Topic:
ELECTRIC UTILITIES - RESTRUCTURING; ELECTRIC UTILITIES; LEGISLATION;
Location:
UTILITIES-ELECTRIC-RESTRUCTURING;
Scope:
Court Cases; Connecticut laws/regulations;

OLR Research Report


March 16, 1998 98-R-0392

FROM: Kevin E. McCarthy, Principal Analyst

RE: Electric Restructuring Bill-Stranded Costs Provisions

You asked for a description of the stranded costs provisions of sHB 5005, "An Act Concerning Electric Restructuring." You asked for the rationale for allowing electric companies to recover their stranded costs and whether there are any estimates of the amount of money involved.

SUMMARY

Stranded costs are electric company costs that the Department of Public Utility Control (DPUC) has approved for recovery in rates that may not be recoverable once the generation market is opened to competition. The bill opens the electric generation market to competition starting in 2000 and provides electric companies with an opportunity to recover three types of stranded costs. These are (1) the above-market costs of generating plants and related assets, (2) regulatory assets (DPUC-approved expenses that have been incurred but not yet recovered), and (3) the above-market costs of long-term purchased power contracts.

The bill specifies how DPUC must determine these costs. The DPUC-approved costs are recovered through a competitive transition assessment (CTA), which will be imposed on all users of the electric distribution system. The costs of regulatory assets and certain long-term contracts can be securitized (refinanced) through the issuance of state revenue bonds.

CGS 16-19e establishes the principles of utility ratemaking, which include a requirement that rates be set to allow utilities to recover their investments and operating costs. In addition, the electric companies have raised equity arguments in favor of their recovery of their stranded costs.

There are no authoritative estimates of the total amount of stranded costs available at this time. The bill requires DPUC to determine certain stranded costs by January 1, 2000, and the stranded costs of nuclear power plants by January 1, 2004. To estimate these costs at this time, one would need to know: (1) the date the Millstone nuclear plants will return to service, (2) their value in a market that does not currently exist, and (3) the long-term market price of electricity. Small changes in the last variable would substantially affect the market values of the plants and long-term contracts.

DESCRIPTION

Definition

The bill covers three types of stranded costs, those associated with generation assets such as power plants, regulatory assets, and long-term purchased power contracts. Generation asset costs must have been incurred before July 1, 1997, and approved for inclusion in rates. They do not include any costs associated with decommissioning a plant, nor any costs that DPUC found were due to imprudent management. Regulatory assets are essentially IOUs given to an electric company by DPUC for expenses, notably taxes, it has incurred but has not yet recovered in rates. They also include the unrecovered costs of conservation and environmental protection programs. Long-term contract costs are the above-market portions of contracts that the company was required to enter into by law. For example, state law requires electric companies to buy the power produced at resource recovery facilities at a rate that is well above the market cost of this power.

Determination

The bill has separate provisions on the determination of each type of stranded costs. For generation assets that the company has not divested, DPUC must calculate stranded costs as the difference between a plant's book value and the market value of prudently run comparable plants. Plants that are worth more than their book value must be netted against those that are worth less than book value. Regulatory assets are valued at book as of January 1, 2000. DPUC must calculate the stranded costs of long-term contracts with a fixed present value at that value. A contract has a fixed present value if the buyer is obligated to pay a specific amount each year or if the buyer buys out the contract. For other contracts, DPUC must annually calculate the difference between the contract price and the market price.

Recovery

The company must mitigate its stranded costs in order to recover them. Mitigation must include divestiture of generating plants, obtaining commitments from the purchasers of these plants that will hire affected workers at their current salaries, and good faith efforts to reduce the costs of long-term contracts. The bill identifies several other types of discretionary mitigation techniques.

A company cannot get any stranded cost recovery unless it puts its non-nuclear generating plants up for auction. It cannot recover any stranded costs for a nuclear power plant (including associated regulatory assets) unless it is operating. If the non-nuclear plants are sold above their book value, the difference goes to reduce the stranded costs of nuclear plants and long-term contracts. The nuclear plants must also be put up for auction by 2004 for the company to collect stranded costs for them.

Approved stranded costs are recovered through the CTA, which applies to all consumers regardless of their electric supplier. DPUC must start collecting the CTA, which is considered state rather than electric company revenue, on January 1, 2000. It must set the CTA at a uniform rate within each customer class across the state. Starting January 1, 2004, DPUC must set the rate in accordance with the way it allocated generating costs among classes on July 1, 1998. But the ratio between the rate charged residential customers to the rate charged industrial customers cannot exceed the 1991 ratio in electric rates for these two classes.

