Smart & Clean Energy and Ground Transportation

Regulatory Alternatives for Complex Problems Like Smart Energy

One of the most critical, confusing, yet underestimated (and often overlooked) problems in a complex problem like managing energy, security, etc is the regulatory and business structure in place to ensure the participants have the appropriate incentives to do what’s in the best interest of the public. “…democracy is the worst form of government except all the others that have been tried” — Winston Churchill. You could amend this to say “…capitalism is the worst form of economic structure except all the others that have been tried”. Our system in the United States is well suited to ensuring maximum return for shareholders. In theory, that provides the most efficient way to also ensure activities are in the best interest of the public. This works reasonably well for providing consumer products and services, entertainment, transportation, etc. However, the more difficult it is to measure the quality of an activity (relevant to expectations and goals), the longer it takes for the results to be measured (think years or decades to measure environmental impact or be subject to a massive cyber attack, at which point it’s too late), and the more complex the environment, the more we need to question the ability of the market to do what’s in the best interest of the public. Of course, this falls into the realm of government regulation and oversight, however, unfortunately the same rules apply – the more complex the issue, the less likely the government is going to have the wisdom, budget, incentive and wherewithal, to do this properly. (A big part of that problem is the very nature of how voters choose their elected officials, how information is disseminated to the voters about their political candidates, etc, but we won’t get into that here).

So when it comes to determining how to best ensure that a public utility, for example, deploys smart grid technology to ensure we can go more green, use power efficiently, prepare for an infrastructure of Electric Vehicles (EV’s), have adequate security (using a wireless communications infrastructure), we broadly have 2 choices: Assume senior management will do what’s in the best interest of the public due to the market penalizing them for doing otherwise vs. government regulation. In this case, it actually makes sense to do both. Government compliance is clearly needed because the utilities are quasi-monopolies, there are long time frames involved, the utilities have special rights of way, etc. However, since government regulation is not perfect, these companies are for-profit (they usually split their profits with the ratepayers), to ensure management is reasonably efficient without expensive, stifling, and ineffective government meddling. So we are assuming that somewhere in the mix, is the intelligence, foresight, and incentive to what’s in the public’s interest. Considering that energy policy is one of the most complex topics on the planet, and looking at current activities, it’s reasonable to conclude that this is probably not the case. The CEO’s job of a for-profit corporation is simple: Maximize shareholder value and don’t do anything illegal. Since most utilities are public companies, and since the stock market is inherently a short-term focused “management system” (i.e. quarterly results is what virtually all investors want, including the average person like you and me), you can’t blame a CEO for not doing what’s in the public’s interest – it’s not his/her job, and he’ll get fired for doing otherwise. So it’s up to the regulators, who unfortunately have a similar problem. In this case, their boss is the state government, rate payer advocacy groups, etc. who also measure short term results; are there disruptions in service, what are the costs, and measure simple metrics like percentage of energy coming from green sources (which are constantly being adjusted because this is in conflict with one of the other objectives – cost). They need to manage conflicting objectives, all on extremely limited budgets. So it’s not clear who (if anybody) is really in charge of thinking deeply about this complex problem of doing what’s in the best interest of the public (e.g. reducing carbon emissions, energy independence, environmental impact – all very long term problems). This system is clearly inefficient and maybe also ineffective at doing what’s in the public’s best interest, but the real question is, can we do better?

So let’s broadly look at some options:

Advantages Disadvantages
Let the stock market reward the correct behavior In theory this is most efficient. The stock market is short term focused. It often assigns blame to an entire industry, not a company.
Compliance / government regulation Cover for weakness in the market system. Regulators don’t have the resources to enforce anything other than simple metrics which affect rates and services to the customer. It is also not their job to set policy. It is elected officials job to set policy, but this is so complicated, it will never be effectively handled in a public environment.
Fining companies for violations (e.g. HIPPA HITECH) May have more “teeth” than compliance, and be more effective in that it doesn’t require specific actions on the part of the utility that might be otherwise treated as a check off item. Complexity and politics around choosing the right metrics. Possible costs due to lawsuits and refusal to pay.
Senior Management / Board personal Liability for failures (e.g. Sarbox) Simple. Extension to the market approach. It might not be reasonable to assume that the CEO should take actions that might get him fired for spending too much money, thus activities that deflect blame such as deploying ineffective technologies will likely take hold. One can also argue if it reasonable to assume that a CEO should be involved in details at that level and be personally liable for the behavior of managers who are all fighting to look good and get promoted – and this includes saving money.
Public or 3rd Party Expert Review (e.g. selection of the AES encryption algorithm) Seems most efficient and effective. Many folks will engage in this process without even getting paid. Too many opinions and purposeful creation of confusion by meddling agents of lobbyists. Not clear how this is enforced.How do you choose an official 3rd party and ensure they are not being influenced.
Management signoff acknowledging the concerns of third party of public review. (i.e. enhancing the liability approach) Seems highly efficient and effective Similar to public review, too much noise and meddling.
Insurance companies underwriting liability (e.g. has shown some effectiveness in the medical space) Insurance companies are reasonably efficient and intelligent and can influence their customer’s behaviors. This would probably have to work in conjunction with assigning more corporate and personal liability. Not clear how effective this can be.
Guidelines / voluntary Sounds great, easy to avoid dealing with the issue. Often this actually works in politics! Utterly ridiculous and useless.
Good intentions of management Sounds great. Any such CEO would never make it to the CEO position, and even if he/she did, they would be fired for spending the money.

I certainly don’t have the answers, what do you think? This is a subject matter certainly worth of much more debate. The problem of course is, who has the incentive and resources to ensure that such a debate occurs and is efficient and effective, and results in action? People in this industry joke in various inner circles that China is much more effective and efficient than the US. You can see the results – China’s now dominance of renewable energy technologies, transmission lines for long haul transfer of power, etc. It would be interesting to compare the above table between the US and China. What does this mean for us? It’s anybody’s guess. For now we have to work within the system, and if we’re lucky we’ll eventually get to where we need to go, it’s just going to be a long and hard path as the battle between profits and doing what’s in the public’s best long term interest will continue unabated.

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One response

  1. Gary

    The electric utility industry in this country was originally created within a regulated environment. The reason for this was the private sector would simply not undertake the level of investment and risk necessary for the creation of electric generation, transmission and distribution infrastructure.

    Operating within this regulated environment, the US became the world leader in the creation of electric power infrastructure and it served this country very well. It was only after this infastructure was substantially created that the downside inherent in any government controled entity became the predominant factor. This resulted in a movement in recent years to progressively deregulate the industry.

    Our country is at a new crossroad in the creation of our electric power infrastructure with energy independance and carbon emmissions becoming the drivers in the creation of new growth. Just as it was necessary to create a regulated environment for the electric industry to establish itself from the very beginning, it will be a necessary evil to create a regulated environment for the industry to now recreate itself. I am afraid; however, that our leaders in Government lack the wisdom and foresite to get it right.

    April 11, 2011 at 1:59 pm

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