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FERC Should Not Assist Stranded Cost Recovery

Regulatory Comments and Testimony

Title

FERC Should Not Assist Stranded Cost Recovery

 

UNITED STATES OF AMERICA

Before the FEDERAL ENERGY REGULATORY COMMISSION

In the matter of:

____________________________________

(Recovery of Stranded Costs )

by Public Utilities and ) Docket No. RM94-7-001

(Transmitting Utilities )

____________________________________)

 

To: The Commission

COMMENTS OF THE COMPETITIVE ENTERPRISE INSTITUTE

ON THE NOTICE OF PROPOSED RULEMAKING OUTLINE

 

I. OVERVIEW

II. WHAT'S AT STAKE: SAVINGS TO CONSUMERS FROM ELECTRICITY DIRECT ACCESS

A. Enhanced Consumer Savings and Wider Choice

B. Taxpayer Savings

1. Savings from federal agency direct access to energy

2. Decreased spending on the Low-Income Home Energy Assistance Program

III. WHY THE FERC SHOULD NOT HELP UTILITIES RECOVER STRANDED COSTS

A. The Pretended Regulatory Compact

1. Ratepayers were not consulted

2. Utilities never a genuine natural monopoly

3. Obligation to serve is not a burden

B. Investors' Choice Vs. Customer Captivity

C. Strandings Will Not Occur Immediately and Will Be Minimized with a Non-Recovery Rule

D. Non-Utility Firms Have Never Been Able to Recover "Strandings"

E. Stranded Cost Recovery Rewards Inefficiency

IV. NOTE ON FAIR TREATMENT OF UTILITIES IN THE ABSENCE OF STRANDED COST RECOVERY

V. NOTE ON A COMPETITIVE GRID

VI. CONCLUSION

COMMENTS OF THE

COMPETITIVE ENTERPRISE INSTITUTE

ON THE NOTICE OF PROPOSED RULEMAKING

FERC SHOULD NOT ASSIST STRANDED COST RECOVERY

Submitted by

Clyde Wayne Crews, Jr.

Fellow in Regulatory Studies

August 4, 1995

One thing you have to remember is that this is not an argument about who can supply power the best or how the customer can benefit. It is purely about money--who's gonna get it, who's gonna pay it.

Don Jordan, Chairman, Houston Industries (Palmeri, 1995, p. 52)

 

The Competitive Enterprise Institute (CEI), a Washington-based public interest group established in 1984, works to educate and inform policymakers, journalists and other opinion leaders on market-based alternatives to political regulations and programs. CEI appreciates the opportunity to submit these comments for the consideration of the Federal Energy Regulatory Commission.

I. OVERVIEW

CEI submits these comments to the Federal Energy Regulatory Commission (FERC) for one primary purpose: To urge that the FERC ensure that stranded costs of utilities not be assessed on either bypassers or captive ratepayers, but are mitigated by utilities themselves and finally absorbed by utility investors where necessary. Many arguments support this stance. In the nature of things, stranded costs must be absorbed by someone, and that someone must necessarily be either electricity buyers or the utility investors. CEI believes investors should bear that responsibility. At bottom, if utilities successfully secure a governmental guarantee of stranded cost recovery it will enable them to do exactly what monopoly regulation is supposed to prevent: charge the public more than the competitive price for electricity.

Allowing stranded cost extractions from consumers is an open rejection of the historical "public interest" justification for regulatory intervention into the marketplace. A policy of allowing utilities to recover stranded costs prior to a marketplace determination of which facilities are actually useless will permit maintenance of an otherwise unsustainable profitability, reduce the number of competitive suppliers of electricity, and thereby reduce customer choice and well-being. Costs of those facilities that do prove useless should be borne by the utilities themselves. The costs to society of competitors who never emerge and prices that never fall to their unregulated lows are real costs, though not visible to the naked eye of the public in the way that stranded costs are visible to the eyes of regulators and the utilities. Consumers, usually dispersed and unorganized, have no well-established forum at the FERC.

