March 25, 1998 98-R-0420
FROM: Kevin E. McCarthy, Principal Analyst
RE: Electric Restructuring and Securitization
You asked the following questions:
1. which states have implemented securitization as part of their electric industry restructuring initiatives, and how did it work; and
2. how are stranded costs recovered in states that have adopted restructuring legislation.
You also asked how utilities have used the proceeds of securitization bond. We have been unable to determine this to date. In California, the only state where securitization has been implemented, the legislation did not limit the use of the securitization bond proceeds, and the state's Public Utility Commission has not tracked their use. We have called the utilities, and will provide the information you have requested if and when the utilities provide it.
Although six states have authorized securitization as part of their restructuring legislation, only California has actually issued securitization bonds. In California, utilities can seek to finance part of their stranded costs using bonds that are issued by a state authority and are backed by a charge imposed on all electric consumers. The bonds carry a lower interest rate than the capital the utility had been using. The utilities must use the cost savings to reduce rates for residential and small commercial customers by 10%. The state has authorized the issuance of $7.3 billion in bonds, of which $6.1 billion have been issued.
Utilities are allowed to seek recovery of their stranded costs in the ten states that have adopted restructuring legislation; in some cases they are statutorily entitled to recovery of certain costs. The states generally define stranded costs to include costs associated with generating plants, regulatory assets, and purchased power contracts that cannot be recovered in rates in a competitive market. Illinois takes a different approach, defining stranded costs in terms of the utility revenues that are jeopardized as a result of competition in the electric market. In all of the states, stranded costs are recovered by a charge imposed on all users of the electric distribution system, regardless of who supplies the user with electricity.
Securitization is a form of refinancing that involves the creation of a financial security such as a bond, which is backed by a revenue stream pledged to pay the principal and interest of the security. In the context of electric restructuring, the term refers to the issuance of bonds to reduce stranded costs, i.e. costs currently recovered in rates whose recovery would be jeopardized in a competitive market. OLR memo 97-R-1006 explains this concept in greater detail.
Although California, Illinois, Massachusetts, Montana, Pennsylvania, and Rhode Island have authorized securitization, only California has implemented this provision. The Pennsylvania Public Utilities Commission has authorized the issuance of $1.1 billion in bonds, but none have been sold to date.
California's restructuring legislation authorizes electric companies to finance part of their stranded costs through the issuance of rate reduction bonds by the state's Infrastructure and Economic Development Bank, a quasi-public entity. The bonds are backed by a nonbypassable charge that covers the utilities' stranded costs. The utilities transfer their right to collect this charge to the Bank, in exchange for receiving the proceeds of the bonds. Once the bonds are issued, neither the state nor the Public Utilities Commission can rescind the right of recovery. The charge must be adjusted periodically to ensure that there is sufficient revenue to pay the principal and interest on the bonds, as well as on-going costs such as servicing fees.
The legislation required the state's three investor-owned utilities to submit securitization applications to the Public Utility Commission by June 1, 1997. In September 1997, the commission authorized the issuance of $3.5 billion in bonds for Pacific Gas & Electric (PG&E), $3 billion for Southern California Edison (SCE), and $800 million for San Diego Gas and Electric (SDGE). In December 1997 the Bank issued $2.9 billion of bonds for PG&E, $2.5 billion for SCE, and $700 million for SDGE. Most of the bonds have an expected repayment term of ten years. As a condition of the issuance of the bonds, the companies were required to reduce their rates for residential and small commercial customers by 10%.
The ten states that have adopted comprehensive restructuring legislation (California, Illinois, Maine, Massachusetts, Montana, Nevada, New Hampshire, Oklahoma, Pennsylvania, and Rhode Island) differ in how they define stranded costs, but there are several common elements. With the exception of Illinois, each state has defined stranded costs to include the above market costs of generating plants and purchased power contracts, as well as regulatory assets (costs that the state utility regulatory commission has approved for deferred recovery). Each state allows certain other costs, such as those associated with nuclear power plant decommissioning, to be considered stranded. Most of the states limit stranded costs to costs incurred before the effective date of the legislation with certain exceptions.
In general, the legislation does not entitle utilities to recovery of their stranded cost, but instead provides them with an opportunity to recover them. But Pennsylvania entitles utilities to recovery of certain stranded costs while merely allowing them to seek recovery of generation plant costs.
Illinois' legislation takes a different approach to the determination of stranded costs. It takes the revenue that a utility would have earned in the absence of restructuring and then subtracts the costs of distribution (which will continue to paid through regulated rates), the market price of the electricity, and certain other adjustments.
OLR memo 98-R-0069 describes the stranded cost and securitization aspects of restructuring legislation in California, Illinois, Massachusetts, Pennsylvania, and Rhode Island in detail. Table 3 of OLR memo 97-R-0068 compares in chart form the definition of stranded costs and recovery method authorized by restructuring legislation in each of these states other than Illinois, plus New Hampshire. OLR memo 97-R-0776 includes information on these topics for Maine, among other states.