Merchant Transmission Projects: Opportunity or Fantasy?

Merchant Transmission Projects: Opportunity or Fantasy?

April 01, 2003

There is little incentive at the moment to build new power plants in the United States because of the amount of spare generating capacity. Wholesale electricity prices have fallen to levels that make it  impossible in many cases to finance additional projects. At the same time, in some parts of the country, transmission bottlenecks prevent sellers of low-cost power from delivering their product to areas where power prices are higher. This has led many companies to look at the possibility of buying sections of the existing grid or of constructing new transmission lines. Chadbourne hosted a workshop in Houston in March about the regulatory thicket through which anyone wanting to get into the merchant transmission business must navigate, the ownership structures that independent transmission companies are using, and the issues they face in doing business. The following are excerpts from that discussion. The speakers are Bob Shapiro and Adam Wenner, two regulatory lawyers from the Chadbourne Washington office, Philip Hanser from the Brattle Group, and William Hieronymous from Charles River Associates Inc. 

Regulatory Thicket

MR. SHAPIRO: Let me start with an abridged history of utility regulation. 

You may recall that, at one time, dinosaurs roamed the earth and it was very warm, and electricity was really not needed. And then it got cold, Thomas Edison invented the light bulb, and monopolists set up electric utilities. Franklin Roosevelt persuaded Congress in 1935 to pass two important pieces of legislation — the Public Utility Holding Company Act and the Federal Power Act — in an effort to
rein in those monopolists. Jimmy Carter a few years later persuaded Congress to pass still more energy legislation, including the Public Utility Regulatory Policies Act, or “PURPA,” in order to  encourage competition. George Bush I put another important bill through Congress called the “Energy Policy Act” in 1992. It created something called “EWGs.” 

Then everyone forgot about regulation altogether and Enron roamed the earth and, like the Pied Piper, the power industry followed it into the sea. 

And then everyone started out handing business cards at job fairs. 

To the question,“What does this have to do with transmission,” the answer is very little. The reason is that transmission, unlike generation, has never been perceived, at least until now, as a  competitive business. It has always been heavily regulated. It is a bottleneck monopoly. 

While the Federal Energy Regulatory Commission has undertaken a number of regulatory initiatives, very little has moved forward in the transmission area. Many proposals are pending. There remains a serious question whether FERC can do very much in this area without significant federal legislation, and there remains a question whether the FERC initiatives are even relevant any longer given the current state of affairs in the power industry where major power companies are simply fighting for their lives.

I will talk about four statutes that come into play when someone wants to acquire transmission assets. The main one is the Federal Power Act. Most of my talk will be about the Federal Power Act and the initiatives under it, but three other pieces of the regulatory puzzle that are relevant for this discussion are PUHCA, PURPA and the Energy Policy Act of 1992. 

Federal Power Act

Starting with the Federal Power Act, be aware that it covers all of the United States, except Alaska, Hawaii and a small part of Texas called the Electric Reliability Council of Texas, or “ERCOT.”

The Federal Power Act labels as a “public utility” any person who owns or operates facilities that are subject to the commission’s jurisdiction. Jurisdictional facilities include transmission facilities used in interstate commerce and transmission contracts. It excludes facilities that are owned by municipalities, federal power marketing agencies, and federal coops. Those are coops that have federal financing from an agency in the US Department of Agriculture called the Rural Utilities Service, or what used to be called the Rural Electrification Administration. 

FERC has authority under the Federal Power Act to set rates and remedy anticompetitive and unduly discriminatory practices. It is this part of the Federal Power Act that has been used to try to open the transmission system and get the integrated intrastate network moving to a fair, competitive playing field. 

FERC has authority to order electric utilities to let independent power plants interconnect with their transmission grids. FERC has authority to order utilities to provide transmission service and enlarge transmission capacity needed to provide transmission service. The Energy Policy Act in 1992 added a procedure for would-be transmission customers to ask for a transmission service from a utility
that controls the grid and, if it does not receive a timely response to its request, to complain to FERC.

What has FERC done with all these powers under the Federal Power Act?

It has issued since 1996 a series of orders and proposed rulemakings. I will mention them fairly rapidly. They are Orders 888, 889 and 2000, a proposed policy statement on new transmission pricing, a proposed rulemaking on “standard market design,” another proposal to adopt a standard interconnection agreement for electricity generators connecting to the grid, and some case-by-case adjudications of transmission issues. 

