Energy & Utilities Café serves as a platform to generate casual conversations about Energy and the Utilities Industry. The content here is meant to strike curiosity and to encourage discussions on the topic for everyone, even if you are not an expert in the field – because energy matters to all.

While we are beginning to understand what an electric utility is and of its four main functions, a few thoughts arise:

“How does a utility make money? Is it only through electricity sales? And what is their business model? More importantly, if there is no competition, how do we know the electric rates we pay are fair?”

Very good questions, and for that, we first must talk about the utilities’ business structures. We will discuss the 3 main business structures: Investor-Owned Utilities (IOU), Municipal Utilities, and Cooperatives. However, around the world there are also National and State-Owned utilities, among other business structures as well. Those two won’t be covered, so you should Google search those terms for more info.

Join me in this journey to learn more about Electric Utilities. Let’s have a Casual Conversation.

Utility Business Models

Utilities owned by a group of shareholders and that are publicly traded are  aptly called Investor-Owned Utilities (IOU). They are for profit companies with the purpose of generating revenue for their owners just like a regular business. IOUs are said to be vertically integrated, meaning they may own all, or most, of their functions (generation, transmission, distribution, and retail sales). Utilities that are vertically integrated are said to have a monopoly (no competition) in their service territory. Service territory monopolies were proposed over 100 years ago by industry leaders along with the government to encourage companies to invest in the creation of an electric grid ¹. Because they are for-profit organizations enabled by a monopoly, IOUs electricity rates (prices) are tightly regulated by the government, along with state and local authorities. More on this later.

According to the U.S. Energy Information Organization, there are only 168 IOUs in the United States from a total of around 3000 utilities, as of 2017 . However, IOUs sell electricity to about 72% of people in the country ².

Municipal Utilities are owned and operated by the cities, communities, and territories they provide electric service to. They can serve large territories like Los Angeles, CA, and Austin, TX, or smaller ones such as Brownsville, TX, and Cedar Falls, IA. There are about 2000 municipal utilities in the United States ². Business decisions regarding operations, electric rates, expansion, etc. are determined by the city or community leaders along with state regulation. Most municipal utilities, excluding the larger ones, do not own generation due to their limited resources; they purchase electricity from different sources such as a wholesale market and independent generators. Municipal Utilities have less oversight than IOUs -the electricity rates and intended revenue is usually set by local government and industry leaders. In some regions, electricity rates can be used to attract businesses by providing special pricing or services as part of the city’s economic growth plan.  

Rural Electric Cooperatives are non-profits. They are found in communities where other means to provide electricity did not exist before the community members combined resources to create them. If they meet and adhere to specific operation and business guidelines, these utilities receive financial support from the government through the Rural Electrification Act of 1936 ³. As one can imagine, very few electric cooperatives own generation due to limited resources. Currently, there are about 800 cooperatives in the U.S. with the largest one, Pedernales, located in Johnson City, TX ².

“Great information but…that doesn’t tell me how a Utility makes money.”

Right, fair enough

On one hand, Municipal Utilities and Rural Electric Cooperatives have local leaders, their own community members, and local regulating bodies to determine prices that allow them to cover costs and turn a profit. On the other hand, IOUs are for profit companies which need to be tightly regulated to protect the consumer. Therefore, the state Public Utility Commission (PUC) determines the profit a Utility can earn through something called Rate Cases ⁴, and each state has its own PUC (CA PUC; TX PUC). A Rate Case is a set of documents the utility submits to the PUC listing all expenses and costs needed to run and maintain their business. The PUC determines a reasonable profit for a Utility in something called “Revenue Requirement” This is calculated by accounting for all infrastructure costs [generation, transmission, equipment], operating costs and expenses [salaries, etc.], and Assets. The total amount is then multiplied by a predetermined rate of return ⁵. This method can be a source of controversy- Utilities do not get to mark up costs like maintenance and infrastructure but they do get a return when they invest in new assets. This can lead to a Utility receiving more benefit from buying or investing in new infrastructure than from repairing existing pathways or being more efficient. However, the work of the PUC is critical to maintain a balance for both.

“Ok, so the PUC determines how much money a Utility makes, but what about competition? Isn’t competition good? We have it in most products.”

 Yes, we do. There was an attempt to bring competition to utilities a couple of decades ago; they called it deregulation. However, deregulation was only partially adopted; some areas like Texas have a competitive electricity market, but most areas do not.  The reasons for and the concept of deregulation will be examined in our next post. See you next time! 

We encourage you to find out more about this topic. Start by checking the following references:

• (1) Philipson, L., & Willis, H. L. (2006). The Electric Industry and its Traditional Regulated Structure. In Understanding electric utilities and de-regulation (pp. 1-27). Boca Raton, FL: CRC/Taylor & Francis. U.S.
• (2) Energy Information Administration – EIA – Independent Statistics and Analysis. (2019, August 15). Retrieved October 18, 2020, from https://www.eia.gov/todayinenergy/detail.php?id=40913
• (3) Records of the Rural Electrification Administration [REA]. (2020). Retrieved November 04, 2020   from https://www.archives.gov/research/guide-fed-records/groups/221.html
• (4) What is a General Rate Case (GRC). (2020). Retrieved November 05, 2020, from https://www.cpuc.ca.gov/General.aspx?id=10431
• (5) Ghadessi, M. (2017). Utility General Rate Case – A Manual for Regulatory Analysts. Retrieved November 06, 2020, from https://www.cpuc.ca.gov/