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Here’s what stood out to former agency staffers.
The United Nations climate conference wants you to think it’s getting real. It’s not total B.S.
On a permitting bill shocker, spiking gas bills, and China’s nuclear progress
It was approved by the House Natural Resources Committee on Thursday by a vote of 25 to 18.
On Turkey’s COP31 win, data center dangers, and Michigan’s anti-nuclear hail mary
Members of the nation’s largest grid couldn’t agree on a recommendation for how to deal with the surge of incoming demand.
The members of PJM Interconnection, the country’s largest electricity market, held an advisory vote Wednesday to help decide how the grid operator should handle the tidal wave of incoming demand from data centers. Twelve proposals were put forward by data center companies, transmission companies, power companies, utilities, state legislators, advocates, PJM’s market monitor, and PJM itself.
None of them passed.
“There was no winner here,” PJM chief executive Manu Asthana told the meeting following the announcement of the vote tallies. There was, however, “a lot of information in these votes,” he added. “We’re going to study them closely.”
The PJM board was always going to make the final decision on what it would submit to federal regulators, and will try to get something to the Federal Energy Regulatory Commission by the end of the year, Asthana said — just before he plans to step down as CEO.
“PJM opened this conversation about the integration of large loads and greatly appreciates our stakeholders for their contributions to this effort. The stakeholder process produced many thoughtful proposals, some of which were introduced late in the process and require additional development,” a PJM spokesperson said in a statement. “This vote is advisory to PJM’s independent Board. The Board can and does expect to act on large load additions to the system and will make its decision known in the next few weeks.”
The surge in data center development — actual and planned — has thrown the 13-state PJM Interconnection into a crisis, with utility bills rising across the network due to the billions of dollars in payments required to cover the additional costs.
Those rising bills have led to cries of frustration from across the PJM member states — and from inside the house.
“The current supply of capacity in PJM is not adequate to meet the demand from large data center loads and will not be adequate in the foreseeable future,” PJM’s independent market monitor wrote in a memo earlier this month. “Customers are already bearing billions of dollars in higher costs as a direct result of existing and forecast data center load,” it said in a quarterly report released just a few days letter, pegging the added charges to ensure that generators will be available in times of grid stress due to data center development at over $16 billion.
PJM’s initial proposal to deal with the data center swell would have created a category for new large sources of demand on the system to interconnect without the backing of capacity; in return, they’d agree to have their power supply curtailed when demand got too high. The proposal provoked outrage from just about everyone involved in PJM, including data center developers and analysts who were open to flexibility in general, who said that the grid operator was overstepping its responsibilities.
PJM’s subsequent proposal would allow for voluntary participation in a curtailment program, but was lambasted by environmental groups like Evergreen Collaborative for not having “any semblance of ambition.” PJM’s own market monitor said that voluntary schemes to curtail power “are not equivalent to new generation,” and that instead data centers should “be required to bring their own new generation” — essentially to match their own demand with new supply.
A coalition of environmental groups, including the Natural Resources Defence Council and state legislators in PJM, said in their proposal that data centers should be required to bring their own capacity — crucially counting demand response (being paid to curtail power) as a source of capacity.
“The growth of data centers is colliding with the reality of the power grid,” Tom Rutigliano, who works on grid issues for the Natural Resources Defense Council, said in a statement. “PJM members weren’t able to see past their commercial interests and solve a critical reliability threat. Now the board will need to stand up and make some hard decisions.”
Those decisions will come without any consensus from members about what to do next.
“Just because none of these passed doesn’t mean that the board will not act,” David Mills, the chairman of PJM’s board of managers, said at the conclusion of the meeting. “We will make our best efforts to put something together that will address the issues.”
California energy companies are asking for permission to take in more revenue. Consumer advocates are having none of it.
There’s a seemingly obvious solution to expensive electricity bills: Cut utility profits.
Investor-owned utilities have to deliver profits to their shareholders to be able to raise capital for grid projects. That profit comes in the form of a markup you and I pay on our electricity bills. State regulators decide how much that mark-up is. What if they made it lower?
A growing body of evidence suggests they should at least consider it. In principle, the rate of return on equity, or ROE, that regulators allow utilities to charge should reflect the risk that equity investors are taking by putting their money in those utilities, but that relationship seems to have gotten out of whack. Among the first to draw attention to the issue was a 2019 paper by Carnegie Mellon researchers which found that since the 1990s, the average “risk premium” exhibited by utility ROEs as compared to relatively risk-free U.S. Treasury bonds has grown from 3% to nearly 8%.
