How Government Regulation of Utilities is Costing Consumers More - Report by The School of Public Policy

CALGARY, May 21, 2013 /CNW/ - Energy consumers are facing cost pressures from multiple directions. Wholesale natural gas prices have been climbing substantially from their record lows. Oil prices have only recently cooled slightly after reaching nearly $100 a barrel (WTI) earlier this year. That makes it that much more important to minimize costs to retail buyers, wherever possible. There is little room in the energy network for unnecessary costs. But in a regulated system, profits for utilities must remain healthy too, if we expect them to stay active in the market.

The way that government agencies regulate pipelines in Canada appears to be increasing costs beyond where they need to be in order to fairly serve both utilities and customers. By relying on traditional rate-of-return regulation models — which calculate price-rates based on the regulated firm's cost of capital (that is, how much it costs the company to finance its operations) — regulators, including the National Energy Board and the Alberta Utilities Commission, reward firms for over-investing in their operations, rather than reducing costs.

So, utilities are motivated to prolong the period in which they can earn a return on their capital, since it is one of the few opportunities they have to increase profits under the widely used rate-of-return regulatory model. That results in utilities keeping assets on the books — and paying for them — longer than they might otherwise need to. The end result is a distortion of the decisions made by regulated firms and, ultimately, higher prices for consumers.

Regulators that take a passive role in setting the rate of return for their industries, ironically, are likely to see their idleness pay off. Firms with a freer hand will seek to accelerate the depreciation of capital assets, reducing costs more quickly. The result is that consumers pay more in the short term, but substantially less over the long term.  Author Kent Fellows argues that "regulators would be wise to put significant effort into scrutinizing all new investment made by the firms they regulate."

SOURCE: The School of Public Policy - University of Calgary

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Morten Paulsen

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The School of Public Policy - University of Calgary

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