Stranded investment is mostly intrastate.

Let the states work free of uncertainty.

Recent activity in both chambers of the U. S. Congress shows federal lawmakers seeking to help the electric industry move toward competition. More than likely, election-year politics will stand in the way. Even so, Congress can go one better: It can step aside and let the states lead the way.

The greatest concern lies in stranded costs (em utility assets and obligations valued on company books at above-market levels.

Regulators feel a responsibility to compensate utilities for the cost of actions once found prudent or taken at the regulators' own behest. In fact, the public officials who have taken a stand on stranded costs have all called for substantial recovery, including the Federal Energy Regulatory Commission (FERC), the California Public Utilities Commission (CPUC), Republican Michigan Gov. John Engler, the Democratic leadership of the Rhode Island House of Representatives, and most recently, the Ohio Public Utilities Commission, in two decisions issued April 11 affecting Centerior Energy. Importantly, no policymaker has gone on record to say that utilities should bear the brunt of costs in the transition to competition.

Nevertheless, the uncertainty over the division of state and federal authority has hampered attempts to move closer to competition. Notwithstanding calls on both sides for some form of "cooperative federalism," the FERC's assertion that it holds exclusive authority to set standards for retail wheeling looms over the restructuring process. Without compromise, clarification, or deference to state action, this situation will persist (em with a chilling effect on state regulators, who fear losing all say over the utility activities they have long administered.

A second speed bump involves the evolving separation of the generation, transmission, and distribution functions. Both the FERC and the CPUC are moving in the direction of turning over the operation of utility transmission lines to an independent

system operator, or ISO. Some state regulators feel that full divestiture might prove necessary to prevent self-dealing, discrimination, and other market power abuses; but most seem willing to wait to see whether functional disaggregation, coupled with an ISO, will be enough to ensure a fair and open competitive environment. A forced sale of utility assets at this time would likely prove inefficient, given continuing uncertainty about ultimate industry structure. Such a sale would also create a glut of resources on a market ill-prepared to value and finance the transactions.

What can Congress do?

First, it can define a transition period (em in the range of five to seven years (em and prompt state regulators to mitigate stranded costs and experiment with retail wheeling programs whose impact is wholly or predominantly intrastate. Second, federal legislators could structure the operation of ISOs on a national or regional basis, including a method to evaluate how effectively they promote fair and equal access to the nation's transmission grid for any potential power supplier.

These steps, taken in concert, would encourage state policymakers to move aggressively, both to resolve the stranded-cost issue and deploy competitive structures that might survive beyond the immediate transition. With these regulatory steps taken by the states in an atmosphere not chilled by jurisdictional uncertainty, Congress will find itself better able, after the transition, to delineate the proper division between state and federal authority, especially if important issues remain.

Before jumping into the fray, though, federal lawmakers must accept that competitive markets produce winners and losers, among both customers and suppliers. State initiatives have been stymied because, in large part, they have sought to ensure competitive benefits to all customers, while safeguarding utilities and independent power producers. As long as policymakers seek to assure that no one will lose out, a competitive market will remain out of reach. t

Steven M. Fetter is senior director of the Global Power Group at Fitch Investors Service, a credit-rating agency based in New York City. Mr. Fetter formerly served as chairman of the Michigan Public Service Commission.

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