Stranded costs are those costs that electric utilities are currently permitted to recover through their rates but whose recovery may be impeded or prevented by the advent of competition in the industry. Estimates of these costs run from the tens to the hundreds of billions of dollars. Should regulators permit utilities to recover stranded costs while they take steps to promote competition in the electric power industry? On both efficiency and equity grounds, we argue, the answer to that question should be yes.
To begin with, we take issue with a particular rhetorical device commonly employed in this debate. Some imply that those who favor recovery fear competition in the electric power industry. That is not our position. Competition in generation is desirable. And more to the point, it's inevitable.
Stranded costs represent expenditures incurred by a utility in the past in meeting its obligation to serve all customers within the area for which it held an exclusive franchise granted under the traditional regulatory regime. Costs that face stranding include, among others:
1) Assets used for electricity generation
2) Costs for purchased power and fuel required under long-term contracts
3) "Regulatory assets" (expenses deferred to keep rates low temporarily)
4) Outlays for social goals, such as subsidies to low-income users
5) Incentives for renewable energy.
Regulatory agencies approved these outlays. Many were imposed on the utilities; some served to hold down prices to electricity customers. However, the entry of competitors who are not burdened by such inherited expenses can prevent utilities from recovering those costs. Such a scenario has been questioned both on the basis of equity and economic efficiency.