Stranded Assets and Efficient Pricing for Regulated Utilities: a Federal Tax Solution

Abstract

Most businesses recoup their investments in property, plant, and equipment from the income they earn from using those assets. When changes in markets, technology, or regulations reduce income from those assets or increase operating costs, businesses may not recover their full investments in those “stranded assets.” Unregulated firms generally contain these risks by diversifying assets and income streams, procuring insurance, or engaging in hedging transactions. Public utilities, however, must obtain a regulator’s permission both to manage these risks and to pass the costs of those assets forward to consumers. Globally, over $20 trillion in global fossil fuel assets may be stranded as countries pass climate change legislation. To date, investor and consumer concerns about stranded costs have delayed the adoption of carbon pricing schemes, spurred the rejection of greenhouse gas regulation altogether, and formed the basis for bankruptcy filings, takings litigation, and demands for relief. This article makes four contributions. First, it clarifies that under the existing tax and regulatory rules, the economic benefits of substantial tax subsidies are currently being passed forward to consumers, artificially reducing fossil fuel electricity rates, encouraging waste, and increasing emissions. Second, it quantifies the extent of stranded assets held by public utilities in the United States, pulling data on unrecovered capital from the securities filings of the fifteen largest firms in the country. Third, it argues that U.S. tax measures have left fewer assets to be stranded, identifying $110 billion in “accumulated deferred income taxes” or “ADIT,” the tax savings from deferral, as a source of recovery. Finally, the article proposes a change in tax and regulatory policy that will enhance efficiency, remove one of the supports for carbon lock-in, and help manage the threat of stranded assets, smoothing the transition to a carbon-neutral economy.