Regulation Built the Trap It Was Meant to Prevent

The rule designed to stop utilities from building bad plants is keeping them from closing bad plants. That’s not a bug in the regulatory theory — it’s the theory working exactly as designed.

Gautam Gowrisankaran, Arik Langer, and Mar Reguant published a paper in the American Economic Review that should embarrass anyone who thinks utility regulation is a solved problem. The core finding: prudency review, the regulatory mechanism invented to stop utilities from gold-plating their balance sheets with overbuilt capacity, is now the mechanism trapping them in obsolete fossil plants as the energy transition unfolds. The incentive structure flipped without anyone updating the rules.

Here’s how the trap works. Prudency review says a utility can only pass capital expenditures through to ratepayers if regulators deem those expenditures prudent. The rule made sense when utilities had every reason to overbuild — capital was the profit base, and regulators were the only check. But the same rule now governs retirement decisions. A utility that wants to close a coal plant and build a solar farm faces a genuine risk: regulators might rule the replacement imprudent, strand the new investment, and leave the ratepayer holding the bill. So the rational move — the move that protects the utility’s shareholders — is to keep running the coal plant until regulators make the call for them. The old plant is already approved. The new plant might not be.

Everyone says utility regulation is too permissive. The opposite is closer to true: utility regulation is too sticky. It was calibrated for a static industry with a 40-year asset lifecycle and a threat environment centered on overbuilding. Neither of those conditions holds today. The energy transition requires retiring plants on a schedule dictated by climate math and cost curves, not by depreciation schedules approved in 1987. When the regulatory frame doesn’t match the industrial reality, the regulated firm doesn’t adapt — it waits.

This is not an argument against regulation. It’s an argument that regulation encodes assumptions, and assumptions expire. The prudency doctrine encoded the assumption that the dangerous move was building too much. Today the dangerous move is retiring too slowly. The doctrine didn’t update because regulatory doctrines almost never update — they accumulate. Each layer of protection against the last crisis creates a new friction for the next one. The result is a palimpsest of rules that made sense sequentially and are collectively incoherent.

The stakes are concrete. The U.S. grid has something like 200 gigawatts of coal and gas capacity that is economically obsolete — cheaper to retire than to run — but institutionally sticky. That stickiness is not laziness or corruption. It’s rational response to a regulatory incentive that was never designed for a moment when the economics of energy reversed. Changing the incentive requires changing the doctrine, which requires regulators to admit the doctrine was wrong, which is the thing regulators are least designed to do.

Gowrisankaran, Langer, and Reguant are not writing a polemic. They’re fitting a model to data and reporting what the model says. What it says is that the welfare loss from regulatory friction during the energy transition is large, and that the friction is structural rather than accidental. You can’t fix this by appointing better regulators. You have to redesign the rule.

The grid is the largest collective-action problem the American economy has to solve before 2040. We’re trying to solve it with institutional machinery that was built to solve a different problem. The prudency doctrine is one bolt in that machinery. There are hundreds more just like it.

Institutions don’t fail by losing arguments. They fail by winning the wrong ones — and then making it structurally difficult for anyone to revisit the win.