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

Fortnightly Magazine - May 15 1996

it would lose under the FORFEIT scenario. In this case, then, the utility should choose the KEEP option if possible, retaining the customer at risk and charging them market-based rates.

Variable Case: Price & Grid Fluctuate; Wheeling Expands

How do stranded-investment estimates change as conditions vary from those discussed above?

Lower Prices Favor FORFEIT.

As wholesale prices increase, stranded-cost estimates fall for the FORFEIT option (see Figure 1 on page 23). Indeed, if wholesale prices are sufficiently above the utility's cost of generation, then stranded investment can be negative (i.e., the utility can earn more money selling on the wholesale market at spot prices than sell- ing to retail customers at embedded-cost prices). This negative relationship between prices and stranded investment depends on transmission capacity, however. Where transmission capacity is low, stranded investment is nearly invariant with wholesale prices.

Under the KEEP option, the utility's losses also depend on wholesale price. As the wholesale price increases, the utility's loss decreases because the difference between its production cost and the wholesale price declines. Because the utility's production cost depends partly on its purchase or sale of electricity to meet native loads, transmission constraints affect stranded-investment estimates. These effects are more pronounced under the FORFEIT option.

Constraints Affect FORFEIT More. The relationship between transmission capacity and the level of stranded investment under the FORFEIT option depends on the relationship between wholesale prices and utility marginal cost (see Figure 2). When wholesale prices are close to marginal cost, transmission capacity has little effect on stranded-investment estimates because there is little profit to be earned on purchases and sales. Where wholesale prices fall below marginal cost (in which case the utility would purchase power), increasing transmission capacity increases the amount of stranded investment. The utility will buy as much power as it can up to the transmission limit, but under the retail-wheeling scenario, the utility's marginal cost is lower than in the base case, so it has less need to buy on the spot market. Thus, increases in transmission capacity benefit the base case more than the wheeling case, leading to increases in stranded-investment estimates. The reverse is true at higher wholesale price levels. Here, as the transmission capacity is increased, the utility sells more power. In the retail-wheeling case, the utility's marginal cost is again lower so it can sell more power on the wholesale market. Thus, at high wholesale prices, the utility earns more money on the spot market with retail wheeling than without.

Under the KEEP option, the utility's losses depend only slightly on transmission constraints. As explained above, the utility's production costs may depend on its wholesale purchases or sales to meet native loads. The KEEP and FORFEIT estimates are closest to each other when transmission capacity is large.

More Choice Favors KEEP. Losses under the FORFEIT option increase more than linearly with the number of retail-wheeling customers (see Figure 3). With low wholesale prices as retail wheeling increases, the utility buys less and less (because its marginal cost decreases with increased wheeling), and eventually begins to sell on the spot market.