Antitrust in 60 Seconds: Public Utility Regulation
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This article, the latest entry in DisCo’s “Antitrust in 60 Seconds” series, explores public utility regulation, the inverse of free market competition. This post explains what public utility regulation is, and what makes something a utility.
The 60-Second Read:
Public utilities are capital-intensive companies providing essential public services. Because utilities’ physical infrastructure networks structurally insulate them from competition, public utilities law interacts with competition law in unique ways. Despite some commentators’ use of the term “public utility” to describe prominent websites, they are not, and these services are distinctly unfit for the benefits and obligations of public utility treatment.
Specific criteria for utilities are that they: (1) provide an essential, usually non-differentiated commodity — such as gas, electricity, or water; (2) over a capital-intensive infrastructure network utilizing public rights-of-way; (3) usually on a ‘full requirements’ basis; (4) with government authorization.
Utility regulation is a non-market-based approach to providing public services essential to human needs, characterized not by marketplace competition, but rate regulation, conditioned on service obligations. Over time, the scope of what we consider to be utilities has shrunk. Historically, the concept once included transportation services, infrastructure and even wireline networks like broadband service. Today, however, private enterprise provides competing, differentiated versions of many of these services. Even at its broadest construction, however, public utilities regulation has never been understood in a manner that would include edge-based Internet services such as websites, search, social media or multi-sided markets on the Internet. This is because these services fit none of the criteria that distinguish utilities from competitive private enterprise.
In competition discussions involving modern technology, some commentators have suggested certain Internet websites are, or should be, subject to “public utility regulation”, in some cases as an alternative to conventional competition enforcement.    What is public utility regulation, why does it matter, and why has this term entered into vogue?
What is public utility regulation?
Public utility regulation is a non-market-based approach to the provision of certain essential public services. It is characterized not by marketplace competition, but rather rate regulation of a (usually) sole-source provider — either publicly or privately owned — conditioned on service obligations. Because the model generally contemplates only one provider, antitrust law generally does not apply to rate-regulated activities, because there is no meaningful “market.”
Various statutory definitions exist for “public utility” in state and federal law. Because definitions are generally propounded for a particular legislative purpose, state and federal law vary.
Public utilities under federal law: For purposes of federal law, “public utilities” are owners or operators of infrastructure that move electricity or natural gas across state lines. How do we know this? The federal U.S. Code defines public utilities in various places. The authorizing statute for the Federal Energy Regulatory Commission, 16 U.S.C. § 824(e), defines utilities to include anyone owning or operating facilities involved in interstate electricity transmission. The Public Utilities Holding Company Act of 1935 (PUHCA), 15 U.S.C. § 79b (repealed and re-enacted via the Energy Policy Act of 2005), an early constraint on how public utilities could be owned, specifically defined a public utility company as “an electric utility company or a gas utility company.” Provisions of the Internal Revenue Code also define public utilities using similar parameters.
If federal definitions of “public utilities” are generally confined to gas and electricity providers, what about state laws?
Public utilities under state and local law: State laws that create state and municipal utilities commissions tend to be broader. They often include water/irrigation and wastewater/sanitation services within the definition. Some state laws even extend “public utility” to include common carrier transportation or wire service — e.g., public transit and transportation infrastructure, and telegraph, telephone, and cable television). One could argue this is a historical artifact, but it is still the case that last-mile telecommunications services benefit from utility-like treatment by localities for such local matters as land use and public rights-of-way.
So what exactly makes a utility a utility? What distinguishes utilities is that they provide (1) an essential, non-differentiated commodity; (2) over a capital-intensive infrastructure network; (3) to the public, often on a ‘full requirements’ basis; (4) with government authorization.
Harvard Prof. Susan Crawford explained as much in WIRED last year:
“Utilities are things, physical networks, that public utility commissions regulate: electric, gas, communications, water, and wastewater, mostly. These commissions typically ensure that utilities provide reasonably priced, adequate, and efficient services to customers, while allowing the companies involved to recover their costs plus a fair return to their investors. These physical networks are considered to be “affected with the public interest.” They often have franchises from the government that give them benefits like special rights of access to rights-of-way in exchange for their promises to serve.”
These criteria are common to all utilities, as described in greater detail below.
(1) Utilities provide essential, non-differentiated commodities.
A fundamental characteristic of utilities is the service of basic needs like heat, cooling, water and wastewater, or what economists and scholars have long categorized as “public functions.” State and federal law agree that gas and electricity are included, and many state laws include water, wastewater, and irrigation, which less frequently involve federal law because municipal infrastructure networks tend not to be interstate.
The uniformity of state laws on this aspect illustrates another characteristic of utilities: the good or service that the utility provides is non-differentiated. That is, one kilowatt of electricity is identical to the next; one cubic foot of natural gas cannot be easily differentiated from another. Whether a megawatt of electricity is produced by a coal-fired generator or a nuclear power plant, the end user cannot differentiate.
