Michael V. Seitzinger
The issue of stranded costs is one of the larger transitional issues facing the electric utility industry. Stranded costs are defined by recovery proponents as those costs that were legitimately and prudently incurred under the "old" regulatory regime that are not economically recoverable under the "new" competitive regime that is being entered. Alternatively, opponents characterize stranded costs as unrecoverable business investments that were known to the utilities. The issue of stranded costs arises in two situations.
PURPA Contracts. Under section 210 of the Public Utility Regulatory Policies Act ("PURPA"), the utilities are required to purchase power from qualifying power production facilities and qualifying cogeneration facilities at a price set by state public utility commissions. Following the enactment of PURPA, contracts were formed between the utilities and independent power producers ("IPPs") pursuant to section 210. These contracts require generally that the utilities pay the IPPs for the costs the utilities would have incurred had they generated the energy themselves. These costs are defined as "avoided costs." The amounts to be paid to the IPPs are fixed for the length of the contracts. Although the cost of generating power has decreased, the contracts require the utilities to continue to pay above-market prices to the IPPs. In a restructured environment that promotes lower market prices, the utilities could be subject to even greater losses.
Some utilities have attempted to have their contracts reevaluated at the state level by state public utility commissions. In Freehold Cogeneration Associates v. New Jersey, 44 F.3d 1178 (3d Cir. 1995), reh'g denied, 1995 U.S. App. LEXIS 4709 (3d Cir. 1995), cert. denied, 516 U.S. 815 (1995), an IPP challenged an order from the New Jersey Board of Regulatory Commissioners that directed it to either renegotiate the purchase rate term of its contract with a utility or negotiate a buy-out of the contract. The order resulted from the utility's claim that the contract was no longer economically viable; that the amount the utility was required to pay the IPP no longer reflected the actual decreased cost of generating electric power. The federal Third Circuit found that the state was preempted from reexamining the contract. Federal regulations enacted pursuant to PURPA exempt qualifying facilities from state regulation of electric utility rates. In addition to finding the state's actions preempted, the Third Circuit found that reconsideration of the contract would deprive the IPP of the benefits of its bargain with the utility. The Third Circuit's decision has been viewed as affirming the sanctity of existing contracts between the utilities and IPPs.
Restructuring legislation that eliminates prospective mandatory purchase obligations, but maintains existing contracts between the utilities and IPPs is unlikely to be successfully challenged. Congress has broad discretion to adjust economic life. Further, its interest in maintaining existing contracts arguably does little to alter the settled expectations of the utilities and IPPs which executed contracts pursuant to section 210.
Investments in Power-Generating Facilities. The second situation giving rise to the issue of stranded costs involves the investments made by the utilities in their power plants. Stranded costs relating to investment in nuclear power plants may be the most significant of all stranded costs. Under current rate base regulation, a utility is entitled to recover the market cost of its investment by charging a price that is equal to the average cost of producing power. In a restructured environment, the market price available to the utility could be less than its average cost of producing power. If that occurs, a significant portion of the utility's investment could become stranded. While the legitimacy of stranded costs has been debated in the past, many now seem to agree on some form of recovery.
Fact Sheet on the Administration Position: A fact sheet on stranded costs can be found at DOE.
Definitions and Analysis of Stranded Cost Issues: This page is prepared by the Regulatory Assistance Project, a nonprofit organization interested in restructuring issues.
Discussion of the Regional Impacts of Stranded Costs.
DOE Analysis (.pdf format) of Regional Impacts
DOE Options for Stranded Cost Mitigation. This site is part of DOE's larger report The Changing Structure of the Electric Utility Industry.
Electric Utilities: Deregulation and Standard Costs - CBO report.
Heritage Foundation: A discussion of stranded cost recovery.
Page last updated January 9, 2001.