Utilities are often considered a safe haven in times of upheaval in the markets. Society's basic needs for clean water, a steady supply of gas for heating or cooking, or electricity to turn the lights on transcends economic cycles of boom and bust, expansion and recession.
But there is another reason that utilities offer relative earnings stability, and it has nothing to do with our essential needs for water or power. It has to do with the law. Utilities are the only sector of the market where the right to earn an adequate and reasonable return is actually enshrined in federal law via Supreme Court precedent.
In the United States, utilities are considered natural monopolies: It would be inefficient for example, to have two power lines running to your house or four different water pipes competing for your business. So in a series of court cases at the turn of and during the first half of the 20th century—most notably the Minnesota rate cases in 1890 and Hope Natural Gas vs. the Federal Power Commission in 1944—the US Supreme Court found that in return for utilities' accepting an obligation to provide safe and reliable service to customers, that governments should promise to approve and allow rates that allow utilities to earn a "just and reasonable" return on the "prudent and useful investments" they incurs to meet that obligation. This is what is known today as the "regulatory compact."
In Smythe vs. Ames in 1898, the Supreme Court assigned the role of determining what constitutes "just and reasonable" to independent state level commissions.
Here's how this all works today: Let's say a utility determines that it needs to spend $1 million to replace the gas pipes in your neighborhood. It petitions approval to the local state commission.
If the utility commission determines that that $1 million is "prudent and useful," investment it then determines how the utility should pay for it, and what return on this investment is "just and reasonable" to both the ratepayer AND importantly to the utility's OWNERS—all of which is prescribed by federal law.
Typically, commissions direct utilities to finance about 50% of these investments using cash—oftentimes retained earnings in the business—and 50% with debt, often long-term corporate utility bonds. The commission then determines a reasonable return on the 50% of the investment that was paid with shareholder cash, known as an "allowed return on equity." This is customarily about 10%. So on a $1 million investment paid half with shareholder cash (or $500K), the utility is given the ability to increase its annual bottom line net income by about $50 thousand.
The commission then reviews all of the related costs for things like labor, benefits, insurance, maintenance, taxes, and finally the interest on the debt that was borrowed to arrive at a revenue number that the utility will need to achieve to earn that $50k bottom line result, each and every year going forward. This is known as a "cost of service" approach to ratemaking.
In this example, grossing up all of the expenses might equate to an allowed revenue increase of $150 thousand. The commission then divides this money due to the utility by the number of customers that it serves, and each customer's individual usage, to determine the new, higher per kilowatt, or gallon, or cubic foot rate that the utility can charge you, rate increases that are protected by federal law. This regulation is one reason why utility earnings have historically been reliable in both good times and in bad.