Illinois has yet to face the issue, but when it does, it may find the road blocked by jurisdictional rules at the FERC. According to estimates by Moody's Investor Service, the state of Illinois would face stranded costs of nearly $6 billion if it should mandate retail wheeling to allow the state's electric utility customers to choose their own supply of electricity.
And, if this prediction should hold true, and if utilities should be made to forfeit some of those costs, then the Illinois Commerce Commission (ICC) and the other state public utility commissions (PUCs) will likely assume the job of calculating the stranded cost to be recovered (em one that could prove daunting.
Nevertheless, with all that has been written about the various methods for calculating stranded costs, the choice of method is not the critical issue. The more difficult task comes later: How can stranded costs be legally recovered in practice? That is the primary question that should concern legislators, regulators and financial analysts. Unlike the wealth of discussion about estimating strandable costs, not much has been written about recovery mechanisms. In fact, it always seems to be assumed that if stranded cost recovery is allowed, then such costs can be recovered. However, this assumption may prove overconfident.
So far, neither the ICC nor the state legislature has had occasion to address formally the question of utility recovery of stranded costs, but the issue has never strayed far from view.
Last year, for instance, the Illinois Commerce Commission approved retail wheeling experiments proposed by Illinois Power Company and Central Illinois Light Company (see sidebar), but was not called upon to issue an opinion on strandable costs, since neither company had sought recovery for any costs that might be left stranded by the experiments.
Meanwhile, in the legislature, the Illinois General Assembly had began work in 1995 on a comprehensive electric industry reform bill, and a Joint Committee on Electric Utility Regulatory Reform (formed by Senate Joint Resolution 21), was set up to prepare a final legislative proposal by November 8, 1996, with assistance from a Technical Advisory Group (TAG) designed to gather information, review the various restructuring proposals, and report back to the Joint Committee.
Unfortunately, although not unexpectedly, the TAG was not able to achieve a consensus on any particular plan. However, before turning the matter back to the Joint Committee, the TAG did issue a report in May 1996. That report indicated general agreement among the utilities and other parties on allowing retail direct access and on the recovery of at least some of the utilities' strandable costs. This agreement seems consistent with the guiding principles that the TAG agreed to in November, 1995. These principles call for competition, "a structured and rational transition period," and flexibility. The ability of the TAG to reach agreement on direct access illustrates the industry's acceptance that government sanctioned competition is inevitable.
Turning back to Illinois Power and CILCO, and their retail wheeling experiments, the authors cannot say how the stranded costs, if any, would have been treated by the ICC had the commission addressed the issue. However, given the limitations of Illinois case law, we suspect that this matter might have been treated in the same manner that the stranded costs created by special anti-bypass contracts have been treated since the mid-eighties: There would be no immediate recovery, but ICC would consider of the revenue shortfall in the companies' next rate cases.
Unlike special contracts, where ratepayers benefit from the continued contributions to fixed costs, recovery of losses stemming from unbundling would have been difficult to justify. In an effort to
eliminate the barriers to demand-side management, the ICC attempted to allow utilities to recoup the revenues associated with foregone sales through a special rider. However, the Commission was later overturned by the courts, which found that customers should not be billed for services they did not receive.
Two Basic Methods
While the subject is marked by technical nuances, one can define two basic approaches for calculating strandable costs. There is the "top-down" approach, a relatively simple calculation of the system-wide revenue loss brought on by competition. And there is the more difficult (and assumption-filled) "bottom-up" approach, which compares the worth individual utility assets to the market value of such assets. The jury is still out on whether the benefits of improved precision achieved with the "bottom-up" approach will outweigh the drawbacks, such as extensive litigation over the numerous assumptions that are employed.
Many of the methods now under discussion amount to nothing more than variations of these two basic approaches. The Moody's "break-even price" method, for example, is somewhat reminiscent of a "top-own" approach. Most of these methods can be applied on ex ante or ex post, using estimated or actual market values and prices.
Nevertheless, the selection of a method for calculating stranded costs should not be our major concern. If legislators or regulators are particularly troubled by the selection of a methodology, they can always resort to a mechanism for reconciliation. (However, that mechanism could eliminate the incentive for utilities to mitigate their strandable costs, much like the FAC (fuel cost adjustment) and PGA (purchased-gas adjustment).
