Utility Business Models

Vertically regulated investor-owned utilities (IOU)

When electric first got started, typically the generators were small, and so was the usage. A home typically had a few 40-watt light bulbs, and a generator was typically less than a megawatt (~50 kilowatts was typical) Electric companies electrified one or two blocks in a town or a city and might employ less than a dozen people. There were no rules about who could sell to who. Overhead wires could run on both sides of the street from competing companies. This clutter caused issues, and city councils passed laws requiring a license to serve, this was the basis of the franchise system used today.

Generator size and efficiency grew faster than load leading to more investment needed than revenue from the customers, as the distribution needed to grow to serve more customers. In most communities, the government could not raise taxes enough to cover the cost of a system, so they offered licenses to private investor groups. Many of those investor groups formed companies with stock, and the IOU was born.

These initial companies signed agreements for 99 years to provide electricity, in return for exclusive territory rights, in return the IOUs promised to serve everyone in their franchise area (today referred to as service area). Many of the early franchise agreements expired 20 years ago and were renewed for another 99 years.

In the early days, the IOU was expected to supply everything (including in some cases, wiring in the house, and appliances). This included the distribution infrastructure and the generation, as generators grew in size the idea of transmission was created to support moving more electricity.
While the IOUs were created, regulation was being created. Part of the franchise agreement was the requirement to allow some economic regulation. The two have gone hand in hand for more than a century. Because there was an ever-growing need for capital investment, the regulators designed a mechanism to reward the investments. That mechanism was “return on invested capital” (ROIC). ROIC was set using a mechanism called regulated rate of return. Typically, the rate of return was tied to the interest rates money could be borrowed at.

Over time the regulatory rules have gotten complicated, including fuel riders and dedicated operations and maintenance (O&M) for items like vegetation management (tree trimming). Almost every IOU has unique rules they operate under from regulation, even in the same state. These unique rules come from 100+ years of community needs and negotiations with the regulators. Few IOUs are still vertically integrated.

IOUs use FERC accounting, most complaints about utility accounting apply only to the IOUs.

IOUs are typically the largest property tax payers in a community.

Also IOU stocks are in almost every retiree's portfolio because of the steady value of the stock and the regular dividends.

Next Post: Deregulation and IOUs

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Utility Business Models - Part #9