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Financial News

Fortnightly Magazine - February 1 1995

a time approaches, a number of troublesome issues can be expected to come to the fore. These will surely include the questions of who is really responsible for the excess capacity, who should bear the unnecessary costs of it, and to what extent the industry is serving the best interests of investors, ratepayers, and the public. . . . Excess capacity can be expected to become generally viewed as the result of either misguided conscious choice or faulty planning [by management]."An Illusory Compact

Then came the 1980s and a new term-the "prudence review." Utilities countered the risk by claiming protection under a "regulatory compact." Unfortunately, the concept was based more on hope than precedent.

Excess capacity stood as high during the mid-1980s as in the late 1970s. The industry's reserve margin reached 35 percent in 1985, 12 years after the energy crisis. With construction programs winding down, excess capacity made disallowances feasible. Enough plant remained in operation to serve customers well for some time to come. For the time being, a rate disallowance would not compromise a utility's access to capital markets. The question arises: Does a regulatory compact really exist?

Some observers point to the Supreme Court's famous 1944 Hope decision for the source of the compact. See, FPC v. Hope Natural Gas Co., 320 U.S. 591 (1944). But that case offers little support. The Hope case set up an "end result" test. The proof lay in access to capital markets. Ratemaking was thrown open to political forces. To gain the political advantage, utilities would add capacity to avoid service deterioration, prompting need for capital. But when excess capacity arose-and need for capital fell-utilities could not raise support for rate requests. The political consensus fell apart. The "regulatory compact" proved illusory.

The present situation in some respects marks an extension of the mid-1980s. The plants that were then added to rate base are the same ones that today lie exposed to stranding. Utilities carry scant leverage with which to induce favorable rate treatment from the regulators. As was true in the mid-1980s, utilities today do not need to build new capacity. That role has largely passed to independent power producers. Access to capital markets has likewise diminished in importance.

Accordingly, shareholders will likely bear most of the cost of stranded investment. This prospect lies rooted in the failure of managements to defend shareholder interests when excess capacity emerged in the 1970s. Shareholders have paid the price twice over-first with book value dilution in the 1970s, then with prudence reviews in the 1980s. A third accounting looms with stranded investment.Charles M. Studness is a contributing editor of PUBLIC UTILITIES FORTNIGHTLY. Dr. Studness has a PhD in economics from Columbia University, and specializes in economics and financial research on electric utilities.


Nuclear Construction

Plants Added to Service After 1983

Start or Restart DatesDiablo Canyon Nos. 1 & 2 1968

Susquehanna Nos. 1 & @ 1973

Beaver Valley No. 2 1974

Byron No.2 1974

Comanche Peak Nos. 1 & 2 1974

Grand Gulf 1974

Millstone No. 3 1974

Perry 1974

San Onofre Nos.