Electric Utilities’ Broken Economic Incentives Are Obstructing the Green Transition

In an increasingly warming world with ever-growing sources of energy demand, the US urgently needs to decarbonize its energy system. To achieve this, it will have to build a lot more high voltage transmission lines, a lot faster. But in our current electric utilities industry, the same actors responsible for developing the infrastructure essential to decarbonization are also incentivized against building it at the scale required.

In a new brief, Roosevelt’s director of corporate power, Niko Lusiani, describes how incumbent shareholder-owned utility corporations use their power at key nodes in the energy system “to slow and inflate the cost of the energy transition.” The industry’s patchwork and outmoded regulations create misaligned economic incentives that pose significant dangers to the green transition. This hurts consumers, who need affordable, reliable electricity in both the short and long term. Regulatory reforms could both incentivize the construction of new green energy projects and stabilize energy markets.

Utilities Are Gatekeeping the Energy Grid

The shareholder-owned utility Entergy—which serves customers in Arkansas, Louisiana, Mississippi, and Texas—provides a clear example of how misaligned economic incentives lead utilities to protect their economic interests at the expense of clean, affordable, and more resilient energy systems. As a regulated utility, Entergy earns a guaranteed rate of return on its investments in generation facilities and grid infrastructure. This allows Entergy to provide a steady financial return to its shareholders, so long as it can continue to expand the scale of investments or increase sales to its captive customer base.

The troubling result of this economic model is that Entergy benefits from obstructing other power providers from accessing its market. One of the key ways it can do this is by blocking transmission lines that serve to connect power from faraway generators to its local service area. Transmission infrastructure improves the reliability and affordability of the energy grid by connecting disparate economic and geographic regions. This integration also allows for renewable energy to be developed where most suited, and delivered where most needed, making it an essential piece of the energy transition. However, for incumbent utilities, it increases the competition they face in meeting demand from their ratepayers. A 2024 NBER working paper found that two power plants operated by Entergy profited from transmission constraints between the southern and northern region of the Midcontinent Independent System Operator, the wholesale electricity market where the utility operates. Should those constraints be lifted, the paper estimated that those plants stand to lose $930 million in revenue.

Shareholder-owned utilities are the primary actors responsible for investing in and developing the transmission system, making their misaligned incentives a major problem for decarbonization. The Southern Delta region where Entergy operates is projected to need extremely high levels of transmission growth in coming decades. Under these conditions, Entergy is set to play a significant role in how and whether essential infrastructure gets planned and built.

When other companies have tried to step in and build lines connecting neighboring regions to Entergy’s service areas, the incumbent utility has a track record of creating obstacles to the projects in order to protect and at times even expand its fleet of fossil fuel plants. In one such case, Clean Line Energy (CLE) abandoned a $3.5 billion transmission line project in 2017 after failing to receive the necessary approval from the Arkansas Public Service Commission. The commission issued its decision against the line after Entergy filed an objection to the project. Roosevelt Fellow Joshua Macey describes how regulators’ decision in favor of Entergy’s objection served to prevent a project that “would have reduced electricity prices in the southeast and provided enough clean energy to power over a million homes a year.”

The Current Market Causes Energy Costs to Soar

The problems in the energy market are only magnified further when you look beyond individual utilities to Regional Transmission Organizations (RTOs), the nonprofit bodies tasked with operating the transmission grid across utilities and running wholesale energy markets. One worrying example this summer came from PJM, the Mid-Atlantic RTO that spans 13 states and the District of Columbia. The organization’s latest capacity auction resulted in a nearly tenfold increase in costs, much of which will be borne by consumers. Price spikes of this magnitude signal serious shortfalls in electricity markets. As Heatmap’s Matthew Zeitlan put it, PJM’s problem “calls into question whether the decades-long project of structuring electricity generation, transmission, and distribution into something like a market is even working anymore.”

The cause of the price spike in PJM stems from a number of factors limiting reliable sources of power supply. The grid operator faces a vast queue of proposed renewable projects waiting approval to connect to its grid, while it simultaneously opposes recent policies intended to improve and expedite the pace of interconnection. Furthermore, PJM downgraded the reliability rating of its natural gas plants, recognizing that increasingly prevalent extreme cold weather events will make these resources less dependable than previously thought. Transmission is also a key part of the problem: In 2023 PJM received a D+ rating on transmission planning according to one study, reflecting the region’s insufficient interregional transmission and planning policies that ignore state clean energy plans in favor of incumbent fossil fuel interests.

Some commentators will use the recent price hikes to argue that retiring coal fuel plants is too costly for consumers. However, coal retirements only create energy shortfalls when grid operators fail to adequately plan and invest in the energy transition. As Roosevelt’s Lusiani highlights in his brief, the governance failures of grid operators like PJM are downstream of the rules shaping the economic incentives of shareholder-owned utilities.

A Better System Can Deliver the Energy Transition

Rather than expect utility companies to make investments that are antithetical to their economic incentives, policymakers must craft rules that align private and public interests. There is nothing sacrosanct about the present form of either shareholder-owned utilities or modern electricity markets. Policymakers created both through a mix of experiment and compromise in balancing private and public interests. Governance is not a matter of more or less intervention into an otherwise pristine “free market,” but instead consists of tailoring political-economic structures in accordance with policy goals. Furthermore, there is no case more pressing for the state’s role as crafter of economic provisioning processes than a just transition away from fossil fuels.

It is clear that building a reliable, affordable, decarbonized energy grid will require fixing the outmoded and defunct procedures through which utilities plan, develop, and build. Federal policymakers recently instituted a number of reforms impacting the rules regarding interconnection procedures, permitting and siting, as well as planning and cost allocation. However, while procedural reforms are necessary, they will not fully address the underlying tension between utilities’ incentives and the goal for a clean, reliable, and affordable grid.

We can build the zero-carbon energy system we need, but it will require fixes that incentivize, channel, and discipline transmission investment. This can be done by policies such as:

• Applying performance-based ratemaking to transmission utilities. Performance–Based Ratemaking (PBR) offers one way to more precisely realign utility incentives. PBR can be combined with “revenue decoupling” in order for lower cost investments to be rewarded when they align with public policy objectives. For example, where regional integration may presently threaten utilities’ revenues or opportunity to maintain and grow the investment base they earn a return on, PBR and revenue decoupling can serve to reward desired activities (planning, collaborating on, and building supra-local transmission), while insulating utilities from negative economic impacts these may have.
• Instituting a National Grid Planning Authority with the power to channel transmission investment. This authority would: “(1) holistically forecast system needs and changes through long-term scenario planning and (2) develop a plan to cost-effectively and efficiently support the country’s energy future by developing a blueprint of interregional and regional transmission line additions and upgrades that becomes the baseline of all FERC-overseen regional planning efforts.”
• Enabling a more active role for federal financing and development. The government can take on risk and act in the interest of multiple parties where the private sector is dissuaded or lacks the capabilities to do so.
• Encoding the option for public ownership in the case that utilities fall short of national grid planning requirements. Public ownership of energy utilities has precedent in both the past and present of the American electricity industry.

Transitioning to a zero-carbon grid will require addressing utilities’ misaligned economic incentives, which slow the build-out of renewable energy sources and the transmission infrastructure necessary to support them. The recent cases discussed here are warning signals. It is essential that policymakers not get trapped defending incumbent utilities and the outmoded rules that shape them at the expense of affordability, reliability, and a system that allays profound climate risks. They have the authority and tools to avoid that route, but doing so will require a redirection of utility rules.