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The Utility Business Model Is Built for a Different Era. Regulators Are Starting to Notice.

2026-02-24 · 00:00 UTC ·Michael Lee Michael Lee Distributed Grid • ·9 min read

Brief

Michael Lee, formerly US CEO of Octopus Energy, contends that the U.S. utility business model is misaligned with the needs of a modern grid. The regulated cost-of-service framework rewards utilities for building assets rather than for reducing system costs, relieving local congestion, or improving customer outcomes. That problem is becoming more acute as the industry enters what Morningstar has called a utility 'super-cycle': EEI projects more than $1.3 trillion in utility capex from 2026 to 2030, supported in part by fast-rising data center demand. Lee argues that the investor narrative—monopoly franchises, guaranteed returns, and unprecedented growth in rate base—ignores a mounting regulatory risk that could undermine sector valuations.

His thesis is that rate increases and public frustration are eroding the 'social permission' that monopoly utilities rely on. He points to New Jersey’s 33% residential price increase over two years and growing state interest in performance-based regulation as signs that lawmakers and regulators are beginning to challenge the legacy model. The financial mechanism matters: if allowed ROEs compress from 9.5%-11% toward a market-based 6%-7% cost of equity, utilities could suffer both earnings declines and valuation multiple contraction. Lee uses standard utility assumptions—a 65% payout ratio, 35% retention ratio, and 7% cost of equity—to argue that sector valuations could drift from nearly 2x book toward 1x book. Still, he sees an opportunity for utilities that treat the distribution grid as a platform, using distributed energy and flexibility tools to defer capital spending, improve reliability, and earn under outcome-based incentives rather than pure asset accumulation.

Why it matters

Michael Lee argues that the core problem in U.S. utilities is not management quality but the regulated incentive structure: utilities earn by deploying capital under cost-of-service regulation, which discourages lower-cost, customer-centric alternatives that could reduce congestion on distribution and transmission networks, even as poles-and-wires charges now exceed 50% of total bills in many markets.

Key details

  • The sector is entering a capex boom: the Edison Electric Institute projects more than $1.3 trillion of utility capital spending from 2026-2030, with examples including Duke Energy’s $103 billion plan and Southern Company’s $81 billion plan, much of it tied to load growth from data centers.
  • Lee’s central risk thesis is that aggressive rate-base growth can trigger a political and regulatory backlash: in New Jersey, residential electricity prices rose 33% in two years, prompting Governor Sherrill to make utility affordability part of Executive Order No. 1, while EQ Research says nine states are pursuing some form of performance-based regulation in 2026.
  • The article highlights a widening challenge to allowed returns on equity: Mark Ellis of the American Economic Liberties Project argues that regulated ROEs of 9.5%-11% are far above utilities’ actual cost of equity of roughly 6%-7%, and proposes 'competitive direct equity' so institutional investors bid to supply equity capital rather than regulators relying on utility testimony.
  • Using a Gordon Growth Model framework, Lee argues utilities’ premium valuations are vulnerable: with a typical 65% payout ratio, 35% retention, and 7% cost of equity, lower allowed ROE would both reduce net income and compress valuation multiples; if ROE falls to about 7%, market value should converge toward roughly 1x book value rather than the nearly 2x book many utilities trade at today.
  • Lee sees an upside path in performance-based regulation and grid-platform economics: utilities that can use distributed-grid technologies to defer billions in traditional capex while improving reliability and affordability could earn more under outcome-based frameworks than under legacy cost-of-service regulation, though that would require organizational and possibly investor-base changes.
Source evidence

title: The Utility Business Model Is Built for a Different Era. Regulators Are Starting to Notice.
author: Michael Lee Michael Lee Distributed Grid •
contenttype: article
publication: LinkedInEditors
published: 2026-02-24T00:00:00
sourceurl: https://www.linkedin.com/pulse/utility-business-model-built-different-era-regulators-michael-lee-bm03c/

word_count: 2002

The Utility Business Model Is Built for a Different Era. Regulators Are Starting to Notice.

I left Octopus Energy last year, where I served as the US CEO and where we worked on some of the industry’s most innovative rate designs to promote flexibility. Throughout that work, I kept running into the same question: why are utilities, the companies best positioned to lead the energy transition, the ones least able to move?

We could optimize how energy was consumed for power plant efficiency. But we could never optimize customer usage to reduce localized congestion on distribution or transmission networks. We could only work within the competitive markets tied to power plants. Poles and wires costs are now more than 50% of total costs in many markets, and we were blocked from creating efficiency on this side of the bill.

What I found is that the people running utilities are not the problem. The incentives and economic model are. The way utilities earn money actively discourages the investments needed to create a low cost and customer-centric grid. The incentives point in the wrong direction, and almost everyone inside the system knows it. But it’s how the industry and all of its vendors make money in the status quo. And nobody has an incentive to change it… yet.

