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STRENGTHENING THE CRITICAL LINK
David K. Owens is executive vice president of the business operations group at Edison Electric Institute.
To create a vibrant energy market, we need a strong transmission system. And it starts with policy.
While it represents just 11 percent of the national average cost of delivered electric power, transmission is the vital link to the establishment of robustly competitive wholesale markets. Originally designed as a highway to link generators to loads and to enhance reliability through interconnections with other utilities, the transmission system is being asked to perform functions never intended—to operate as a superhighway. Through its landmark Orders 888 and 2000, the Federal Energy Regulatory Commission (FERC) has required nondiscriminatory open access to transmission and the voluntary formation of regional transmission organizations (RTOs) aimed at enhancing access to and efficient operation of the grid.
The theory is simple: Well functioning wholesale markets, with robust transmission networks, will lead to an increase in the diversity of supply sources available to evolving retail markets, benefiting customers.
The reality is that the transmission grid is under significant stress, leading some policymakers to conclude that the goal of efficient competitive electric markets is illusory unless transmission is enhanced. Everyone knows it's not as simple as stringing more lines—some policy groundwork needs to be done to strengthen the market, attract investment, and benefit customers.
An Urgent Need to Expand Transmission
Expansion of the transmission system certainly has not kept pace with growing electricity demand. Between 1998 and 1999, transmission congestion was up 40 percent; between 1999 and 2000, it was up 140 percent. (See Figure 1.)
Moreover, transmission investments have been declining for almost 25 years at an average rate of $120 million per year. (See Figure 2.) Transmission investment in 1999 was less than half of what it had been 20 years earlier.
The North American Electric Reliability Council (NERC)—the reliability watchdog of the bulk power network—outlined the problem in its "Reliability Assessment 2000-2009": "Transmission congestion will worsen, and as a result, transactions will continue to be curtailed until other appropriate congestion relief measures are implemented. The continuing upward trend of NERC transmission loading relief procedures (which allow a transmission owner to decline transactions to ensure the reliability of its system) during a relatively mild summer (2000) in the Eastern Interconnect, is indicative of the persistence of congestion in various areas of the transmission system. Few major transmission system facility additions are planned for the near future. As competitive electricity markets continue to develop, it is likely that the transmission system will be operated at levels of power flow and in configurations not previously experienced."
From Need to Resistance
But whatever the need to build new transmission, getting it built is no easy task. The most significant obstacle is gaining siting approvals for new transmission lines, which has become almost impossible because of myriad challenges in the process of regulatory review and approval. These obstacles include the complicated state regulatory review process; involvement of many local government agencies, the courts, and federal and tribal governments; and the participation of competing interest groups. The public sentiment against transmission expansion is illustrated in the catch-all phrases NIMBY (not in my backyard), NOPE (not on planet Earth), and BANANA (build absolutely nothing anywhere near anyone). Indeed, one only has to look at the trials and tribulations over the Chisago transmission line project—first proposed in 1996—linking facilities in Minnesota and Wisconsin. Or the Wyoming-Cloverdale line proposal to link West Virginia and southwestern Virginia—a proposal first made in 1990! Or the Connecticut Siting Council's recent rejection of a proposed 300-MW transmission cable, which would run below Long Island Sound, linking New Haven, CT, to Shoreham, NY. TransEnergie US has been developing that project for almost three years. FERC recognizes the benefits of this interconnection and is reported to be upset by the decision.
The siting situation is likely to become even more complicated and contentious as regional markets are developed through FERC's Order 2000. The order requires RTOs to have a planning process in place for the expansion of transmission to maintain reliability. This requirement challenges the traditional belief that transmission facilities serve only small regional or local markets. Thus, it is conceivable for the RTO planning process, under FERC's approval, to identify new regional transmission that state and local authorities flatly reject because they do not perceive a direct benefit for constituents.
To address such gridlock, Congress is being urged by the Bush administration and others to convey new authority to FERC (similar to its authority for natural gas pipeline enhancement) for the expansion and construction of transmission facilities. Such authority could be in collaboration with states.
One form of such legislation would allow an RTO (or a member of an RTO or an entity whose application is consistent with a planning process approved by an RTO) to submit a transmission expansion plan for the construction and expansion of facilities to FERC for approval. FERC would be required to approve the planning process if it
- permits the input of all market participants and other stakeholders in the area and other interconnected regions;
- is designed to determine efficient solutions to relieve constraints in the transmission system without preference for either transmission or generation as a solution; and
- provides for aggrieved persons to contest plans through an alternative dispute resolution process and a thorough review by the commission.
Under this approach, if an RTO or other applicant later requests a certificate of public convenience and necessity to construct a facility developed by means of a transmission expansion plan, FERC would have to grant the certificate upon making certain findings, including a finding that a state was either unwilling or unable to provide necessary approval within a reasonable period of time.
From Siting to Rate Incentives
Siting approval is not the only barrier to transmission expansion. Financial incentives are also urgently needed to encourage new transmission construction—these include higher rates of return and other appropriate pricing incentives that will attract the capital necessary to fund needed investment in transmission expansion.
