the high ROE is resulted in utilities only building the most capital intensive thing available, then every utility would be building nothing but wind and solar and batteries. Right? Those are, don't have no operating costs. You get, you know, if you're going to spend $40 or $35 a megawatt hour on solar versus that same dollar per megawatt hour over the lifetime of that asset on gas, you don't get any recovery on the gas part of the gas plant. And yet, utilities still invest because the ROE are so high, they could still get enough money, enough value, enough dividends, do their investors by investing in a gas plant. So this idea that, well, we're just, they're just not high enough and that's why they're not investing in the things that we want. Doesn't seem to have empirical truth to it. It just doesn't, isn't hold up to me. I think what Matt would say is, well, we don't just want them to invest in wind and solar and batteries. We also want them to invest in transmission lines and gas plants and everything else. Just we need more electricity infrastructure. So utilities have operational spending and capital spending, you know, the maintenance and stuff, the kind of stuff you need ongoing and then new stuff. And it's important here that the return on equity only applies to the capital part. So this is what you call what many people call what I have called on the pot of millions of times a cat X bias. Like they would rather spend money on the stuff that they can get a return on. So one of the obvious flaws here is that this incentivizes them to underspend on maintenance and operation. Yes. And you talk about this again to reference my colleague, Kara's conversation with you on phone space regulation. There's all sorts of options available on that. But there's other issues with this idea of, oh, well, utilities will spend more if we just give them a higher R O E because they can't raise infinite dollars. If they could, you know, they would do it at any R O E, there's only so much money that they can raise and deploy in a year and lowering the R O E actually increases the headroom so they can build more megawatts of whatever resource at a lower R O E. They can build more transmission for the same cost if you lower the R O E. So you actually can build more for the same price when you lower the R O E. So in the expert understanding, lowering R O E, A is not intended to slow build out and B would would not have the practical effect of slowing build out. Is that accurate? That is fair. And I even have a hypothesis that, you know, I don't think this is universally held by all folks that are in this space, but I wonder sometimes that if you lowered the utility R O E because you know, they're so inflated right now. If you moved the R O E down to closer to the cost of equity, would the utility actually have a reason to spend more because the amount, you know, the way utilities deliver value to investors is through dividend payments. And that's based off of the total number of dollars of returns that they produce and they would earn more returns if they invested in more capital intensive projects. So there is this like a little bit of counterintuitive possibility. Again, I, you know, there's not good empirical evidence whether this is or isn't true. And if somebody were to have pushback on this, I would completely understand it and would welcome to hear it. But I think there is a hypothetical a theoretical wherein reducing the utility forces the utility to find more projects that it needs to invest in in order to deliver the same amount of returns, the same amount of dividends to its investors. So you think it might actually accelerate investment. It's very counterintuitive and the question is would that outpace the savings that you get from the increase. There's like, you know, it's second and third and fourth order effects are completely unknown. Well, another thing you say about the impact of how is that they make the transition more expensive overall. And this I feel like, this is what sort of irritated me about Matt's thing, is like if you are a business in a competitive market, you have natural incentives to economize, to do the most possible, with the least possible resources. That's a natural market pressure. But these utilities are not in markets. They have no such market pressure. So if you want them to economize, if you want them to do the most they can with the resources they have, you have to incentivize them to do so. If all the grid's problems are solved by just building more crap, instead of using the stuff we've already built better, that's gonna be the most expensive, conceivable way to do the energy transition. So like even if you just want a rapid transition, this is the cost effective way to do it, is to utilize your. - Yeah, I just want to put it a slightly different way, which is, I didn't read Matt's response, I haven't read Leah's initial thing, but right now the utilities are spending a ton on transmission, on distribution, on new resources. There is no shortage of spending from the utilities, and it's actually resulting in a lot of commissions starting to push back saying, we have an affordability