That research led to this series, which are my learnings and my thesis to unlock a low cost grid.

Full analysis with sources on Substack.

The Utility Business Model Is Built for a Different Era. Regulators Are Starting to Notice.

Utility stocks are at all-time highs. Capital plans have never been bigger. Earnings guidance looks strong through 2030. If you read the investor presentations, everything looks great.

But regulators and legislators across the country are pulling on a thread that could unravel the financial logic behind all of that optimism.

Boom Times

The Edison Electric Institute projects more than $1.3 trillion in utility capital expenditure from 2026 to 2030. Morningstar calls it a “super-cycle.” A significant share is driven by data center load growth, raising a question worth its own discussion: who should pay for grid upgrades when the customer driving the need has a trillion-dollar market cap?

Individual company plans reflect the scale:

Every major utility is telling a version of the same story.

The pitch to investors is essentially: we have a legal monopoly, a guaranteed return on everything we build, at a rate of return without any market competition, and more to build than ever before. That pitch is not wrong. But it contains a risk that most utility equity analysts are not fully pricing. Volatility is the new normal, not just in power markets, but perhaps also in utility regulation.

The Counter-Signal

Meanwhile, a different kind of momentum is building.

These states are not all doing the same thing. Some are compressing ROE toward cost of capital. Others are building incentives that reward reliability, affordability, or clean energy outcomes. The most interesting approaches do both: pay a fair, market-based return on investments while also rewarding utilities for delivering outcomes customers need. Those ideas are complementary, not competing. But the details of implementation matter enormously, and early attempts have produced cautionary tales.

Social Permission Is Eroding

Utilities operate under franchise rights granted by the state. But the monopoly only works with social permission: customers accepting the arrangement because they get reliable power at a fair price.

In New Jersey, residential prices rose 33% in two years. When Governor Sherrill took office, one of her first executive orders addressed utility affordability directly. When utility rates become a campaign issue and a first-day executive action, that permission is breaking down. Wildfire liability is accelerating this in ways most investors have not priced in.

At a first-principles level, utilities sell trust. They happen to also sell electricity and build infrastructure, but they principally sell trust. Electricity is invisible. Customers cannot see, hold, taste, or smell it. They just get a bill 15 days after the month ends with a demand to pay or the lights turn off. This trust is destroyed if bills feel unfair or if tail-risk events occur. Without it, everything else, including selling power, building infrastructure, earning a return is in jeopardy.

The Competitive Capital Question

Mark Ellis, a former executive at Sempra and now a senior fellow at the American Economic Liberties Project, makes a sharp case that the gap between allowed ROE (9.5% to 11%) and actual cost of equity (roughly 6% to 7%) is unnecessary. His proposal: competitive direct equity. Let institutional investors bid to provide equity capital the way they bid in debt markets or compete to buy shares in an IPO. Right now, utilities get to tell regulators what they think is a fair price for their equity. But in Mark's view, let the market clearing price determine the cost of equity. No estimation. No circularity. Just competition.

The Earnings Pressure Nobody Is Pricing

Utilities are effectively investment companies. They earn a regulated return on deployed capital. Banks and investment companies that face market competition for their capital trade at roughly 1x book value. Utilities trade at nearly 2x book because regulators allow returns well above the market cost of equity for the utility's capital. As the threat to those excess earnings grows, a multiple closer to 1x becomes more likely over time.

The feedback loop is straightforward:

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The utilities pushing hardest on the accelerator are the ones most likely to trigger the backlash that compresses the returns their growth stories depend on.

The sensitivity math follows from the Gordon Growth Model. A utility's sustainable earnings growth equals its ROE multiplied by its retention ratio. At a typical 65% payout and 7% cost of equity, the implied P/E multiple moves mechanically with ROE. The numbers below are illustrative, scaled to approximately $75 billion in equity, roughly the projected book equity of a top-five U.S. utility by 2030 after planned rate base growth and equity issuance.

Two dynamics compound. Net income falls as ROE compresses. But the P/E multiple also de-rates because lower ROE from lower earnings growth, which reduces the premium investors are willing to pay. It follows directly from the math: when the growth rate drops, the denominator in the Gordon model widens, and the multiple contracts.

At 7% ROE, approximately equal to cost of equity, market cap converges toward 1x book. This math applies across the sector, not to any single company.

The Opportunity

PBR and ROE compression are only existential if a utility cannot actually reduce costs and improve performance. However, for a utility that can, performance-based frameworks become the upside case for their investors and for customers alike. The distribution grid, operated as a platform rather than a passive delivery network, has enormous untapped value for utilities to monetize and doing so is aligned to customer benefits. Technologies exist today that defer billions in traditional capital spending while improving reliability. More needs to be created. The utilities that figure this out will earn more under performance frameworks than they ever earned under cost-of-service.