“An error or bias of merely one percentage point in the allowed return would imply tens of billions of dollars in additional cost for ratepayers in the form of higher retail power prices,” the authors wrote.
Subsequent research reproduced and built on those findings, showing that a generous ROE creates a perverse incentive for utilities to increase their capital investments, leading to excess costs for consumers of $3 billion to $11 billion per year. Now, the ex-chief economist of a major U.S. utility company, Mark Ellis, is putting his own analysis out there, arguing that unreasonably high ROEs are costing U.S. energy customers $50 billion per year, or over $300 per household.
Not only does this hurt consumers, it also makes the energy transition more expensive and less politically palatable.
That’s what environmental and consumer advocates are worried about in California, where the Public Utility Commission is currently considering requests by the state’s four largest energy companies to raise each of their ROE. Utilities in the state have reported record profits amid a worsening affordability crisis. On Friday, the commission signaled that it would instead lower the companies’ ROE — although not nearly as much as advocates have recommended. A final decision is expected in December.
“It’s a joke,” Ellis, the former utility executive, told me of the commission proceedings. “If you read the proposed decision, they don’t address any of the facts or evidence in the case at all.” His own analysis, which he submitted to the California commission on behalf of the Sierra Club, proposes that an average ROE of 6%, down from about 10%, would be justified and has the potential to save California energy customers more than $6 billion per year.
Utilities, of course, disagree, and have brought their own analysis and warnings about the risks of lowering their ROE. Regulators are left to sort through it all to figure out the magic number — one large enough to appeal to investors, but not so large as to throw ratepayers under the bus.
How does the ROE work its way into your bill? Let’s say your local utility, The Electric Company, has a regulated return on equity of 10%, and it plans to spend $100 million to build new substations. Utilities typically finance these kinds of capital projects with a mix of debt (loans they will have to pay interest on) and equity (shares sold to investors). Then they recover that money from ratepayers over the course of decades. If The Electric Company raises half of the capital, or $50 million, via equity, an ROE of 10% means it will be able to charge ratepayers $5 million on top of the cost of the project. That additional $5 million is factored into the per-killowatt-hour rates that customers pay. The profit can then be reinvested into future projects, issued to shareholders as dividends, paid out to executives as bonuses — the list goes on.
The energy research group RMI, which agrees that the average utility ROE is much too high, estimates the surcharge currently makes up between 15% and 20%% of the average customer’s utility bill. “Setting ROEs at the right level is necessary to bring forward a rapid, just, and equitable transition,” RMI wrote.
Utilities, however, say the “right level” is likely higher, not lower. They warn that in reality, lowering their ROE would trigger a cascade of negative effects — credit downgrades, higher borrowing costs, lower stock prices, investors taking their money elsewhere — that would push energy rates up, not down. These effects would also make it more difficult for utilities to invest in projects to clean up and expand the electric grid.
Timothy Winter, the portfolio manager of a utility-focused fund at the investment firm Gabelli, told me this “virtuous cycle” runs in both directions. Higher ROEs lead to a lower cost of capital, which leads to more investment, better reliability, and lower rates, he argued. Winter said that if California regulators reduced utility ROEs to 6%, investors would flee the state.
Between growing wildfire risk and the bankruptcy of California’s largest utility, PG&E, California energy providers are too exposed to warrant such low returns, he said. As a comparison, he noted that U.S. Treasury bonds, which are generally viewed as risk-free, yield about 4%. “If it’s a 6% return with an equity risk, they’re not going to do it,” he said of investors.
I probed Winter a bit more on this. Is that really true given that utilities are still, in many ways, the opposite of risky investments? They have captive customers, stable income, and are seeing skyrocketing growth in demand for their product.
This caused him to spiral down into an investor’s worst nightmare scenario. “Yes, there is a risk,” he said. “If a regulator is willing to give a 6% return and they used to give 11%, how do I know they’re not going to decide, okay, rates keep going up, next rate case it’s going to be 4%?” After that, he said, how can investors be sure the government won’t end up taking over the utility altogether?
