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Stranded Investment Surcharges: Inequitable and Inefficient

Fortnightly Magazine - May 15 1995

that can be eliminated if regulators simply choose not to impose them. However, suppressing competition simply wastes the world's resources by denying end users any access to power sources more efficient than the utility's. Worst of all, regulators with the power to suppress ("manage") competition will probably use it either incompetently or politically. Competition is about the opening of opportunities that even competitors cannot always anticipate.

An Inefficient Tax

More than just a matter of fairness, stranding compensation represents a tax on end-users. Like any other tax, it produces revenue at some cost to economic efficiency. That loss stems from under-consumption of power when users pay an after-tax price that exceeds the real resource cost of that power. If compensation must be paid by customers who wish to relocate or arrange their own power supplies, the stranding tax will discourage some economically warranted departures from utility service. The loss will be magnified if it also delays investments in efficient nonutility plants that would serve bypassers. This issue has already surfaced at the wholesale level. (In Cajun Elec. Co-op. v. FERC, 28 F.3d 173 (D.C.Cir.1994), the U.S. Court of Appeals remanded the stranding compensation provisions in Entergy Corp.'s open-access tariff to the Federal Energy Regulatory Commission because of their questionable effect on competition.)

Imposing compensation on a broader customer base also produces economic inefficiency. If compensation imposes a surcharge on the energy component of a two-part tariff, consumption falls below the economically warranted level. On the other hand, if compensation is added to the demand charge, it will misshape load patterns and perhaps generation investments by making capacity appear more costly. Another inequity is that customers who left or downsized before compensation was imposed will escape a tax that recovers investments made to serve them. Customers arriving now or in the future will find themselves paying for mistakes the utility made before they came along.

An Interminable Transition

Administratively, compensation will be anything but simple, and the investments to which it applies will be anything but obvious.

California's utilities have submitted lists of uneconomic assets to state regulators that contain more than just nuclear plants and overpriced qualifying facility contracts. As in economics, there is surely a supply curve of stranded assets. The bigger the reward for finding stranded investments, the more of them utilities will manage to find. As compensation arrives, the possibilities for gaming will multiply, particularly if the payments are based on comparisons between booked costs and market prices. California's current planning process for new resources provides a likely scale model of what will happen when the value of entire systems is at stake. In that process, disagreements over costs have turned into long-lived battles of attrition between computer models. The conflict has become so complex that California now has legislation regarding admissible models and their uses.

Once begun, compensation will surely perpetuate itself. Stranding dockets will become yet another forum in which parties can seek rate relief or otherwise special treatment. Having been compensated for one set of bad investments, utilities will have good reason to want such a