crisis, we can't raise rates, right? So there is a backlash to just unfettered expenditures, which is another reason why utilities don't do it. It is so complicated, right? There are all of these second-order effects, there's a lot of theory, there's a lot of differing opinions, and so it's never as simple or as unnew-wanced. Maybe this is why we never got into it on energy Twitter. (laughing) This is definitely even in an hour, we're not gonna, we're, we're, you know, we're 50 minutes into this thing, and we're not even close to scratching much more than the surface. - So another thing you say about XSRIs is they make utilities less competitive, explain that briefly, 'cause I thought that was significant one. - Oh yeah. Yeah, so in a handful of states, utilities that wanna build new resources have to go through competitive procurement processes, right, so you wanna build whatever resource it is, gas, wind, solar, batteries, whatever, you have to put it up for bid, and you can bid on your own RFP, but the decision has to be, you know, at least heavily weighted towards costs. And if a utility is earning 10 and 1/2% on their investment, and an independent power provider or independent developer is willing to accept a 6% or 7% return, then all other things being equal, who's gonna be at a lower cost. - Right. - So particularly in states where there's competitive procurement processes, you know, we can't expect, you know, if you're a fan of the utility and you want them to compete in these things, they'll be more competitive. And if you want these utilities to have fair competitive processes, just fair procurement processes, if they can't compete, then, you know, I think it's hard to expect that that process is gonna be executed in a fair way. - But Joe, like, I mean, maybe I'm not getting this right, I'm not even, but like, if you, if you're saying the return on equity we're giving you is so high that it basically prices you out of the market and all these other developers are gonna be able to come in and build cheaper than the utility, is that not extremely obvious, de facto evidence that the rate of return is too high. I mean, you're setting it higher than what the market is telling you to be. It seems like that alone is like very obvious evidence that it's too high. Am I misinterpreting that? That's why we're talking to it. I agree. - Yeah. I mean, obviously, like, a lower return could attract capital, you can prove that by pointing out and showing that it's happening in your own, in your own auction. You know what I mean? Like, this is as clear a demonstration as you could ask that the cost of equity is lower than what these utilities are getting because there's a bunch of private entities who are competing and succeeding with that lower rate of return. All right, so what we come to now is what would happen if we reigned this problem in? So you have sort of like, on either end of this, on one end you have the utilities themselves. Who, as you know, if a PUC so much as twitches in the direction of trying to rein in their returns or trying to rein in their rate increases or trying to rein them in at all, they go nuclear, they go to war and they have a lot of power. We saw what happened in Connecticut with Marisa Gillette. Basically, she tried to fight against some rate increases and the utilities mounted basically a smear campaign against her that got so intense that the governor had to boot her out. So the utilities will say, if you mess with our returns at all investment in your state will collapse. We'll go invest elsewhere. You won't be able to have the electricity. You'll need you'll have blackouts. Ah, this guy will fall, et cetera. Then on the other, I guess, end of that debate, you have Mark Ellis who's saying, look, just make the ROE same as the COE and that will just make utilities market participants like any other market participant and things will go fine. Things will go fine if you do that. And that would mean as we've gone over extensively really substantial like 50% plus cuts in their margins. They're making Mark Ellis says, that would be fine. All that would happen if you did that is you would reduce the sort of surplus profits of investors and everything else would be fine. Where in between those two options should we land here? How should we think about what would happen if you lowered the ROE to COE? Which again would mean reducing ROE from like 10.5, 11% down to something more like four or five percent. Hey there, everybody. Don't worry. I'm not going to tell you about a new mattress or push a credit card on you. This isn't an ad. There are no ads on volts. It is supported entirely by listeners like you. If you'll indulge me for a second, I'd like to ask for your support. I started volts because we're all surrounded by depressing news about climate change and misinformation about clean energy. And it's never been more important to share the stories of the real people on the ground doing the real work of transition and all the ingenuity, encourage, and public spirit they are bringing to it. People are hungry to hear these stories, to learn from and find inspiration in them. I've heard from