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Stranded Cost Recovery: A Practical Argument for Utilities

Fortnightly Magazine - June 1 1997

Why do they think the electric industry built a plant with no contract when no reasonable business would? The electric industry has always viewed the Regulatory Compact as an implied contract. In the future, IPPs will build many merchant plants because the market will be open, and transmission will be available to send the power across whole regions. These conditions did not exist in the past.

IPPs should recognize that often the largest share of stranded assets comes from contracts signed under the Public Utility Regulatory Policies Act. If the IPPs wish to enforce these contracts, they should support utilities who seek to recover stranded costs. The law is well established in the U.S. that once a party to a contract has fulfilled its bargain, the other must reciprocate (em even the U.S. government. %n1%n

The alternative may be a utility bankruptcy, which doesn't help IPPs. Thus, although damages claimed by IPPs under rejected PURPA contracts are probably equal in priority to claims by unsecured creditors in a Chapter 11 bankruptcy against a utility, such equality offers little solace to IPPs, who won't get paid their contractual rate for three years while the proceedings are pending, and won't collect interest as an unsecured creditor.

So who pays for these stranded assets? Is it the customer's duty to pay for the assets the electric industry constructed to fulfill its duty to serve? By analogy, should the host utility in a competitive market retain a duty to serve customers that no one else wants? Once a utility begins to serve these customers, will it have the opportunity to recover its prudently incurred costs if someone cheaper comes along? If the Regulatory Compact is not all it was supposed to be, perhaps utilities should demand an answer on stranded cost recovery as a condition to serve. Or perhaps these unwanted customers should form a pool, similar to an uninsured motorists' pool, and require each utility serving an area to serve a proportionate share of the pool.

Today, an analyst might well describe our service territories at Tucson Electric Power as next to worthless. Many competitors have called on our largest customers in an attempt to "cream skim." Such attempts have forced us to lower prices to these large customers. Meanwhile, the Regulatory

Compact implores us to continue serving our "less-desirable" (less-profitable) customers at below cost.

Some would acknowledge that the Regulatory Compact once existed, but say they will now do away with it. That is fine; regulators should enjoy the right to change the rules on a prospective basis. In fact, to achieve competition, it should be encouraged.

Just Compensation

Even today, the Regulatory Compact limits utility earnings (the rate of return) on prudent investments dedicated to public use. If a utility builds a plant or a transmission line that operates at below-market costs, it is only allowed to earn a regulated return on its actual cost. An electric utility is never allowed to charge a market rate and hit a "home run" for its investors, as do their unregulated competitors. This mandate (em to