Securitization and Stranded Cost Recovery*

By Hall, Walter R., II | Energy Law Journal, January 1, 2004 | Go to article overview

Securitization and Stranded Cost Recovery*


Hall, Walter R., II, Energy Law Journal


I. INTRODUCTION

Securitization is a financing tool which has been employed for many years to expand the availability and reduce the cost of consumer and business credit. Securitization achieves this purpose by obtaining funds from the securities markets by means of specially developed securities whose attributes are carefully shaped to minimize investment risk and thereby to obtain a high investment rating with corresponding reduced interest cost. Were a business or financial intermediary to raise these funds by issuing its own securities, the securities' investment risk and associated cost would typically be greater due to the business and financial risk of that business or intermediary. Such risks are avoided through securitization because return of and return on investors' capital is obtained from dedicated assets (thus the name "asset-backed securities") rather than the business fortunes of the securities' issuer.1

For the past two years, state legislators and Public Utility Commissions (PUCs) have debated whether this tool can effectively be employed to assist in the transition from a regulated to a competitive market for electricity. In 1996, two states, California and Pennsylvania, adopted legislation designed to make this tool available in their states. In May and June 1997, despite growing opposition to its use by certain electric market participants, two additional states, Montana and Rhode Island, enacted similar legislation.2 Supporters of securitization argue that it is an "eloquent" solution to one of the more difficult problems (stranded cost recovery) of the transition from a regulated to a competitive electricity market and provides a solution which is "win-win" for both utilities and ratepayers. For the utility, it provides stranded cost recovery while preserving financial integrity, while for the ratepayer it produces rate reductions from existing PUC-determined just and reasonable rates.3

Various published analyses, however, have expressed concern that the securitization process may be unfair to ratepayers and may create insurmountable competitive advantages for existing utilities in the new electric marketplace. Indeed, some opponents of securitization have termed it a "swindle" and refer to the proposed securities as "nuclear mistake bonds." They argue that, while providing ratepayers with only "minuscule" rate reductions, securitization provides utilities with legislatively guaranteed recovery of their stranded costs, which costs are by definition uneconomic and of little or no value to ratepayers. Opponents object to utilities' entitlement to recovery of stranded costs in the amounts proposed to be securitized and assert 1) that stranded costs cannot be accurately measured and the inaccuracy would both be confiscatory to ratepayers and injurious to utility competitors; 2) that the up-front capital infusion from stranded cost recovery provided by securitization permits utilities a substantial competitive advantage in the new marketplace; and 3) that securitization will, at a minimum, substantially delay ratepayer receipt of the benefits of competition and may actually increase, rather than decrease, ratepayer-borne costs.4

This article examines the securitization "tool" and seeks to define circumstances where its use is beneficial. Its thesis is that securitization, where properly applied, is but a financing tool which can achieve savings for ratepayers. To be effective, however, this tool requires that certain underlying cost recovery patterns and industry restructuring conditions be present. By improving utility financial integrity, securitization also increases share value and thereby benefits shareholders. Where these conditions exist, securitization should be employed by legislators and regulators. Disadvantages asserted by opponents can be avoided or acceptably mitigated by careful Grafting of the regulatory decision, the legislation permitting securitization, or both. …

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Securitization and Stranded Cost Recovery*
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