Consumer well-being is not the motive for calls to reimburse stranded costs: Ratepayers were not responsible for the creation of these costs, and are unambiguously better off without paying them. Except where bypass bargains are made between utilities and dissatisfied customers, ratepayers will not pay those costs unless forced to by the regulator. In fact, the only reason a notion as economically and morally preposterous as stranded cost reimbursement has credibility is because utilities are regulated by an agency rather than by consumers. In no unregulated field of endeavor can a seller force purchasers to buy a product they do not want or to pay for the seller's useless equipment and inventory.

Since consumer well being is the stated goal -- and the only legitimate goal -- of federal regulation, the FERC -- except where recovery has been provided for contractually or where voluntary bargains are struck -- should announce that it will not contemplate wholesale or retail stranded cost requests or those arising in the context of municipalization, and leave the matter entirely up to states. If the latter path is chosen, there will be an opportunity for limited competition among states to minimize stranded cost recovery and thus benefit customers. The FERC should make its announcement at once to eliminate uncertainty about its own role and encourage firms to act quickly to mitigate their own stranded costs out of necessity, through a realization that regulators do not exist to make them whole, but only to protect consumers subject to a monopolized industry. Such is the proper precedent to establish. Future generating facilities will also eventually be stranded by competition, and at some point in the future transmission itself will become competitive. Without setting proper rules of the game now, utilities will want to recover those "strandings" as well since regulators will have demonstrated a willingness to oblige. Power is a dynamic industry that promises many unforeseen "strandings" over the coming years. It is important for the FERC to come out unequivocally against stranded cost recovery to protect consumers.

II. WHAT'S AT STAKE: SAVINGS TO AMERICAN CONSUMERS FROM ELECTRICITY DIRECT ACCESS

A. Enhanced Customer Savings and Wider Choice

Americans will save vast amounts of money as direct customer choice in electricity becomes a reality. The electricity industry boasted sales of $198 billion in 1993. The average price of electricity in the country across all user sectors (residential, commercial, industrial and other) is now about 7 cents per kilowatt-hour (kwh), but that price varies tremendously across regions within each sector despite the fact that electricity is a highly uniform product (see chart).

Average 1993 Revenue per Kilowatt-Hour By Sector and Census Division

All Sectors Residential Commercial Industrial Other

U.S. Average 6.93 8.32 7.74 4.85 6.74

New England 10.01 11.24 9.85 8.26 12.66

Middle Atlantic 9.50 11.34 10.15 6.58 9.65

East North Central 6.50 8.34 7.39 4.56 7.04

West North Central 6.04 7.27 6.31 4.44 6.45

South Atlantic 6.61 7.84 6.70 4.72 6.41

East South Central 5.23 6.24 6.51 4.16 5.95

West South Central 6.34 7.89 6.93 4.38 6.65

Mountain 6.15 7.60 6.70 4.29 5.68

Pacific 7.43 8.59 8.80 5.10 4.63

Alaska/Hawaii 10.48 11.83 10.69 8.86 12.42

 

Highest:* 10.01 11.34 10.15 8.26 12.66

Lowest: 6.04 7.27 6.31 4.16 4.63

Difference: 3.97 4.07 3.84 4.10 8.03

Source: Energy Information Administration, Electric Power Annual, 1993. (*contiguous states)

The wide-ranging price disparities between the highest and lowest regional cost in each sector point to extraordinary embedded inefficiencies. As the price differences across high- and low-cost regions illustrate, competitive purchase of electricity by economic sectors promises dramatic economic savings to those who can escape captivity. Bypassing the local high-cost utility company in favor of direct access to power generators located in another state or region can save customers billions of dollars and compel the electric utilities to offer the lowest prices possible to stay competitive or to leave the industry. New independent power generators for handling peak loads can sometimes inject power into the grid at under 3 cents per kwh.

