Utility regulators on Thursday pledged to investigate massive cost overruns at Xcel Energy’s Monticello nuclear plant and slashed the utility’s rate increase request for its 1.2 million Minnesota customers by more than half off its original request.

The state Public Utilities Commission also allowed the company to charge its ratepayers only part of the $655 million expense for the five-year upgrade to the Monticello nuclear reactor. Xcel customers will end up paying roughly half the 9 percent interim increase that the electric utility began collecting on Jan. 1.

“This started out as the largest rate increase in history, and we had hundreds of millions of dollars in cost overruns,” Commissioner Dennis O’Brien said.

The commission rejected Xcel’s request to significantly boost the basic residential monthly charge, which is paid regardless of how much electricity is used.

Commissioners approved an increase to $8, up from $7.11, but denied Xcel’s request for a 40 percent increase to $10.

Xcel defended its request and investments in the electrical system, and said the utility offered proposals to mitigate the rate hike and to address unique circumstances.

“We continue to believe our request was reasonable and necessary to continue providing high-quality service to our customers,” David Sparby, CEO for Xcel’s Minnesota regional operation, said in a statement.

Cutting Xcel’s request means the permanent rates end up lower than the present interim rates, so overpayments since Jan. 1 will be credited to customers plus 7.45 percent annual interest. It is the fifth Xcel electric rate increase since 2005, but after being pared back by regulators, not the largest.

More rate increases are likely in the coming years because Xcel says it needs to recoup from Minnesota customers its continuing investments in generation and transmission assets.

In another development, Sparby also wrote to Minneapolis Mayor R.T. Rybak Thursday offering to work with the city to provide more clean energy. Renewable energy advocates have been lobbying City Hall for action on the issue, raising the prospect of the city setting up its own power company and kicking out Xcel to achieve that goal.

Rybak warmly replied the same day, saying Sparby’s comments “gave me real hope that we can seize opportunities that have been missed in the past.”

But Xcel got a cooler reception at the all-day PUC deliberations in St. Paul. In votes adverse to Xcel, the PUC authorized a less-than-requested 9.83 percent return on equity, rejected the utility’s electric sales forecast and left open whether Xcel can eventually charge customers for some nuclear investments. The effect of those decisions was to reduce the 2013 rate increase.

Overall, regulators pared the increase below the $126 million, or 4.7 percent, level recommended by an administrative law judge in July. But commission and utility officials late Thursday did not have an immediate calculation of all the changes. Xcel originally had sought a $285 million, or 10.7 percent, increase, but had twice reduced its request.

The Minnesota Commerce Department, the attorney general and several private interests, including the Chamber of Commerce, fought against the large increase. Commissioner Betsy Wergin said the case was the most contentious in her five years as a regulator.

Commissioners made it clear that some major utility investments that didn’t get applied to customers’ rates in 2013 will be reconsidered in Xcel’s next rate hike request. Last week, Xcel CEO Ben Fowke said the company will file a sizable Minnesota electric rate case for 2014, possibly asking for increases spread over two or three years.

One question getting special attention is how much Minnesota ratepayers will end up paying for the $655 million project to extend the life and boost the output of the Monticello nuclear power plant. The project ended up costing more than twice the 2008 estimate of $320 million.

For its investigation of the cost overrun, the commission agreed to retain an expert in nuclear matters to offer advice on whether all the spending was prudent. Xcel has agreed to cooperate in the investigation.

“It may be that all the decisions that were made, at the time they were made, were quite reasonable and prudent,” said PUC Chairwoman Beverly Jones Heydinger. “And that is what we need to find out.”

Commissioners voted to allow only a portion of the Monticello upgrade cost to be added to rates this year, something that’s subject to change later if the investigation finds the overruns were imprudent. The investigation could take up to six months.

In regulatory filings, Xcel has defended the cost increase for upgrading the Monticello plant, citing schedule changes, vendor issues, evolving regulations and unexpected work. The plant has restarted, but awaits permission from the U.S. Nuclear Regulatory Commission to operate at a 12 percent higher power level.

For the first time, the commission decided that refunds for Xcel’s excessive interim rates will be reimbursed at the same overall rate of return approved for the company. That 7.45 percent interest rate is significantly higher than rates applied in other interim rate hike refunds, which were based on the prime rate.

Regulators left until the next rate case some major costs related to rebuilding the Sherco 3 power plant in Becker, Minn., after a catastrophic 2010 accident. The unit, Xcel’s largest in Minnesota, is expected to be back on line this fall.