By Adam Wenner and Amanda Riggs Conner

A recent Federal Energy Regulatory Commission decision increases the risk that competing third-party projects will be granted priority to use excess capacity on transmission lines that developers have built to connect their own wind, solar or geothermal projects to the grid.

Not surprisingly, most population centers are not located in areas with constant high winds, thousands of acres of empty land or steaming geothermal wells. As a result, to serve load, renewable energy developers frequently must build their own transmission lines to reach the grid so that utilities can deliver the power to customers. Since transmission lines can extend for tens or even hundreds of miles, rather than being located at a single site, developers can face the same, or sometimes greater, development risks with the intertie as those associated with the development of power projects.

Under its open access transmission policy, FERC imposes the same obligations on independent power developers to make unused transmission capacity available to third parties as it does on traditional utilities. Although FERC requires these third party customers to pay to use this transmission capacity, it limits payments for transmission service to the developer’s “cost-of-service.” “Cost-of service” ratemaking compensates the developer for the construction and operating costs of the gen-tie lines, but includes only a regulated utility rate of return and, therefore, is not likely to compensate the developer for the non-utility type development risks it undertook.

This approach provides an incentive for a developer to bide its time while another developer attempts to permit, procure rights-of-way, finance and construct a transmission line, and offer to purchase transmission service only if the other developer succeeds.

Pending Proceeding

FERC is currently addressing the intertie open access issue in a proceeding involving a 212-mile line constructed in connection with a geothermal plant located in Nevada. The original owner of the project built the line to deliver the power from the plant to the Southern California Edison Company transmission system.

In December 2009, the current project owner sought a FERC ruling that would exempt it from the requirements to file an open access transmission tariff and to offer unused transmission capacity on its line to third parties. The project owner also sought FERC confirmation that it has “priority rights” to the capacity used for its geothermal project as well as priority rights on its planned expansion of capacity of the line. Another geothermal project developer intervened in the FERC proceeding and took the position that granting these requests would violate FERC’s prohibition on “banking” unused transmission capacity, making the capacity unavailable to other potential users.

The project owner’s filings cited FERC’s ruling in a similar case that involved a dispute over access to the Sagebrush transmission line, a 46-mile transmission line extending from the Tehachapi region of California to the SCE system. The Sagebrush line is owned by Sagebrush Partnership, whose partners are the owners of the wind projects that use the line. A third party, non-owner, Aero Energy, requested FERC to rule that it could use available capacity on the line for its wind project. The Sagebrush partners argued that, as owners of the line, they should be entitled to reserve available capacity for their own future projects.

FERC rejected the Sagebrush partners’ argument, noting that “[h]aving built the Sagebrush Line, Sagebrush now wants to bank unused transmission capacity until it, and no one else, wants to use it.” FERC instead ruled that the Sagebrush partners may not reserve all of the Sagebrush line’s transmission capacity to themselves since that would violate FERC’s authority to require a transmission owner to provide open access transmission, so long as providing transmission to third parties does not adversely affect the reliability of the lines. However, FERC said that if a line owner could demonstrate that it had “specific, pre-existing generation expansion plans” that would require it to use additional transmission capacity on the Sagebrush line, those plans will take precedence over a third party’s requested use of the line.

Following review of the Sagebrush partners’ expansion plans, FERC concluded that only one of the partners satisfied the standard, finding that it had “specific expansion plans with definite dates and milestones for construction of wind generation” that will use additional firm transmission capacity on the line and that the owner had expended “considerable effort” to achieve these milestones. FERC granted priority rights to the owner for the additional capacity, thereby allowing it to bank this capacity for future use.

In the proceeding involving the 212-mile line, which is now before FERC, the owner of the line says that it satisfies the Sagebrush test because it has specific development plans for developing additional geothermal projects, that it has diligently pursued these plans and, as a result, it is entitled to priority rights for all of the planned capacity on the line. It pointed out that developing geothermal projects can take more than 10 years and that it has undertaken a number of activities demonstrating its commitment to future projects, including engaging in the exploration and geothermal development necessary to support them. The owner said it acquired pre-existing priority rights in the gen-tie line, paid a premium for geothermal development rights because of the line, and spent more than $25 million in developing additional projects. In addition, it entered into leases with the US Bureau of Land Management and submitted interconnection requests to the California ISO to interconnect the planned new generation, which conducted feasibility studies regarding the interconnection of new generation to the gen-tie line. Finally, the owner said it is in the process of negotiating purchase power agreements for the output of its planned geothermal projects and obtaining federal, state and local permits to develop these projects.