Economist Robert J. Michaels of California State University at Fullerton put it succinctly to the Wall Street Journal: "[R]atepayers have been buying overpriced electricity." A 1 cent per kwh drop in the average electricity cost of 7 cents translates into a savings to residential and industrial customers of $28 billion per year (Bailey, 1995). One study concludes savings to consumers could reach $80 billion per year if utility monopoly powers were removed (Tabors, Caramanis & Associates, 1995), a gigantic figure relative to the industry's annual sales. Despite these current overpayments by consumers, utilities want consumers to pay them for uneconomic plants, the so-called stranded costs.

Competition, when instituted, will ensure the lowest possible costs, especially if forward-looking steps are taken toward making the grid itself competitive. Many envision a point at which household customers can select a power supplier much the way they now select long-distance phone services. During the development of an electricity marketplace, some large purchasers may contract directly for electricity from suppliers, or alternatively, they may purchase power from a pool or clearinghouse in which up-to-the-minute changes in the price of electricity are reflected. Obviously such conditions promise far superior service for customers than today's system.

This debate will invite fundamental questions, including questions over the role of regulatory bodies such as the FERC: Is the FERC actually protecting the public, or by endorsing and prolonging stranded cost recovery is the FERC instead protecting entrenched monopoly interests and its own existence? Genuine deregulation ought to establish a path by which the roles of the FERC and state regulatory bodies ultimately become irrelevant and such agencies can be dismantled. Such a scenario envisions full "retail wheeling" or direct customer access, in which utilities are regulated not by government but by competition, and ultimately by competition across a contestable, privatized grid (or grids). The halfway approach to competition that the FERC appears to be pursuing -- that of establishing wholesale wheeling but remaining vague on retail wheeling while fully accepting the legitimacy of stranded costs -- will create tremendous inefficiencies that will be difficult to rectify later, and that will probably lead to new rounds of claimed stranded costs.

Customer choice is obviously not just a matter of saving dollars. Under direct access, those concerned about the environment will be free to purchase power from any source of their choosing, whether solar, wind, geothermal, or biomass, or other. Direct access and a right to compete with conventional energy sources has the potential to make these sources increasingly competitive, but to the extent they do cost more the premium will not be hidden from ratepayers.

B. Taxpayer Savings

By assuming a leadership role on the matter of competition in electricity, the federal government can advance the separate goal of saving taxpayer dollars.

1. Savings from federal agency direct access to energy: Allowing federal agencies that purchase electricity -- particularly the defense department -- to bypass the local utility and purchase electricity from the lowest cost provider could save taxpayers hundreds of millions annually. According to House Committee Report 104-131 accompanying H.R. 1530, the 1996 defense authorization bill, the Department of Defense spends $2 billion per year on electricity and could save about 20% through competitive procurement and management efficiencies. That amounts to roughly $400 million annually, or $2 billion in taxpayer savings over five years.

2. Decreased spending on the Low-Income Home Energy Assistance Program: The FY 1995 Labor/HHS appropriation included $1.319 billion for the Low-Income Home Energy Assistance Program (LIHEAP). These dollars go to various ends: about 60% of funds for heating costs, 1% for home cooling, 12% for crisis aid, and 12% for home weatherization, and about 10% for administration. The dramatic decreases in electricity prices that competition will bring can mean a significant decrease in the need for the portion of LIHEAP that funds electricity subsidies.

III. WHY THE FERC SHOULD NOT HELP UTILITIES RECOVER STRANDED COSTS

The primary historical justification of economic regulation has been to protect customers from monopoly, not the other way around. The public interest case for regulation and the duty of the regulator has never been to protect the monopolist from customers. But now, in an awkward--although foreseeable--twist of fate, the tables have turned. Electric utility monopolies now want government protection from their customers.

As the American Public Power Association aptly put it in the organization's filing on the FERC's 1994 notice of proposed rulemaking on stranded costs, "[w]e must avoid the crowd mentality and cast a cold eye on the bare facts" (December 6, 1994). Stranded costs are already sunk, and are not the responsibility of consumers in the electricity industry any more than they are in any other industry that experiences a massive shakeout. Now, the question is what institutional arrangement maximizes output of electricity, protecting the widest possible choice for customers and at the lowest possible cost. Stranded cost recovery on the backs of ratepayers is not a valid part of that arrangement.

