THE FIRST NECESSITIES OF PROGRESS

Tom Kuhn is president of Edison Electric Institute in Washington, DC.

Industry has never had more at stake in reaching consensus on a national energy policy.

Today, as it did throughout the last century, the shareholder-owned electric utility industry meets the nation's energy needs in the face of wide-ranging challenges. As always, it works with state and federal policymakers and the financial community to assure adequate and reliable service, produce reasonable returns to shareholders, and boost the economy and quality of life for the nation.

But today is perhaps the industry's most challenging time. We face sagging investor confidence in an economic downturn, at the very time the country needs to spur investment in new generation and transmission—and at the very time electric markets are struggling toward standardization and many are questioning the role and nature of competition in those markets. Among the industry's stakeholders—in Congress, the Federal Energy Regulatory Commission (FERC), the Securities and Exchange Commission (SEC), the state commissions, Wall Street, the Environmental Protection Agency, Department of Energy, and society in general—the debates rage as to how to address those issues.

Still, as Thomas Edison said, "restlessness and discontent are the first necessities of progress." To ensure affordable and reliable electricity, support a recovering economy, and enhance national security, the country needs several things. It needs policies that encourage new generation and take advantage of its many fuel resources. It needs policies to encourage investment in transmission and expand a constrained system. It needs a standard set of rules governing power markets on a regional basis that will provide for a more robust wholesale electricity market. Perhaps most important, the industry needs to boost the confidence of the investment community.

Those are the "next" necessities of progress.

Policy for Generation
In some regions of the country, there may be an excess of generation capacity for the short-term, but that does not guarantee that we will have adequate generation to meet future demands. In 10 years, our economy will require more than 100 new gigawatts (GW) of capacity. The Energy Information Administration projects we will need 355 new GW by 2020 to meet a demand that is expected to increase 45 percent, also taking into account plant retirements. Many call short-term overcapacity a glut, but the truth is that lower demand in an economic downturn can quickly disappear with a more vibrant economy: Growth in the gross domestic product will fill the gap quickly.

To meet projected demand, the new generation portfolio requires the flexibility of many resources. No one fuel can balance all our energy and environmental needs. Fuel diversity helps ensure reliability, efficiency, and self-sufficiency, benefiting both the economy and our national security.

Our nation's energy policy can help preserve fuel diversity in several ways.

• Coal-based generation, for example, represents 52 percent of electricity in this nation, and plentiful coal reserves make the fuel a domestic strength. Tremendous progress has been made in dramatically reducing emissions from coal-based powerplants at the same time coal use has increased. The development of clean-coal technologies can help us use this resource even more cleanly and efficiently—and the best way to encourage that is through tax incentives and research and development (R&D) funds.
• Ninety percent of new generation being built today is gas-based. Expanding our domestic gas reserves and building a safe pipeline infrastructure is necessary to support this new construction.
• Nuclear energy provides 20 percent of our power today—maintaining that base and encouraging the development of the next generation of nuclear plants is critical. Congress can help accomplish both objectives by renewing the Price-Anderson Act (limiting nuclear liabilities), providing decommissioning relief, and funding new R&D initiatives. We also should ensure that the development of Yucca Mountain as a waste depository proceeds apace.
• Hydropower relicensing policy continues to hamper one of our cleanest sources of power by making it difficult for plant managers to renew licenses and by creating uncertainty. Streamlining that policy is an essential element of a national energy policy.
• Thanks to substantial tax incentives and R&D initiatives, renewable generating technologies are making great strides. Moreover, many states actively encourage renewable use through measures that reflect the resource mix available in each state, while the federal government has promoted re-newables with tax incentives. These approaches, rather than the mandatory renewable portfolio standards seen in recent legislative proposals, should continue.

Likewise, our environmental policy should support fuel diversity while recognizing the progress that already has been made. After all, good environmental policies and economic success can, and should, go hand-in-hand. Environmental issues will continue to be a major focus in 2003. This likely will include consideration of the Administration's Clear Skies Initiative and other multi-emission proposals which, if done right, could provide significant regulatory certainty and help achieve our environmental objectives more efficiently and cost-effectively. We also anticipate significant activity on the Administration's voluntary climate initiative, which is intended to provide environmental benefits while allowing for economic growth, as well as efforts to reform the New Source Review program and develop new mercury and Clean Water Act rules.

Policy for Transmission
The need for expanded transmission capacity to facilitate growth and regional transactions is also crucial. Originally built for intrastate power delivery, the transmission grid has become a "superhighway" for interstate transactions. Between 1999 and 2000, transmission congestion—as measured by the North American Electric Reliability Council (NERC)—grew by more than 200 percent. In the second quarter of 2002, transmission congestion was almost three times the level experienced during the same period in 1999.

As a result of such pressures on the system, transmission capacity is being constrained in many regions of the country. And, in some instances, electricity from power suppliers and marketers exceeds availability of transmission capacity, raising serious questions about the system's future reliability and its ability to support the development of competitive power markets across broad regions of the country. This weighs on consumers: A recent FERC study estimates that transmission bottlenecks cost consumers more than $1 billion over the past two summers.

Investment in transmission has been declining for two decades at a rate of nearly $81 million a year. More than $50 billion is needed to enhance the system. Currently, transmission investment is at an all-time low. Rates of return are too low to attract needed investment, particularly in light of such challenges as the difficulty in siting transmission facilities, uncertainties concerning the role of transmission owners under FERC's new standard market design, and investor caution.

