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The latest tempest in the energy market is the perceived lack of infrastructure investment. The solutions – including those in SMD – point out the basic dichotomy of cost of service regulation and open market price action. Regulators make lousy traders. Under cost of service regulation, the regulator acts as a monopoly buyer on behalf of all the consumers. They exchange high assurance for the utilities of payoff on the option premiums required to pay for utility investment in return for the utility’s sale of fixed price calls on energy to customers (called tariff rates). The regulator, by offering low risk for return on investment, makes utility infrastructure investment fairly attractive. Therefore, to avoid over investment the regulators needed – through the “used and useful” test – to control the quantity of this “regulatory transaction” that the utilities can sell to the customers. In essence, the regulators had set themselves up to have a constant selling pressure from the utilities, and the regulator retained the ability to determine when they wanted to commit the customers to new capacity. The potential risks in cost of service are that the regulator buys too costly an option, too many options, or the wrong type of options. They had the assurance that they always had willing sellers. Now we move to open markets – it was fine in the beginning when the marketplace anticipated significant returns. The market appears to have been wrong. Now the regulator sees an evaporation of selling pressure. The marketplace appears less willing to invest and they have the ability to wait for buying pressure prior to investing any more. The problem is that there is currently no viable long-term market to make that buying pressure evident. This leaves the regulator with the risk that there are not enough sellers and that supply may be inadequate. From the political risk perspective (witness California), the worst position for a regulator is inadequate supply. If I were a seller (i.e., investor) I would figure the best thing now is to see if the buyer (the regulator) will get nervous and raise the bid. The obvious way for the regulator to do this is to return to the cost of service type transaction – resource planning and then access to assured cash flow streams. That then places the regulator back in the position of controlling the amount of the transaction allowed – in essence, picking the winners. This appears to be the infrastructure plan under SMD. That is the situation that the industry is faced with – the reality that capitalistic open markets are designed upon economic risk allocating capital based on economic – not engineering – efficiency. This creates the risk for regulators that supply will be inadequate – a risk that may not be acceptable. If regulators want the market to have assured supply then they must either create a market structure that creates adequate price signals to solicit investment or return to cost of service regulation. The current plans of regional planning to assure supply sounds like an attempt to create a “risk free” regulatory transaction. That is, by definition, an impossibility. Every transaction has a risk – the key is to identify the acceptable risks, determine the transaction that avoids those risks and creates the greatest market incentive to motivate desired behavior and to then monitor the market activity to verify the market activity and incentives match the assumptions of the transaction. Which takes us back to the question – are regulators qualified to be trading on behalf of the customers? The apparent answer – from the obvious reluctance of regulators to structure markets based on options – is no.