A. The Pretended Regulatory Compact

Utilities claim that their right to recovery of stranded costs stems from the regulatory compact, from their construction of assets on behalf of consumers along with an obligation to serve them. In that case strandings -- strictly speaking -- can only apply where a retail franchise is abrogated by the states, at the level at which the "obligation to serve" supposedly applies. Nothing the FERC has done so far has stranded any retail assets, and there is no federal "obligation to serve" that would merit stranded cost recovery at the wholesale level, where transactions are governed by contract (McDiarmid, 1995). Strandings are supposed to apply to the monopoly franchise, which is at the transmission and distribution level. Yet even at the retail level, the case for imposing stranded costs on captive ratepayers is groundless for many reasons.

1. Ratepayers were not consulted: Utilities are using the notion of an imagined "regulatory compact" to club captive ratepayers. Utilities in essence are saying to customers, "We took on this undertaking voluntarily, but now that we're not needed anymore we're going to make you pay us to go away." Economist Robert Michaels highlights the opportunism of such a notion by pointing out that the phrase "regulatory compact" did not appear in the literature until 1983 and 1984 (1995).

Ratepayers were never asked if they wanted to take part in a regulatory compact with utilities, nor did ratepayers ever sign such an agreement, nor would utilities and customers in the early 1900s -- even if they had made such an agreement -- have had any right to bind future generations of ratepayers to such an agreement. And even if they had signed such an agreement and could somehow bind posterity, any such contract would have included the right to opt out once cheaper service became available. Customers -- no matter the product or service and no matter the regulatory environment -- owe no allegiance to the manufacturer, and no seller has the luxury of assuming he is entitled to customers. There can be no unchosen customer obligations to pay for that which one does not want to buy, only voluntary exchanges between seller and buyer. The basic prerogative of customers is the right not to buy; otherwise the exchange is not a trade but a robbery.

These basic facts starkly contrast with the "worldview" of the Edison Electric Institute (EEI), which truly regards customers as somehow obligated to a bargain they never struck, unentitled to any choice in the matter. If states don't extract money from retail customers who bypass, EEI wants the FERC to "serve as a backstop to the states" where states decide against imposing stranded costs, and to "avoid policies that allow retail customers to evade costs that were incurred to serve them," stating that [a]ll customers must pay their appropriate share of previously approved system costs and commitments" (Edison Electric Institute, 1994). This mentality is alien to competitive business.

2. Utilities never a genuine natural monopoly: Not only were ratepayers not consulted about a compact, it appears utilities motives were anything but pro-consumer in setting up the existing system of state regulated monopolies with exclusive franchises. Power companies have been regulated since their 1879 beginnings, primarily by municipalities up until the 1910s when state regulatory bodies began to assume oversight. The generally accepted tale of exploitative monopoly would imply that customers were abused by utilities until regulators stepped in to correct for market failures. Instead, competition thrived. According to Burton N. Behling (1938):

There is scarcely a city in the country that has not experienced competition in one or more of the utility industries. Six electric light companies were organized in the one year of 1887 in New York City. Forty-five electric light enterprises had the legal right to operate in Chicago in 1907. Prior to 1895, Diluth, Minnesota was served by five electric lighting companies, and Scranton, Pennsylvania had four in 1906. (Cited in Demsetz, 1968, p. 59.)

Economist Harold Demsetz (1968) noted that "producing competitors, not to mention unsuccessful bidders, were so plentiful that one begins to doubt that scale economies characterized the utility industry at the time when regulation replaced market competition." Bidders with access to the marketplace were all that were necessary to keep prices near competitive levels. Market failure in the utility business, such that it existed, was not related to unexploited economies of scale or an inclination of the "natural monopoly" to exploit consumers in the absence of regulation, but to the common ownership of rights of way and the accompanying failure to properly price access to the transmission and distribution paths, which may have led to overuse. Market failure, arguably, was primarily aesthetic.

