When Électricité de France stepped in to buy Constellation Energy’s nuclear assets and help the company avoid bankruptcy, the Maryland Public Service Commission conditioned the sale on a set of...
Stranded Investment: Utility Estimates or Investor Expectations?
bridges the transition from regulation to competition. Use this result to estimate the change in the value of equity due to the coming of competition.
This method requires data on the utility's past performance and its estimated future earnings per share, looking forward from 1989. One can then discount these two figures (past earnings from 1980 to the present; future earnings to 2008) by the rate of return on common equity that regulators authorized in the 1989 rate case. This present value indicates calculated (or "realized") returns after 1989. The 1989 stock price shows the "expected" returns in 1989. If the present value of realized returns is less than the price of the stock in 1989, then investors will not have earned the returns they expected.
If future payouts are required to make investors whole, regulators must determine how to build them into rates and allocate them among customer classes. Since only the present value of payments matter for this proposed method, payments may be made in either a lump sum or a steady stream. Adjustments may prove necessary if the utility's realized future performance diverges significantly from the model's predictions, if, for instance, adverse market conditions bring an unexpected revenue shortfall that renders the utility incapable of meeting its commitments to bondholders.
Any adjustments, however, should be determined as the need arises, rather than as fixed amounts computed in the heat of a transition to a market with an uncertain future. Estimates of unrecoverable plant values are sensitive to assumptions about future market conditions and the speed at which retail competition will spread. %n5%n Once-and-for-all determinations are not necessary for access to capital. Uncertainty about future markets and stranding recoveries has adversely affected the financial health of only a few utilities. %n6%n
Identifying the Benefits
Returning to investors an amount consistent with their expectations under the old regulatory regime is fair, efficient and better grounded in reality than giving them a payoff that depends on the vagaries of regulatory accounting. The Financial Expectations method accounts for the returns long-term investors actually realized in the past and for the returns they are likely to earn after competition comes. It reduces their recovery if their past returns exceeded those authorized by regulators, and augments recovery if past performance fell short.
This method is far from a perfect solution, but may emerge as the best without reopening a decade of regulatory dockets. Ideally, investors should be able to keep supernormal returns made by good management that earlier stranded some investments. Investors should also be denied payments that make up for substandard performance by less competent managements. Retrospective redeterminations, however, are unlikely to impose heavy burdens on scarce regulatory resources in return for questionable benefits.
A reasonable compromise on stranded cost begins by presuming the existence of a Regulatory Compact. Under that compact, however, investors accepted a ceiling on their returns. Fairness to ratepayers requires that they pay no more than is required to give the investors the amounts for which they contracted. These amounts may be quite unlike those calculated by the lost-revenues or