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[This page is a series of focused write-ups on applications in securitisation. For other applications, see the Securitisation Applications section on the Securitisation home page.]
Securitisation by public utilities' earnings:
Application of securitisation to recovering a part of capital costs of public utilities has been one of the most talked about applications of securitisation. Public utilities (such as electricity companies) normally work on a cost recovery mechanism: the price of their output is computed so as to recover the costs with a fixed return on equity. In this context, securitisation is a public benefit if and only if it would lead a lower overall cost of borrowing, and hence, reduce the utility's costs, to be passed on the consumers.
One of the common applications of securitisation has been to recover "stranded costs" of electricity utilities. Stranded costs refers to such part of the costs of a utility which is not recoverable from consumers due to transition from a regulated to a competitive environment. That is to say, when utilities were working on a regulated cost-recovery system, the whole of their costs were recoverable from customers in a cost-recovery based pricing. But as they graduate to a free pricing system, the prices are market determined, in which newer entities with more modernised generation methods are able to generate at lesser costs, and hence sell at lesser costs. Thus, a part of the uneconomic generation costs of the older entities are left unrecovered, as such these costs are referred to as "stranded costs".
Governments are often forced to allow the utilities to recover these stranded costs in form of a surcharge.
The option of securitisation of such stranded costs recovery has been used by several US State utilities, as it allows the utility to borrow at lesser-than-otherwise rates, or to pay off a part of the equity of the company thus making the entity more efficient, both in terms of taxes and overall return on equity.
Links:
For an article on securitisation by public utilities, click here.