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Recovery of stranded investment is clearly the central point of contention in the debate over utility competition. Customers oppose competition and utilities favor it (em for what appear to be clear-cut reasons. Recovery would delay the benefits of competition for customers, but would give utilities additional cash and temporary protection against competitive price pressures. The battle has unfortunately turned into a morality play that centers on the right to recover stranded investment. Utilities argue that the "regulatory contract" entitles them to full recovery; customers claim that no such entitlement exists.

These polarized positions obscure complicated self-interests that often conflict with public positions. Stranded investment, recovered or not, will have a major impact on the competitive positions of utilities relative to each other, which will also affect customers. Accordingly, both utilities and customers must consider recovery in terms of what is optimal. The optimal amount of recovery for utilities will vary from full recovery to partial recovery to no recovery.

Recovery and Cash Flow

Shareholder interests require that utility managements maximize the risk-adjusted present value of future cash flows. The historical cost of a utility's assets has nothing to do with this. What matters is future cash generation. Since utilities will be competing head-to-head with each other, a utility must consider the impact that recovery of stranded investment by rival utilities will have on its future cash flow. Recovery of stranded investment by a utility will increase a utility's future cash flow; recovery by rivals will diminish it.

A utility could obviously use the cash flow from stranded investment recovery in many ways that would benefit

shareholders. For instance, it could transfer the funds directly to shareholders through dividends or by buying back stock. It could use them to strengthen its balance sheet by retiring debt or preferred stock, thus strengthening its competitive position. It could also invest them in its core business, enhancing its future cash flow stream and improving its competitive position.

Conversely, a utility's competitive position could be undermined by the extent to which a rival invests recovery funds in its core electric business or uses them to retire debt or preferred stock. A utility's competitive position will be more seriously undermined 1) the greater the rival's stranded investment recovery, 2) the more directly the rival competes with the utility, and 3) the more the rival employs the funds to attack the utility.

No matter how it is handled, stranded-investment recovery will be a dominating factor in the transition to competition. The question is who the winners and losers will be. If there is no recovery, some of the utilities with the greatest stranded investment exposure will probably face financial crises. With full recovery, on the other hand, the competitive position of some of these utilities will improve to a point where they will be strong enough to create financial distress for some of the utilities that have little or no stranded investment exposure. Stranded-investment recovery could turn a patsy into a fearsome predator, and vice versa.

How Much Recovery is Enough?

In determining the optimal level of stranded-investment recovery,