Stranded cost recovery and cooperative electric utilities.

• Author: Lyon, Carl F., Jr.

Both federal and state legislative and regulatory bodies have been moving decisively toward deregulation of major portions of the electric industry. Major legislation has been enacted in a handful of states, most notably California and Pennsylvania. Major electric industry restructuring proposals are also pending before legislative and regulatory bodies in Arizona, Idaho, Illinois, Michigan, New York, New Jersey, Vermont and numerous other states.

Although important aspects of these deregulation efforts remain unresolved (and will differ from state-to-state), major elements have taken shape. To date the primary input into this process from the electric utility industry has been from the vertically integrated investor-owned utilities, which are jurisdictional in nature and these rates are regulated by state public service commissions. However, electric utility restructuring legislation will also have profound implications for cooperative electric utilities, which differ substantially in structure and nature from investor-owned utilities.

The purpose of this article is to discuss some of the special issues that restructuring legislation may raise for cooperatives and to suggest possible approaches to these issues.

Background

The business of providing electric service historically has been viewed as a natural monopoly in the United States. A single utility generally has been authorized to provide electric service throughout a designated service area. The utility is obligated to provide reliable electric service to all members of the general public within the designated service area. This generally has included an obligation not only to install and maintain low-voltage electric distribution lines, but also to ensure a reliable source of energy supply, and to arrange for high voltage transmission of electric energy to the local distribution system. In return for accepting these obligations, the utility generally is granted the exclusive right to provide electric service within the designated area.

During the last two decades, a sizable industry of non-utility generators ("NUGs") has developed to compete with traditional utilities in the supply of electric energy. Particularly in light of technological advances in combustion turbine technology, together with dramatic reductions in the price of natural gas burned in such generating facilities, NUGs often have been able to produce electricity at costs substantially below the average cost of the local utilities. Beginning with the Public Utilities Regulatory Policy Act of 1978, and continuing with the Energy Policy Act of 1992, Congress has made it easier for NUGs to displace energy produced by traditional utilities in meeting the requirements for energy supply within their service areas. In many cases, NUGs have sought to "bypass" the local utility altogether by installing electric generating plants on the sites of major industrial or commercial users.

This "cherry picking" of utilities' largest electric customers now threatens the economic viability of all traditional utilities, investor-owned, cooperative and municipally-owned. The historic practice of prohibiting NUGs from competing in the supply of electric energy conflicts with long-standing federal policies encouraging competition. Many commentators and consumer advocates believe that this practice also has resulted in artificially high electric rates.

Traditional utilities have taken the position that they would be unable to recover the full amount of their prudently-incurred costs of generation-related assets and obligations in a fully competitive energy supply market. The position of the investor-owned utilities has been that opening the electric generation markets to full competition without providing for full, or at least partial, recovery of the investor-owned utilities' "stranded costs" would violate the "regulatory compact" pursuant to which the investor-owned utilities were induced to make investments in generation-related assets and to incur generation-related obligations. Most state legislation enacted to date, including legislation in California and Pennsylvania, proceeds from this proposition, at least in part.

Protected recovery of "stranded costs" during transition to a deregulated generation industry

The legislative and regulatory proposals being debated around the country are notable for their variety: some mandate immediate retail rate reductions and immediate retail access to choice of generation service providers, others provide for rate freezes or caps and phased-in access for various customer classes over time. One common, critical element in virtually all of the state restructuring legislation pending or enacted to date is the protected recovery of some measure of a utility's "stranded costs" through the imposition of a non-bypassable transition charge on the customers within a jurisdictional utility's historic service territory. Depending upon the circumstance, the transition charge takes the form of a onetime payment or a continuing usage-based charge collected as part of unbundled rates. The transition charge is said to be "non-bypassable" because it is to be paid by end-users of electricity within the utilities' historic service territory, even if the end-user subsequently purchases its electricity from another service provider or, in some cases, even if it subsequently self-generates.

As a further elaboration on this concept, most legislative proposals have included provisions designed to facilitate "monetizing" some or all of a utility's stranded costs through the issuance of debt securities that would provide the utility with a lower cost of capital, or provide other economic benefits in a deregulated environment. These obligations are variously denominated from state to state as "rate reduction bonds," "transition bonds," "qualified intangibles bonds" or any number of other designations. In theory(1), the utility or its surrogate (commonly either a government entity or a utility-sponsored grantor trust) would issue debt obligations in an amount equal to its stranded costs (or some portion thereof defined by statute or regulatory order). Optimally, the resulting obligations would be non-recourse to the general credit of the utility, would not be subject to the bankruptcy risk of the utility and would be secured solely by the non-bypassable transition charges to be paid by end users of electricity over a specified period of time. The amount and timing of transition charges would be mandated by statute or by a final, non-appealable regulatory order. With those structural characteristics the obligations could attain the highest possible rating by the national rating agencies and therefore the lowest cost of funds to the sponsoring utility(2). The expectation is that monetizing stranded costs in this fashion would result in a net rate reduction for consumers by replacing higher cost equity capital and traditional utility debt with lower cost, AAA-rated, non-recourse debt. For example, in its "Staff Report on Electric Industry Restructuring" dated December 19, 1996, the staff of the Michigan Public Service Commission estimated that, given certain maturity and interest rate assumptions, AAA-rated bonds could achieve a net rate reduction to consumers of approximately 9%.(3) In the enacted and proposed state legislation around the country, the "monetization" provision is generally made available to investor-owned utilities, but is not uniformly available to cooperative utilities.

One illustration of the monetization approach is the California model, Assembly Bill 1890 ("A.B. 1890"), signed into law by Governor Wilson on September 23, 1996. This model calls for accelerated rate relief of at least a 10% reduction in total rates for residential consumers, commencing January 1, 1998 and continuing through March 31, 2002. This is to be accomplished by: (1) "monetizing" a portion of the investor-owned utilities' stranded costs through the issuance of...