people who changed majors or careers after hearing episodes of volts. People using it in classrooms and community groups, even state legislators who have passed bills inspired by specific episodes. Sharing these stories matters. It makes a difference. If you have found value in it and want to help me continue doing it, I hope you will join the community of paid subscribers at volts.wtf. It's about the cost of a cup of coffee a month. If you don't like subscriptions, you can make a one-time contribution. Leave a review on Apple or Spotify or just tell a friend about volts. I am grateful for any and all support. If you're already a paid subscriber, thank you. And now, back to the show. How should we think about what would happen if you lowered the RWE to COE? Which again, would mean reducing RWE from 10.5, 11% down to something more like four or five percent? Well, I think probably be closer to 7.5%. But that's still a pretty substantial difference to 11. Or 10.5, which I think is about where the average is last time I've looked. And I think it depends on how you get there. It's path-dependent. If one regulator in one state for one utility makes that change, there is a market available to investors that they can pick and choose where their money goes. And so I can understand the reductions to get from 14% 15% RWE that we had in decades past down to 10% didn't happen overnight. It didn't happen with one commission making that choice. Now, if the National Association of Regulating Utility Commissioners, if all of them, all 200 of them, were to agree all the same time, which seems like a very daunting task. Implausible, but is that legal, I wonder? Like, are they allowed to sort of like collude? They pass resolutions. I have no idea what the legal regime is. Oh, yeah. Like in that hypothetical, in that wave of magic wand worlds, Mark is probably right. So if they were all as a collective, moved back. Like if RWE at every one of the 50 whatever state commissions were, say, dropped by three points, a uniform three points across the nation, investors and utilities relative to one another, the position was the same, right? They would all be suffering the same thing. So they would all be in the same relative position. And I don't think any of them would stop investing, you know, what I mean. So as you say, I think if you could do this all that once, it would be fine. Yeah. And the other thing that like I think is important to acknowledge is utilities have gone through bankruptcies and come out the other side, very able to attract capital. So attract Acting capital is not something that has historically been a challenge for regulated electric utilities. Well, let me ask you about this, because Mark, I think I forget if this is in his paper or if it was in conversation or something else he wrote, but basically, Mark is like, I would be fine getting rid of the pretence of PUC's setting rates of return at all. This whole regulatory construct is silly. Financial markets have evolved to the point where there are many, many different ways of raising money and utilities could just go out and raise money and invest it like normal market participants and they would be just fine. I think he thinks the whole regulatory construct has been rendered pointless by events. I'm guessing that is not a super popular or widely held. It is really innovative. This idea of putting, we talked earlier about resources getting put up for competitive procurement, a reverse auction essentially, doing the same for finance is an amazing, innovative idea. I will say I have had more than one commission staffer and more than one commissioner come up to me and ask me what I thought of this idea. I think it's one of the most interesting ideas I've read about in a long time. Then they ask me, how do we do this? How do we actually operationalize and implement this? I regrettably have said, I don't know. I really hope that is the mark. If you're listening to this pod, I hope that's the next paper you're writing because we need somebody as smart as him to map out exactly the steps and processes necessary to make that happen. I wonder who is the legal, who would do that? Is it an individual PC that would vote itself out of operation? Could an individual PC do that? Would have to be a legislative decision at the state level? Would you have to do something federal? Would FERC have to get involved? It's all unclear to me how that would. I think you would still have the returns baked into rates. I think it's just the amount of the returns would not be administratively set by the regulator. This was my interpretation. It would be, oh, we have. By market conditions, we've signed a loan agreement with Axe Capital or whoever. This was the lowest bid. We need to give these returns. Instead of the 10.5%, it's now 6.5 or 7.5 or 8.5, whatever it is. This is a hypothetical, Joe, obviously. We're both. I can't believe that if you're a big utility, you're in a time of massive demand growth, etc. You're out on the market trying to raise capital. I would bet my I-teeth you can raise capital for cheaper than 11-fricken percent if you're out on the market doing this in the finance