Stranded Costs

William J. Baumol & J. Gregory Sidak


Through the end of the twentieth century, the most critical regulatory issue facing electric utilities was stranded costs, which can be defined as those costs that the utilities were permitted to recover through their rates but whose recovery may have been impeded or prevented by the advent of competition in the industry. These costs represent expenditures incurred by a utility in the past in meeting its obligation to serve all customers within the area in which it held an exclusive franchise, granted to it under the traditional regulatory regime. The article explores whether entry of competitors who were not burdened by these stranded costs could have prevented incumbent utilities from recovering their costs. In this article, we explain why it generally benefits consumers for stranded costs to be recovered as part of the price of service. In part I of this article we discuss the efficiency justifications, and in part II the equity justifications, for recovery of stranded costs. In part III, we briefly discuss the takings implications of stranded costs. In part IV, we discuss a utility’s duty to mitigatestranded costs.

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