The D.C. Circuit once observed that the Mobile-Sierra doctrine is “refreshingly simple.” In fact, however, the doctrine has become incredibly nuanced and complex over time. In two...
With no need for new capital, utilities have lost political pressure, exposing the regulatory compact as an illusion.Recovery of stranded investment today marks the central issue in the debate over electric utility competition. Unfortunately, the utility argument in favor of recovery is flawed. It assumes that utilities invest in plant to meet a public need; that a regulatory compact guarantees cost recovery; that the public must acquiesce. But consider the circumstances that prevailed when the utilities took on the investments now deemed at risk for stranding. Those circumstances suggest no such public need. Moreover, the idea of a regulatory compact presents a self-serving view. It does not square with the hard realities of ratemaking politics. The utilities stand on weak ground.Investment at Risk
In general, only the newest and most expensive plants face exposure to stranding, in part because cost-of-service ratemaking loads capital costs at the front end. The capital cost included in rates is derived by multiplying a plant's undepreciated cost by an allowed return. Since a plant's undepreciated cost declines to zero over its life, so do the capital costs included in rates. All else equal, new plants will carry higher capital costs for ratemaking purposes than old plants.
For the most part, nuclear plants make up the newest and most expensive of generating facilities, while fossil-fueled plants tend to be older and less costly. As a result, exposure to stranded investment rests almost exclusively with nuclear plants. Can we place a value on this exposure? Capitalizing the reduction in overhead costs needed to make a plant cost competitive produces estimates of overcapitalization (stranded investment) of $50 billion for nuclear plants and a $30 billion estimate for fossil-fueled plants (see, PUBLIC UTILITIES FORTNIGHTLY, Dec. 1, 1994, p. 40).
Almost all of this stranded nuclear investment stems from 34 nuclear units that went into service after 1984. These 34 units account for about 70 percent of the industry's undepreciated nuclear investment-about half the entire investment in generating assets. The case for the recovery of stranded investment thus hinges on whether the electric utilities built these plants in response to a public need.Lingering Construction
Construction on all but two of these 34 nuclear either started or was restarted between 1974 and 1978-that is, after the energy crisis of 1973 (see sidebar). During the 15 years that preceded the energy crisis, the electric industry had enjoyed very stable electric demand growth of about 7 percent a year. Capacity increases were keyed to meet this growth (the industry had not been troubled with sustained excess capacity). Reserve margin averaged 19.4 percent during the five years before the energy crisis, reached 20.8 percent in 1973.
The rise in electric rates that accompanied the energy crisis produced an abrupt decline in the long-term growth rate of electric demand. Electric rates surged 28.3 percent in 1974. Peak demand growth plunged from 7.8 percent in 1973 to 1.6 percent a year later. Reserve margin jumped from 20.8 percent in 1973 to 27.2 percent in 1974. With peak demand rising 2.2 percent in 1975, the reserve margin