On stranded cost recovery in the deregulation of the U.S. electric power industry

Natural Resources Journal

Volumn 37, Issue 1, 1997, Pages 59-92

  Maloney, Michael T ^a   Mccormick, Robert E ^a   Sauer, Raymond D ^a  

^a NONE

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EID: 21944453790     PISSN: 00280739     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (61)

1. This is the major conclusion of our monograph, MICHAEL T. MALONEY, et al., CITIZENS FOR A SOUND ECONOMY FOUNDATION, CUSTOMER CHOICE, CONSUMER VALUE: AN ANALYSIS OF RETAIL COMPETITION IN AMERICA'S ELECTRIC INDUSTRY (1996). This monograph is the basis and background of the analysis and conclusions we present here.
2. The divestiture of AT&T was an antitrust case, not a legislative mandate. Hence, it is not exactly comparable to deregulation in airlines, trucking, and electricity.
3. William J. Baumol & J. Gregory Sidak, Stranded Cost Recovery: Fair and Reasonable, PUBLIC UTILITIES FORTNIGHTLY May 15, 1995 at 20.
4. See also BAUMOL & SIDAK, TRANSMISSION PRICING AND STRANDED COSTS IN THE ELECTRIC POWER INDUSTRY, (1995).
5. In more elaborate valuation analysis things like taxes, working capital requirements and capital structure are included. We abstract from these here in the interest of simplicity and because they do not affect our conclusions.
6. Costs are lower because the plant produces less output and hence less labor and materials are used.
7. It is important to recognize that we have built this scenario upon the assumption that the capital has no alternative uses nor any salvage value. It is worthless for any purpose except the production for which it was built.
8. Event analysis uses stock market and financial data to assess the impact that investors incorporate into their perception of future events. The technique is widely used in finance and economics. For an example of the methodology, see Michael T. Maloney & Robert E. McCormick, A Positive Theory of Environmental Quality Regulation, J.LAW & ECON., Apr. 1982, at 99.
9. We used a simple market model to adjust the portfolio returns. We regressed the daily electric utility value-weighted portfolio return on the value-weighted market return over the period January 1, 1990, through May 31, 1993. The estimated portfolio beta over this period was .52. Estimates are based on data available from the Center for Research in Security Prices, University of Chicago.
10. Andy Pasztor, Who Will Make Electric Power in California?, WALL ST. J., Feb. 17, 1994, at B1.
11. Caleb Solomon, As Competition Roils Electric Utilities, They Look to New Mexico, WALL ST. J., May 9, 1994, at A1.
12. Warren Getler & Dave Kansas, Stock Buys by Utility Industry Insiders May Have Been Misguided, Analysts Say, WALL ST. J., May 11, 1994, at C1.
13. This measure of the equity value of securities in the United States economy includes stocks listed on the NYSE and AMEX and stocks traded on the NASDAQ, as reported by the Center for Research in Security Prices, University of Chicago.
14. As a practical matter, regulators charged with computing stranded costs using this technique should adjust the market value of equity by the fair market value of non-utility assets such as excess cash, earnings retained in land, and other holdings.
15. These figures are derived from Table 2.
16. See, e.g., LESTER BAXTER & ERIC HIRST, OAK RIDGE NATIONAL LABORATORY, Oak Ridge, Tennessee, ESTIMATING POTENTIAL STRANDED COMMITMENTS FOR US. INVESTOR-OWNED ELECTRIC UTILITIES (1995).
17. This figure is the same as the number generated in the last scenario by coincidence only. As above, this figure can be derived from the data present in Table 2. Specifically, the market value of equity in 1995 and the book to market ratio can be used to derive the book value in 1995. The probability of stranded cost recovery assumed in this scenario is .39.
18. See Katherine Daigle & Michael T. Maloney, Residual Claims in Bankruptcy: An Agency Theory Explanation, J. LAW & ECON., Apr. 1994 at 157, for a review of the law, references, and an analysis of the outcome of the bankruptcy process.
19. This simple approach ignores any option value imbedded in the long-term, fixed price contract.
20. Throughout our analysis we assume that the existing PURPA contracts perpetuate and are not violated by legislation or court rulings. We are not proposing that these contracts be nullified. We have not analyzed the details of these contracts and the firms that produce power under them.
21. Hawaiian Electric Industries is excluded because it is not interconnected.
22. See MALONEY, et. al., supra note 1.
23. Id. Vol. I at 25.
24. Recall that we have already factored into our computations of output expansion the additional maintenance time required when plants run longer.
25. An enlightening introduction is found in Ron Winslow, Utility Chapter 11 Filing May Mean Problems for Consumers, Investors, WALL ST J., Apr. 17, 1984, at 37. The story starts, "No electric utility has declared bankruptcy in years - not since the Depression in fact."