Demsetz further argued that "economic theory does not, at present, provide a justification for [regulatory] commissions insofar as they are based on the belief that observed concentration and monopoly price bear any necessary relationship." He concluded that arguments in favor of utility regulation can be defended on the basis of an inclination toward "mild socialism," but that economic arguments "do not allow us to deduce from their assumptions either the monopoly problem or the administrative superiority of regulation." Even prior to the possibility of retail wheeling it was by no means certain that cost-plus regulation was superior to market rivalry, even assuming the existence of natural monopoly.

Research has confirmed this. Prior the wave of state regulation of utilities between 1907 and 1914 (when 27 states embraced state regulation of utilities), utilities were regulated by municipalities, which often awarded overlapping franchises, thereby creating vigorous competition. However in 1907 New York and Wisconsin passed laws transferring regulation to the state level, a model that quickly was adopted elsewhere. State regulatory bodies were given the power to convert existing franchises into "indeterminate franchises" which the municipality could dissolve at will by buying the assets. State commissions were further given the power to fix rates, to control entry by "certificates of convenience and necessity," and regulate additions to capacity. Local authority to grant franchises was effectively expropriated by this procedure (Geddes, 1992). One could quite reasonably argue that potential competitors prevented from ever offering their services were in a sense "stranded."

Regulation appears to have furthered the interests of producers rather than customers. For this massive state regulatory takeover to have been in the public interest, prices would have had to decline and quantity of power supplied would have had to increase after the transition. This, however does not appear to have been the case, as regulation appeared to make producers rather than customers better off. In contrast to the public interest theory of regulation, this outcome is consistent with the so-called positive theory of regulation which argues, as Geddes put it, that "state regulation was instituted not to correct private market failure and to increase social welfare, but to provide firms with a way to insulate themselves from the discipline of competition." Greg Jarrell (1978) determined that customers paid more for electricity under rate of return regulation after the transition than they did under competition.

Jarrell divided states into the early-regulated and the late-regulated and found that prices in the early-regulated states were 46% lower than prices in the late-regulated states (after correcting for variations in demand and costs) at the time of regulation. The utilities regulated first were the ones charging the lowest prices, supporting the private interest theory that regulation here is a pro-producer rather than a pro-consumer undertaking. Following regulation, the early-regulated states experienced a 26% increase in rates relative to price changes in the late-regulated states. Output of electricity was also reduced, and profitability and return on assets in the early regulated states was increased after regulation, further supporting a private interest interpretation of the drive to supplant municipal regulation with state regulation.

The purpose of regulation apparently was not to fight monopoly at all, but to foster it; to sacrifice interests of smaller, competitive producers to larger ones. This clearly is not a "compact" that customers would have agreed to. By expropriating for decades -- with no opportunity for relief -- customers' opportunities to purchase lower-cost, non-state-regulated electricity, utilities have thus been compensated for today's stranded costs. If anything, to the extent further study of the issue were to comport with Jarrell, utilities could be said to owe customers a back payment for the lack of competition that has existed in the entire industry since about 1924, when regulation was shifted up from the municipal to the state level. By demanding that the FERC protect retail stranded costs in the event states fall short, utilities now want to shift regulation to a higher government level yet again for the same reasons -- to protect themselves from customers, decrease industry output, and increase prices and profits.

3. Obligation to serve is not a burden: The foregoing discussion indicates that the "obligation to serve" is not a genuine burden but instead a sought after privilege. Rather than being an imposed burden, the "obligation" was sought after and achieved through a driving out of competitors and an elimination of the necessity to compete for customers within the exclusive territory. The obligation to serve is a euphemism for government guaranteed market share, a right which utilities apparently aggressively fought to secure.

B. Investors' Choice vs. Customer Captivity

Utilities are not now taking their case for stranded cost recovery to the captive general public, nor are they likely ever to do so. Such a move would likely be an abrupt non-starter. Recovery of strandings is a case that can only be made to a regulatory agency, an appeal that only such a body would entertain -- validating, but perhaps not proving, the "public choice" school of economics' argument that regulatory agencies typically become captured by the regulated. Other businesses that make poor investment decisions have no agency to appeal to that has the legal power to make its "customers" pay for the mistakes of the seller. Ratepayers perceive that utilities were never compelled to make most of the investments that are now stranded -- never mind that regulators approved the programs. And ratepayers would immediately perceive that utilities have an incentive in today's scenario to maximize the claimed amount of uneconomic investment to receive the greatest amount of recovery dollars.

