Probably the most contentious issue in the negotiations leading up to the restructuring legislation was how to deal with “stranded costs.” Stranded costs are defined as capital investments by the regulated utilities that are contained in the regulated rate base but not collectable in the future if consumers switch to other suppliers. Public Act 142, passed as a package with P.A. 141 in 2000, gave state guarantees of $2.2 billion in utility refinancing to lower incumbent utility costs. In addition, the two utilities, DTE Energy and Consumers Energy, were guaranteed compensation if electric restructuring required them to close facilities.[9]

Some investments and commitments by utilities may well have been unrecoverable outside of regulation. For example, regulated utilities across the country were required to purchase power from independent power producers (known as “qualifying facilities”) under federal law, and entered into long-term contracts with such suppliers that are still in effect. Other costs defined as “stranded” were probably not unique to the regulatory environment, but nonetheless were eligible for recovery under P.A. 142. Further, P.A. 141 required that customers switching to alternative suppliers pay an extra charge for stranded cost recovery by incumbent utilities. Thus, a portion of rates paid to alternative suppliers went directly to their competitors. Even though competition was later restricted, the utilities were never required to pay back those stranded costs. Instead, Michigan ratepayers paid these costs and were not repaid when the utilities were protected from competition by the 2008 legislation.

A 1997 Mackinac Center report discussed the lack of economic justification for most if not all stranded cost recoveries by the large utilities. The following excerpts from that report apply equally well today:

The bottom line on this divisive issue is that stranded cost compensation is almost never justified …  

A good test that regulators can employ to determine if any compensation should be considered is the following: If a utility can show that it made an investment at the insistence of regulators, and resisted the action but was forced to move forward anyway, then it has a better case for compensation. In a recent study advising Pennsylvania regulators, Dr. Jake Haulk, research director for the Pittsburgh-based Allegheny Institute for Public Policy, concurs but adds important qualifications to this simple test that are applicable for all state and federal regulators.

Any utility which can show that it was ordered to make expenditures that it would not have undertaken on its own, and which other utilities were not ordered to make, should be given some opportunity to recover those outlays. The guiding principle here must be this; to what extent has the utility been uniquely disadvantaged by regulators or government agencies? If all utilities have been treated the same by regulators, the playing field will remain level after competition is introduced and hence there is no reason to allow stranded cost recovery …

Rarely have utilities fought proposals by regulators to mandate the construction of new facilities or requirements to undertake other activities. If utilities showed no reluctance to move forward with the projects regulators urged them to pursue, then they clearly have no grounds for recovery. And even in those few cases where limited recovery might be approved by policy makers, utilities should be asked to do everything in their power to mitigate these costs before they are absorbed by third parties. Regulators might even want to encourage utilities to divest themselves of certain assets for which they are claiming compensation. This would at least allow the utility to recoup some of the costs associated with the asset and would simultaneously ensure that customers or new competitors are not stuck footing an unnecessarily large bill.[10] [Citations omitted, and are available in the original report.]

By this economic standard, the stranded cost recoveries following the 2000 legislation were excessive. A strong argument can be made that the large utilities should have been required to pay back a large share of these stranded costs to Michigan ratepayers when the 10 percent cap was imposed in 2008. Looking forward, any claims that large utilities are entitled to even more compensation for stranded costs or other cost related to a transition to greater competition should be viewed with great skepticism.


[9]  This comment uses the term "stranded costs" loosely, and notes that the utilities also received "transition cost" payments to compensate them for the transition to having to compete and "securitization" charges to help them lower their debt. The charges are explained further in Theodore R. Bolema, “Assessing Electric Choice in Michigan” (Mackinac Center for Public Policy, 2004), accessed Oct. 29, 2013, http://goo.gl/0aixCb; Diane S. Katz and Theodore R. Bolema, “Proposals to Further Regulate Michigan’s Electricity Market: An Assessment” (Mackinac Center for Public Policy, 2008), accessed Oct. 29, 2013, http://goo.gl/CKqEhn.

[10]  Adam D Thierer, “Energizing Michigan’s Electricity Market” (Mackinac Center for Public Policy, 1997), accessed Oct. 28, 2013, http://goo.gl/B8lx8e.