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Recovering Stranded Costs: Not "If," But "How"

Fortnightly Magazine - January 15 1997

the commission addressed the issue. However, given the limitations of Illinois case law, we suspect that this matter might have been treated in the same manner that the stranded costs created by special anti-bypass contracts have been treated since the mid-eighties: There would be no immediate recovery, but ICC would consider of the revenue shortfall in the companies' next rate cases.

Unlike special contracts, where ratepayers benefit from the continued contributions to fixed costs, recovery of losses stemming from unbundling would have been difficult to justify. In an effort to

eliminate the barriers to demand-side management, the ICC attempted to allow utilities to recoup the revenues associated with foregone sales through a special rider. However, the Commission was later overturned by the courts, which found that customers should not be billed for services they did not receive.

The Calculation:

Two Basic Methods

While the subject is marked by technical nuances, one can define two basic approaches for calculating strandable costs. There is the "top-down" approach, a relatively simple calculation of the system-wide revenue loss brought on by competition. And there is the more difficult (and assumption-filled) "bottom-up" approach, which compares the worth individual utility assets to the market value of such assets. The jury is still out on whether the benefits of improved precision achieved with the "bottom-up" approach will outweigh the drawbacks, such as extensive litigation over the numerous assumptions that are employed.

Many of the methods now under discussion amount to nothing more than variations of these two basic approaches. The Moody's "break-even price" method, for example, is somewhat reminiscent of a "top-own" approach. Most of these methods can be applied on ex ante or ex post, using estimated or actual market values and prices.

Nevertheless, the selection of a method for calculating stranded costs should not be our major concern. If legislators or regulators are particularly troubled by the selection of a methodology, they can always resort to a mechanism for reconciliation. (However, that mechanism could eliminate the incentive for utilities to mitigate their strandable costs, much like the FAC (fuel cost adjustment) and PGA (purchased-gas adjustment).

Moreover, if state lawmakers should adopt a mandatory retail wheeling law that provides for stranded cost recovery, they would also probably provide some guidance regarding the choice of method. Indeed, some legislators have already raised concerns about the validity of ex ante administrative determinations of market price (em the key to estimating stranded costs.

The Recovery:

Fraught With Uncertainty

How can stranded cost be legally recovered in practice? That is what should concern the legislators, regulators, and financial analysts.

A surcharge, applied against rates for unbundled transmission and distribution (and set by state regulators) would offer the simplest mechanism for recovery of stranded costs. This method would allow states to follow the doctrine of cost causation: impose stranded costs on the parties responsible for them (em namely, the departing customers.

Jurisdictional Conflicts. Unlike the gas industry, however, where the Federal Energy Regulatory Commission (FERC) enjoyed primary jurisdiction over transition costs, the electric industry debate will be complicated by federal-state jurisdictional conflicts. By