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Stranded Utilities: How Demographics, Not Management, Caused High Costs and Rates

Fortnightly Magazine - June 1 1997

coal to utilities in Wyoming is only about half the national. Given all the exogenous cost factors beyond those reflected in the model, it would be surprising if management and regulatory variation together accounted for more than a small share of the variation in utility rates among states.

Unrecovered Costs:

Financial Impact

What is the practical financial impact of a full or partial denial of stranded cost recovery under a competitive regime? %n10%n

The nuclear-capacity variable in the model allows for the generation of rough, minimum estimates of the effect of stranded investment on electricity rates. From these estimates, the minimum impact on utility finances of a full or partial denial of recovery can be calculated.11

The greatest nuclear penalties are concentrated in the Northeast, and to a lesser extent, the South. Excluding New Hampshire, which is plainly a special case, the average penalty for states so burdened is about 1 cent per kilowatt-hour, and in the Northeast and Illinois, closer to 2 cents. (Chart 2 shows the estimated added cost in each state from nuclear investment. The estimates compare predicted electricity prices without nuclear capacity to predicted prices with it.)

Based on national average operating ratios, failure to recover the excess costs imposed by nuclear investment would usually have cut utility profits by half or more in 1994, in those states where nuclear generation capacity exists. In Connecticut, New Hampshire, Pennsylvania, Illinois, Nebraska, South Carolina and Alabama, profits would have been converted to losses.

Owing to the greatly differing size of state markets and the utilities serving them, the absolute amount of the 1994 loss in earnings that would have followed from a failure to recover nuclear costs differs greatly as well on state-by-state basis (see Chart 3). Losses would have exceeded a billion dollars in each of seven states: New York, Pennsylvania, Illinois, North Carolina, South Carolina, Virginia and California. At an estimated $2.3 billion, losses would have been greatest in Illinois, with Pennsylvania ($1.9 billion) coming in second, and New York ($1.5 billion) and California ($1.4 billion), third and fourth.

In total, the income losses amount to $22.8 billion. This total corresponds to an aggregate cost imposed by the choice of nuclear, as opposed to fossil-fueled, capacity of a like amount. Although this cost is pretax, its capitalized value is well more than $100 billion, consistent with current estimates of the amount of stranded investment overall.

Outlook: Disruption Beyond

the Inevitable

The potential impact of stranded costs suggests that disallowing their recovery may disrupt power markets to an economically unwarranted degree.

If electricity services were homogeneous, and the social value of reliable power fully reflected in rates currently paid, the loss of local generation capacity might impose no higher risk than did, for example, the exit of garment factories from New York City. However, neither of these two conditions holds.

A simple analogy to the American automobile industry will serve as an example (see Sidebar). In that industry (em also capital-intensive, like electricity (em import restrictions and "Buy American" campaigns ultimately proved necessary to purchase an orderly, if not