While rate of return regulation served the electricity industry and consumers well for many decades, it had embedded in it a number of incentive problems that made for inefficient operation of electric utilities and some behavior by regulators that was not always in the public interest. In particular, rate of return regulation gave electric utilities incentives to over-invest in capital - the so-called "Averch Johnson" effect. Regulators, in turn, labored under incomplete information regarding the state of the utilities that they were supposed to regulate. Even on their best day, the utilities knew more about the power grid than their regulators, so utilities could more easily get regulators to approve investments. Public utility commissioners are aided by large technical staffs, but at the end of the day, these staff members had expert knowledge but still had less data and system information than the utilities.
Recognizing that generation could be competitive over large regional areas, and that transmission and distribution needed to retain some form of regulation, the restructuring of the electricity industry consisted of the following fundamental changes:
In the United States in particular, restructuring has proceeded unevenly. Around half of U.S. states now have a power sector that has been restructured in some way. The other half still operate following the regulated utility structure that we discussed in Lesson 5.
You have reached the end of Lesson 11! Double check the What is Due for Lesson 11? list on the first page of this lesson to make sure you have completed all of the activities listed there before you begin Lesson 12.