A number of public utility companies and state public service commissions are pressing the Federal Energy Regulatory Commission to reconsider its policy of “socializing” the cost of grid improvements. Will the policy stand?

As the NewsWire went to press, Congress seemed poised as part of the energy bill to overturn the policy by requiring independent generators to pay the cost of such improvements.

Background

Owners of independent power plants must connect their plants to the nearest utility grid in order to move their electricity to market.

Interconnection requires construction of a radial line and may also involve construction of other equipment like a substation to step up the voltage, a ring bus or circuit breaker to prevent damage caused by power surges, and system or network upgrades — improvements to the grid itself — to accommodate another power plant. The utility usually constructs most of the intertie. The generator reimburses it for the cost.

FERC policy on who should pay the cost of grid improvements — as opposed to the direct intertie — has been evolving. Its policy since 2000 has been that it is inappropriate to make independent generators pay for “network upgrades” (defined as improvements to property on the utility side of the “interconnection point”). It believes the cost of grid improvements should be borne by all users of the grid through the general tariff that the utility charges transmission customers rather than charged solely to the generator. FERC recognizes that this puts the utility in a bind because the utility must make the grid improvements today to accommodate the generator’s power plant, but it takes time to collect money through rates to cover the cost. Therefore, FERC allows the utility to collect the cost from the generator as an advance that must be repaid over time. This policy is reflected in a series of orders issued to settle individual disputes between generators and utilities.

In late July, FERC adopted a set of standard interconnection procedures and model interconnection agreement that generators and utilities will be expected to use in the future. These require repayment of amounts advanced for network upgrades within five years with interest. The FERC announcement codifying this pricing policy is called Order No. 2003 (Standardization of Generator Interconnection Agreements and Procedures, Docket No. RM02-1-000).

As is typical, the order was greeted by a host of requests for rehearing. Critics charge the “socializing” the cost of grid improvements will lead to poor siting decisions, since generators will have no incentive to put their power plants in places where fewer upgrades will be required to the grid. Order No. 2003 requires utilities to repay generators any amounts advanced for network upgrades within five years with interest.

Complaints

FERC received a number of requests for a rehearing soon after the order was issued. The South Carolina Public Service Commission argued that permitting generators to be reimbursed for any of their network upgrade costs amounts to “cost socialization,” violates cost-causation principles (which hold that properly designed rates should produce revenues from each class of customers that match, as closely as practicable, the costs to serve each class or individual customer), promotes economic inefficiency, and is inequitable to ultimate electric consumers. The South Carolina PSC recommended that the FERC “implement a pricing policy that encourages siting in a location that minimizes the need for network upgrades, and consider alternatives to cost socialization to provide generators with incentives for making economic efficient siting decisions.”

The Alabama Public Service Commission told FERC that it is concerned making all grid users pay for upgrades “would unjustly and inappropriately impose the vast majority of the costs of generator interconnections on native load customers who are likely to receive little to no benefits from many of the new generator interconnections covered by the Rule.” The Alabama PSC also charged that FERC is using its pricing policy as a stick (or a carrot, depending on one’s point of view) to force utilities to cede operating control over their grids to regional transmission organizations, or RTOs. That’s because FERC has given RTOs and ISOs more latitude to decide who should pay for network upgrades in their areas. Utilities that have not turned over operating control of their transmission facilities to RTOs have less room to maneuver. Utilities and state commissions in the south and west have been the fiercest opponents of the FERC RTO policy.

Southern Company Services, Inc. urged FERC to adopt an approach of deciding which upgrades benefit all grid users and having the utility bear these, but charging independent generators with the costs of other grid improvements.

The National Rural Electric Cooperative Association and the American Public Power Association challenge the factual predicate for FERC’s pricing policy, arguing that “it is not clear that consumer subsidies are required to encourage the construction of competitive generation.” According to the NRECA and the APPA, “the competitive generation market has been dramatically overbuilt in the past several years,” and “it provides consumers little comfort if the Commission adopts a policy that encourages the construction of additional generation, but ensures that it is located inefficiently, in a manner that either require the construction of unnecessary transmission or causes unnecessary congestion.”

What Did FERC Order?

Approximately 60% of interconnection agreements between independent generators and utilities are filed with FERC unexecuted because the parties cannot agree on terms. FERC is tired of acting as a mediator. It adopted standard procedures and a model agreement in late July in the hope that this would allow it to spend less time mediating disputes.

The new procedures and model agreement apply whenever an independent power plant that is more than 20 megawatts in size wants to connect to the grid. They require public utilities that offer transmission services to offer nondiscriminatory standardized interconnection service to such generators. FERC said that Order No. 2003 will “prevent undue discrimination, preserve reliability, increase energy supply, and lower wholesale prices for customers by increasing the number and variety of new generation that will compete in the wholesale electricity market.” According to FERC, the delays caused because the parties cannot agree on terms for interconnection provide an unfair advantage to public utilities that own both transmission and generation facilities and, ultimately, undermine the ability of generators to compete.

The new standard procedures and model agreement only apply to new interconnection agreements, and with some exceptions described in an article by Adam Wenner elsewhere in this issue of the NewsWire, do not affect the terms or conditions of existing interconnection arrangements.

Network Upgrades

Under new standardized procedures, all facilities and equipment between the generator’s power plant and the point of interconnection with the public utility’s transmission system must be paid for entirely by the generator seeking interconnection with a public utility.

