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Financial News

Fortnightly Magazine - July 15 1996

their right to buy at the competitive market price. In effect, they are asking customers to redistribute funds to the utilities without receiving anything in return.

Justifying Recovery

The rhetoric of stranded-cost recovery tends to obscure the fact that four separate types of commitments are at issue: nuclear decommissioning costs, uneconomic purchased-power contracts, regulatory assets, and stranded investment. Nuclear decommissioning and purchased-power contracts involve future cash obligations; regulatory assets and stranded investment involve sunk costs. Purchased-power contracts were forced on reluctant utilities; nuclear plants exposed to stranded investment were willfully built by the utilities despite excess capacity, and sometimes even despite discouragement from regulators. Thus, the task of justifying stranded-cost recovery varies enourmously.

The strongest case can be made for recovery of nuclear decommissioning costs. These costs are unavoidable and socially necessary. They must be paid by someone. If the owner of a nuclear plant goes into bankruptcy, they will become a public obligation. These costs should be billed to the distribution customers for whom the plants were built.

The uneconomic purchased-power costs, on the other hand, are contractual costs that can be renegotiated. After all, 1) regulators and legislatures forced these contracts on utilities, and 2) the power producers often undertook obviously uneconomic projects that carried inherent risks. At the same time, however, the producers responded to the incentives and risks of the free market; the workings of the system should not be suspended to protect them. The public interest demands that these contracts be restructured, and a case can be made for sharing the costs between the utility, its customers, and the power producers.

Regulatory assets and stranded investment are sunk costs, often carrying a questionable pedigree. In effect, they form part of the residue of a system that allowed utilities to earn healthy returns despite widespread inefficiencies and abysmal technological progress. Every announcement of cost-cutting is a testimonial to past inefficiencies, and the failure of the industry's heat efficiency to improve over the last 30 years speaks volumes about utility indifference to innovation. And yet, some utilities want regulators to construct special mechanisms that shield them from market forces and deny customers the right to competitive prices.

Most likely, utilities will lose the greater part of the battle to collect stranded costs. Therefore, utilities would be wise to strike deals that treat current rates as price caps and free their companies from the constraints of allowed returns as compensation for stranded investment. Utilities would retain the benefits of all cost reductions during the transition (em those from transmission and distribution as well as from generation. At the same time, utilities would carry the risk related to customers that took advantage of freedom of choice. By rapidly cutting costs, a utility could realize net savings equivalent to substantial stranded-cost recovery over three to five years. t

Charles M. Studness is a contributing editor of PUBLIC UTILITIES FORTNIGHTLY. Dr. Studness has a PhD in

economics from Columbia University, and specializes in economics and financial research on electric utilities.

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