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Stranded Cost Recovery: A Practical Argument for Utilities

Fortnightly Magazine - June 1 1997


Society is better off when the electricity is produced using the least additional amount of assets. Public utility consumers should make decisions based upon what is good for society, not what is good for any one customer. Arguments will be made that competition is good for society so PUCs should permit competitors: I couldn't agree more. But, the electric industry can encourage competition in a manner where society bears a huge cost of constructing unnecessary plants, while abandoning old plants with a lower marginal cost. Or the electric industry can encourage competition in a manner that has the lowest economic cost and favors the most rational allocation of resources. I prefer the latter.

The adoption of a non-bypassable stranded asset charge also provides a remedy for an economic trap, mixing and matching economic systems. The U.S. has two major economic systems: the free market and the regulated market. In the free market, prices are set by the market and the "invisible hand" does allocation. In the regulated market, regulators set prices. Because there is no market allocation mechanism, the U.S. has adopted such allocation mechanisms as least-cost planning, integrated resource planning, certificates of convenience and necessity, etc. To mix and match the two systems by allowing regulated prices to escape to the free market without the correct allocation pricing mechanism is to invite disaster. New York and Maine proved it with PURPA prices.

One of the first things business school teaches is not to consider sunk costs when pricing. Yet the electric industry bases its pricing model almost entirely on sunk costs. These costs, let loose in the free market, dramatically signal the need for a new, cheaper capacity. Ironically, the electric industry has an oversupply of capacity in many regions. The electric industry simply cannot let regulated costs loose in the free market without chaos. The adoption of a non-bypassable transition charge will quickly remedy this and allow the market to receive the correct marginal cost signals.

If unneeded plants are built, the cost will be spread to other people. Economic theory demands that someone pay that cost. Higher demand for new plants will raise the cost of material for their plant. Higher demand for natural gas will raise its cost, which will be felt by other industries and home-heating customers. The customers escaping regulation may benefit, but others will pay. From an economic point of view, a non-bypassable, stranded cost recovery mechanism leads to the best result for society as a whole; and that should be the test for regulation.

In the long run, competition makes the best regulator for electric generation. There still remains a need for technical regulation for system stability and reliability, but for cost control, competition is unequaled. But before regulators open the floodgates, there is one last task left: To fulfill bargains made and the promises granted. Only then allow the swift sunrise of competition. t

Charles E. Bayless is chairman, president and CEO of Tucson Electric Power Co.

1See, United States v. Winstar Corp., et al., 116 S.Ct. 2432 (1996).

2483 U.S 299,