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

Fortnightly Magazine - May 15 1996

At high levels of retail wheeling, the utility is unable to sell as much as its marginal cost would suggest because of transmission constraints.

Losses under the KEEP option increase linearly with the number of retail-wheeling customers. Thus, per wheeling customer, KEEP losses are invariant with the amount of wheeling because neither prewheeling production costs nor wholesale prices depend on the amount of retail wheeling.

Input Costs a Wash. Other factors affect stranded-investment estimates but have no effect on the utility's interactions with the wholesale market. Because these factors affect the utility's income statement and balance sheet directly, they have the same effects under both options. These "accounting" factors include the fixed costs of generation (utility-owned as well as power-purchase contracts), regulatory assets, administrative and general costs, and the costs of social programs.

A Final Analysis

The amount of stranded investment a utility will face depends on whether it keeps or loses sales at risk of retail wheeling (see Table). Factors that affect wholesale markets are crucial under the FORFEIT option: variable production costs, wholesale-power prices, and transmission constraints, for example. Fixed generating costs (initial cost, depreciation, taxes, and fixed O&M), public policy programs, and income-tax rates are examples of accounting factors.

Under the KEEP option, utility revenues reflect the supply price (purchased-power price) at wholesale. Under the FORFEIT option, resale revenues depend more on the market-based sales price, which, in our analyses, is equal to or less than the supply price. Also, the FORFEIT option remains vulnerable to the fact that the utility may find itself unable (because of generation and transmission constraints) to resell all of its free capacity and energy on the wholesale market. On the other hand, the FORFEIT option allows the utility to choose when to buy and sell on the wholesale market, based on the time-varying relationship between its marginal costs and wholesale prices.

Clearly, when the wholesale price is higher than the utility's marginal cost, the utility is better off keeping the sale. How much better off will depend on transmission capacity, the percentage of customers that wheel, and the difference between supply and sales prices in the wholesale market. The KEEP option is generally preferable where the wholesale price increases relative to the utility's marginal cost, the percentage of customers that wheel increases, or the difference widens between supply and sales prices in the wholesale market. t

Stan Hadley, Eric Hirst, and Lester Baxter are all researchers in the Energy Division at Oak Ridge National Laboratory in Tennessee. Their research focuses on electric industry restructuring issues, such as stranded commitments, ancillary services, and public policy functions.

1 For additional details see E. Hirst, S. Hadley, and L. Baxter, Methods to Estimate Stranded Commitments for a Restructuring U.S. Electricity Industry, ORNL/CON-424, Oak Ridge National Laboratory, Oak Ridge, TN (January 1996).

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