As political pressure mounts to rein in electric utility profits, several energy industry experts warn that efforts to cap or lower return on equity (ROE) could ultimately do more harm than good — raising costs for consumers, deterring investment, and weakening grid reliability.
The debate is playing out in statehouses across the country. In Pennsylvania, Gov. Josh Shapiro used his recent budget address to criticize utility profits as too high, adding to a broader push among some policymakers to curb what they see as excessive rates of return.
But critics of that approach argue the consequences could ripple beyond utility balance sheets.
“Legislatively mandated lower ROEs would be detrimental to utility credit quality by weakening utility cash flow,” said John Quackenbush, president of JQ Resources LLC. “Just as a bad credit score makes it more expensive for a household to get loans or mortgages, a lower credit rating means higher borrowing costs for utilities.”
“Since a utility’s cost to deliver electricity is passed on to customers, higher utility borrowing costs mean higher electric bills,” added the former chairman of the Michigan Public Service Commission.
Quackenbush and others point to Connecticut as a cautionary tale.
“Connecticut is the most recent example of aggressive rate suppression,” he said, explaining that Connecticut utilities were downgraded by multiple credit rating agencies because of the adverse regulatory environment in the state.
“The credit rating agencies observed weaker credit quality in Connecticut utilities because of punitive regulatory and legislative actions since 2020 that weakened utility cash flow,” Quackenbush said. “Connecticut became among the least supportive regulatory environments and created a credibility deficit from which a newly reformed PURA is trying to dig out.”
He thinks that punitive decisions, including on ROEs, demonstrated that investor capital wasn’t welcomed in Connecticut and incentivized investors to reallocate their investment capital elsewhere in New England and across the United States.
That shift in investor sentiment can have lasting consequences, Quackenbush added, pointing out that artificially lowered ROEs work at cross-purposes with a reliable and hardened grid, decarbonization, severe weather preparation, and economic development.
“Legislatively mandated ROEs would disadvantage a state’s utilities as they compete for capital with other utility and non-utility investments in the globally competitive capital marketplace,” said Quackenbush. “Investors have a fiduciary duty to select investments in jurisdictions with reasonable regulatory treatment. Investors provide capital where it is welcomed and treated fairly. It is unrealistic to expect utilities to make significant grid investments if their access to capital has been artificially hampered by legislative mandate. ROE override tells investors to go invest in another state.”
He also warned that legislative intervention in rate-setting risks undermining the regulatory framework that has long governed utilities, and a legislative override of a commission’s ROE decision-making would signal a hostile regulatory environment.
“If a legislature guts commission ROE authority, it signals they care more about creating the short-sighted illusion of customer ‘benefit’ for the upcoming election-cycle rather than fostering long-term customer benefits,” said Quackenbush. “However well-intentioned, legislative ROE override would raise costs to customers, not reduce them.”
The state-regulated ROE is designed to balance the costs to customers with ensuring that utilities have adequate access to capital to deliver reliable electric service.
Regulatory commissions make ROE decisions based on evidence and expert testimony that is offered by multiple parties and heavily scrutinized through cross-examination. Legislatures would be sending a signal to ignore the evidence, including that offered by consumer advocates, and would rather impose an artificial cap, experts said.
Responding to financial signals
Jeff Ostermayer, a spokesman for the Consumer Energy Alliance, echoed those concerns, pointing again to Connecticut.
“Connecticut is the prime example of an organized campaign to lower utility return on equity to a point where it chills investment,” Ostermayer said. “Harmful regulatory decisions caused all five of the state’s regulated utilities to have their credit ratings cut, leading Bank of America to declare Connecticut ‘probably the worst regulatory environment in the country.’ Prices for Connecticut customers rose during this time and are among the highest retail electricity rates in the country. All of this comes at the expense of consumers in Connecticut.”
Utilities, like any business, respond to financial signals, he said, and will make investments that reflect the realities of their political and regulatory environment.
“If ROEs are too low, retained earnings will be reduced, thereby reducing equity available for future investments,” explained Ostermayer. “Ultimately, this will increase debt and future cost of capital, which could chill (or increase the cost of) investment in critical infrastructure needed to ensure the reliable delivery of electricity to customers.”
If lawmakers intervene directly in setting returns, he added, the message to investors is unmistakable.
“This clear violation of the regulatory compact and the whole concept of prudency will signal to investors that the state is closed for business. Capital will flow to other states with more stable regulatory environments,” said Ostermayer. “We are already seeing this with large-load customers looking to states like Georgia, Arizona, and Louisiana.”
The long-term cost implications, he said, can outweigh any short-term savings.
“There may be initial rate suppression in the short term, but medium- and long-term costs will likely rise as fewer reliability and resiliency investments are made, increasing outages and long-run costs for customers,” said Ostermayer. “It is generally more affordable for customers if electric companies make proactive investments to harden the grid than to pay more later to respond to outages caused by storms or cyberattacks.”
At the same time, not all stakeholders agree that current ROE levels are appropriate.
David Springe, executive director of the National Association of State Consumer Utility Advocates, said many consumer advocates think returns have been too high.
“Generally speaking, most of our members tend to think that ROEs have been too high for some time,” Springe said. “The conversation should perhaps be focused on regulatory approaches that can help lower costs to consumers, like increasing the amount of debt in the capital structure or utilizing securitization for large capital expenditures. And yes, ROE reduction can be a part of that conversation.”
While investment patterns may shift, Springe thinks that utilities are unlikely to abandon core responsibilities.
“Investments might slow or be reprioritized or financed with other forms of capital…, but it is unlikely that a utility will simply abandon necessary system upgrades or in any way put the safety and reliability of the system at risk,” he said.
Still, critics of aggressive ROE cuts argue that the stakes are high, particularly as utilities face mounting demands to modernize the grid, integrate new energy sources, and withstand increasingly severe weather.
“If policy changes from one administration to the next, it will be hard for utilities to plan needed infrastructure to serve their customers,” said Dylan D’Ascendis, a partner at ScottMadden Inc. “It also signals that the returns set by edict are no longer market based.”
Quackenbush is on the same page, saying legislatively mandated lower ROEs would endanger economic development and inhibit the achievement of state policy goals.
“Weaker utility cash flow and credit rating downgrades signal an increased cost of capital for both debt and equity, which ultimately increases customer bills,” Quackenbush said. “The ripple effect of utility credit downgrades is to disincent infrastructure investment at a critical time when capital is needed to invest in the grid, achieve state policy goals, and attract economic development.”
Quackenbush thinks that customers are better off being served by financially healthy utilities that have the earnings and cash flow to attract equity and debt on reasonable terms, as well as the resulting ability to provide safe, reliable, affordable and clean utility service.