markets. I think cost of equity is around 7.5. I think you could do it for about 250 basis points less. If you reduced these, as we said, you would undo some of the impacts. You would, to some extent, undo the KAPEX bias. Although there is an interesting solution to this that I think we should at least mention somewhere that I think they're doing in the UK, which is the basic flaw here is that they're getting return on capital investments and not on operational investments, which to me, just very obviously, the problems that are going to arise from that seem obvious to me. I'm a little puzzled at what they were thinking at the time. What the UK has done is rather than divide up KAPEX and OPEX, they're setting rates based on what they call TOTEX, which is the two combined. That seems like a good idea to me, albeit I'm in a fog of ignorance about most of this stuff, but how does that strike you? Is that idea catching on at all? RMI, we wrote a paper about exploring the options for TOTEX ratemaking. We did some exhaustive research on whether or not state law would allow for it, which we weren't able to find definitively that they couldn't. The way I phrase that was quite legally so. >> I'll just say I'm able to prove the negative. >> Full disclosure, not a lawyer. So yeah, if you Google search RMI and TOTEX ratemaking, you'll find a really interesting report that we've written on it. I think it's hard to square TOTEX ratemaking with Ellis' idea for raising capital. >> Yeah, it's a different direction. It's going to be the almost the opposite direction, it'll be putting more in PC hands. >> At the beginning, when you had me on, I said, I'm not looking forward to the emails. That's because this is such a sensitive topic. >> Help listeners understand who are the fighters here? It's sensitive. There are factions that are at war with one another. Who are they interests here? Who are they going to be the authors of the angry emails? >> Well, so I have nobody, I really do. I think I've tried to lay it out not to try to paint a picture one way or the other, but to try to take a neutral snapshot of where we are today. But there are three folks that when are we comes up, they immediately get energized. Either you could decide what direction the energy is going. But there's the utilities who have a fiduciary to their investors. And it is not in the fiduciary interest of investors for the ROE to be lowered. >> Yes, it's such a perverse incentive. We should just dwell on that for a second. Like I said, that is the business they're in. The business of convincing PCs to give them lots of money. So of course, they have no incentive at all to be honest about this. Their duty to their shareholders is to squeeze their PCs as hard as possible. Like they're doing their fiduciary duty by bullying PCs, basically. >> Yeah, I mean, you have a very well established position of how you view utilities. I think we're not going to get into the exact same page there. But yeah, I mean, I work in these proceedings. Historically, it used to be an expert witness. Now, advise commissions and consumer advocates. And I tend to work with the realities that are in front of me today. And the realities are we should expect the utilities. It's very easy to understand where they're coming from. >> Yeah, let me ask you this though. I mean, I understand for obvious reasons why they're going to use their power to fight against this. That's clear enough. But do they like, you know, you cited these studies. There's a lot of, you know, but the else's whole paper, there's a lot of empirical work showing that ROE is way above COE. Do the utilities have counter studies? Do they have an empirical argument of their own? Are they just saying, uh, leave us alone? Like, have they mounted up an actual credible counter case? >> Yeah, so this brings us to the second group of individuals who tend to get sensitive around ROE. And that is commissioners and commissions themselves because they're the ones approving this. And I've met commissioners I agree with, I've met commissioners I've disagree with. I have never met a commissioner who didn't want to do a good thing, the right thing. They, you know, every commissioner I've ever met wants to work in the public interest and thinks that they are working in the public interest. And they are subject to rules and regulations and laws that require them to make decisions based off of evidence in the proceeding. And in some states, in some states, if one expert said it should be 10.5%, and one expert said it should be 7%, those are the only two things the commission can do. They have to choose one of those two things. >> Oh, really? They can't just like say, oh, nine sounds like a compromise, a good compromise to us. In some states they can't, but in some states they can't. In other states, it almost never gets to that. They get settlements. And all of the parties agreed to the settlement and the commission can only approve the settlement. >> Right. >> There's precedents like, oh, we've used this methodology for decades. That commissioners been there for two years. >> Right. Yeah, like they would have to, I think, PUCs, especially like