Public Utilities and Their Regulation

Public utilities are economic entities “vested with the public interest,” also known as “common calling enterprises.” “Vested with the public interest” is a centuries-old concept based on the common-law notion of “status,” a complex set of rights and responsibilities associated with the provision of services of public necessity. Those who engage in common calling enterprises are bound by status to provide goods and services in accord with the needs of the broader community.

Public utilities are defined by the necessity of the goods and services they provide and the inherent market power they possess. Public utility services are essential because of both what is provided, such as water or electricity, and the network system of delivery. Many public utilities are infrastructure organizations, entities that maintain the fabric of social and economic institutions by providing network connectivity for individuals and continuous interconnections among buyers and sellers. The demand for public utility services is time critical; even relatively brief service interruptions can result in significant economic loss and social disruption. Due to the necessity of utility services, consumer demand is highly price inelastic, and governments assert oversight responsibility.

Historically, grist mills, granaries, docks, wharfs, toll roads, intra-urban transport systems, and railways were considered to be public utility entities vested with the public interest. Currently, electric power, natural gas, telecommunications, and water and sewerage are considered to be the core public utilities, although not all aspects of their supply are public utility in nature. For example, natural gas transmission and distribution are public utility services, though natural gas production is not.

Most utility markets will not sustain numerous independent suppliers. Instead, utility markets are served by a very limited number of entities, most often by a single firm. Public utilities firms are often referred to as “natural” monopolies because their control of utility markets is rooted in technologies of production rather than artificial constraints such as anticompetitive practices or governmental grants of exclusivity.

Public utility technologies are capital intensive and manifest extensive economies. Public utilities typically require 5 to 10 times as much investment per dollar of revenue as do economic enterprises in general. Many factors lead to the capital-intensive nature of utilities. Utility services often require permanent physical connections between suppliers and consumers. Utility supply systems, such as electricity, natural gas, or telecommunications, are tightly coupled, highly interdependent, and subject to significant [Page 1744]reliability externalities; changes in the level of use by one customer can affect the reliability of service for others. Unlike airplanes or parking garages, when public utility demand exceeds the available supply, system failure can ensue, resulting in a loss of service for all customers. Because there tends to be little or no storage, high levels of service reliability can only be maintained by building system capacity significantly in excess of expected peak demand.

There are various types of public utility economies. Transmission systems, for example, exhibit economies of scale; when fully utilized, the larger the capacity of a natural gas pipeline or electric transmission line, the lower the average cost of delivery. Local distribution systems exhibit economies of density; the cost per customer served decreases as service area density increases. Utilities have economies of diversity; the cost of having a single firm serve a number of different types of customers is less than the costs of having different firms serve different types of customers. The combination of the various types of economies leads to market “cost-subadditivity”; it is less expensive for one firm, or at most a very small number of firms, to provide service to an entire market than it would be to divide market service among many firms.

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