EBF 483
Introduction to Electricity Markets

6.2.3 Regulatory Capture

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The Public Utility Commission is supposed to act in the interest of consumers (while allowing the utility to earn enough profit). But the regulators themselves can have adverse incentives because they work in a highly political environment and because they are regulating one of the most complex systems ever created by humankind. The set of challenges faced by regulators is sometimes summarized by the term "regulatory capture," which refers to the regulated industry having a substantial amount of influence on the decisions that regulators make.

The first problem is known as the "Revolving Door." The life of a regulator is finite. Positions to public utility commissions are often appointed by a state's governor. When a new governor takes office, they can appoint new regulators. Once they are done serving on the public utility commission, many regulators go and work directly for the industries that they formerly regulated, either as utility employees or through consulting or lobbying firms.

You can see how this might give regulators incentives to make decisions that are advantageous to the regulated industry. Regulators who try to be tough with industry are less likely to find high-paying jobs within that industry after their time on the public utility commission is over.

The second problem is more of an economic one, namely incomplete information. Maybe the material on how power grids work at the beginning of this class made your head spin. This is with good reason - the power grid is incredibly complicated. People with electrical engineering degrees spend their entire careers learning about how it works.

Most public utility commissioners, however, aren't engineers. As political appointees, most come from a law or public service background. In one sense this is perfectly reasonable. Regulators need to make decisions that are consistent with existing public utility law, and you would not expect an engineer to understand law any more than you would expect a lawyer to understand the details of how the power grid works (although some do, and they are very well positioned for it).

This imperfect information is important. Suppose that you were a public utility commissioner, and you were handed an engineering study which claimed that a major city would endure a significant blackout if the utility was not allowed to install $10 billion of new equipment and earn profits on that equipment, paid for by ratepayers. How would you be able to critically evaluate the claims made in that engineering study? In reality, some state public utility commissions have extensive staffs of engineers and economists that advise the regulators. But other states do not, and for those states the imperfect information problem is more likely to impact what regulators allow utilities to do.