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Fortnightly Magazine - January 15 1995

A competitive market for electric power raises the point that some utility investments might be overvalued, giving rise to "stranded investment." Nevertheless, actual utility exposure to stranded investment may prove less severe than reported, according to a recent study we conducted at Resource Data International, Inc. (RDI), Retail Power Markets in the U.S., (em perhaps the first detailed analysis of stranded investment from generating assets, performed on a unit-by-unit basis for all power plants in the United States.

The move to competition implies "transition costs" (em costs that might become "stranded" if they cannot be recovered in a competitive market. The most critical and visible factor affecting cost recovery (em and whether investment becomes stranded (em is the gap expected to arise between regulated retail rates and unregulated competitive prices. In a competitive market, prices will no longer reflect average "bundled" costs; instead, they will track the demand/supply equilibrium in the power markets. Because competitive market prices may show little or no relation to historic average embedded industry costs, we may see the market mark down certain utility assets and liabilities below book value.

This problem (em high capital costs on the books and low prices for power in the marketplace (em appears most serious for newer, capital-intensive plants, and nuclear units in particular. Faced with competition, many utilities will have to write down the book value of capital-intensive plants and forgo recovery of some portion of the fixed costs to continue operating the plant. For some plants, the market price of power may not climb high enough even to recover variable costs, let along such items as nuclear decommissioning costs. Management may be faced with the decision to close such underperforming plants. Closure would expose the entire undepreciated book value of the plant to loss.

Our study concludes that possible exposure from stranded generating assets totals only about $73 billion (em considerably less than many recent, highly publicized estimates. We calculated the $73-billion figure on a unit-by-unit basis for 8,829 generating plants (em representing all plants at all investor-owned (IOUs) and public utilities. We analyzed and compared the variable generating costs and embedded fixed costs to monthly market-clearing price forecasts for 60 separate market areas. Then, at a company-by-company level, we aggregated the difference between the revenues and costs associated with each generating plant. The potential stranded investment equals the portion of fixed costs that could not be recovered from operating revenues.

We found that more than 45 percent of the stranded generating assets were concentrated in Texas, Illinois, Pennsylvania, and Ohio. The problem was also highly concentrated among utilities (em the 10 IOUs with the highest exposure accounted for 50 percent of the stranded investment among IOUs (46 percent of the industry total). For some companies, the problem could prove particularly severe. For instance, we found that one company with over $6 billion in stranded assets would have to raise rates by 7 cents per kilowatt-hour for seven years to recover the cost without a writeoff. How well U.S. electric utilities deal with potential stranded investment, either alone or with