Stranded costs, takings, and the law and economics of implicit contracts

Economic Analysis can help resolve the stranded cost controversy that has arisen in debates over electricity market deregulation. ''Stranded costs'' are costs electric utilities will not recover as power markets move from protected monopolies to an open, competitive environment. We describe the stranded cost problem, its magnitude and the prominent arguments for and against recovery. An economic analysis of implicit contracts can clarify whether there should be a legal duty to compensate utility shareholders for unrecovered costs. However, efficient approaches to electricity deregulation should rely on more than analysis of contracts. The politics of deregulation, as reflected in optimal compensation for regulatory ''takings'' of property, also affects the desirability of stranded cost recovery.