Public Utilities: Big Investments, Regulated Returns

Energy is a fundamental currency. It underlies the cost to extract materials, manufacture products and provide services. Understanding how public utility companies earn their profits and how those profits are regulated provides us important insight into the relationship between utilities and DER.

Public Utilities: Big Investments, Regulated Returns

Traditional utilities operate under a system called rate-base regulation.

1. Vertical Integration: Utilities typically own the entire electricity supply chain; from power generation all the way down to the local wires that bring the power to you. Their business model is built on investing heavily in this energy infrastructure.
2. Rate Base: A utility's rate base is essentially the total value of its physical assets: power plants, transmission lines, distribution networks (poles, wires, transformers), and other essential equipment minus accumulated depreciation. Rate base is the utility's investment portfolio of infrastructure. Regulators closely review and approve what assets can be included in this rate base.
3. Pass-Through Charges: Select costs that the utility incurs are allowed by regulators to directly pass on to customers without a markup for profit. These include expenses like purchasing power from a third party or for maintaining infrastructure.
4. Regulated Profit: Since utilities often operate in a monopoly environment, Public Service Commissions (PSCs) determine the rates utilities can charge. A key component of these rates is allowing the utility to earn a fair rate of return, or Return on Equity (ROE), for their investors. This ROE is calculated as a percentage of their approved rate base. So, a 10% ROE on a larger rate base means more profit for the utility's investors.

For a utility, building a multi-billion-dollar power plant or expanding a transmission line is a huge opportunity. It directly expands their rate base, allowing them to increase charges to customers and earn a stable, regulated profit for their investors.  Two large utility projects in Montana come to mind:

1. NorthWestern Energy to Participate in Regional Transmission Projects
2. NorthWestern Energy announces deal to acquire larger share of Colstrip power plant

This of course does not guarantee profits.  The TXNM Energy's 2024 annual report does an excellent job at describing in detail the following utility risk categories:

1. Regulatory Risks
2. Operational Risks
3. General Economic and Weather Risks
4. Financial Risks
5. Governance Risks

DER poses significant risks to utilities:

1. Power generated by DER become expenses passed through on which no profits are made by the utility.
2. DER reduces demand for utility power by producing power onsite. 
3. DER can provide intermittent power that requires the utility to install surplus generation capacity and load stabilizing technology.

So how do we bridge this gap of motivations between DER developers and utilities?  Concessions are made on both sides.  For example: 

1. Regulators require utilities to purchase power from select sizes and types of DER through legislation like PURPA and net-metering.
2. Onsite power is now incorporating more energy storage to stabilize load and generation.  
3. DER incorporate important safety devices that protect the grid workers during an outage.  

In some cases, organizations are choosing to completely cut ties with utilities and build their own vertically integrated microgrids that reduce energy costs, increase power resilience, and provide full control of their power.

The relationship between utilities and DER developers is complicated and requires a difficult balance to be struck.  With the rapidly changing energy landscape these relationships will also need to continue to evolve.