On the other hand, utility investors aren't captive. They have always enjoyed choice in dealing with the utility where utility customers have always lacked it. There are many ways in which utility investors have already been compensated for risks of stranding. The basic rule of investing is to "diversify," so that the impact of unfavorable market conditions on any one portion of the investment portfolio does not significantly damage the whole. Utility investors not only have enjoyed choice and the opportunity to diversify around utility risk, they have enjoyed superior returns that have compensated them for the risk of stranded investment and other political risks that have become a part of the landscape, such as the risks of municipalization, bypass, and regulatory refusal of rate increases. According to the National Association of Regulatory Utility Commissioners in a 1993 report, "utility companies were both less risky and a substantially more profitable investment vehicle for common stockholders than the average non-regulated corporation over the past 21 years" (NARUC, 1993). Rate regulation--which was supposed to hold returns at the fair market level -- has actually served utility investors quite well.

The sole reason for utilities' clout in the stranded cost debate is the fact that they own the transmission and distribution lines thanks to exclusive franchises. If transmission lines had been separate from generation as a rule from the beginning, this debate would not be taking place and we would likely already be wheeling power at the retail level.

C. Strandings Will Not Occur Immediately and Will Be Minimized with a Non-Recovery Rule

When a retail, industrial, or commercial customer decides to bypass a utility, the utility is not necessarily stranded. Utilities will always confront a range along which they may lower rates to retain bypass customers and thus avoid immediate if not indefinite bypass. This is why magnitude of stranded costs is impossible to determine beforehand and a pre-competition estimate by utilities will be as high as possible. An up-front valuation of stranded cost compensation will be arbitrary. Utilities should protect themselves from strandings as much as possible by moving toward better-defined commercial contracts, and will be forced automatically to do so if the FERC indicates immediately that it will not recognize stranded cost recoveries. Utilities already have a history of imposing contractual bypass fees on those large customers who leave the service area or move to another state, and this is the proper approach to take toward strandings.

Utilities have always had the opportunity to protect themselves from wholesale strandings through contract specifications. Retail strandings, which clearly are the largest potential source of strandings, could be minimized by bargaining in many cases. Where a customer expresses an interest in switching to a new power supplier, the utility may be able to bargain with that customer and agree on a satisfactory price at which the customer is retained. The utility obviously will not receive its pre-competition regulated rate of return, but may be able to cover fixed costs overall. This forces out the true value of any strandings and requires the utility itself to minimize shareholders' losses since imposing them on customers would not be not an option. High cost utilities could also offer discounts and expand their customer base into other utilities' territories -- just as other firms will attempt to expand into the utility's own territory -- and to the extent that large facilities feature economies of scale, reduce per-unit costs and recover strandings that way. If wheeling helps generate an increase in power demand (through lower prices), the high-marginal-cost utilities might still be needed at peak load, meaning price won't be driven down as much as expected early on, thereby preserving facilities for a longer time. There's no way to know beforehand, further illustrating how pre-competition stranded cost assessments are arbitrary.

Scale economies are supposed to define falling average cost technology that allows one firm to produce at lower cost than two or more other firms. The point at which scale economies are no match for quicker and more adaptable non-utility generators will vary. Large utilities might have a reasonable chance of reaping economies of scale, and perhaps recovering fixed costs, if they expand aggressively enough in the new open access environment. Since these are base load operations perhaps they can develop better contracts with peak load outfits. Nevertheless, a prerequisite for creating and maintaining efficient markets is customers' ability to shop elsewhere when the service received is no longer satisfactory, so if such efforts do not succeed it is not the ratepayers' burden..

