The leading cause for rising electricity bills for most Americans comes from an old and popular policy where the fuel costs are placed on your bill. Pearl Street Station Finance Lab is pleased to share “Learning to Share: A Primer on Fuel Cost Pass-Through Reform,” an overview of fuel cost-sharing and fuel risk-sharing reforms for states, authored by Pearl Street Station’s Executive Director, Albert Lin, PSS’s advisor Jeremy Kalin of Avisen Legal, and Rocky Mountain Institute’s Kaja Rebane.
Electric utilities in the United States spend billions of dollars annually buying fuel to generate electricity. These costs often make up a sizable share of customer bills, and unlike other bill components, they can vary substantially from month to month. This makes it imperative that utilities manage their spending on fuels carefully—but most utilities have no financial incentive to do so. In most states today, utilities are allowed to pass on 100 percent of their actual spending to customers through policies called “fuel adjustment clauses” (FACs).
FACs create a problem that economists call “moral hazard.” Moral hazard exists when one party does not suffer the consequences of making bad decisions, so it takes bigger risks as a result. Current 100 percent pass-through policies create moral hazard because if utilities manage to reduce fuel costs (for example, by negotiating better prices or reducing their fleet’s reliance on fuel) their customers receive all of the benefits, and if utilities manage their costs poorly, their customers pick up the bill. The most rational and economic activity for the utility is to focus on obtaining fuel and largely ignore the price being paid for it.
Ever since FACs were implemented in the early 1970s, there has been this moral hazard problem. However, in recent decades its real-world consequences have grown with greater utility reliance on certain fuels despite declines in capital costs for non-fuel alternatives. So long as customers pick up the entire fuel bill, everything looks like a fuel-free technology in the eyes of the utility and the only rational course of action is to stick to older established activities.
Customers paid around $70 billion dollars for just natural gas used for electricity generation in 2022. Imagine if the policies from 50 years ago were updated to reflect the changes in technologies? Utilities would balance risks and costs between all technologies and not just pick the one which shifted the largest operating risk 100% to their customers.
Fuel cost sharing is needed if you want markets to function properly in the economy. For example, food crops like corn, wheat, soybeans, sorghum, and cotton rely heavily on fertilizers to obtain the yields required to feed and clothe us and many other parts of the world. With natural gas as a vital input for those fertilizers, farmers and other industrial users relying on natural gas must compete with a legal monopoly (the regulated electric utility) that buys at any price and just adds it to their customer’s bill. This was not a big deal until about ten years ago when natural gas began to replace coal as the primary technology for generating electricity. Today, the electric utility industry is the natural gas industry's largest customer. In some states, the electric utility buys more natural gas than all other users in the state combined. How can industries needing fertilizer survive in a world where the largest competitor doesn’t need to worry about the price it pays?
We hope you will consider the points made in this primer and begin to think of ways your work can help update the current practice of how fuel costs are shared. Eliminating the moral hazard and allowing our regulated utilities to evaluate and choose the best mix of technologies improves the efficiency of our entire economy.