Electric Utility Restructuring
Briefing Book
Congressional Research Service Library of Congress
Redistributed as a service of the National Library for the Environment

Legal Issues

Michael V. Seitzinger

Federal and State Jurisdiction  |  Stranded Costs  |  Antitrust Issues  |  Tax Issues

Federal and State Jurisdiction

It is quite possible that electric utility restructuring bills will be introduced in the 107th Congress. These bills will likely address numerous aspects of retail competition, including the jurisdiction of the Federal Energy Regulatory Commission ("FERC") in a restructured environment. The enactment of state restructuring legislation by many of the states highlights the complex relationship that is likely to be forged between the federal government and the states. As advocates of states' rights maintain that the states should be permitted to implement retail access without interference from the federal government, those who believe in a uniform system of competition contend that the lowest rates for electric power are attainable only through federal legislation. The evolution of the electric utility industry from one that was primarily local to one that is now largely interstate in nature has fueled the argument for expansive federal legislation.

Jurisdiction Over Transmission Services. FERC regulates transmission access and the sale of wholesale electric energy in interstate commerce. States may regulate the retail sale of electricity within the state, including regulation of those facilities that distribute electric power.

Retail Reciprocity. Retail reciprocity requirements allow a state or state public utility commission to prohibit out-of-state utilities which operate in states "closed" to retail competition to market power to retail consumers in the "open" state. Although at least four states have included such requirements in their restructuring legislation, one possible issue in federal restructuring legislation may concern whether there should be a statutory reciprocity provision. The need for federal reciprocity language is supported by the U.S. Supreme Court's treatment of similar state reciprocity requirements. In numerous cases, the Court has refused to uphold state reciprocity requirements because of the burdens such requirements impose on interstate commerce.

While a state may not interfere with interstate commerce on its own, Congress may confer upon the states the ability to restrict commerce. Thus, if Congress enacts electricity restructuring legislation that permits states to impose reciprocity requirements, such requirements are likely to be permissible.

Stranded Costs

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.

Web Sites

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.

Antitrust Issues

The Energy Policy Act of 1992 ("EPAct") grants authority to the Federal Energy Regulatory Commission ("FERC") to order a utility to transmit third-party power across its transmission lines. In response to EPAct, the FERC issued Order 888, which requires utilities to provide nondiscriminatory open access to transmission lines. The ability of competing electric power generators to transmit electricity over existing transmission lines raises concerns about market power and horizontal and vertical mergers that may hinder true competition in a restructured environment.

A horizontal merger is a combination of two or more companies that compete directly with each other. A merger of two or more utilities could have a profound effect on competition by making it difficult for smaller competitors to have open access in some markets. For example, the merger of two vertically-integrated utilities could result in a single company controlling the network over which an entire region's power is transmitted. Many believe that such a company would not only be in an unfair strategic position to deal with competitors, but could also affect the relative success of competing generators.

In 1996, the FERC issued a policy statement that establishes the factors it will consider in determining whether a proposed merger is consistent with the public interest. Order 592 includes a competitive analytic screen that serves to guide the FERC through a four-step decision-making process. First, the FERC will identify relevant product markets. Second, it will identify relevant geographic markets. Third, it will measure supplier concentration in the identified markets. Fourth, it will evaluate the implications of any changes in concentration. Order 592 follows the 1992 Horizontal Merger Guidelines of the Department of Justice and the Federal Trade Commission that are used to evaluate potential mergers in other industries.

A vertical merger is a combination of two businesses that maintain a buyer-seller relationship. In the electric utility context, vertical mergers involve generally the consolidation of electric power generators and natural gas suppliers. These mergers raise concerns about vertical market power in geographic markets in which many of the generation units are gas-fired. A merger of a gas company and a generator could result in a reduced supply of gas to competing generators within a particular market. Another concern involves sensitive information that a natural gas supplier may have acquired in the process of providing gas to a competing generator. Observers fear that a merged entity could use this information to make strategic decisions in bidding situations.

Tax Issues

Any restructuring of the electric utility industry will have to deal with several aspects of federal, state, and local tax structures. Federal tax laws that relate to deductions and the timing of deductions will affect those investor-owned utilities whose facilities are made unprofitable in a restructured environment. The exclusion of publicly owned utilities' net income from federal and state-local income taxes and the exemption of interest income on public utility debt from federal individual and corporate income taxation might affect the willingness of public utilities to join the competitive network. This tax-exempt status of debt used to finance publicly owned transmission systems will be affected when investor-owned electric power generators use these publicly owned lines to compete. Under current law, publicly owned utility debt could lose its tax-exempt status if more than 10% of its revenue is generated by the power sales and/or transmission rights given to investor-owned utilities.

A competitive environment is likely to prompt not only lower electricity prices, but less tax revenue for state and local governments. State and local governments collect gross receipts taxes, property taxes, franchise fees, and net income taxes from the utilities. Lower prices and decreased property values could result in a significant loss for state and local governments.

Page last updated January 9, 2001.

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