The intervenor in the FERC case challenged the claims that the gen-tie owner satisfied the Sagebrush test, contending that its plans are not sufficiently concrete. In a ruling issued in September 2010, FERC held that the gen-tie owner had not presented sufficient evidence of specific pre-existing plans to establish priority for its future projects. In order to develop a more detailed factual record on which to base its final decision, FERC permitted the line owner to submit further evidence of pre-existing development plans. In response, the owner submitted more than 1,500 pages of documents in support of its position. The case is now awaiting a decision by FERC, and FERC’s decision will establish an important marker of which gen-tie developers must be keenly aware.

Open Access Tariff

FERC also ruled that the gen-tie owner must file an open access transmission tariff or “OATT” that establishes the terms and conditions under which it will provide transmission service to third parties on the line. Any OATT must generally conform to FERC’s pro forma tariff, but FERC said it would consider waiving or modifying certain OATT requirements to reflect the fact that the line is not an integrated transmission system, but rather is a radial line used only to transmit power from a power plant to the SCE system.

In November 2010, the gen-tie owner filed its OATT for transmission service on the gen-tie line. In the filing, it requested waivers of or proposed modifications to many provisions of the pro forma OATT, since the OATT was designed for use by large utilities and accordingly needed to be modified to reflect the services that could be provided by the owner of a gen-tie line.

FERC rejected many of the gen-tie owner’s requests for waivers or modifications. In particular, it required the gen-tie owner to include pro forma OATT provisions that allow transmission customers to delay commencement of their transmission service by paying a fee, establish detailed procedures for scheduling transmission service, require the transmission provider to offer scheduling, system control and load dispatch, and reactive supply and voltage control ancillary services or explain to customers how the services may be obtained, and impose deadlines on a transmission provider for completing studies of the impact of a transmission service request on the transmission line and any required upgrades.

FERC also required the gen-tie owner to revise its descriptions of the methodology it uses to calculate available transfer capability. It also required the gen-tie owner to justify its proposed customer creditworthiness standards, which deviate from FERC’s standard conditions to account for the fact that the gen-tie owner cannot assume significant credit risk. According to FERC, the gen-tie owner had not shown that its proposed variations were “consistent with or superior to” the FERC pro forma OATT, which is the standard FERC applies when a traditional utility or independent transmission company seeks to customize an OATT.

The gen-tie owner further requested FERC to rule that the pro forma OATT terms not apply to the transmission capacity needed for the gen-tie owner’s existing geothermal plant or for its projects under development. FERC rejected this proposal, finding that the gen-tie owner had not justified this proposed exemption, in that it did not explain how it would implement transmission service for the existing capacity or for the future expansion capacity over the line and, in particular, it did not explain how the transmission service will be included in available transfer capability calculations. FERC directed the gen-tie owner to submit a revised OATT that reflected FERC’s conclusions.

Self-Help Steps for Developers

Developers who are following the ongoing FERC proceeding are taking extra precautions and incurring additional expenses to ensure that they retain the rights to excess capacity on their own gen-tie lines.

For example, several affiliated companies are currently developing wind projects in California as phases of a large wind project, which are in various stages of development. The projects include gen-ties lines interconnecting with the California grid. None of the gen-tie lines is longer than six miles, and one is less than two miles.

The project developers recently filed a petition for a FERC declaratory order confirming that they are entitled to the transmission capacity on the gen-tie lines to deliver the output of their projects to the grid. This was not a simple or inexpensive exercise since a petition for a FERC declaratory order carries a filing fee of more than $23,000 and involves numerous filings, especially if the claim is challenged. Two of the projects commenced operation before FERC finally ruled on the petition.

FERC confirmed in a February 2011 order that the project companies have priority rights to the full capacity over the gen-tie lines. FERC found that the companies have specific, pre-existing plans with definite dates and milestones for the development of generation that would use the full capacity. It explained that for most of the projects, the companies had already entered into interconnection agreements with the California ISO and power purchase agreements for the output of their projects. FERC also found that the companies had presented evidence that they intend to construct additional projects that will use the remaining capacity on the lines, including specific milestones for construction, as well as a demonstration of progress in completing these milestones. Consistent with FERC’s long-standing open access transmission policy, the companies must offer transmission service over the gen-tie lines on any unused capacity under an OATT if they receive a request from a third party.

Problems With FERC’s Policy

In addition to forcing developers to waste resources seeking FERC confirmation that they will retain priority rights on their gen-tie lines, the FERC policy encourages sub-optimal decision making by developers.

A developer that would otherwise proceed with a development plan for multi-phased projects that allows adequate time to complete each milestone, but would risk forfeiting excess gen-tie capacity by proceeding under that timeline, would be incentivized to avoid this risk by artificially expediting its development plan. Expedition would include preparing detailed plans for project development earlier than otherwise called for—which can mean that performance data from the operation of earlier phases will not be available to “fine tune” later phases—applying for permits earlier than would otherwise be the case—and since many permits include milestones, artificially expediting studies and development schedules—ordering equipment solely to demonstrate that commitments have been made, entering interconnection queues and reserving (and paying for) transmission earlier than would have been the case, and otherwise undertaking activities for the sole purpose of developing a record that will pass FERC’s standard and enable the developer to retain priority rights on its excess gen-tie capacity.