traditionally, very quiet backwater of public administration, like expecting PUC commissioners to do notably radical or brave things is probably futile. >> Let's circle back to that because the thing that I have learned that I had zero appreciation for when I first worked in this industry. And now I think it's the most undervalued yet most important thing is utility commissioner soft power. >> Interesting. >> I want to circle back to that. The third group of people are the consumer advocates, the members of the National Association of State Utility Consumer Advocates in Asuka, the attorneys general state consumer advocate, office of public affair, they all have different names, citizens utility board. And they were telling us this in the 90s, right? >> Yeah, I would think they would be all over this. This is kind of their whole, this is their whole daily one. >> Yeah. And so, they've been talking about this forever. And so they get really energized and you know, I'm sure they will I hope that they do reach out to me and say oh Here's a great example of this and here's an example that counters the illustrative thing that you said They have been in the trenches for years and in many cases decade are they as As a collective sympathetic to the Bellis's view. I mean it does seem like it would be the most I guess consumer friendly I don't know the history. It didn't help that he includes an entire section saying that they're oh right They're idiots I forgot about that. Yes, he does Take a few swipes at them in the paper You know, I think I I will say there are a lot of there's some things in in his paper that I agree with and there are some things That I disagree with and that's at the top of my list of things I disagree with like yes consumer advocates higher the same Experts that testify for utilities, but that's because expert testimony is like theater and the first thing you do the first Five to ten pages of an expert witnesses testimony is them bragging about themselves and creating pop and circumstances establishing credibility you have to be a credible witness and Hey, I helped set the utility our release for these other ones And I think yours is too high is a really credible argument to be making Mark Ellis by the way also has you know loads of credibility So you don't have to use those witnesses that are other witnesses available and that's why RMI my team has just launched Raypayer lab which is an entire platform dedicated to providing technical assistance to consumer advocates because Why would a consumer advocate have dedicated? You know, they only have one race every three years Which is the case in some states? Why would they have a You know an on-staff expert on the topic they might not so yeah, we want to build in house expertise that we can then Serve in the interest of the consumer. So what would you like to see? I mean one thing is that sort of unclear to me is like if the world became convinced of the correctness of Mark Ellis's take on this exactly what the You know what this sort of sort of damacly's reform is like what's the one big step? You could take to do all this at once not clear to me. I'm guessing that you know RMI has in mind a sort of more incremental Gentler way of Nudging these ROEs down over time is that kind of what you are after? Well, I think there's a couple of things first of all I think it makes total sense to Discontinue the use of authorized ROEs to estimate cost of equity right we need to throw that right off the window We need to discontinue the practice of Using authorized ROE of other utilities and the use of peer groups does that ROA you throw that off the window And then I think it's really important to start thinking about using differentiated ROE to say There are some investments that are just regular maintenance capital expenditures that you have to make And there are some that are in in service of specific state mandated public policy goals And you can differentiate the ROE on those things and that will make a difference But then you're really getting into policy then you're getting into like straight-up policy These are subject to policy then basically like your PUC is making policy though I mean, I would imagine that that would have to be done in service of you know New York State has XYZ goal or Has implemented or D I live in DC and DC we have public policy goals for the utility Why not reflect them in in ROEs right is anyone doing that? There are very few examples differentiated ROEs very few examples are we're starting to see it come up in gas utilities Oh right. Yeah for Sinalis actually wrote me and wanted me to ask you about this like is anyone I mean one thing you might want to do with one of these blended utilities is raise the ROE on their electric investments and lower the ROE on their gas investments to nudge them over time toward electricity for instance Yeah, if you certainly if you were in a state where you have decarbonization goals, right that would make a lot of sense Interesting and and so who like in your mind? I mean there are these reforms you can do But like how do you solve and this kind of was the last question on my list here and in some