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Stranded Investment: Is the Sale Worth Keeping? (A Look at Utility Options)

Fortnightly Magazine - May 15 1996

its obligation to serve that customer's year-round, hour-by-hour loads, it can pick and choose when it will sell this "surplus" power on the spot market. Third, transmission losses and congestion might otherwise limit a utility's ability to sell on the spot market. Finally, corporate or regulatory policy may limit the utility's willingness or freedom to offer a discount to customers.

Base Case: Modest Growth, Constant Costs, Limited Wheeling

To illustrate the differences between the KEEP and FORFEIT options, we used data from the U.S. Energy Information Administration to create a hypothetical electric utility (Utility A) suitable for analysis. We did not create a typical U.S. investor-owned utility, however; rather, we created one with a substantial amount of stranded commitments.

In 1995, Utility A's retail sales totaled 22,700 gigawatt-hours; peak demand reached 4,610 megawatts (Mw). At an average retail rate of 8.25 cents per kilowatt-hour (¢/Kwh), Utility A's revenues totaled $1.75 billion, for a net income of $148 million and a return on equity of 11.5 percent. Utility A also owns generating units with a combined capacity rating of 4,210 Mw. Two long-term power-purchase contracts provide another 1,600 Mw of capacity, bringing Utility A's reserve margin up to 26 percent.

With inflation at 3 percent a year, modest load growth of 1.1 percent per year, no fuel price hikes, no new generating units coming on line, and no new investment in existing generating units, Utility A's assets will decline from $4 billion in 1995 to $3.3 billion by 2005. In addition, all production costs remain constant in real dollars, causing retail rates to decline from 8.25 to 6.7¢/Kwh over the same period.

Assume further that retail wheeling begins in 1996, with 10 percent of each customer class remaining eligible from 1996 through 2005. (In reality, however, the timing and amount of retail wheeling would depend on utility rates, wholesale prices, customer price elasticity, and the outcomes of the restructuring proceedings occurring around the country.) Assume also that retail sales and transmission rates are the same in the retail wheeling case as they are in the base case. Thus, for purposes of this analysis, all costs of retail wheeling fall on utility shareholders.

By choosing a FORFEIT option (eligible customers choose wheeling service to buy from competitors), Utility A incurs a loss in earnings attributable to the lost load, but its annual loss in earnings falls from year to year, from $25 million in 1995 to $19.2 million in 2000, and to -$0.1 million in 2005. This reduction in losses in later years reflects a decline over time in the fixed-cost component of electricity costs, as well as a rise in wholesale prices after 2000. On a net-present-value (NPV) basis, the earnings loss totals $100 million (em 8.2 percent of utility equity as of 1995. Nevertheless, Utility A's potential loss is small (compared to that estimated for many U.S. utilities) because we assume that only 10 percent of the utility's load lies at risk.

By retaining the loads of its retail-wheeling customers, Utility A would lose only $82 million (em 18 percent less than