With natural gas prices climbing, clean energy advocates say regulators need to reconsider a Nixon-era practice that lets utilities pass along fuel costs to customers with little regulatory oversight.
Since the early 1970s, ratepayers have typically been the ones to pay — or benefit from — fluctuations in power plant fuel prices, which often show up on customers’ bills on a separate line called a fuel adjustment clause. It has been a good arrangement for customers for much of this century as the fracking revolution drove down natural gas prices and replaced more expensive coal.
That dynamic was shaken last year by a historic winter storm that caused natural gas prices to spike across much of the central United States, leaving customers with bills they will be paying for years. Russia’s invasion of Ukraine and the related energy market disruptions have further raised prices.
Clean energy advocates say the passthrough nature of fuel costs means utilities have little motivation to change their generation mix in response to rising prices. As a result, critics say there’s less incentive for utilities to seek lower-cost alternatives to natural gas and coal such as wind and solar.
Jeremy Kalin, an attorney and a former Minnesota state legislator known for his clean energy advocacy, and the Pearl Street Station Finance Lab’s Albert Lin recently studied fuel clause adjustments for the Rocky Mountain Institute and plan to publish research papers and participate in state regulatory and legislative debates over the practice.
“We looked at what the drivers of consumer inflation are in the Midwest and Minnesota and we think that this is one of the top five drivers,” Kalin said. “It’s just sort of baked in and all of a sudden it shows up on your bill, and you can’t do anything about it.”
The National Energy Assistance Directors Association, which represents directors of low-income weatherization programs, predicts winter natural gas costs will jump 34% and have increased 66% since 2020. Xcel Energy said consumers can expect to pay on average $165 more this winter than last year. Consumers will see most of the increases in the fuel adjustment clauses of their bills.
Ron Binz, a regulatory expert from Colorado who once chaired that state’s public utilities commission, has testified in several hearings on adjustment clauses. They include one this year in South Carolina where he suggested that Duke Energy’s reliance on proposed new natural gas plants appears less risky than it is because customers will pay for the fuel regardless of its cost.
The adjustment clause allows utilities to continue using coal and natural gas because “they absorb none of the risk,” Binz said. Utilities continue to buy natural gas for their plants on the spot market where prices can escalate quickly instead of considering more predictable 20-year, fixed-price wind and solar contracts or increasing programs for energy efficiency, Binz said.
The regulatory structure incentivizes utilities to own energy production rather than buy it more cheaply from other producers because “it doesn’t grow their earnings,” he said, adding that “it would make more sense all around to use progressively more renewable clean, but also variable resources, like solar and wind.”
Fuel cost pass-throughs became common as a response to the 1973 embargo by Arab members of the Organization of Petroleum Exporting Countries during the Arab-Israeli War. The embargo left utilities with no way to recover escalating fuel costs except through rate cases that often took a year or more to complete. Regulators in most states gave utilities the option to charge ratepayers directly for some or all the fuel costs. Utilities argue the pass-through is fair since they earn no money on it and the price reflects the actual energy cost.
But the adjustment clause now includes items far beyond fuel. For example, coal producers sometimes expand the scope of contracts with utilities to include services ranging from preparing coal for production to managing ash ponds that result from the plant’s waste, Lin said. Utilities attach those costs to the fuel adjustment.
“Some say that’s good for the consumers because private industry is more efficient than if the utility does it,” he said. “Others would say no, this is a terrible practice because it replaces the utility of their core competency, which is supposed to be operating and running these electricity generating assets.”
In addition, utilities routinely mask their fuel supply agreements, leaving ratepayers and advocacy organizations without the financial data related to the cost of fossil fuel plant generation, Kalin said. He and Lin believe that those agreements would show many utilities continuing to buy energy from coal and natural gas plants even when less expensive options exist.
A 2017 S&P Global report backs up the claims of Kalin and Lin. The report points out the adjustment clause “effectively shifts the risk associated with recovery of the expense in question from shareholders to customers” and helps utility financials by not impacting the bottom line or triggering a rate case.
Lin and Kalin see two approaches to the growth of energy costs contained in the passthrough clauses. One is to have regulators review the charges annually, a practice followed by eight states. The other is to require utilities to have a small risk in energy prices, giving them incentives for better performance and penalties if they miss their projections.
The Minnesota Public Utilities Commission ordered annual reviews of adjustment clauses in 2003 before revisiting the issues a few years ago and finalizing rules in 2017. Three years later the commission began reviewing fuel adjustment clause estimates for the following year.
Commissioner Joseph Sullivan pointed out that at least twice regulators prohibited utilities from charging customers for all or part of costly investments. In the largest case the commission this year reduced by $58.5 million charges associated with Winter Storm Uri, he said, and recently required Minnesota Power to refund nearly $4.5 million to ratepayers after it included charges related to problems at Boswell Energy Center in Cohasset.
He sees the reviews as necessary for protecting ratepayers’ interests and pointed out that for years adjustment clauses were “automatic” with much oversight. The commission and the Commerce Department “are digging through all these filings and saying ‘that shouldn’t be there, that’s a question, or that’s okay,’” Sullivan said. Utilities know the commission will hold them to the numbers they submit as fuel costs for the following year and any additional charges will be examined, he said.
Lin believes utilities need “some skin in the game” by having some risk in the adjustment clause through what’s sometimes called performance-based ratemaking. Utilities would be responsible for between 2% and 10% of the fuel costs, he said. Hawaii, for instance, allows utilities to earn incentives by becoming more efficient or face penalties for risky bets on technologies with unstable pricing, such as natural gas.
Lin said Midwest states could pilot regulation like that used by Hawaii because the region has access to wind and solar and few ties to fossil fuel producers. Such reform might redirect utility energy purchases toward cleaner and cheaper sources. “I think most people would look at it and say a stable industry getting its supply from a historically volatile — and getting more volatile — industry is just asking for trouble,” he said.