senses the most important question Which is how do you solve this first mover problem? Like I guarantee everybody in the PUC world saw what happened in Connecticut Like it's real clear where the power balance currently lies So I'm skeptical you're gonna get like a brief PC Is it a legislature who's who's taking the first step here? How do you get a network? How do you get a You know what I mean? How do you get a group movement started here? Well, I think one is we have to get smarter about the evidence we put in front of the commission Because again the commission is is held to making decisions based off of In fact, I believe in a letter that that commissioner wrote She mentioned when she was making decisions if one party told her the sky was red and the other said it was green She couldn't decide that it was blue And I thought that was like, you know a fantastic line That's why we need to get better information in front of the commission But that's that one seems like an easy problem to solve, right? I mean, there's a lot of information that you could just have sort of ready to go And just file it everywhere. There's you know what I mean like that seems like a very solving I mean, yeah, but you would need a centralized platform Yeah, like who's doing who's doing that? Well, that's the cool afraid pair lab So rate pair lab is where um where we hope to build those resources that you know any consumer advocate or You know in a lot of states the commission themselves have public staff That can file testimony in a rate case can pull that information and use establish the fact That hey, R.O.E.s have gone down. They used to be 15. They're now 10. It's not the end of the world Make sure you put all of that into the record right so you could almost argue that no PUC has really Fairly considered this yet Because all of this evidence that we're talking about has not sort of been put all in one place in front of one yet Well, there are states that already don't allow some of these Practices that have resulted in the drift um, I don't think there's any state that has you know really solid differentiated R.O.E. Plus all like I don't think anybody's doing it perfectly But they're you know, this is not a new if you're in this world. This is not completely new I give full credit to Mark's paper For launching it into the mainstream. I mean this was a topic that only a handful of folks that I was aware of Well, I would say it's a combination of of Mark's paper which did shake a lot of things up But also just the immense political pressure currently to bring down energy costs bring down rate costs and like There's a lot of ways to do that that are difficult but like reducing The profit margins of big utility investors seems like politically one of the easiest You know if you're trying to find money to give back to ratepayers That seems like the most politically popular way to do it at least Yeah, I think it's worth acknowledging that in 2020 when the risk premium was at its all-time high There was a lot of fat to cut Utility R.O.E.s have remained relatively flat since then But the cost of equity has arguably gone up a little bit simply because Treasury bills interest rates, you know have gone up quite a bit So there's less fat to trim from R.O.E. But doing it now Sets up that long-term win, right? You can't do nothing There is a real important element of What do you do in a situation where you have somebody like Mark with bulletproof calculations that says the cost of equity is 7.5 and Like that the first actor advantage the first or disadvantage, I guess is a real problem And I think we have to remember and remind ourselves that this is the What's the frame of the Boeing of hardwood? It's you know, it's a slow run But we're in kind of a I mean we're in kind of a crisis situation here Joe like we need a lot more electricity You know, we need to electrify everything. It's way too expensive like Climate blah blah blah like we're in you know, there's so much Pressure here there's so much speed pressure here and that's why we can't rely on any one lever right? This is like You know, we're talking about are we we're talking about investments? No would financial I'm not a financial advisor. I'm not giving financial advice here But no would financial advisor I've ever heard or talked with or read about has ever said only invest in one thing Right, it's all about diversifying or portfolio sure and we needed to do the same for affordability We need to rein in the financing costs Absolutely, we can do that through lowering our we we can do that through the debt equity ratio We can securitize the and just to make your point that you're making right here lowering our oe From 11% to 7% would reduce Rate-payer bills in a meaningful way. This is not purely marginal. This is a real chunk of of costs here I just want to yes establish that and if you wanted to talk you know, we're talking about affordability For a low-income customer their bills are about five times higher than they can afford But we're not gonna we're not gonna reduce costs by 80% right? So yes, we need to do all of these things that reduce total cost But we also need to look if