July 1, 2001
L.A. Loves a Loophole
There's no getting around it...
Stranded Investment Surcharges: Inequitable and Inefficient
Retail competition will render a substantial fraction of existing electric utility plant worthless. Some estimates are so large that the question of compensation for these so-called "stranded investments" overshadows debate on the value of retail competition. Advocates of compensation frequently appeal to a "regulatory compact." They claim that this compact justifies compensation for utilities on grounds of fairness. The case for fairness, however, is badly flawed. Moreover, compensation may adversely affect the efficiency of markets in which competition is emerging. Compensation forces power users to forego productive opportunities to make their own transactions while they finish paying for plants that utilities never should have built. Save for special cases, it is both fair and efficient that utilities take the losses on those plants.
Voltaire said that history was nothing but a fable that had been generally agreed upon. The fictitious regulatory compact that justifies stranding compensation makes for poor history and misleading fable. Despite frequent claims that its roots go back to Hope and Bluefield, the compact is a recent intellectual invention. According to a LEXIS(r) search, the first regulatory and court decisions to mention it only appear in 1983 and 1984. The legislative history of regulation is strikingly devoid of references to a compact, and no known regulation arose from a collaborative effort at which anything resembling a compact was on the agenda. "Stranded investment" carries a similarly short pedigree, and is to this day absent from textbooks on regulation and industrial organization.
The Compact's Fine Print
No industry has ever proposed recovering tens of billions in mistakes from parties on the other side of a metaphorical agreement, particularly one as incomplete and one-sided as the utilities' version of the regulatory compact. In that version, the compact obligates a utility to provide reliable, long-term service in return for a monopoly franchise. Regulators charged with balancing ratepayer and financial interests allow the utility to recover prudently incurred costs, including a reasonable return on capital. Why would a rational end-user sign on as a party to an agreement that offered so few alternatives and so little protection? That ratepayer (known in other industries as a customer) stands at risk of becoming a cash cow whose bills will subsidize those of others who are politically favored. If tapped for this cross-subsidy, the ratepayer's only options are to reduce load, lobby the regulators, or leave the area. Customers who discover more economic power supplies cannot leave utility service, and the utility usually incurs no obligation to negotiate with them. The compact contains no known provisions for termination by a customer, save in extreme cases of self-supply.
On the other side of the compact, the utility's obligation to serve is scarcely a burden if whatever costs the utility incurs are recoverable from customers who have no choice but to pay. Consumers signing onto the compact would have done well to obtain the right to make their own choices in the event that their utility did not "resource" itself at least cost. Instead of allowing users an exit option, the compact offers no relief beyond prudence reviews