�۶���Ƶ

In markets where consumers cannot choose their electric, gas or water utility provider, they face a monopolistic service supplier. This is common in many markets due to the large-scale investments necessary to provide such services. To avoid anti-competitive behavior, natural monopolies must be regulated. Different regulatory models exist around the world. This article compares the US cost-based rate system with Europe’s price cap and incentive-based model, focusing on electric utilities to explore how these different frameworks work and how they influence investment outcomes.

Following the Great Depression, the US utility sector was highly concentrated, prompting concerns over monopolistic practices. In response, the US Congress enacted the Public Utility Holding Company Act (PUHCA) in 1935, introducing federal oversight and curbing abusive pricing strategies. The act empowered the Securities and Exchange Commission (SEC) to regulate multi-state utilities, imposing pricing formulas and restricting cost inflation through artificial increases in the regulatory asset base.¹

The 1970s oil price shock triggered an energy crisis, accelerating the development of alternative electricity sources such as nuclear power. By the mid-1990s, some utilities operating in deregulated markets passed the high capital costs of nuclear infrastructure onto consumers. However, deregulation proved problematic in several states, most notably in California and Montana, where utilities were forced to purchase power at high prices from independent producers, leading to financial distress and – in some cases – state-led bailout.²

A pivotal shift came with the Energy Policy Act of 2005, which delineated regulatory responsibilities: interstate activities were assigned to the Federal Energy Regulatory Commission (FERC), while intrastate regulation remained under state jurisdiction. As a result, some US states maintained fully regulated electricity markets, while others embraced competitive, deregulated models (Figure 1).

Figure 1: US states with regulated (grey) and unregulated (red) retail tariffs for electric utilities.

Across the Atlantic, the government of Margaret Thatcher launched a wave of privatizations in the 1980s, beginning with British Telecom in 1984 and extending to gas, water, and electricity utilities.³ This ushered in a new regulatory framework, RPI-X regulation, originally designed by Stephen Littlechild (1983) for the telecom sector. Under this model, utility returns on a regulated asset base (RAB) were capped in real terms, adjusted for inflation, with the X factor incentivizing efficiency gains over the regulatory period.⁴

The framework evolved to include cost pass-through mechanisms for commodity inputs for gas, water and electricity supply businesses. The new framework is known as RPI-X+Y, where Y represents the pass-through component. More recently, the UK adopted the RIIO model: Revenue = Incentives + Innovation + Outputs, which integrates total expenditure (totex) controls, performance-based incentives and innovation allowances. RIIO-1 was implemented by Ofgem, the UK electricity regulator, in 2010⁵ (Figure 2), with RIIO-2 now in effect for the 2021–2028 regulatory period.⁶

Figure 2: UK utilities’ RIIO allowed regulatory revenue components.

GB allowed revenue components

Regulated utilities offer investors a high degree of earnings visibility and predictability. However, these attributes are subject to erosion from potential regulatory changes. To preserve or enhance returns, utilities typically pursue strategies such as expanding their regulated asset base through capital investment or reducing operating expenditures. They are also incentivized to advocate for higher allowed returns on equity (ROE) to reflect the risk profile of their investment. Regulatory reviews introduce uncertainty, primarily due to information asymmetry between utilities and regulators. In a study of 3,500 US regulatory proceedings spanning four decades, Dunkle Werner and Jarvis (2024)⁸ found that the average approved ROE was 9.92%, trailing requested rates by 0.39%. In the lead-up to such reviews, utilities engage with regulators to influence key parameters, while investors closely monitor proceedings due to the sensitivity of utility valuations to regulatory outcomes. Ultimately, firms with strong regulatory relationships and a consistent track record of operational delivery are better positioned to mitigate regulatory risk, supporting more stable returns and justifying premium valuations.

Comparing the profitability of regulated utilities is inherently difficult due to variations in regulatory regimes. Nonetheless, certain regulatory characteristics – along with a utility’s demonstrated ability to secure favorable outcomes – can help identify those best positioned to sustain higher returns on equity over time.

¹ Electric Choice,
² Electric Utility Deregulation and the Myths of the Energy Crisis. Tyson Slocum from “Energy controversy” issue of Bulleting of Science, Technology & Society, Vol. 21, No. 6, 2001, edited by Steven M. Hoffman.
³ On Restructuring, Regulation and Competition in Utility Industries: the Experience in the United Kingdom and the Implications for Latin America. Andrew Powell. December 1996.
⁴ Littlechild (1983) “Regulation of British Telecommunication’s Profitability”, London: HMSO.
⁵ Ofgem and RIIO
⁶ Ofgem and RIIO
⁷ Energy Institute at Hass (September 2024) “Rate of Return Regulation Revisited”, Karl Dunkle Werner and Stephen Jarvis. p.4,
⁸ Ibid, p.12