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Stranded Cost Recovery: All FERC'ed Up

Fortnightly Magazine - November 15 1996

recovery should not violate the equality of marginal production cost and marginal consumption charge. While the FERC rule violates this condition, and while some commentators argue for a unit-charge recovery, most economists agree that a two-part tariff is the most effective way to design an efficient pricing algorithm.

The access fee part of the tariff should reflect hookup capacity, and should equal the pro rata share of stranded costs amortized into the future at the average electric utility bond rate. The period over which to amortize stranded costs should be 20 to 30 years.

Nevertheless, another and more troublesome issue looms. Who is going to pay how much of the true stranded costs generated by the current system of rate regulation?

There are few easy answers here. A nationally mandated charge weighs heavily on those customers in states and regions that have no stranded costs. A state-by-state approach seems better. But what will be done with utilities that span multiple states? Within states, should customers of a utility with stranded costs be assessed the full bill or should all customers in the state bear the burden? If costs are imposed only upon those customers of the utility with true stranded costs, will customers wishing to completely unhook from the system be allowed to do so without paying anything? At this point, straightforward and simple answers are hard to come by. Note, however, that bad approaches to stranded-cost recovery implicitly answer all of these questions, and always in inefficient and many times ineffective ways.

Here are some positive suggestions:

1) Share the burden of stranded costs, with primary responsibility lying within the state. A 2-to-1 or 3-to-1 sharing rule seems appropriate. That is, 75 percent of the stranded-cost recovery should be assessed on the residents of the state in which the utility operates, and only 25 percent on federal resources.

2) States should set rules for sharing costs among the state's citizens. Some states will assess across all citizens. Some will assess recovery only on those customers already hooked up. Others will adopt different sharing rules.

3)States should determine whether new hookups or other bypasses will avoid stranded-cost recovery charges.

4) Utilities that span multiple states should share stranded-cost recovery across the states, based on hookup capacity.

These proposals certainly involve some legislative and regulatory hurdles. Even so, it is important to recognize that the stranded-cost question becomes substantially simplified when stranded costs are measured correctly. By our estimates, the true value of stranded cost is around $40 billion for the investor-owned segment of the industry. Compared to the estimated gains from competition, this is a trivial amount. t

Michael Maloney and Robert McCormick are professors of economics at Clemson University, Clemson, SC, and recently collaborated on an extensive study on electric utility deregulation prepared for the Citizens for a Sound Economy Foundation: Customer Choice, Consumer Value: Analysis of Retail Competition in America's Electric Industry. They can be reached at maloney@, or Chad A. McGowan is a principal with the McGowan Law Firm, headquartered in Atlanta, GA.


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