The Federal Energy Regulatory Commission (FERC) has set for hearing a request by Koch Gateway Pipeline Co. (KGP) to charge market-based rates for firm and interruptible natural gas transportation...
You've got to reinvest the proceeds (em and not just anywhere.
Recovering stranded investment is sometimes equated to preserving shareholder wealth. In fact, full recovery of stranded investment by itself will not preserve shareholder wealth in most cases.
What is missing all too often in discussions of stranded investment is the role that capital investment plays in the creation of shareholder wealth. Full preservation of shareholder value requires more than recovery of stranded investment; it demands new investment that replaces the original earning power of the impaired assets.
To fully preserve shareholder wealth, any resolution of the stranded investment question must leave the utility's valuation equal to what it would have been if the matter had never come up. That means no net change in: 1) the present value of a utility's prospective stream of risk-adjusted earnings, and 2) the way the market values that earnings stream. Investors must remain just as confident about future earnings as they were before the stranded investment issue arose.
Capitalizing the Income Stream
The effect of stranded investment recovery on shareholder wealth can be illustrated with a numerical example. For this purpose, assume that a steady state exists under regulation in which all earnings are paid out as dividends and the utility's equity investment and earning power are both in constant perpetuity. Specifically, suppose that the utility's equity investment is 200 and that it earns its allowed return on equity of 12 percent. Earnings are thus 24. Since rates are set at a level that enable the utility to earn its allowed return, book value and regulatory economic value coincide. (See table.)
Next, assume competition is introduced and the resulting decline in power prices cuts the expected perpetual earnings from 24 to 12. With earnings halved, the economic value of the plant would also be cut in half from 200 to 100. The difference of 100 would be stranded investment, which is assumed to be recovered in full from customers. Thus, book equity is still 200, but it is now divided between the new economic value of the plant of 100 and recovered stranded investment of 100.
Shareholder wealth, of course, depends on the discount rate at which the market capitalizes the utility's earning power. This rate is assumed to be 8 percent, which implies shareholder wealth of 300 under the initial regulatory conditions, that is, annual earnings of 24 capitalized at 8 percent. Shareholder wealth, after the stranded investment is recovered, is the sum of the capitalized values of the earning stream from the recovered stranded investment and the earning stream from utility operations. Again, an 8-percent discount rate is assumed.
The assumed 8-percent discount rate represents the going financial market
rate at which funds can be invested or acquired. The market value of funds invested at this rate is equal to book value. Assuming the utility undertakes all investment projects with a return above the going market rate, independently of stranded investment recovery, the recovered funds can either be invested at the going market rate, or returned to shareholders who can invest them at