1900–1970 Vertically Integrated, State Regulated • For most of the 20th century, utility regulation was pretty straightforward. Utilities were vertically integrated and wholly regulated by states, which meant utilities would plan and manage all aspects of the electric grid, including generation, transmission, and distribution. • Due to high capital costs and economies of scale, these vertically integrated utilities were granted distinct service territories as natural monopolies. • To protect consumers and ensure affordable, reliable service, utilities were subject to state regulation. Regulation ensures prudent utility investment and establishes a just and reasonable rate of return for utilities. In exchange, utilities accepted an obligation to serve all customers in their service territory, this is referred to as the regulatory compact. • As the electric grid grew to serve more and more customers, the federal government began asserting authority over aspects of electric utilities, including interstate transactions (transmission of electricity and sale of wholesale electricity) through the Federal Power Act of 1935. Technological progress and increasing consumer demand led to increasing economies of scale that contributed to declining rates for consumers through 1967. DEFINITIONS • Natural monopolies do not arise from government intervention but from the unique characteristics of production that favor a single producer when there are very large economies of scale relative to demand for a product. • The regulatory compact is an implicit agreement between states and utilities that guarantees the utility the opportunity to earn a fair return on investment in exchange for accepting an obligation to serve all customers and invest in infrastructure.