Order 2000 certainly provides a framework for innovative rate proposals to be submitted for FERC's approval. The commission stated its willingness to consider several rate approaches:
- a moratorium on transmission rates;
- rates of return that are formulary, consider risk premiums and account for demonstrated adjustments in risk, or do not vary with capital structure;
- nontraditional depreciation schedules for new transmission investment;
- rates based on levelized recovery of capital costs;
- rates that combine elements of incremental pricing for new transmission facilities with an embedded-cost access fee for existing facilities; and
- performance-based rates.
Some utilities took FERC up on its offer to consider innovative rate proposals in their compliance filings last October, and recent orders suggest that FERC is very serious about its willingness to approve thorough, creative proposals to enhance the efficient operation and expansion of the grid.
But confining rate incentives to FERC-approved RTOs does little to address the crisis in the West. FERC must show some flexibility to support all new transmission essential to enhancing grid access and reliability in the West. The commission could also encourage much needed investment through granting higher returns; and it could actively support a reduction in the depreciable life of transmission projects.
FERC is also encouraging a wide array of RTO organization and ownership structures under Order 2000, including for-profit transmission entities (transcos). From the compliance filings to Order 2000, made last fall, it is clear that support of for-profit transmission is increasing.
Frequently cited benefits of such properly incentivized RTOs include lower prices; improved service and reliability; more efficient investment decisions between transmission and generation; and more effective use of new technology. (See the sidebar, "The Results of Incentives." )
"Transcos will be the answer that will allow entrepreneurs to build out and invest in a transmission system that is capable of handling competitive loads reliably," said FERC chairman Curt H€€bert, a staunch proponent of the for-profit model.
From Rate Incentives to Tax Incentives
But even if utilities are intrigued by the prospect of running transmission as a for-profit business, they face significant financial impediments to the sale or spin-off of transmission assets.
Most transmission assets have a tax base substantially lower than book value. Thus a substantial capital gains tax would result from the sale of those assets for the creation of for-profit transmission companies.
To address this barrier, shareholder-owned electric companies have aggressively beseeched Congress to change the tax laws. Last summer, Edison Electric Institute reached a landmark agreement with the American Public Power Association and the Large Public Power Association on a number of important tax issues. A significant component of the agreement would seek tax relief for the sale or spin-off of transmission facilities to participants in independent FERC-approved RTOs.
In addition to this provision, the agreement also supports modification of the private-use provisions of the Internal Revenue Code that make it difficult or impossible for publicly-owned utilities to permit open access to their transmission and distribution facilities. The agreement also would treat costs of interconnection to transmission and distribution facilities paid by a developer to a utility—commonly referred to as contributions in aid of construction—as nontaxable to help facilitate such infrastructure enhancement. Legislation embodying the agreement was introduced in the 106th Congress as "The Electric Power Industry Tax Modernization Act." Similar legislation has recently been introduced in the current House, and efforts are underway in the Senate.
From Incentives to Structure
For-profit transcos must raise capital to acquire interests in desired transmission systems and so will need to create new corporate entities and bring in new participants—financial investors, experts in transmission systems, and so on. The new entities, of course, must comply with the requirements of Order 2000. Among other matters, entities owning or controlling the transmission facilities must be independent of "market participants"—generation-owning utilities and other entities that sell or broker electricity.
But, absent some regulatory or legislative relief, any entity that owns or controls transmission will be an electric utility company, and any upstream owners or investors will be holding companies, required to register under the Public Utility Holding Company Act (PUHCA). Registration would likely scare away potential investors because they may be required to divest all their non-RTO businesses. Moreover, even routine and unrelated corporate and financial decisions may be subject to prior approval.
It probably was not well understood when Order 2000 was issued how significant a barrier PUHCA is to the development of for-profit transcos.
While the preferred path is repeal of PUHCA, the deadline to have RTOs up and running is rapidly approaching. The Securities and Exchange Commission (SEC), which administers PUHCA, could help by adopting a rule deeming a FERC-approved RTO not to be an affiliate or subsidiary company in the application of PUHCA. It could also amend some rules to remove the burdens of SEC approval for routine RTO-related transactions. These actions could be taken without compromising the existing responsibility to protect the public interest and the interests of investors and consumers. Moreover, no regulatory gap would be created: The RTO will still be subject to regulation by FERC and possibly by the states; and depending upon how it is financed, it could be subject to other SEC oversight.
Our List of Things to Do
The strengthening and expansion of the transmission system is equal to the need for new generation. Transmission's role is vital—more than being the link between physical generation and distribution companies, it is the sine qua non of a robust competitive market. And the stronger the system, the more benefit to customers.
But despite the obvious need, obstacles still remain, and we must act as soon as possible to remove them. Because transmission is more interregional than regional, FERC must be given more latitude in making siting decisions. Because investment in transmission construction and modern transmission technologies is based on achieving competitive return for investors, innovative rate structures (some of which are espoused in Order 2000) must be embraced. Because current tax laws for transmission-holding entities inhibit the formation of new RTOs, they must be changed. And because potential transmission investors shy away from the burdensome requirements of PUHCA, it must be repealed. We must do these things now—without accomplishing them, new transmission will have a hard time, no matter how much we need it.
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