To establish the CTA, DPUC can designate two commissioners and part of its staff to negotiate a three-way contract with the company and the State Bond Commission. In addition to setting the CTA, the contract can authorize the State Bond Commission to issue securitization bonds backed by the assessment. The contract is subject to the approval of the three commissioners who did not participate in the negotiations.

Securitization

The bill allows stranded costs for regulatory assets and long-term contracts with a fixed present value to be securitized (refinanced). The State Bond Commission can issue revenue bonds backed by the CTA to reduce the companies' stranded costs for these items, but not for generation assets. Securitization can only be used if a company cannot otherwise reach the 10% rate reduction required under the bill for customers who do not choose a competitive supplier. The bonds can be used to retire prudently incurred debt, amortize regulatory assets, and reduce the cost of long-term contracts. The bonds must mature by 2012. They are not state or municipal obligations and must state so on their face.

RATIONALE FOR STRANDED COST RECOVERY

Two types of arguments have been raised in support of the recovery by electric companies of their stranded costs, legal and equitable. Under CGS 16-19e, utility rates must be set so as to be just sufficient to allow utilities to recover their operating and capital costs, attract needed capital, and maintain their financial integrity, while providing adequate protection to public interests. These standards closely follow the ones established by the U.S. Supreme Court in Federal Power Commission v. Hope Natural Gas Co. 320 U.S. 591 (1940). Precluding a utility from recovering investments it has made with DPUC's approval could be challenged under the Takings Clause of the U.S. Constitution. The right to recovery of stranded costs is not absolute. For example, a utility is not entitled to recovery of an investment that is no longer "used and useful" even if it was prudently incurred.

The electric companies also raise equity arguments in support of their claim to recovery of stranded costs. They note that they made their investments pursuant to state law. For example, both companies have been required to enter into long-term contracts at above market rates with resource recovery facilities pursuant to CGS 16-243e. More generally, the companies assert that recovery is required under the "regulatory compact." The companies assert that historically, they had agreed to serve all customers in their franchise areas in exchange for the right to charge rates that allow them to recover their costs. Please note that there is a great deal of controversy as to the legal significance of this argument.

ESTIMATES OF STRANDED COSTS

There are no authoritative estimates of total stranded costs available at this time. The bill calculates stranded costs for generation assets and long term contracts by comparing their book and market values. There is significant disagreement about the book value of generation assets. For example, Connecticut Light & Power states that the 1997 book values of its nuclear and non-nuclear generation assets are $2.2 billion and $260 million, respectively. The Office of Consumer Counsel states that these values are $1.9 billion and $211 million, respectively.

More importantly, there is a great deal of uncertainty as to the market value of generation assets and long-term contracts. Under the bill, the market value of generation assets will be set by

auction, or by DPUC if there are no qualified bids. In other states that have required divestiture as part of their restructuring legislation, non-nuclear generating assets have been sold for substantially more than their book value. To the extent that this holds true in Connecticut, the proceeds from the sales will reduce overall stranded costs. However, the value of certain plants is highly uncertain due to the suspected contamination of their sites. Moreover, the premium above book value that suppliers have paid for plants in other states may reflect an interest on their part to gain a foothold in new markets. This premium may decrease over time as the market matures.

Since there have been no sales of nuclear plants to date, determining their market value at this time would be highly speculative. In addition, it is not clear that all three Millstone plants will return to service. The bill precludes electric companies from recovering their stranded costs for a nuclear plant until it reopens. The market value of these plants will presumably depend on how well they run, which is unknowable at this time.

Some individuals and groups have equated stranded costs with the current book value of stranded assets, assuming that they will have no market value. The bill does not support this position, in that it contemplates that both nuclear and non-nuclear plants will have value. However, the market valuation of nuclear and non-nuclear generation assets will depend critically on estimates made in the future as to market price of electricity. Preliminary analyses by DPUC and others find that the market valuation of generation assets taken as a whole could vary by hundreds of millions of dollars based on a price variation as small as 0.5 cents per kilowatt-hour.

The latter uncertainty also applies to long-term contracts, many of which are with non-utility

generators such as the Connecticut Resources Recovery Authority that use renewable resources. While many of these contracts have prices that significantly exceed the market price of power, determining their stranded costs depends on the market cost of electricity over the life of the contract, which is often ten years or more. The bill may significantly increase the value of some of these contracts, since it requires suppliers to obtain a specified proportion of their power from renewable resources.

The regulatory asset category is subject to less uncertainty, since the bill measures regulatory assets at their January 1, 2000, values. Even so, there is some disagreement about the current book value of these assets.

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