Retail competition will render a substantial fraction of existing electric utility plant worthless. Some estimates are so large that the question of compensation for these so-called "stranded investments" overshadows debate on the value of retail competition. Advocates of compensation frequently appeal to a "regulatory compact." They claim that this compact justifies compensation for utilities on grounds of fairness. The case for fairness, however, is badly flawed. Moreover, compensation may adversely affect the efficiency of markets in which competition is emerging. Compensation forces power users to forego productive opportunities to make their own transactions while they finish paying for plants that utilities never should have built. Save for special cases, it is both fair and efficient that utilities take the losses on those plants.
Voltaire said that history was nothing but a fable that had been generally agreed upon. The fictitious regulatory compact that justifies stranding compensation makes for poor history and misleading fable. Despite frequent claims that its roots go back to Hope and Bluefield, the compact is a recent intellectual invention. According to a LEXIS(r) search, the first regulatory and court decisions to mention it only appear in 1983 and 1984. The legislative history of regulation is strikingly devoid of references to a compact, and no known regulation arose from a collaborative effort at which anything resembling a compact was on the agenda. "Stranded investment" carries a similarly short pedigree, and is to this day absent from textbooks on regulation and industrial organization.
The Compact's Fine Print