However, all “network upgrades” past the point of interconnection will be funded initially by the interconnecting generator, which would then be entitled to a cash-equivalent refund equal to the total amount paid for the network upgrades, including any tax gross-up or other tax-related payments. This refund would be paid to the interconnecting generator on a dollar-for-dollar basis, as the utility collects for wheeling electricity from the generator’s plant across its grid. Under the final rule, the full amount must be refunded to the interconnecting generator, with interest, within five years of the date on which the generating facilities become commercially operational. Thus, under FERC’s pricing policy, the cost of network upgrades would be borne by all of the transmission customers of the utility rather than by the generator.

The only condition to the generator getting his money back is his power plant must be put into commercial operation. Even if too little electricity is later carried from the power plant over the grid for the utility to recoup the cost of the upgrades through rates for carrying electricity from the generator’s plant, the utility must refund the generator whatever he paid for network upgrades within five years with interest. The utility may decline to refund amounts that are designed to recover out-of-pocket costs, such as the cost of line losses, associated with the delivery of the output of the generating facility.

FERC gave transmission providing entities that are not affiliated with generators or power merchants, such as regional transmission organizations or independent system operators, “flexibility” as to interconnection pricing policy in their regions. This flexibility could, for example, permit utilities that are members of RTOs or ISOs to propose that interconnecting generators fund network upgrades that are not part of a regional plan.

Outlook

Order No. 2003 becomes effective on October 20, 2003. FERC has required all public utilities with open access transmission tariffs to amend their tariffs to comply with Order No. 2003 no later than that date. The fact that a number of utilities and public service commissions have asked for a rehearing on the new standardized policies will not automatically delay the effective date. Thus, all public utilities must make filings with the FERC to amend their open access transmission tariffs to comply with the new rules no later than October 20, 2003.

Several parties have asked FERC to “stay” Order No. 2003 until both it and the courts have had a chance to reconsider the final rule. These requests for a stay will probably be denied. Other parties, such as the New England Power Pool Participants Committee and ISO-New England Inc. and the Midwest Independent Transmission System Operator, Inc., requested an extension of time to make their compliance filings. FERC gave RTOs and ISOs an extension until January 20, 2004 to making their filings. It had not ruled on similar requests from utilities as the NewsWire was going to press in late September.

Precisely when the FERC will address arguments raised on rehearing is unclear. On September 22, FERC issued a “tolling order” granting rehearing of Order No. 2003 but without setting a date for the rehearing. Once the FERC issues a “tolling order,” there is no fixed time within which it must issue an order addressing the requests for rehearing of Order No. 2003.

FERC is unlikely in the end to alter its policy concerning the cost of network upgrades. This means the policy will end up being challenged in court. The challengers face an uphill battle. In the first place, the Federal Power Act permits only persons “aggrieved” by a FERC order to seek court review of that order. Court precedents hold that FERC policies may not be challenged on a theoretical basis. Therefore, parties wishing to challenge the pricing policy will have to demonstrate to a court that they have been harmed by the pricing policy.

This means that it is more likely that challenges to the policy will be raised in specific cases in which public utilities seek to recover from their transmission customers costs of network upgrades under the policy announced in Order No. 2003. For example, in a FERC proceeding involving Public Service Company of New Mexico’s proposed interconnection agreement with an FPL Energy wind farm (Public Service Company of New Mexico, Docket No. ER03-914-000), the New Mexico attorney general expressed his concern that the FERC pricing policy will allow PNM “to recover the costs of interconnecting the wind project in transmission rates paid by all retail customers.” The attorney general said he plans to “ask the New Mexico PRC to order that interconnection costs of the FPLE wind generation project be recovered from the cost causers....” Any such actions by state authorities raise issues of federal preemption. In 1986, the US Supreme Court ruled that states may not prevent regulated utilities from passing through to retail customers FERC-mandated wholesale rates.

The courts probably will give considerable deference to the FERC pricing policy. Particularly in light of the August 2003 blackouts in the northeast and midwest, courts are unlikely to second guess FERC policies aimed at increasing electric system reliability and encouraging investment in generator and transmission infrastructure. Also, a US appeals court in Washington upheld a FERC order requiring all transmission customers of Entergy Service, Inc. to pay for certain specific network upgrades to Entergy’s transmission system earlier this year. The court found that FERC had explained sufficiently its policy that short-circuit and stability-related upgrades that facilitate network expansion benefit all users, not just the newly-interconnecting generator, since the grid is continuously expanding and all users of the grid benefit from its continued reliability. The court also found that there was sufficient support in the record for the FERC’s conclusion that its pricing policy provided a systemwide benefit for all users of the public utility company’s grid. (Entergy Services, Inc v. FERC, 319 F.3d 536 (D.C. Cir. 2003)). FERC certainly will rely on this decision in any defense of the pricing policy established in Order No. 2003.

Nonetheless, the FERC’s pricing policy may be vulnerable to a charge of undue discrimination as to the application of the policy. FERC gave pricing flexibility to RTOs and ISOs. Parties will argue that the FERC has not articulated a rational basis for distinguishing between RTOs and others. If a federal appeals court finds that FERC has not articulated an acceptable basis for distinguishing between transmission providers that are members of RTOs and ISOs and those that are not, the court could either reverse the rule or send the decision back to the FERC for further explanation.