Stranded costs
Encyclopedia
In discussions of electric power generation deregulation
, the term 'Stranded Costs' represents the existing investments in infrastructure for the incumbent utility which may become redundant in a competitive environment.
A large, incumbent monopoly electric power utility will have made substantial investments over the years and will carry debt. The market cost of electricity includes payments on this debt.
As technology improves, the cost of generating electricity falls. A new entrant to the marketplace, unencumbered by debt, can build a modern plant and generate electricity at a lower cost than the incumbent. Logical customers leave the incumbent utility for the new entrant, reducing the utility's revenue, and spreading the debt payments across the fewer remaining customers.
This is often caused by overly long depreciation schedules for large capital investments by utilities. The depreciation schedules were set presuming an ongoing monopoly.
Solutions to the Stranded Costs problem include assigning a portion of the incumbent utility's debt to the new entrant as a condition of entry, or charging all customers in the market area a Stranded Cost Recovery Fee. In some cases, a government may assume a portion of an incumbent utility's debt and assign it to the public debt, thus freeing the utility to compete against new entrants unhindered.
Deregulation
Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces.Deregulation is the removal or...
, the term 'Stranded Costs' represents the existing investments in infrastructure for the incumbent utility which may become redundant in a competitive environment.
A large, incumbent monopoly electric power utility will have made substantial investments over the years and will carry debt. The market cost of electricity includes payments on this debt.
As technology improves, the cost of generating electricity falls. A new entrant to the marketplace, unencumbered by debt, can build a modern plant and generate electricity at a lower cost than the incumbent. Logical customers leave the incumbent utility for the new entrant, reducing the utility's revenue, and spreading the debt payments across the fewer remaining customers.
This is often caused by overly long depreciation schedules for large capital investments by utilities. The depreciation schedules were set presuming an ongoing monopoly.
Solutions to the Stranded Costs problem include assigning a portion of the incumbent utility's debt to the new entrant as a condition of entry, or charging all customers in the market area a Stranded Cost Recovery Fee. In some cases, a government may assume a portion of an incumbent utility's debt and assign it to the public debt, thus freeing the utility to compete against new entrants unhindered.