The Regulatory Compact and the Treatment of Stranded Assets

Abstract

This paper explores how transaction cost economics supports the regulatory compact and can provide guidance on the proper regulatory treatment of stranded assets. Stranded assets are regulated assets that are no longer used for utility service, but have not been fully depreciated. Traditional rate regulation has limited the amount of stranded asset risk exposure to utilities and pipeline companies. However, recent regulatory decisions in Canada have signaled that regulators may alter the way that they treat stranded costs, based on their interpretation of the Calgary Stores Block Supreme Court of Canada decision. Such a change, shifting the risk of stranded assets entirely to shareholders, could result in a major increase in business risk for utilities and energy infrastructure companies, increased rates for services and underinvestment in the industry. An analysis of transaction cost economics illuminates the importance of the regulatory compact, supporting the conclusion that prudently incurred stranded asset costs should be allowed full recovery. The paper ultimately provides policy recommendations for a legislative amendment supported by the economic theory of contracts entrenched in the implicit regulatory compact affecting utilities, regulators and ratepayers.