26. This account of the Seabrook story is taken from HENRY F. BEDFORD, SEABROOK STATION: CITIZEN POLITICS AND NUCLEAR POWER (1990).
27. Id. at 30.
28. Lawrence Ingrassia & Christopher J. Chipello, PS New Hampshire Files Bankruptcy Plea, WALL ST. J., Jan. 29, 1988, at A2.
29. Public Service of New Hampshire, WALL ST. J., May 17, 1991, at C8.
30. Ann de Rouffignac, El Paso Feels Pressure to Reorganize Amid Prospects of Bankruptcy Filing, WALL ST. J., Jan. 6, 1992, at B4;
31. Ann de Rouffignac, El Paso Electric, Reeling with Debt, Files Chapter 11, WALL ST. J., Jan. 9, 1992, at A5.
32. S.&P. Lowers Lilco's Rating Again, N. Y. TIMES, May 24, 1983, at D6.
33. Lilco Declares 25 Cent Dividend on Common Stock, WALL ST. J., Aug. 15, 1989, at C18.
34. New York Regulators Clear Accord on Shoreham, Rates, WALL ST. J., Apr. 6, 1989, at A9.
35. Charles M. Studness, LILCO: The Politics of High Electric Rates, PUBLIC UTILITIES FORTNIGHTLY, Sept. 1, 1995, at 42.
36. John R. Emshwiller, GPU Seeks $450 Million in Bank Credit to Pay for Accident, Avoid Bankruptcy, WALL ST. J., May 3, 1979, at 2.
37. Pennsylvania P&L, GPU Set Price Accord On Electricity Supply, WALL ST. J., June 6, 1979 at 12;
38. GPU Agrees to Buy Some Electric Power from Canada Firm, WALL ST. J., July 10, 1979 at 4;
39. GPU Unit Seeks Annual Rate Rise of $113 Million, WALL ST. J., May 7, 1979, at 2;
40. Jersey Central P&L Is Granted $70 Million Annual Rate Boost, WALL ST. J., Sept. 7, 1979 at 2;
41. GPU Unit is Told to show Why Its License In Pennsylvania Shouldn't Be Rescinded, WALL ST. J., Nov. 2, 1979 at 12;
42. GPU Utility Granted Interim Rate Increase by Pennsylvania PUC, WALL ST. J., Feb. 11, 1980 at 38;
43. General Public Utilities Says Two Units Plan To File for Rate Boosts, WALL ST. J., Mar. 3, 1980 at 14;
44. GPU Unit Granted $34.2 Million Boost in New Jersey Rates, WALL ST. J., Apr. 2, 1980 at 5.
45. General Public Utilities Sets Its First Payout on Common Since '79, WALL ST. J., Apr. 3, 1987 at 39
46. Frederick Rose, Troubles Beset Utility After Its Chief Makes An Abrupt Departure, WALL ST. J., Aug. 22, 1989 at A1.
47. Tucson Electric Co. Might Have to Seek Bankruptcy-Law Aid, WALL ST. J., May 17, 1990 at B9.
48. Restructuring Plan Gets Approval of Shareholders, WALL ST. J., Nov. 18, 1992 at A4;
49. Rhonda L. Rundle, Tucson Electric Completes Revamp, Averting Bankruptcy-Law Protection, WALL ST. J.,. Dec. 16, 1992 at A4.
50. See JAMES LEIGLAND & ROBERT LAMB, WPP$$: WHO IS TO BLAME FOR THE WPPSS DISASTER (1986).
51. Even before the massive cost overruns had taken place, the finance director of the Public Utility Commission in New Hampshire found that the generating capacity (PSNH) proposed for Seabrook was not needed and would unnecessarily raise the electricity bills of New Hampshire consumers.
52. BAUMOL & SIDAK, supra note 2.
53. W. Brian Barrett, et al., The Effect of Three Mile Island on Utility Bond Risk Premia: A Note, J. OF FIN., at 255 (1986).
54. Robert M. Bowen, et al., Infra-Industry Effects of the Accident at Three Mile Island, J. OF FIN. & QUANTITATIVE. ANALYSIS, at 106 (1986).
55. As discussed below, producers can voluntarily contract with buyers to share this risk by a long-term contracting relation in an unregulated environment.
56. It bears noting that institutional investors are substantial owners of most public utility stock. For instance, 38.2% of all Duke Power common shares are held by institutions. On average, across the entire portfolio of publicly traded utilities, 31.3% of all common shares outstanding are held by institutions.
57. We have obviously abstracted from the various classes of users for the sake of simplicity here.
58. Rent seeking costs are also relevant here, but it appears that these will be incurred regardless of whether recovery is imposed or not. If there were no question that recovery would be denied then these costs would be minimized.
59. The court said in Cajun Electric Co-op Inc. v. F.E.R.C., 28 F.3d 173 (D.C. Cir. 1994), that imposing generation cost on transmission fees is an illegal tying arrangement under antitrust law.
60. An alternative to two-part tariffs is to use the general taxing authority of the state to provide the lost wealth. In other words, states could levy an income tax and pay these proceeds to the electric utilities to cover their lost income from lower electric prices. Of course, most any observer would say that this is politically unlikely. Therein lies the point. A two-part tariff is nothing more than a consumption tax on electricity consumers. Neither a tax on electric consumers or a general tax has any operational implications for the electric power industry. Why one might be considered unlikely and the other a real prospect is an intriguing question. Given that almost all income-tax payers are also electricity consumers, the distinction is economically vacuous. The fact that a tax and subsidy scheme smacks of corporate welfare does not change the color of the horse.
61. This forecast assumes that input prices remain constant. In MALONEY, et al., supra note 1, we explore alternative scenarios where input prices are influenced by output expansion.