The authors believe that there are approaches that can mitigate the artificial incentives and associated sub-optimal behavior.

First, the exponential scale economies associated with using higher voltage transmission lines must be recognized in the discussion, since these scale economies mean that the per unit costs for all developers will be lower if larger (for example, 500 kV rather than 230 kV) gen-tie lines are constructed.

Second, the environmental degradation caused by one higher capacity line is considerably less than that caused by the construction of several lower capacity gen-tie lines and the associated transmission corridor. (For an informative discussion of scale economies in transmission, see “Interstate Project: 765 kV or 345 kV Transmission,” available on American Electric Power’s website, http://www.aep.com/about/i765project/technicalpapers.aspx.)

A Better Way

Not surprisingly, this is not the first time that FERC has encountered this type of issue. Beginning in gas pipeline certificate cases and continuing in its “merchant transmission” decisions, FERC has incentivized and, in some instances, required developers to offer to expand the capacity of their projects to accommodate all users that are willing to make the requisite financial commitment. In gas pipeline cases, FERC has the direct authority, through the Natural Gas Act certificate process, to require developers to build pipelines with sufficient capacity to serve all users and has stated that it can require capacity expansion as a condition of granting a certificate of public convenience and necessity.

Under the Federal Power Act, which governs electric transmission in the continental US except for the ERCOT region of Texas, FERC lacks certification authority. However, it clearly has the authority to impose a similar requirement to “expand the gen-tie capacity to serve all users” by conditioning its granting of market-based rate authority on gen-tie developers agreeing to expand the capacity of their lines to serve all users that agree to make the requisite financial commitment.

Similarly, in decisions involving merchant transmission, FERC requires the transmission project developer to conduct an “open season” auction for capacity rights. This requires the developer to provide adequate public notice of the upcoming auction and to use transparent bidding procedures with evaluations by a disinterested decision maker—usually an economic consulting firm. Recent FERC decisions have approved the “anchor tenant” approach, in which, in order to demonstrate to potential bidders that the line is viable and therefore participating in the auction is not a futile exercise, the project developer negotiates with a large customer ahead of the bid process for a percentage (for example, 50%) of the project’s capacity. Bidders in the open season compete for the remaining capacity, with assurances that they will not pay more than the anchor tenant. Although FERC has not yet addressed a case where an affiliate of the transmission project developer is an anchor tenant, its decisions indicate that it would not prohibit such an arrangement, provided that third parties are able to obtain non-discriminatory pricing and terms of service.

The “gen-tie auction” approach that the authors propose would incorporate the open season process into the gen-tie development process. In seeking FERC approval for market-based rates for the generation project, the developer of a generating project that includes a gen-tie line would have the option of conducting an open season process pursuant to the standards that have been applied in merchant transmission cases. This would specifically include the generator or an affiliate as an anchor tenant that has agreed to sign up for transmission capacity on the new line. The generator could sign up for a percentage of the capacity of a specified line—for example, X% of a 230 kV line—or just for a stated amount of capacity—for example, 250 MW—with the line to be sized to accommodate all users. The generator would proceed with the open season process, would determine the appropriate configuration to accommodate all interested customers, and would enter into precedent agreements with customers that would impose secured obligations to fund their portions of the line.

In exchange for having opened up its transmission planning and development to all interested parties, the gen-tie project sponsor would be exempted from the FERC “use it or lose it” rule for a specified period, roughly corresponding to the planning and development cycle of its renewable resource project. The underlying principle is a “speak now or forfeit your open access rights,” at least for projects for which a third party reasonably could have been expected to make financial commitments during the stated period—for example, three years. Under the gen-tie auction policy, only parties that put development funds at risk would be entitled to priority transmission rights during the development cycle.

All parties, including consumers of the power being produced, would benefit from the economies of scale that would result. This approach would eliminate the false incentive for developers to make concrete plans to develop subsequent phases of their projects because the developer would be exempted from the requirement to offer to enter into long-term commitments for unused capacity on their shares of the transmission line. Third parties who would otherwise raise complaints will instead be required to “speak now, or hold your peace until the next development cycle.”

FERC has scheduled a technical conference to consider issues relating to ownership of and priority accss rights to new transmission projects, including the appropriate balance between FERC’s policies on open access and the needs of gen-tie project developers. The conference will be held on March 15, 2011 from 9:30 a.m. to 4:00 p.m. in FERC’s offices in Washington, D.C. A free webcast of the technical conference will be available and can be viewed by locating this event in FERC’s calendar of events on its website, www.ferc.gov.