D. Non-Utility Firms Have Never Been Able to Recover "Strandings"

As Robert Michaels (1994) points out, in 220 years of speculating on the nature of competition since Adam Smith, economists got along fine without ever developing such a concept as "stranded costs." The idea is a new invention. No other business has ever had such a "right" in its arsenal to shield itself from the effects of dynamic competition. Furthermore, disallowing stranded cost recovery simply protects consumers in the way that prudence reviews by commissions sometimes do already.

The utilities already do recover some "stranded costs" where they have provided for them in contracts and where the FERC permits them upon municipalization, and, like other firms, they have the opportunity to mitigate them where possible. But sometimes businesses fail, and technological change is a big reason. The typewriter has recently been "stranded" by the word processing computer, and the Post Office has been stranded by the Internet. On the "strandings" theory, we should be required to send the U.S. Post Office 32 cents every time we bypass it when sending an e-mail message over the Internet -- clearly a preposterous idea that would prevent the widespread use of e-mail. Fuel cells and other devices soon may allow customers, even on a small scale, to "strand" utilities, and it is rather clear in such cases that the customer is not liable to the utility for simply disconnecting. Technology has simply bypassed the large-scale utility and the customer simply has taken his business elsewhere. Like any other business, utilities should not be permitted to hamstring development of an entire industry by requiring the public to pay for unneeded facilities when we should be moving on to newer ones.

It also is instructive to ask, what good would it do to pay stranded costs? Either the assets are still useless, in which the sole effect is to bail out shareholders at the expense of customers, or they'll be needed during the upcoming busy wheeling environment, in which case they aren't stranded at all and the utility will have received a windfall. Michaels (1995) points out that "[a]dvocates of compensation fall oddly silent about what utilities are to do with the payments," and that regulators should require that the funds be earmarked to shrink the utility by retiring debt and transferring ownership -- which is precisely "how firms in unregulated industries get rid of their stranded investments, usually at a loss." Otherwise, Michaels argues, we'll be paying strandings yet again in the future. Irwin Stelzer similarly writes, "I worry that, after a painless transition during which stranded costs are recovered, these utilities will again find themselves in difficulty, and we will once again gather to devise ways to shield them and those who sell to them from the gale of creative destruction to which they should rightly be exposed" (1995, p. 8).

E. Stranded Cost Recovery Rewards Inefficiency

Wisconsin Electric Power Company CEO Richard Abdoo at a House Energy and Power Subcommittee Hearing on July 13, testified that "our company has written off its uneconomic assets, so allowing others to recover stranded costs would penalize us" (APPA, 1994, p. 12.). In the wholesale arena, utilities had the opportunity to negotiate "notice of cancellation" or exit fees. Therefore with mandated stranded cost recovery, the worst managed facilities benefit the most while prudently managed utilities will be punished by having to pay rivals' stranded costs when seeking access to the poorly managed utility's lines. Moreover, if they hadn't owned transmission lines and a captive rate base, utilities would have thought twice about some construction projects. Nuclear power plants, for instance, were obviously a questionable enough undertaking because a liability ceiling set by the 1957 Price-Anderson Act was required to get the industry off the ground. A 1988 Department of Energy study found that "[w]ithout this insurance the nuclear power industry would not have developed" (cited in Bradley, 1993, p. 16).

Regulators also must determine how much of their efforts will reward speculators relative to the "widows and orphans" utility shareholders that are the purported focus. A federal guarantee of stranded cost recovery introduces the possibility of "gaming" of the system. Once speculators determine that they will be the recipients of stranded cost payments they may be inclined to buy utility securities with the expectation of gains.

IV. FAIR TREATMENT OF UTILITIES IN THE ABSENCE OF STRANDED COST RECOVERY

The goal of preventing stranded cost recovery is not to punish utilities but simply to protect consumers from the ill effects of decisions they had no part in making by an industry that had no business being monopolized in the first place. But at the same time, there is no right on the part of customers to "enslave" utilities during the move toward open access to the grid that utilities now own. Accommodating the flows of electricity on the grid, correcting for adverse impacts of loop flows, and upgrading the grid require will require arduous planning, scheduling, and switching efforts. Utilities deserve to be fairly compensated and, when competition is here, to be released from most governmentally imposed constraints that induce poor decisionmaking -- such as demand side management requirements and other social costs imposed by states -- and those that prevent utilities from diversifying into other profitable utility or non-utility businesses.