affordability is your goal. We can't just look at our way We can't just look at reigning in utility overall spending. We have to do that. That is a necessary thing to do, but it is not sufficient. There's a bunch of stuff to do. Yeah. But this is an important piece, and I think Leah, including it as one of her three, I think reflects the fact that the Democratic party, I think, is sort of swinging around kind of what's happened here, the political dynamic is the Democrats sort of went all in on affordability before they had really fully thought out the program behind it. So it's getting filled in now, but I do think this is one that is a, substantively correct for the reasons we've discussed. I think it is true that ROEs are too high, and it is true that reducing them would probably put some money back in great pair pockets with no undue impacts on this. And I also think it's politically, I think it sounds good, right? And we're going to cut back on piratic utility profits is a very good populist, you know, it sounds good populist. So this is only a piece of the agenda, as you say, but I do think this is a good one. It's where substance and politics come together, I think here. Yeah, and I need to say two things to that. One is, my role as a principal on the RMI electricity team is not political. We wrote a whole menu of options, the electricity affordability toolkit, and it is available to folks of all political persuasions and affiliations. I need to say that. I think everybody knows this about RMI by now, Joe. But we'll say it again. It's important. Two, I think if you go to that toolkit, you will see there are a lot of options. It's not a thin list of things. And one of the things that I want to just name on there, because we didn't get a chance to talk about this, is that while R always have remained at fairly high levels, the intrinsic risk to the utility has dropped because of things like cost trackers and fuel pass through and all these other things that the utility has done to insulate it from risk, which is one of the reasons why it is a low risk investment. And those things have driven volatility and higher costs to customers. The braining some of those things in should be paired with, if you're willing to pass a walkie regulatory legislative action, please can I interest you in some additional regulatory actions and fully fund your consumer advocate, fully fund your commission. >>Fully fund your PUC, yes. >>Absolutely. >>Let them have a budget so that they can hire. >>Yeah. I meant to say that earlier, but I want to say that every time PUC is coming up on the show, which is, as you know, quite frequently, a lot of the problems that beset them, and this is true of public administration generally, and NEPA, and go down the list, a lot of these problems could be solved if you just fully staffed and funded the fricking agencies involved in administering this. >>Yeah. And the consumer advocate is effectively the oversight. They also provide a really important balance to the conversations. They're in every single one of those proceedings. And so, yes, fund up the commissions, let them staff up, but also do the same for consumer advocates. And we've seen states let go of consumer advocates and close those offices and be like, that I think is something that needs to get revisited. >>I just want to stress this one more time because I don't know how common this misconception that Matt has is out there. But just to say it one more time, these reforms we're talking about, specifically lowering ROE. You know, there's a bunch of reforms for affordability that you've sort of touched on. There's a million. But this one in particular, there's no conflict between implementing this reform and having utilities build out power infrastructure rapidly. Those are not at odds. >>If anything, I think they might be mutually inclusive, but they are certainly- >>Yes, I think they are complimentary. >>Yeah, they are certainly not contradictory. >>Okay. Well, Joe, this is as you say, as anyone who's involved in utilities knows we could spend 10 hours just discussing the basics of how rate cases work, etc., etc., but I think we've done a pretty good job here of giving an overview. Basically, just like utility investors are making more money than they need to make and one way of reducing costs on ratepayers is transferring a little bit of that excess profit back into ratepayer. Pockets, it is both substantively defensible, I think, and a good political plank and not beyond human kin. Like, I think people can understand basically what's going on here, the dynamics going on here, especially after this discussion. So anyway, thank you. >>Thank you for having me. >>Thank you for listening to VOLTS. It takes a village to make this podcast work, shout out especially to my super producer, Kyle McDonald, who makes me and my guests sound smart every week. And it is all supported entirely by listeners like you. So if you value conversations like this, please consider joining our community of paid subscribers at VOLTS.wTF. We're leaving a nice review or telling a friend about VOLTS. We're all three. Thanks so much, and I'll see you next time.