Will allowed returns for regulated utilities keep up with inflation?

Abstract

Over the course of 2022, and continuing into this year, the Federal Reserve has raised interest rates rapidly in the face of inflation not seen since the 1970s. Inflation is affecting utility finances, putting upward pressure on labor costs and investment costs for new plant. It is also increasing the cost of capital, a key parameter regulators use in establishing utility rates. In this article, we examine the tools in the regulatory toolkit that are typically used to assure that the approved utility rates are reflective of the utility’s cost. We highlight several mechanisms that have been used in past periods of high inflation to ensure that rates continue to be cost-reflective, even as cost pressures mount. We conclude by noting that the mechanisms, while appropriate in today’s high inflation environment, should also be flexible enough to allow for rates to reflect lower inflation levels when inflation does subside.