[BETA] Fortnightly

And why policy on

stranded costs defies

a traditional legal or

economic analysis.

There are sound economic reasons why policymakers should allow electric utilities to recover stranded costs through a competitively neutral network access charge, or some similar fee. First, differences in the quality of utility management appear to have contributed little to differences in electricity rates among states. Second, without recovery of stranded costs fundamental features of electricity markets, coupled with variation in rates and costs, may greatly magnify the social costs of industry deregulation. These market features include: non-homogeneity of electric service; probable divergence between its marginal cost and its social value; and inadequate market incentives to properly limit nuclear and other environmental risks.

In the long run, failure to recover the costs of stranded investment may jeopardize the solvency of many utilities and reduce the availability and reliability of electricity supply to large customer groups. In fact, such a failure could impose public safety and heath hazards well beyond those which may presently exist.

Overall, many of the arguments presented pro and con on the issue of stranded costs fail to account for the special nature of electric service. Analyses based on equity, law or static economic efficiency alone may not suffice. An analogy may be drawn to the domestic automobile market (em another industry once threatened with massive unrecoverable costs. For the nation's car makers, import restrictions proved necessary to moderate the social costs of a transition to greater competition. In the use of electricity, of course, the addition of nuclear risks to the equation make caution all the more essential.

Equity and Fairness:

No Single Point of View

To justify recovery of stranded investment, utilities resort to equity. They cite a series of handicaps that do not hobble unregulated firms, such as an obligation to serve, government-dictated depreciation rates and other limitations. Utilities claim such restraints saddled them with investments that otherwise they would not have made, or might have depreciated more quickly, if permitted.

Utilities also cited a presumed understanding termed the "Regulatory Contract." William J. Baumol postulated this contract, under which regulators "implicitly committed themselves to protect the regulated firm from a broad class of losses as an offset to their preclusion of large profits." %n1%n In Baumol's view, the potential losses arising from stranded costs form a part of this "broad class of losses" to which utilities are meant to be immune.

Others have countered with the antitrust arguments posed in the Cajun Electric case %n2%n (em that is, that recovery of stranded costs through a transmission (or distribution) charge transfers wealth unfairly from consumers and owners of nonutility generating facilities to utility stockholders. Also, critics note that no mention of a regulatory compact existed in literature until 1983. %n3%n Finally, some argue that full recovery credits utilities with perfect foresight, indemnifying stockholders from decisions that in retrospect were unwise.

Ultimately, both the definition of stranded investment and the apportionment of its cost are likely to be a matter of negotiation and/or litigation. Thus, it would appear premature to assume that any single stakeholder-group