Travis Miller, a senior equity analyst at Morningstar, was more measured. He hesitated to tell me whether a 6% ROE would hurt utilities’ ability to raise capital. “What usually happens” when regulators lower the ROE, he said, “is the utilities just decide not to invest very much, so then they don’t have to raise capital.” He would expect the California utilities to “invest to maintain reliability and that’s about it,” meaning that “a lot of new data center build that is planned in California would have to go elsewhere.”
Return on equity also isn’t the only thing investors look at, Miller added. They consider the overall regulatory environment. Is it predictable? Is it transparent? He said there have been cases where regulators cut a utility’s ROE but the overall regulatory environment remained strong, and other instances where the cut to ROE was “another sign of a deteriorating relationship” — a phrase that brings to mind Winter’s panic about government takeovers. (I should note, advocates for public takeovers of utilities cite this whole dynamic around the need to woo investors and the perverse incentives it creates as a key justification for their cause. Publicly-owned utilities — which serve about 1 in 7 electricity customers in the U.S., including in large cities like Sacramento, Los Angeles, and Seattle — don’t charge an ROE.)
When I spoke to Ellis about his proposal, I fired off all of the utility arguments I could think of. Won’t utilities stop building stuff and making the investments we need them to make if they can’t earn as much? “They have a legal obligation to continue to invest,” he said. But will they be able to raise equity? They don’t necessarily need to raise new equity, he responded, suggesting that utilities could reinvest more of their profits rather than distributing the money as dividends. This is not how utilities traditionally operate, he admitted, but it’s an option.
Prior to taking up the consumer cause, Ellis spent 15 years in leadership and executive roles at Sempra Energy, the parent company of San Diego Gas and Electric and SoCal Gas — two of the companies that petitioned for higher ROE. “I know how they think about this issue,” he told me, asserting that the arguments the companies make to regulators do not match how they think about ROE internally.
During our interview, Ellis described the current state of utility regulation of ROE in California as “reprehensible,” “egregious,” “heartbreaking,” and “a huge injustice.”
In the analysis he submitted to the utility commission, Ellis not only makes the case that the average U.S. utility’s ROE is much higher than is necessary to attract capital, but also that the potential impacts to consumers of lowering it — i.e. the potential to hurt a utility’s credit rating and increase its cost of debt — would be outweighed by customer savings.
He argues that to justify their requests for higher ROEs, the utilities use forecasts from biased sources, cherry-pick and manipulate data, and make economically impossible assumptions, like that earnings will grow faster than GDP.
Stephen Jarvis, an assistant professor at the London School of Economics who has conducted research on ROE rates, has reached similar conclusions about them being excessively high. Nonetheless, he told me he sympathized with the challenge regulators face. He said there was no “right” answer for how to calculate the appropriate ROE. “Depending on the assumptions that you use, you can come up with quite different numbers for what a fair rate of return should be,” he said.
The sentiment echoes the preliminary decision the California Public Utilities Commission issued last week, when it observed that all of the proposals submitted in the proceeding were “dependent on subjective inputs and assumptions.”
Ellis said the decision contained a “smoking gun,” however, proving that the commission didn’t really do its job. Changes in ROE are supposed to reflect changes to a company’s risk profile, he said. The risk profile for Southern California Edison, which is facing lawsuits related to the Eaton Fire and already paying out hundreds of millions of dollars to survivors, has certainly changed in a different way than its peers. Regardless, the commission made the exact same recommendation for each utility to reduce ROE by 0.35%. “The Commission clearly is not looking at the evidence.”
There is likely some truth to that. “It’s more art than science,” Cliff Rechtschaffen, who served for six years on the California Public Utilities Commission, told me when I asked how the people in those seats attempt to calibrate ROE. He acknowledged there was a self-reinforcing element to the process — regulators look at where investors might go if the rate of return is too low, and use that to determine what the rate should be. “But the rates of return that are set in other jurisdictions are, in turn, influenced by the national utility market, which includes your own utility market,” he said.
Similarly, regulators rely on market analysts, investment advisors, investment bankers, and so on, who have an inherent interest in building up the market and ensuring healthy rates of return, he said. “That makes it harder to discern and do true price discovery.”
Rechtschaffen said he was glad that environmental and consumer advocates were bringing greater scrutiny to ROE, adding that it was the “right time” to do so. “Particularly in this environment where utilities have forecast that they’re going to be spending tens of billions of dollars on capital upgrades, do we need the same rates of return that we’ve seen?”