Starting in 1996 in Order 888, FERC ordered all utilities under its jurisdiction to file open access transmission tariffs, or a schedule of rates that anyone wanting service could pay for transmission. An interesting feature of Order 888 is that nonjurisdictional utilities — utilities that are not subject to regulation by FERC under the Federal Power Act, which include municipal utilities, Rural Utility Service-financed electric utility cooperatives, and federal power marketing agencies, as well as utilities in Canada and Mexico — are required also to file open access tariffs, even though they are not subject to regulation by FERC, if they want to use the open access tariffs of jurisdictional utilities. In other words, they do not have to do it, but if they do not, they will not have access to neighboring utility grids. 

FERC in later orders read Order 888 also to require utilities to allow anyone wanting transmission service to be able to connect to their grids. 

A companion order was Order 889. This created the socalled OASIS system.“OASIS” stands for “open access sametime information system.” It is a real-time information system that lets users see what capacity each jurisdictional utility has for additional transmission. It also has real-time information on transmission pricing. It requires that all requests for transmission and all responses be posted on the Web. The goal is to create a level playing field for all generators and other electricity sellers who are using the transmission systems of vertically-integrated utilities. 

The next significant order was Order 2000 issued in 2000. It came about primarily because the Energy Policy Act of 1992 failed to include authority for FERC to order regional transmission organizations, or RTOs, that would control regional sections of the grid. There was language in the draft legislation that lost at the eleventh hour, and FERC lost the authority that it wanted, so, in other words, it ended up the authority the authority to order utility to transfer control over their grids to RTOs. What FERC has been trying to do ever since is to do administratively what it was never given
authority to do by Congress. And that has led a number of people to wonder what the real scope of authority is that FERC has over this whole area, and also may help to inform why FERC has not gone farther than it has today. 

The goal of the Order 2000 was to put in place RTOs nationwide by December 2001, but in fact as of March 2003, only two RTOs have been more or less completely approved — the Midwest ISO and PJM. Others have had some aspects approved, but obviously things have gone fairly slowly compared to what FERC set as its goal in 2000. 

The goal was to have utilities transfer operational control over their transmission facilities to RTOs. A key principle for RTOs was a separation between market participants and the people who are controlling the RTO. Each RTO was supposed to have sufficient regional scope to bring economies of scale. 

FERC remains concerned that entities like the New York ISO and New York power pool are too small to function effectively as RTOs. 

FERC determined that what it has done so far is not enough. RTOs have not come into being as quickly as it hoped. Consequently, it initiated more rulemakings with the goals of giving the vertically-integrated utilities an incentive to give up ownership or control of their transmission grids, of making it easier for independent generators to obtain interconnection and transmission service, and of the construction of new transmission capacity.

These new initiatives were principally the introduction of incentive pricing for independent transmission and new transmission, an attempt to impose a standard market design, and a model  interconnection agreement that all utilities and independent generators would be expected to use in the future, and the adoption of a fairly simple regulated transmission policy — the so-called “or” policy — for pricing regulated transmission interconnection. 

FERC has issued a number of orders on transmission policy. The agency tried to bundle them all together in a single proposed policy statement on transmission pricing on January 13 this year. Basically what FERC is trying to do is to create incentive rates to induce utilities to transfer ownership and control over their grids to RTOs and to build new capacity on the grid. The main carrot for new construction is the ability to earn up to 300 basis points in additional return above what a utility would ordinarily be allowed. 

This is regulated transmission. Merchant transmission is another story. FERC has been willing for purely merchant transmission to allow essentially unregulated rates — whatever can be negotiated with customers. However, to date, merchant systems have been fairly limited mostly to undersea cables.

Under the proposed policy, action must be taken by December 31, 2004 to receive the incentives. The incentive rates would be guaranteed through December 31, 2012. FERC has sought comment on whether additional incentives are needed and also how to encourage certain new technologies. 

The big rulemaking that has been debated for the last nine months is the proposal for “standard market design.” 

The goal is to remedy undue discrimination in the use of the transmission grid. One very controversial issue is that FERC proposes to exercise jurisdiction over the transmission components of bundled retail transactions — that is, transactions in which the customer receives electricity and transmission as a single product. This is something that many oppose. The goal of standard market design is to have each RTO serve as a completely independent transmission provider. It would make all the important transmission decisions, including decisions about availability, the need for
and implementation of transmission expansion, congestion management. Each RTO would create a