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Stranded Cost Do's and Don'ts
[Papers & Pubs] [Stranded Guide]

Do’s and Don’ts for Stranded Cost Legislation

William B. Marcus, Principal Economist, JBS Energy, Inc.

Adapted from a presentation to the National Council of State Legislatures, Las Vegas, Nevada,  July, 1998

I was asked to discuss several topics, including the legislative and regulatory roles in stranded cost determination and the role of securitization of stranded costs as a panel member at the 1998 NCSL conference. These notes cover eight specific elements of what legislators should and should not do in writing the portion of restructuring legislation dealing with stranded costs.

1. Set the framework, don’t delve into the details. 

    The definition of stranded cost is very complex.  Little is cut and dried, even in areas that some might think are straightforward on the surface, such as regulatory assets.  Detailed prescriptions on how to define stranded costs became homes for a number of special interest provisions benefiting utilities in California’s legislation.

2. Do not require 100% stranded cost recovery; let regulators make the decision. 

    Recovery of 100% of stranded costs is not just an ideological question.  It is a question of regulatory structure and incentives.  If the legislature requires recovery of 100% of stranded costs, that encourages utilities to ask for more categories of costs to be included as stranded and forces regulators to work harder to weed out meritless requests.  It also does not recognize that certain estimating techniques may produce higher stranded cost estimates than simply divesting generation and receiving a market price and removes the abilities of regulators to correct for this fact.  Requiring 100% recovery also reduces the incentives of utilities to mitigate or reduce these costs.

3. Net good and bad assets. 

    A utility does not have the right to stranded cost recovery for assets whose cost exceeds their market value while keeping for shareholders the benefits of assets whose cost is less than their market value.

4. Prohibit secret processes. 

    If a utility cannot inform the public of the entire basis of its request, it should not get the money. Confidentiality and secrecy in the stranded cost process can stifle public debate and prevent embarrassing or anticompetitive requests from being aired in public forums.  In some cases, blatant subsidies for unregulated utility businesses have been included in stranded cost requests, but the public was kept in the dark by gag orders.  In many other cases, utilities use one set of numbers that yield high estimates of stranded costs while using different numbers to say that their nuclear plants are cost-effective.  The public needs to know these things.  Legislators and governors would be impeached, recalled, or voted out of office if they levied secret taxes without telling the public why they were needed.  Electric ratepayers deserve no less.

5. Do not permit regulators to give utilities operating subsidies for existing generation. 

    What is past may be stranded.  Future costs are almost never stranded and can be avoided by closing uneconomic plants.  Subsidies distort markets.  They can reduce the market price, increasing the stranded costs assigned to unsubsidized assets.  They can harm competitors, and they can make it uneconomic to build new market-based generation even in the face of power shortages. 

6. Promote utility divestiture of most generation. 

    Divestiture is good for markets by reducing both wholesale and retail market power and the opportunity for utilities to cross-subsidize their generation and retail arms.  Divestiture, by definition, provides a better estimate of market price than administrative determination by a regulatory body. Moving to a market-based system and reducing the role of regulation should start with divestiture.  It is clear that what a third party actually would pay for an asset is a more accurate determination of its value than the answer that comes out of a black box computer model, particularly one whose data are kept secret.  Divestiture can be promoted by allowing a smaller percentage of stranded cost recovery on assets that are not divested.

7. Securitization is a tool, not a panacea, and is not a substitute for good regulation. 

    It can reduce the carrying costs for stranded assets after the regulators have sharpened their pencils on the initial requests.  But it doesn’t substitute for regulatory action.  Because it only reduces costs for assets that otherwise would be in the utility rate base, it should not be used for purchased power contracts.

8. Don’t oversell securitization. 

    In California, securitization has been falsely sold to customers who are not clearly being told that their 10% rate reduction today will be financed with higher rates starting in 2002.

Failing to follow these steps not only tilts the playing field unjustly toward the utilities, but can endanger the whole restructuring process.  Several of the reasons why a California initiative is challenging restructuring are because the California legislature didn’t follow these steps.  It required the Commission to give the utilities 100% of stranded costs for nuclear power; it gave nearly $2 billion in additional operating subsidies to nuclear power, and it set up a residential rate reduction financed by securitization that was then oversold to consumers who were not informed about the plan’s higher rates in later years.


AquaCalc LLC. telephone +1.916.372.0534 e-mail: sales@aquacalc.com

[Stranded Guide]