Stranded costs are those costs that electric utilities are currently permitted to recover through their rates but whose recovery may be impeded or prevented by the advent of competition in the industry. Estimates of these costs run from the tens to the hundreds of billions of dollars. Should regulators permit utilities to recover stranded costs while they take steps to promote competition in the electric power industry?
Fortnightly Magazine - May 15 1995
The Minnesota Court of Appeals has upheld a Minnesota Public Utilities Commission (PUC) ruling that Minnegasco's appliance sales and service business should be charged for the value of goodwill related to Minnegasco's name, reputation, and image. The court also ruled that the cost of responding to emergency gas leak calls should be shared by the utility and its appliance service businesses (Docket Nos. C5-94-1820 and C7-94-1821).
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.
Southern California Edison (SoCalEd) has unveiled a plan to slash its electric rates 25 percent by 2000, in anticipation of increased competition. The goal is a "real" price decrease (that is, adjusted for inflation), which translates into a system average price reduction from the present 10.7 cents per kilowatt-hour to below 10 cents. SoCalEd will consider a broad range of initiatives, most of which will require the approval of the California Public Utilites Commission. Included is an immediate rate freeze for residential and small business customers through 1996.
Electric utilities now face the risk that existing assets, costs, or contract commitments may be "stranded" by increased competition, leaving shareholders rather than customers to bear the costs. Have shareholders already been compensated for this risk?
Some argue that shareholders have automatically been compensated for this risk by an allowed rate of return equal to the cost of equity capital determined in efficient capital markets.1 If so, forcing shareholders to bear stranded costs may seem fair.
The Independent Power Producers of New York, Inc. (IPPNY) has released an initial white paper on restructuring the electric industry in New York State. The paper concludes that electric rates in New York are too high and suggests paramount objectives: 1) all customers should enjoy direct access and choice among electric suppliers, and 2) disaggregation of vertically integrated utilities must occur in such a way that the surviving natural monopolies (em the wires businesses (em remain financially indifferent to customer choice of supply.
The question I am asked most frequently is "Who will emerge as the 'winners' and 'losers' among today's electric utility companies?" The short answer is painfully simple. The winners will offer the best prices (a.k.a., the low-cost producers). The losers will be unable to cut prices to meet the market (a.k.a., the high-cost producers).
Unfortunately, real-world answers rarely come in black and white. The electric utility industry enjoys less pricing flexibility than one might imagine.
The New York Public Service Commission (PSC) has frozen 1995 electric rates for Long Island Lighting Co. (LILCO) and for Consolidated Edison Co. (CE), emphasizing the need for both utilities to control costs. CE had asked the PSC to approve a three-year rate plan that includes a $223-million (3.6-percent) increase the first year. According to Fitch Investors Service, both orders offer constructive and clear signals that the PSC will attempt to strike a reasonable balance between investor and consumer interests.
Real-time Pricing, Not Restructuring
Richard Abdoo's article, "Wisconsin Electric's View of a More Competitive Industry," (Feb. 15, 1995), brought this quote to mind: "We trained
hard. . . . But it seemed that every time we were beginning to form up into teams we would be reorganized. I was to learn later in life that we tend to meet any situation by reorganizing; and a wonderful method it can be for creating the illusion of progress while producing confusion, inefficiency, and demoralization" (Petronius (em 256 BC).