As the U.S. Congress works to pass federal legislation introducing competition into the electric utility industry, one of the most divisive issues regulators and policymakers must grapple with is that of stranded cost. In a recent study completed by Resource Data International, we have found that an important issue will be how "negative" stranded costs are handled.
At the heart of our study is a detailed, plant-by-plant, analysis of stranded costs for every utility in the country. We estimate that the total above-market stranded cost nationally is $202 billion. The lion's share of this stranded cost ($86 billion) results from heavily financed nuclear power plants. Utilities with stranded costs, however, are able to offset some of their stranded nuclear costs with other generating assets that have market value higher than current book values ($17 billion offset). The second largest component of stranded costs results from power purchases from other utilities ($54 billion). The third largest component is regulatory assets ($49 billion). The final component of stranded costs, a nagging relic of the Public Utilities Regulatory Policy Act of 1978, consist of $42 billion in above-market power-purchase contracts from nonutility generators. Utilities with stranded costs will be able to offset a small portion of these costs through long-term, above-market sales to other utilities ($12 billion offset). These stranded costs burden all portions of the utility industry: investor-owned utilities account for $147 billion; public utilities for $33 billion; and cooperatives for $22 billion.
Stranded costs are highly concentrated within the industry. In fact, just 20 utilities account for more than half of the $202 billion of stranded costs. Another group of utilities have "negative" stranded costs. Specifically, the market value of these utilities' assets in a competitive market is higher than the existing net book value of the assets. We estimate that these utilities have stranded benefits of almost $59 billion.
The majority of these stranded benefits result from low-cost generating assets. Kentucky Utilities, one of the lowest cost producers in the country, provides a good example of a utility with assets where the market value is substantially higher than the current book value. In 1998, RDI estimates that the net book value of KU's coal-fired generating assets will be $181 per kilowatt. To put this number into perspective, a new combined cycle plant can cost as much as $450-$550 per kW and a new coal-fired plant costs even more. We estimate that the market value of these assets is $440 per kW, two and a half times the current book value. If KU could charge what the market will bear for its generation, its customers' rates would increase. Of course, the state regulatory commissions, prodded by consumer groups, will be looking for ways to capture the difference for retail customers. Other utilities that have generating assets that are valued considerably higher by the market than they are on the books include PacifiCorp, New York Power Authority, Oklahoma Gas and Electric, Ohio Power Company, and Appalachian Power Company. In the states where these and other similarly postured utilities operate, the impact of customer choice on retail rates will be a major political and regulatory issue.
U.S. utilities own more than 655 GW of generation assets. The net book value of these assets in 1998 will be $227 billion, or about $346/kW. RDI estimates that the market value of these assets is only $187 billion. Nearly half of all utility generation investments are accounted for by nuclear generation. The market value of these plants is only one-fifth of the remaining undepreciated investment in the plants. For all other classifications of generation, however, the estimated market value of the assets is higher than the book value, resulting in the stranded benefits.
The political interests of consumers and utilities will vary widely in different states. In states with high stranded costs, utilities will fight to protect their shareholders while consumers and new market entrants will fight for immediate benefits from deregulation. In states that have negative stranded costs, utilities will fight for immediate deregulation while consumers will fight to ensure that their rates do not increase as a result of deregulation. Caught in the middle will be states that have utilities with both substantial above-market costs and substantial below-market costs.
Christopher Seiple is principal at Resource Data International Inc., an energy industry consulting and information management firm specializing in market and competitor analysis.
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