Moreover, if state lawmakers should adopt a mandatory retail wheeling law that provides for stranded cost recovery, they would also probably provide some guidance regarding the choice of method. Indeed, some legislators have already raised concerns about the validity of ex ante administrative determinations of market price (em the key to estimating stranded costs.
Fraught With Uncertainty
How can stranded cost be legally recovered in practice? That is what should concern the legislators, regulators, and financial analysts.
A surcharge, applied against rates for unbundled transmission and distribution (and set by state regulators) would offer the simplest mechanism for recovery of stranded costs. This method would allow states to follow the doctrine of cost causation: impose stranded costs on the parties responsible for them (em namely, the departing customers.
Jurisdictional Conflicts. Unlike the gas industry, however, where the Federal Energy Regulatory Commission (FERC) enjoyed primary jurisdiction over transition costs, the electric industry debate will be complicated by federal-state jurisdictional conflicts. By asserting jurisdiction over jurisdiction over unbundled, retail transmission, the FERC has made a relatively simple process far more demanding.
The FERC has announced that it intends to apply a "functional-technical test" to mark the elusive "bright line" separating "transmission" facilities (where the FERC believes its jurisdiction ends) and "local distribution" facilities (where the FERC believes state jurisdiction begins). Under this test, FERC will employ seven "indicators" to determine whether the utility facilities used to provide retail wheeling are "transmission" or "local distribution."
The Illinois commission and several other PUCs have objected to this test and to FERC's claim of authority over unbundled transmission. The consensus is that under the Federal Power Act, the act of unbundling transmission services should not trigger FERC jurisdiction.
More Than Turf. To an outside observer, these objections are probably seen as nothing more than a turf battle. However, it is important to recognize the implications for state regulators that follow this loss of jurisdiction.
In comments on the proposed FERC Order 888, several parties, including the Illinois Commerce Commission, expressed concern that under certain circumstances, there may not be any distribution facilities upon which states could impose surcharges. Therefore, without transmission jurisdiction, retail wheeling surcharges may be lost as a means for stranded cost recovery.
In an effort to preserve the ability of state PUCs to recover retail stranded costs through distribution surcharges, the FERC responded to these concerns in its final Order 888 by stating that it would give deference to the recommendations by the state PUCs regarding what is transmission and what is distribution. In theory, this sounds reasonable. In practice, the FERC has so far remained true to its word in cases like PG&E and New England Power; however, neither of these cases involves full-scale retail wheeling programs, where the stakes and the level of complexity is expected to be higher. Hence, states that are seeking a uniform mechanism to recover stranded costs may find that they cannot rely exclusively on distribution surcharges.
Voltage-Level Issues. The FERC does not and cannot offer any assurances that the case-by-case application of its "functional-technical test" will produce a finding that "local distribution" facilities are utilized in all retail wheeling scenarios. Without the clear opportunity to employ distribution rate surcharges, the FERC's efforts to preserve a state's ability to recover retail stranded costs through distribution rates will prove meaningless.
Furthermore, some industrial customers throughout the country are currently taking power at what may be considered transmission-level voltages or served by what may be deemed a transmission facility under FERC's functional test. In Illinois, roughly 11% of the four major utilities' total load is served by such facilities. Even if the radial lines connecting some of these customers to the utility grid are deemed "local distribution" facilities, industrial customers may attempt to bypass distribution facilities to avoid paying surcharges.
Exit Fees? Of course, states could employ other recovery mechanisms, such as exit fees. But, unlike wholesale arrangements, there is not always a written contract between retail customers and utilities. In Illinois, for example, residential customers do not have an explicit, individual contract with a utility. It is not clear what exit fees can be attached to. To what extent can a residential customer be bound by a franchise agreement that a municipality has entered into with a utility? The question has never been answered. Perhaps the FERC was relying on its policy on wholesale stranded cost recovery, and the typical contractual relationship that makes it possible to negotiate or impose a wholesale exit fee, when it suggested exit fees as an alternative to recover retail stranded costs.
There is also what FERC proclaimed in Order 888 to be the authority of the states over "the service of delivering electric energy to end users." However, this alternative is no more comforting. Although we do not accept the argument, we do acknowledge a certain logic to the premise that if unbundled transmission is in interstate commerce, and if a stranded-cost charge affects the terms and conditions of that service, then the states should not have the authority to provide for recovery. Futhermore, we find the FERC's statement in Order 888 to be disturbing:
Should a situation arise in which a state regulatory authority concludes that it has no ability to address retail stranded costs, or the appropriate state courts ultimately determine that a state regulatory authority does not have the authority to impose retail stranded cost, a utility may seek recovery [from FERC] through its [FERC]-jurisdictional retail transmission rates . ...
