Rate-Based Return on Investment
The very model by which electricity utilities are permittred to make money in order to stay in business is fundamentally flawed. The existing regulatory system promotes waste and inefficiency rather than innovation and efficiency. In regulated electricity markets a utility typically operates in a system sheltered from the free market. In other words the price of power is not set by the market but rather a government regulator. Even in regions where power sector restructuring has taken place there is usually a higher proportion of government influence than other sectors.
Typically a utility decides what it would like to charge per unit of energy and then seeks approval for its ‘rate’ from the regulator. What usually happens is that the utility will base its proposed price on funds needed to recover investments on the infrastructure it needs to build to supply electricity- both wires and or generating capacity depending on whether the utility is involved in generation, wires, or both. The regulator, in turn, will usually approve a rate which will allow the utility to both amortize its investments and make a profit. The problem with this system is that it rewards inefficiency. The more money utilities spend on infrastructure the more likely they are to be allowed rate increases. Utilities have no incentive to make investments in efficiency because their profits are proportional to increasing power generated and transported. Less kWh generated means less need for new infrastructure means less profits for the utilities. Options that improve efficiency, including conservation and decentralized energy, are thus rendered less competitive.
DE struggles therefore, not because it is technically inferior or even because it is more expensive; but just because it cannot compete in the game the way the rules are currently written. Those utilities that do invest in efficiency can be penalized by regulators by not havig rates approved.