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Stranded Cost Recovery: All FERC'ed Up

Fortnightly Magazine - November 15 1996



Recovery: All FERC'ed Up

By Michael T. Maloney, Robert E.

McCormick, and Chad A. McGowan

The "lost-revenues" approach in Order 888 ignores the fact that cash flow drives

asset valuation . . .

. . . the key to measuring uneconomic investment.

Order 888, the new rule from the Federal Energy Regulatory Commission (FERC), is a sham (em for both consumers and producers. And it is probably illegal.

Order 888 grew out of the so-called mega-NOPR (Notice of Proposed Rulemaking), in which FERC sought rules for open access in electric transmission and, in particular, rules for the recovery of stranded costs. In turn, the mega-NOPR stemmed from the Cajun case,1 in which the Cajun Electric Cooperative had sought to buy its power from afar but use its local utility's transmission facilities for delivery, and had then sued the FERC after the Commission allowed Entergy to recover stranded-generation assets through its transmission tariff.

The D.C. Circuit Court agreed with Cajun that the FERC had not followed the proper procedure in setting the tariff, but the court went further. It gave its unsolicited opinion about what it thought the tariffs should look like (em it offered dicta that tariffs should not tie the recovery of stranded-generation assets to transmission charges. The court said such ties would violate antitrust law.2 In spite of that warning, that is exactly what the FERC did in Rule 888.3

Possibly, when the FERC fashioned the rule, it thought that it could pass antitrust muster by the form of the stranded-cost recovery. Rule 888 takes a "revenues-lost" approach to the assessment of stranded costs. It explicitly eschews asset identification. Hence, it does not explicitly link stranded generation assets with transmission prices. While this approach may sidestep the Court's concern about tying contracts, the revenues-lost approach is a sham when applied to stranded costs.4

Stonewalling Consumers

The alarming characteristic of Order 888 is that it views revenue as a property right of the utility with no regard for nature of the underlying capital investments that are said to be stranded.

Under Rule 888, the term should be stranded income, not stranded costs. The lost-revenues approach defined by FERC Rule 888 works in the following way: A customer that wishes to buy power from a different generator than its current supplier negotiates a transmission tariff for receiving the electricity over its existing utility's lines. Rule 888 allows the tariff to include a charge for recovery of stranded costs. The rule says that the utility currently providing service is allowed to build into the transmission tariff the revenues it will lose by the proposed competitive exit of the customer.

Consider a simple example. Say that Duke Power serves a wholesale customer, the City of Abbeville, SC, which in turn wants to buy power from Georgia Power. Since Abbeville does not own transmission facilities that connect with Georgia Power, it must negotiate with Duke for transmission. Under Rule 888, Duke gets to assess its lost revenues and recapture them in the transmission tariff. The recovery is based on what Abbeville is currently