The Skinny on Caps and Stranded Costs
- August 7, 2003
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When it comes to rate caps and stranded costs, size does matter. Bigger stranded cost charges sooth utilities and hurt consumers, while longer rate caps reassure consumers but increase risk and possibly pain for utilities.
Our review of stranded cost charges and rate caps in Pennsylvania reveals that normally the charges are big and the caps are long (see the chart below).
For example, in the case of PECO, the system average stranded cost charge is a whopping 26 percent of the total rate. To put it another way, PECOs regulated rates are on average 26 percent above the market price for electricity. But, PECOs generation charges are capped until 2010.
The six largest Pennsylvania utilities requested over $18 billion in stranded costs and were authorized to collect $11billion in the restructuring case settlements (PECO, PPL, Met, Ed, Penelec, and West Penn) and decisions (Duquesne). PECO ($5.26 billion) and PPL ($2.97 billion) had by far the highest stranded cost awards, primarily because of uneconomic investment in nuclear power plants. Penelec received the least ($386 million).
It is critical to understand that none of these charges were or are new. All these dollars had been placed in rates by regulators prior to restructuring in 1996.
PECO has the highest system average CTC/ITC payment of 2.43 cents/kwh, while Duquesnes was 2.24 cents/kwh, and PPLs is 1.3 cents/kwh. The CTC/ITC comprises a whopping 26 percent, 25.5 percent and 19 percent of the total customer rate for PECO, Duquesne and PPL respectively.
Even for the utilities with much lower CTC rates, the CTC creates a significant impact on bills. For West Penn, the system average rate of 0.54 cents/kwh still comprises 9.8 percent of the total consumer rate, while the 0.53 cent/kwh system average CTC for MetEd comprises 7.5 percent of the total rate, and the Penelec CTC charge of 0.14 cents/kwh comprises 2.1 percent of the total rate.
These rates translate to large monthly payments. In the PECO territory, a residential customer who used 600 kWh last month paid $16.44 in CTC/ITC charges (2.67 cents for the first 500 kWh and 3.09 cents for the next 100 kWh).
For a larger commercial customer in the PECO territory requiring about 1MW with a 60 percent load factor, the CTC/ITC costs are about $11,410 monthly, or $136,920 for the year.
To put these rates in perspective, the PECO system average CTC/ITC of 2.43 cents/kwh is higher than the system average distribution charge of 2.35 cents/kwh, much higher than the system average transmission charge of 0.45 cents/kwh, and more than half as much as the system average price of default generation of 4.56 cents/kwh that is actually sold to customers.
Thars gold in that thar pain
Always looking for the bright side, customers paying the highest CTC rates will see the greatest rate reduction when they are eliminated. All Duquesne customer classes completed payment of the CTC by June 2003, receiving a system average rate reduction of 25.5 percent. For residential customers, the rate cut in March 2002 was about 20 percent. For residential heating customers, the rate cut in March 2003 was about 40 percent.
PECO customers can look forward to system average rate cuts at the end of 2010 of about 26 percent, while PPL customers can look forward to system average rate cuts at the end of 2009 of about 26 percent. While both rate caps and stranded cost charges certainly are conceptual horrors to utilities and consumers respectively, the pain really hasnt been so bad. They are together a reasonable package deal to ease the transition to a competitive market.
From the consumer point of view, the rate caps guarantee that consumers spend less and less of their income for electricity. Rates today are no higher than in 1996 and more than 13 percent lower in inflation adjusted dollars.
For the utilities, stranded cost collection facilitated a much easier adjustment to the competitive market, too. Without stranded cost charges, many of Pennsylvanias electric utilities would have gone bankrupt with unknown effects on service. Of course, even with stranded cost payments, Allegheny Energy has come close to Chapter 11 as a result of a series of misjudgments and bad deals.
With revenue reductions ranging from 2 percent to 26 percent, will utilities survive the end of CTC collections? The utilities should have used the transition period to write down uneconomic costs and pay off debts on the uneconomic generating plants. With lower debt to carry on their books, they should be able to maintain healthy debt to earnings ratios.
The generation portfolios or other financial and investment decisions by the utilities may or may not be profitable depending on what happens in the market. Yet, the risk of being wrong, and the profits from being right will rest with the company. For stranded cost payments must be a once-and-done-forever deal.
Consumers no longer will be required to pay generation owners for poor investments. Of the thousands of MWs of generation that has been built since restructuring, exactly 0 MW will qualify for stranded costs in retail restructured states. These generation projects rest solely on their ability to sell their output at competitive prices and be more efficient than the power plant down the street.
Effects on competition
The reasonable and generally successful trade-off of rate caps and stranded cost recovery has one substantial downside. Both rate caps and stranded cost charges have made it more difficult for competitors to enter retail markets. Put simply, they have slowed the development of retail competitive markets and will continue to do so until they end. Despite the addition of stranded cost charges to their electric prices, competitive suppliers at times have offered consumers savings of 5 percent, 10 percent or even 20 percent. During these periods the amount of load served by competitive suppliers increases.
But when wholesale prices increase, the combination of the capped retail rate and the addition of large stranded cost charges to the prices offered by competitive suppliers make it impossible to deliver savings to retail customers. At those times, retail customers return to the utility and default service or dont switch, causing the total load served by competitive suppliers to decline.
So as rate caps and stranded cost recovery end, Pennsylvania should make sure that aggregation, demand response, competitive bidding to serve default customers and other measures to make sure that the local utility does not dominate the retail market are in place. The transition is going well but more work lies ahead. That is the skinny on rate caps and stranded costs.