Stranded cost

Stranded cost (좌초비용) is referred to the cost which is usually exposed in the course of privatization of public utilities, and could possibly spoil the privatization program of the public sector. In the United States, the stranded cost, relatively stable cash flow in a long period of time, may be secuitized to cover the troublesome cost.

Key words
stranded cost, public utilities, restructuring, securitization

Background
When the 1997 banking crisis was put under control, the Korea Electric Corp. ("KEPCO") was the target of restructuring in the public sector. In December 2000, the Act for the Facilitation of Restructuring the Electric Industry was established to separate and privatize the generation businesses of KEPCO excluding the hydro and nuclear generation. However, pervasive concern over possible rate hikes and the nightmarish blackouts in California have brought the anticipated privatization process to a standstill in spite of its apparent merits and advantages.

This article shows a legal analysis and point of view regarding how to apply the securitization of stranded costs incurred during the deregulation of electric industry.

Industrial Restructuring and Stranded Cost
As part of industrial restructuring, many public utilities, which were once under the protection of natural monopoly, requested compensation for prior investments that were deemed uneconomical in a deregulated market. Otherwise, private electric utilities had a competitive edge over the public utilities on the brink of bankruptcy.

These investments, commonly referred to as "stranded costs," may include:

- unrecovered investments in, or costs associated with the closure of, a power plant;

- obligations with respect to above-market power purchase contracts;

- the cost of work force retraining; and

- low-income assistance programs.

In the United States
At first, there were some disputes over the stranded costs between the public entity and the privatized utilities.

In many states of the United States, as a matter of public policy, the legislature and regulatory authorities have provided for recovery of utilities' stranded costs by allowing the utility to pass these costs to the consumer base by imposing a defined surcharge.

Accordingly, the resulting right to collect future tariff revenues for utility customers has become the intangible transition property, which can be transferred to a special purpose vehicle (SPV) for securitization. The goal of securitization is to reduce the utility's cost of capital, thus improving its ability to operate in a competitive market, and to allow utilities to realize compensation for stranded costs sooner than expected.

Korean Perspective
In Korea, the landscape is quite different from that of the United States.

So the statutes, which mandated the full scale reorganization of power generation in disregard of the stranded costs, need to incorporate the following guidelines.

In other words, the statutes should:

- define the stranded costs in a reasonable manner;

- require KEPCO to assess and disclose the prior investments or commitments unrecoverable in a competitive market;

- prohibit KEPCO, which still operates transmission and distribution grid, from differentiating other competitive power suppliers;

- supervise KEPCO's assessment and recovery of stranded costs;

- not impair KEPCO's right to collect the transition tariffs for the purpose of securitization; and

- grant KEPCO the privileges of the public corporations like KAMCO, provided for in the ABS Act.

Prospects
The deregulation and restructuring of the electricity industry seem to be an irrevocable global trend. But the deregulation is by no means any cause for a rate increase. So the stranded costs might be utilized to improve the financial position of utilities through massive securitization programs.

In conclusion, because the tariff-based cash flow stream supporting the securitization can be established by legislative or regulatory authority unlike other asset classes, any future legislation, including the future amendments to the relevant statutes, should adopt the legislative proposals contained in this article.

The possible legislation is expected to stimulate the currently dormant ABS bond market, and make a good example for restructuring of public sector corporations.