We find it unlikely that a state general assembly would allow recovery of stranded costs and not grant its utility commission the authority needed to carry out the task. Is the FERC simply establishing a backstop for stranded-cost recovery through this policy statement? Or does it also suspect that states may not be able to recover stranded costs through anything other than transmission tariffs?
Impediments to Customer Choice?
Of equal concern is authority of the states to mandate retail transmission service. FERC itself seems to recognize the problem (em that if the states cannot regulate unbundled transmission, they may not be able to instruct electric utilities to provide such services. This point marked the crux of the utilities' argument against retail wheeling in the Michigan ABATE cases, and will likely resurface again if utilities remain unsatisfied with state-mandated policies for stranded-cost recovery.
The FERC has done nothing to dispel this notion. In fact, on page 557 of Order 888, among other places, FERC stated:
[W]e do not address whether states have the lawful authority to order retail wheeling in interstate commerce. In addition, we are neither endorsing nor discouraging retail wheeling.
Although the jurisdictional issue has not been, and should not form, an impediment to state restructuring plans, it is important for legislators, regulators and financial analysts to be mindful of its possible impact on the restructuring process. Inflexible rules and laws could easily complicate the transition to a competitive electric industry. Relying solely on the states' perceived authority over unbundled transmission for the recovery of stranded costs is a good example. t
Ruth K. Kretschmer is a member of the Illinois Commerce Commission, having been reappointed for a third five-year term as commissioner in June 1993. She is also chairman of the Committee on Gas of the National Association of Regulatory Utility Commissioners, and chair of the advisory council to the Gas Research Institute. Robert Garcia is an executive assistant to Commissioner Kretschmer, and has also worked as an electric utility analyst in the commission's Office of Policy and Planning.
Illinois Power (em Tariff SC 37:
• Offers maximum of 50 megawatts of transmission capacity
• Customers must have firm demand of at least 2 megawatts
Central Illinois Light (em Rate 33
• Covers 8 largest industrial customers with demands of 10 megawatts or greater
• Offers maximum of 50 megawatts of transmission capacity for up to two years
Central Illinois Light (em Rate 34
• Covers residential and commercial customers in 3 designated areas
• Allows maximum purchase of 5 megawatts off-system, for up to five years.
The FERC's Functional Test
To safeguard state PUC prerogatives to impose a stranded-cost surcharge on distribution, the FERC announced in Order 888 that it would give "deference" to state PUCs on what is transmission and what is distribution.
That policy began to take shape on October 30, 1996, when, the FERC heard petitions filed by the three major, California investor-owned electric utilities (at the direction of the California PUC) asking the FERC for a declaratory order to, among other things, interpret which "transmission" facilities must be placed under the operational control of the California Independent System Operator, and which facilities would be available to the California PUC to support a competitive transition charge (CTC).
The primary difference among the utilities in their characterization of assets involved facilities between 60 and 138 kilovolts (kV). But with two minor exceptions (one involving radial generation ties, the other concerning step-up transformers and substations for the San Onofre nuclear plant), the California PUC had accepted the classifications (transmission, distribution, or generation) submitted by the utilities. The PUC also supported the utilities argument that the ISO could effectively control the transmission system and maintain reliability regardless of whether the facilities were designated as "transmission" or as "local distribution."
Citing Order 888, the FERC said it would defer to the PUC: "Such deference ... is only for the purpose of determining what facilities are jurisdictional ... for the purposes of the state's retail-access initiative." See, Pacific Gas & Elec. Co., et al., Dkt. No. EL96-48-000, Oct. 30, 1996 77 FERC ¶ 61,077.
Speaking at the commission's open hearing, the FERC's James Hoecker contrasted the ruling with a different conclusion reached the same day in a case involving the New England Electric System. In that case, he said, the Massachusetts DPU had not presented a sufficient analysis of its jurisdictional split under the guidelines of Order 888. See, New Eng. Pwr. Co., et al., Dkt. No. EL96-48-000, Nov. 5, 1996 77 FERC ¶ 61,135.
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