ABSTRACT
Before the California electricity crisis, perhaps the most highly charged (pun intended) issue associated with opening electricity markets to competition was whether and how to compensate utilities for the capital expenses they incurred during the regulatory era. If competition brings about lower prices, as its advocates would hope, utilities fear that they would not make enough money to recover some of these costs—hence, that they would be “stranded.” The primary sources of such stranded costs, once estimated at upward of $135 billion, are associated with nuclear power plants and long-term contracts to purchase renewable and cogenerated power under the Public Utility Regulatory Policies Act (PURPA).
Utility advocates argue that a “regulatory compact” implicitly guaranteed cost recovery as part of the utilities’ obligations to provide service. Those opposed to stranded cost recovery allege that utilities should not be rewarded for unwise investments and that forcing consumers to pay for stranded costs will thwart the objective of reducing electricity rates. In principle, deciding who is right should turn on a determination of whether regulators or utilities were in the best position to foresee restructuring and which of them were better able to adapt to the prospect of competition.
Stranded cost recovery has generally been part of the package necessary to build sufficient political support to implement the opening of retail markets. In addition, the federal government supports stranded cost recovery—perhaps not incidentally because the government itself is exposed by virtue of its ownership of electricity generation in the Tennessee Valley and Pacific Northwest. If stranded costs are recovered through surcharges on electricity purchases, it is important to devise methods that preserve competitive neutrality (i.e., not to introduce fees that create artificial cost advantages for either incumbent utilities or new merchant generators). Designing such a recovery system may be easier said than done.