The non-differentiated nature of utility services is important. Differentiated offerings provide the possibility of greater competition. But non-differentiated goods and services like residential water and electricity compete principally on price. Differentiated goods, however, can compete on other metrics, such as the characteristics of the product. Transportation infrastructure, common carriers, and wireline networks were all once argued to be public utilities, but the existence of competing, differentiated versions of these services demonstrated that public utility treatment was inappropriate. Over time, this has led to deregulation and private sector competition.
(2) Utilities are characterized by a capital-intensive infrastructure network.
Utilities require the construction and maintenance of fixed, capital-intensive infrastructure networks to serve customers.
This usually entails using rights-of-way, easements, or similar encumbrances on public and private land — a fact which ensures involvement by local government. The capital-intensive nature of public utilities also means that competing infrastructure networks serving the same customers would be highly inefficient. For this reason, public utilities are usually sole-source. They have a captive audience. You cannot, for example, “fire” your water company and find a competitor to give you water and sewer service, because municipalities usually have only one infrastructure network providing a given essential service like electricity, gas, and water. (A caveat: some regulators have experimented with various forms of facilities-based competition, where more than one company may supply service end-users, but still via the same utility-operated infrastructure.)
As a result, public utilities usually (though not always) tend toward natural monopoly.
This is because it makes little economic sense for two competing infrastructure networks to tear up the same road in building out to the same customers. The same number of customers would face twice the network maintenance costs, while receiving exactly the same commodity from each. As discussed below, however, the quid pro quo of a company being the monopoly provider of a particular commodity is substantial.
(3) Utilities typically offer full-requirements service.
Utilities usually sell to the residential and commercial customers, i.e., end users, in a particular service area. This is where federal and state law diverge: various entities sell electricity, gas, and oil into energy markets, which move commodities over gathering systems and networks of local distribution carriers. For example, power producers like nuclear power plants and coal- and gas-fired electricity generation facilities mostly sell into secondary markets, where electricity is purchased and resold to end consumers. (Mischief in these secondary markets played a prominent role in the California energy crisis in the early part of the century.)
Federal law treats these upstream vendors as “utilities” for regulatory purposes, because they are moving regulated energy commodities in interstate commerce. But their power production and transmission functions occur in a competitive market, they do not provide service to residential and retail customers, and have not made a regulatory commitment to provide an indefinite amount of service.
This points to another important aspect of public utilities: customers’ expectation of full service. Utilities generally provide service on a “full requirements” basis. This means utility customers generally expect that whatever their needs are, the utility will satisfy it, within reason. While there are some exceptions to this rule, open-ended (albeit metered) service is a defining aspect of public utilities. Because it would be inefficient to charge customers to build overlapping, competing networks, customers only have one choice. A quid pro quo of the captive user base is generally full requirements service, because if your public utility cannot meet your demand, there’s no other alternative. Once there are other alternatives, however, and no obligation to serve all comers, the rationale for a sole-source provider and regulator-guaranteed rate of return disappears.
(4) Utilities operate with government authorization.
As noted above, this regulated status is substantially different from free market competition, and it is a status that brings considerable obligations and benefits. One obligation is usually to guarantee service in a given area, on a full requirements basis. Utilities typically serve all customers in a municipality or region, even those who are too remote to serve efficiently. Utilities also typically provide service that is consistent with a “certificate of public convenience and necessity” — government-issued permission to provide service — and provide that service subject to specific filed rates and a tariff that identifies the nature and contours of the utility’s service.
This points to one of the “benefits” of being a public utility: a guaranteed price, set by regulators rather than the market, and no competition. These rates are generally determined by the cost of providing service, maintaining the network, plus a reasonable rate of return on the invested capital. In addition, unlike most private actors, public utilities also can secure easements and access to rights-of-way for building infrastructure.
What’s the relationship between utility regulation and antitrust law?
While this question is better suited to a separate post, the answer in a word is competition. Public utility regulation is a governance mechanism of last resort, adopted when the particular characteristics of a service are such that it is wholly unsuited to being provided by the free market. Utility regulation requires price-setting by bureaucrats, whereas antitrust law ensures that prices in free markets are set by the “invisible hand.”
Can Internet services and social media companies be public utilities?
As should be plainly apparent, none of the criteria above characterize Internet platforms, social media websites, multi-sided online markets, or other edge-based Internet services. These services, although highly useful, are not essential commodities. While surveys suggest you often would have to pay consumers a considerable amount of money to forego these services, they can in fact be foregone.
These services are also unique and highly differentiated. Not only do different companies provide different experiences to multiple sides of a market, but most provide unique experience customized to each user. This is the antithesis of a non-differentiated commodity. Social media sites and Internet services do not face the high fixed costs of entry associated with capital-intensive infrastructure networks. No one launches a natural gas distributor out of their garage with a few friends. Technology services tend not to be ‘full requirements,’ either. Because these products are often provided on a free-to-the-user basis, terms of service often restrict high-volume users from taxing the site’s systems. Finally, no social media service operates with government authorization — at least not in the United States. The fact that licensing schemes have proliferated for Internet services in totalitarian and other less-than-democratic states should be a cautionary fact to any U.S. policymaker embracing the notion of utilities regulators policing platform-based speech.