SJR 91

From: Jean Ann Fox, Vice President

Virginia Citizens Consumer Council

Date: June 30, 1998

Stranded Cost

Stranded cost is the difference between the value of generation-related assets currently in rates that have a net book value equal to or above their market value and the value of generation-related assets currently in rates that have a net book value below their market value, after mitigation efforts, and excluding costs that are avoidable in the future.

Stranded investments are limited to generation-related assets because only generation will be deregulated and subject to competition. It is also limited to investments currently in rates, not future investments or investments made now in anticipation of competition.

The extent of any stranded cost is not knowable today. The underlying assets are included in rates today but what will be stranded is totally dependent on what happens in a competitive market. Estimates made today are about as reliable as predictions offered by the "psychic hotline."

Stranded Cost Is Not Transition Cost

Stranded cost is NOT transition cost, cost of educating consumers, cost of new computer billing systems to make retail choice possible, or cost of environmental programs. Those transition costs should be considered by the Taskforce on consumer protection, education and environment or the Structure Taskforce.

VCCC View of Stranded Cost

1. There is no guarantee, no constitutional protection, no regulatory compact that requires ratepayers to make utilities whole for every penny of investment they have made or every obligation they have incurred.

2. Changes in regulation are not responsible for the uneconomic nature of some utility costs. Market forces have made some investments and contracts above current costs.

3. Utilities are and have always been obligated to provide economic service and to be efficient with no claim to recover inefficient cost.

Utility rates are set to compensate for risk, such as changes in technology, changes in demand patterns, the risk that the utility won't be able to recover all cost of investments. According to testimony filed by VCCC expert witness Dr. Mark Cooper, Virginia Power earned approximately two billion dollars above the risk-free rate of return in the past decade. What did that pay for if not the risk that some investments might not be recovered fully in rates?

4. Management exercised substantial discretion in the decisions to make investments and make contractual obligations, so management must bear the responsibility for its own actions. The burden of strategic actions or mistakes should be borne by stockholders, not ratepayers. Competitive companies frequently find that they cannot recover the costs of investments due to technological and market changes. Those companies write-off these costs, they don't ask the General Assembly to make their customers pay the tab.

5. Virginia is not a "prudency" standard state. Virginia Power in its alternative regulatory case at the Commission repeatedly suggested that prudent investments should be guaranteed recovery. In Virginia, investments must be used and useful over their life to be recovered in rates.

100% Recovery Hampers Competition

Full, guaranteed recovery of stranded costs will cripple emerging competition. In states where utilities were given 100% stranded cost recovery - California, Massachusetts, Rhode Island - there is no competition for residential customers. The CTC charge in California is the reason given by Enron for leaving the residential market.

Recovery of Justified Stranded Cost

There are two circumstances in which costs may become stranded and recoverable from ratepayers:

1. When management had no discretion whatsoever over costs, when costs were incurred directly and entirely by legislative or regulatory edict, when such costs are unrecoverable and when the company has not already been compensated for the risk of stranding.

2. When failure to cover costs would drive the company into bankruptcy.

Even then, these stranded costs should only be a transition item.

Allocating Stranded Cost

The method used to allocate stranded cost should be fair to residential customers. If stranded cost is assigned based on current cost allocation methods, residential and commercial customers will pay more than their share due to peak usage. This would result in a mismatch between cost causation and stranded cost responsibility. Any stranded cost should be billed on a uniform per kilowatt hour basis to all classes of customer.

Sharing the Burden

The goal should be to reduce and then to fairly share stranded investment between customers and shareholders. Requiring utilities to share gives them the incentive to reduce the amount of total stranded investment claimed. Since Wall Street expects utilities to become more efficient and lower costs in the face of competition, why shouldn't Virginia have the same expectation?

Sharing recognizes that incumbent utilities are uniquely situated to take advantage of a competitive market. It also puts investor owned utilities on a par with co-ops and municipal power suppliers who have strong incentives to reduce potential stranded investments because their owners and customers are one and the same.

Sharing is also in the Virginia tradition. When nuclear plant construction was halted, the cost was shared by ratepayers and shareholders. When Virginia Power sold land, the benefits were shared between ratepayers and shareholders.

Conclusion:

Utilities have no right to recover inefficient costs or costs resulting from strategic actions or a company's mistakes.

Utilities are not entitled to compensation for risks or assets for which they have previously been compensated.

New revenue opportunities must be taken into account.

Electric companies must reduce costs that may be uneconomic in a competitive market (mitigation.)

We oppose securitization of stranded cost.

Any justifiable stranded cost must be collected on a per-kilowatt basis so all classes of customers are treated fairly.

Utilities with "negative" stranded investment should credit ratepayers.

The State Corporation Commission should have authority to require divestiture of generating plant to determine the market price of plants.

(Helps with market power concerns.)

The State Corporation Commission should be assigned the task of applying these standards to the fact-specific situation of each electric utility if and when generation is open to retail competition in Virginia.