Getting Energy Regulation Right

John P. Banks
John Banks
John P. Banks Former Brookings Expert

September 2, 2010

It has been said that governments do three things: tax, spend and regulate, and regulation is the least understood. While every industry is regulated to some degree, apart from those directly involved, most people aren’t aware of the day-to-day complexity involved in developing and implementing an effective regulatory framework. It’s sort of like a referee at a sporting event – while important to the game, the best are the ones you never know are there.

Regulation occupies a unique role. It is intended to guarantee a balance in meeting the goals and interests of government, consumers, and industry in an impartial, transparent and accountable manner. Governments want to ensure that their policy objectives are met. Consumers want to be assured that they are being provided a safe and reliable service or product at a fair price, while industry needs a rational and predictable set of rules allowing a reasonable return. This is a difficult balancing act, and usually works quite well until something draws attention to the need for changes. It could be an event that reveals an underlying deficiency in the regulatory process itself, the introduction of new technologies, changes in economic or market conditions, or simply evolving objectives and concerns of the actors involved.  Regardless of the cause, what typically follows is increased attention to regulation and calls to “fix” the regulatory process. Unfortunately, here is where regulation as the least understood of government’s roles comes into play, since sometimes these fixes threaten the regulatory balance. 

This is what is happening in the energy sector posing a major challenge to implementing a sensible and balanced long-term energy policy. Three selected cases over the summer starkly illustrate this dynamic and the importance of regulation. 

First, the oil spill in the Gulf of Mexico has led to clarion calls in the government and amongst citizens and interest groups to strengthen regulation of the oil industry’s offshore drilling practices. The Obama administration has imposed a moratorium on deepwater drilling in the Gulf until November and revamped the regulator overseeing offshore drilling. In addition, legislation in the House and Senate is under consideration that would strengthen regulatory standards for offshore drilling. Steps being discussed include stricter environmental standards, enhanced operational reviews and inspection regime, and changes in leasing federal lands and waters for energy production. The oil and gas industry is worried. Bruce Vincent, chairman of the Independent Petroleum Association of America has stated, “Let’s hope it’s not our Three Mile Island,” implying this move toward more regulation could be draconian enough to threaten the sustainability of the offshore drilling business.

Second, on June 21 the Public Service Commission of Maryland declined to approve Baltimore Gas & Electric’s (BG&E) proposed Smart Grid initiative that included the installation of 2 million smart meters for residential and commercial customers and a Smart Energy Pricing program to replace its existing rate schedule. Competing regulatory interests were again at play.  The utility was looking to modernize its operations, improve efficiency, and save consumers money in the long-term – BG&E estimated that the initiative would save customers $2.6 billion over 15 years. Moreover, the policy objectives of both the federal and Maryland state governments strongly support the smart grid as a necessary foundation for increased efficiency, expanded renewable supplies, and the electrification of transportation. Specifically, the regulator’s approval was required in order for BG&E to receive a $200 million grant from DOE to help fund the initiative. BG&E was also disappointed since it believed that the initiative would support the State’s EmPOWER Maryland initiative calling for a 15% reduction in energy use by 2015. 

But the Commission did not approve the initiative and its cost recovery approach primarily citing the impact on consumers, stating the proposal “asks BG&E’s ratepayers to take significant financial and technological risks, and adapt to categorical changes in rate design…in exchange for savings that are largely indirect, highly contingent, and a long way off.”  BG&E has since re-submitted a revised proposal, and on August 13, the Commission approved it. But smart grid proponents warn that “without state commissions approving the business cases for advanced meters and the smart grid, this is not going anywhere,” according to Ahmad Faruqui, an economist and principal at the Brattle Group.  

Finally, on August 3 the New York State Senate approved a measure that would establish a moratorium on new drilling permits for shale gas in the New York portion of the Marcellus shale formation until May of 2011. The full Assembly has yet to take up this measure. Advocates of shale gas point to the benefits of producing a clean, domestic energy source that provides jobs and other economic benefits for the state. In particular, natural gas from shale is viewed as an opportunity to back-out the use of coal substantially in power generation thus reducing CO2 emissions. Opponents warn of harmful environmental impacts – especially on water resources – of a process that combines horizontal drilling with the use of hydraulic fracturing.   

The intention is not to debate the various viewpoints in each issue. Rather, as we deliberate on the difficult task of formulating an energy policy that balances security, environmental, and economic objectives, let’s not forget how critical regulation is. Virtually all of the most important policy pathways under discussion require scaling what Peter Fox-Penner has termed the “regulatory mountain.” Look at any issue and you see the vital role of regulation: carbon capture and storage, nuclear power, electric vehicles, solar energy, and distributed generation, to name a few. 

The message here is: good regulation is key to a smart energy policy; and good regulation properly balances the interests of government, consumers and industry. It’s incumbent on all stakeholders to keep this in mind, and work together to maintain regulatory balance and achieve our energy goals.