While the world seems to be in a race to electrify everything in the name of sustainability, such an effort can only succeed--both in reducing carbon emissions and ensuring that energy remains reliable and affordable--if there is substantial investment in transmission, distribution, and generation. Unfortunately, ongoing efforts in many states may impede the necessary investment in this infrastructure, which will result in more expensive and less reliable energy for everyone.
For more than a century, utilities have been investing in the transmission and distribution of grids that bring electricity to homes and businesses. In vertically integrated markets utilities invest in generation resources as well.
Economists call these markets natural monopolies because it would be cost-ineffective to have more than one set of power lines connecting homes to the grid. Governments permit such monopolies but they also regulate how much utilities can charge end users for the power they consume under the “just and reasonable” conditions imposed by state and federal regulators.
As part of their rate-setting procedures, each state’s public regulatory body overseeing the tariff process determines a rate of return for the utility. In effect, regulators are ensuring the investments utilities make will provide a level of return commensurate with the risk, thus ensuring continued investment in electrical infrastructure. Poorly-run utilities that make bad decisions do not necessarily get bailed out with higher rates: For instance, PG&E, which failed to adequately maintain its power lines in areas prone to forest fires in California, was forced to declare bankruptcy in 2019, leaving its shareholders with worthless stock.
In a number of states, there is an effort underway to substantially lower the Return on Equity (ROE) utilities are allowed to earn. However, these efforts are counterproductive to the stated goals of elected officials and bureaucrats overseeing the electrical grid. Most states have undertaken concerted efforts to reduce the use of fossil fuels as a source of energy, as well as incentives for the development of intermittent resources--such as wind and solar--which require large areas of land and are usually located in remote regions. We also see campaigns for more battery and storage solutions to sustain the grid’s reliability.
There are growing concerns about the cost of electricity in many areas of the country, especially in the Northeast and California where policymakers are pushing for a faster transition of the energy infrastructure. The cost of any clean energy transition is expensive--production, storage, and distribution must all increase significantly to satisfy demand, keep prices reasonable, and avoid rationing. However, these reliability concerns require capital to address.
According to the Edison Electric Institute, over the past six years utilities have been increasing investment in transmission by a little more than four percent a year. But a recent Princeton University study estimates that to achieve the goal of net zero carbon emissions from the energy grid by 2050 in the United States we would have to double the current trajectory of energy supply system investments. Put differently, we need to quadruple the expected $3.5 trillion to be allocated to an electricity-intensive energy grid transition in the next quarter century. This can only be accomplished if we reduce the regulatory barriers that hinder investment in production and distribution and allow utilities to earn a fair return on their risky investments. Often, the risk comes from government regulators unwilling to approve necessary transmission lines or storage facilities after years of work.
Government-approved rates of return are supposed to reflect the risk premium within markets, and there will need to be substantial incentives to boost capital investment to the levels necessary to keep pace with demand--and government rules dictating more clean energy.
It’s also worth noting that the previous fifteen years’ worth of low-interest rates have disappeared--perhaps indefinitely--which means government regulators attempting to depress utilities’ ROI are doing more to depress investment than they realize.
For decades investors have liked to hold stock in utilities because it represented a safe place to earn a steady rate of return, but those days are long gone. While the current environment, abetted by the government, is seeing a steep increase in energy demand that will likely continue for the foreseeable future--the growth in data centers, the advent of AI, and the electrification of automobiles are all contributing to the increase--the incentives to provide more energy are not going up in tandem.
To meet our energy needs we need streamlined regulations allowing utilities to build new transmission wires to connect the grid as well as take steps to encourage them to invest in a grid that’s lagging behind demand. On the supply side, we need to ensure the return on the utility investment is commensurate with the risks of deploying that capital.