For instance, utilities ought not have to be "supplier of last resort" and bear the risk of a power user who decides to bypass the utility in favor of an alternative supplier. If the bypasser's venture doesn't work out it isn't the utility's responsibility -- unless provided for contractually. The "obligation to serve" should evaporate under competition: competition shouldn't mean customers get to set terms to such a degree that they demand a right to a utility's power only under adverse conditions. Utilities should also be allowed to expand their range of services, such as by entering the telecommunications field, or by leasing their own substantial fiber optic capacity to other users. At least one utility is already developing a "smart home unit" that could enable it to provide phone and cable TV service, and also manage "smart" home appliances (Walsh, 1995).

V. NOTE ON A COMPETITIVE GRID

Although CEI does not address open access questions in these comments on the stranded cost rule, we have indicated throughout this document that the ultimate goal of reform should be to eliminate the need for the FERC's regulation of the grid, rather than to lock in the agency's long term oversight. Rather than focusing on common carrier rates as the long-term solution -- which will be inefficient, distort prices, and probably lead to underdevelopment of key nexus points on the grid -- the agency should investigate ways of making the grid competitive. The transmission "natural monopoly" may be contestable to a degree: To expand, utilities will need to use other utilities' transmission lines, thus have an incentive to keep their own access costs low to avoid retaliation. The potential for gouging of customers by the utilities is of course always present if others have no access to the rights of way along which the grid is built. But since these rights of way exist, and are a "public good" of sorts, FERC should study ways of defining parameters, and coordinating a procedure for utilities and non-utilities and others to develop additions to the grid, or even competing grids on the same rights of way or on existing rights of way along highways and railroad tracks. New technologies will allow the existing grid to transport even more power, just as the original transatlantic cable could handle only 37 calls, but now a fiber optic cable can handle 40,000 calls. A newly developed superconductive film, for instance, can carry 100 times the electricity of current technology, and may eventually change the nature of power transport.

New transmission should not be granted exclusive franchises but should perhaps take the form of shares tradeable on secondary markets. Alternatively the FERC could at least allow bidding for control of the new transmission facilities, and allow bidders to propose to offer the lowest price. Clearly these are complex problems that will require appropriate defining of property rights and coordination with existing rights on the grid, but ultimately it will be a better approach than monopoly regulation because the grid will become competitive and not stagnate technologically. Once competition is introduced, we can afford to wait and see what private actors will negotiate rather than rely on the regulator. No matter how benevolent a regulatory agency may be, the fact remains that regulators operate under bounded rationality, and sometimes arbitrariness or even opportunistic behavior. While answers to these questions at this point in the competitiveness and open access debates are elusive, CEI urges that the FERC not lose sight of their importance, which will loom ever larger in the future.

VI. CONCLUSION

Consumers have much to gain from competition in electricity, but they also have much to lose if stranded costs are imposed on them. Some estimates of the magnitude of stranded costs exceed $200 billion. However, there is no way to determine the true amount without introducing competition and requiring proof that costs have been mitigated as much as possible. Regardless of the true level of strandings, consumers are in no way liable for them, but unfortunately are sitting ducks. Stranded costs should be mitigated by utilities in a voluntary manner to the greatest extent possible, and finally absorbed by shareholders where necessary. Imposing stranded costs hurts consumers by preempting choice, delaying the arrival of competition among generators, and keeping prices artificially high. Stranded cost recovery is openly contrary to the express mission of public interest regulation.

Evidence and Authorities

American Public Power Association (1994), Comments of the American Public Power Association in FERC's NOPR on Recovery of Stranded Costs, Docket No. RM94-7-000, December 6.

Bailey, Jeff (1995), "Purpa Power: Carter Era Law Keeps Price of Electricity Up In Spite of a Surplus," Wall Street Journal, May 17.

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