The taxi cab industry viewed itself as a monopoly of supply. Today, Uber is worth multiples more as a platform business coordinating resources on the network. The utilities that figure out platform economics will earn more under performance frameworks than they ever earned under cost-of-service.

The question is whether incumbents will lead this transition or whether new entrants will capture it instead. To do this they need to restructure their teams and perhaps their investor base too. The monopoly fortress has some cracks in it that are prime for disruptive seasoned executives.

First in a 10-part series on the structural transformation of the U.S. electric utility industry. Next: "PBR Was Supposed to Fix Utilities. Here Is What Actually Happened."

Full analysis with sources on Substack.

Sources

  1. EEI $1.3T capex projection (2026-2030) - RBN Energy

  2. Morningstar "super-cycle" - Utility Dive

  3. Duke Energy $103B capital plan - Utility Dive

  4. Southern Company $81B capital plan - TipRanks

  5. NJ BPU alternative business model RFQ - ROI-NJ

  6. Governor Sherrill Executive Order No. 1 - NJ.gov

  7. EQ Research, nine states pursuing PBR (2026)

  8. Virginia PBR bills (SB 251, HB 903) - Virginia Mercury

  9. Mark Ellis, "Rate of Return Equals Cost of Capital" - AELP

  10. Ellis and McGillis, competitive direct equity - RealClearEnergy

  11. Inside Climate News profile of Ellis

  12. UC Berkeley, "Rate of Return Regulation Revisited"

  13. S&P Global, utility capex forecast

Assumptions note: The 65% payout ratio is the approximate median for large-cap U.S. electric utilities. The 7% cost of equity is consistent with DCF estimates from RMI (7.9%), the Berkeley Energy Institute's central CAPM estimate, and Ellis's market-to-book analysis. The 35% retention ratio driving growth is the complement of payout. These are standard utility finance assumptions but a reader could reasonably argue for a range of 6.5% to 8% on cost of equity, which would shift the implied multiples by 1-2x in either direction.

Sieving Strategic•2K followers

2wWe are at an inflection point. Where should we go from here? Where will we go from here?

Enel North America•960 followers

2wNever overlook the fact that, if the utility can possibly reduce cost and increase performance for a sustained period, political forces will be hammering for rate reductions when the utility expected to keep all the gains for its shareholders. This outcome of taking "unreasonable" gains away from being distributed to shareholders is the typical regulatory trap that utilities seek to avoid with regulators. Hence the model that has survived for years.

OPTERRA Energy Services•2K followers

3wPowerLines

Community Decarbonization…•4K followers

3wRegulated IOUs are toll-taking entities. Should they be investor-owned at all? Can't a non-discriminatory, open access, non-IOU framework unlock more private activity beyond distribution, serving the bulk system? Local distribution feels more like roads, water and sewer when it is only distribution (no gen, no transmission, no storage, etc.). Why not build a platform like this to support private actors serving the market?

Base Power Company•10K followers

3wGreat article

Reader Comments

Jan Sieving: Jan Sieving Sieving Strategic • 2K followers 2w Report this comment We are at an inflection point. Where should we go from here? Where will we go from here?

Jan Sieving: Jan Sieving Sieving Strategic • 2K followers 2w Report this comment

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Beverly Brereton, PhD: Beverly Brereton, PhD Enel North America • 960 followers 2w Report this comment Never overlook the fact that, if the utility can possibly reduce cost and increase performance for a sustained period, political forces will be hammering for rate reductions when the utility expected to keep all the gains for its shareholders. This outcome of taking "unreasonable" gains away from being distributed to shareholders is the typical regulatory trap that utilities seek to avoid with regulators. Hence the model that has survived for years.

Beverly Brereton, PhD: Beverly Brereton, PhD Enel North America • 960 followers 2w Report this comment

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Emily Douglas: Emily Douglas OPTERRA Energy Services • 2K followers 3w Report this comment PowerLines

Emily Douglas: Emily Douglas OPTERRA Energy Services • 2K followers 3w Report this comment

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Jared Rodriguez: Jared Rodriguez Community Decarbonization… • 4K followers 3w Report this comment Regulated IOUs are toll-taking entities. Should they be investor-owned at all? Can't a non-discriminatory, open access, non-IOU framework unlock more private activity beyond distribution, serving the bulk system? Local distribution feels more like roads, water and sewer when it is only distribution (no gen, no transmission, no storage, etc.). Why not build a platform like this to support private actors serving the market?

Jared Rodriguez: Jared Rodriguez Community Decarbonization… • 4K followers 3w Report this comment

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Justin Lopas: Justin Lopas Base Power Company • 10K followers 3w Report this comment Great article

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