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Stranded Cost Recovery: A Practical Argument for Utilities

Fortnightly Magazine - June 1 1997

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clearly constitutes a constitutional "taking" of property for a public purpose. But you will not see the utility industry condemn the taking as unconstitutional. Why not? The answer is simple: The industry believed that the Regulatory Compact yielded "just compensation" for the "taking." First, electric utilities received their service territory. Second, the electric industry received the right to earn the regulatory return on all prudent investments, even if something better came along.

The electric industry believed it had given up the "home runs" in exchange for a promise of a

compensatory return on all prudent investments. For example, the U.S. Supreme Court stated in Duquesne Light Co. v. Barasch: %n2%n "Under the prudent investment rule, the utility is compensated for all prudent investments at their actual cost when made (their "historical cost") irrespective of whether individual investments are deemed necessary or beneficial in hindsight."

Now, however, some would say that the electric industry has given up the upside, but should forfeit its protection against downside risk, to level the field against other firms. Many of these same people, however, are opportunists, not true free-market advocates. They still argue for continued regulation in those sectors where electric industry costs are below market (i.e., in transmission), forcing utilities to forgo upside opportunities. It's only where utility prices climb above market that they would unleash the genie of competition.

In the electric industry, we would never have allowed any governmental entity to "take" our assets and appropriate them for public use without the Regulatory Compact. A bargain was struck; one side alone cannot abrogate it. In fact, such abrogation amounts to an unconstitutional taking of property.

Fundamental Fairness

Some commentators have gone

as far as to suggest that recovery of stranded costs may be "un-American." If recovery of costs that governments mandated and approved for an industry that has already built one of the most reliable and currently cheapest electric systems in the entire world is un-American, then I will readily admit to being a socialist. Fundamental fairness and equity and paying for items specifically built to serve a customer, when a legal duty existed to build them, is American; the alternative is not.

In fact, the Uniform Commercial Code contains a specific section (2-201) dealing with goods made specifically for a customer that cannot be sold elsewhere. The section requires the customer to pay for the goods. That is exactly the situation the electric industry has here, except that the Regulatory Compact is implied and not explicit.

Some may say that the traditional regulated rate of return on prudent investment compensated utilities for the risk that a plant would have to be abandoned. Rate case opinions often run hundreds of pages, but the record is clear: The electric industry was never compensated for this risk.

Not only is stranded asset recovery legally correct in this specific instance, it also is desirable for the long-term good of the nation's economy. People should feel comfortable relying on government's rulings and promises. The government has the ability to change the law. If