Several policy changes can help. The industry needs financial and tax incentives to build and maintain the transmission grid. Right now, transmission owners have longer depreciation rates for tax purposes than other energy providers and face stiff tax consequences if they sell or spin off transmission facilities. Only Congress can change this.

The siting of transmission lines by federal agencies also should be streamlined. In cases where traditional siting approaches do not solve regional needs, Congress should give FERC backstop authority. For its part, FERC should give transmission owners the clear signal that they have the right of first refusal for the construction of new transmission capacity.

Policy for a Standard Market Design
Well functioning wholesale markets go hand-in-hand with transmission investment. FERC's recent standard market design (SMD) notice of proposed rulemaking has the goal of improving the operation of wholesale markets for the benefit of participants and consumers—and Edison Electric Institute supports major elements of it.

The standardization of real-time and day-ahead regional electricity markets with financial transmission rights and locational marginal pricing, as well as the incentives for demand response, are important elements for making markets work and stimulating energy conservation. Standardizing the rules governing power markets on a regional basis is an important step—one of many—to enhancing price transparency and fostering more robustly competitive bulk power markets.

Done correctly, the new rules could bring greater stability to the markets and advance the growth of wholesale competition. FERC's proposal, however, requires much more flexibility in the design of regional transmission organizations; pricing that reflects costs and provides incentives for system enhancement; and preservation of all supply options and business models, including for-profit transmission companies, to finance critically needed transmission infrastructure.

The SMD is an opportunity for us to reverse the trend of declining transmission investment. But first, FERC needs to clarify its transmission pricing and transition rules, eliminate the barriers to transmission enhancements, and take affirmative measures to encourage needed transmission construction. As it stands now, FERC's proposal is too prescriptive, particularly with regard to regional differences and timing of implementation and governance, among other things.

Moreover, the constructive views of all stakeholders must be considered. The commission must work harder to foster state cooperation and to carefully weigh the state input needed for regional institutions to work effectively, particularly in the areas of regional planning and resource adequacy: The responsibilities imposed on utilities and state regulators by state law with regard to planning, adequacy of service, and transmission siting must be respected.

We share FERC's goal of making wholesale markets work effectively and efficiently. Significantly, however, the proposed rule would undermine the growth of electricity markets by failing to apply to government- and cooperatively owned utilities, which together own 25 percent of the nation's transmission. The commission has both the responsibility and the legal authority to require full reciprocity from non- jurisdictional utilities so markets can develop and operate efficiently.

Bringing Old Policies Up to Date
Congress needs to address outdated laws that are inconsistent with a competitive wholesale market. A prime example of this is the Public Utility Holding Company Act. Formed in response to abuses by large holding companies in the 1920s, PUHCA now actually hinders investment, discourages new market entrants, complicates new business models, and works against well-functioning, competitive energy markets—it is poorly suited to today's national companies that operate in regional competitive markets. The Bush Administration, as well as previous administrations, the SEC, and many others, have called for its repeal for years.

The Public Utility Regulatory Policy Act needs reform, as well. PURPA's mandatory purchase obligation is inconsistent with the nature of competition and instead has cost electricity consumers billions of dollars by requiring utilities to lock into long-term power contracts at above market prices.

Some in Congress have proposed new regulation on competitive activities, particularly trading and disclosure practices, and PUHCA-like restrictions—or worse—in other guises. Clearly, Congress, regulators, investors, and the public must have confidence that electricity markets are operating fairly and efficiently. We are committed to working with policymakers and stakeholders to achieve this goal. But many of the measures suggested to dateeven those with good intentions—would distort markets and hinder efficient operations.

Building Confidence
Appropriate legislative and regulatory policies are necessary for our industry to prosper and grow to meet the needs of our customers and the economy. But we also must restore strong investor confidence in the electricity sector. Already, we are working hard to improve upon the business side of operations and to ensure that investors are well informed about our companies' financial operations.

Decreasing liquidity has been a major problem, particularly among the companies with long-term power commitments. In response, last October EEI released a master netting agreement to supplement the already widely used master power contract. The agreement is designed to enable companies to better manage their risks by netting electric, gas, and financial contracts, which in turn will help promote a liquid, well functioning marketplace.

Working with the financial community on our industry's accounting and reporting practices and solidifying corporate governance practices are twin pillars of investor confidence. We are aggressively addressing key financial matters, working closely with the Financial Accounting Standards Board, the SEC, and other agencies as they focus on critical accounting standards, disclosure policies, and governance matters, including implementation of the Sarbanes-Oxley Act. We promote enhanced voluntary financial disclosure from companies and welcome the proposal by chief risk officers of a new set of best practices for merchant energy activities. These guidelines are designed to provide more transparent and comparable financial information about the business and accounting practices of electric power companies, particularly how much risk investors face. By the same token, we are working to ensure that proprietary and competitive information is protected.

EEI and its members are aggressively addressing these issues on many fronts and communicating our progress. We have increased our outreach to Wall Street to inform analysts and rating agencies of our efforts and the legislative and regulatory developments affecting our industry. Recently we conducted an educational session and dialogue on FERC's SMD and its implications. Last year we met frequently with these stakeholders individually and in groups and will continue these efforts this year. We also have an advertising campaign to emphasize the value of electricity, the real growth of our industry, and the stability of our assets.

Necessities of Progress
As Congress continues to pursue energy legislation, FERC wrestles with the SMD, and we address investor concerns, this year will be critical for the industry. We are committed to working with legislators and regulators to make sure that public policies enable us to provide adequate electricity infrastructure for the nation and attract the investment capital necessary to accomplish this crucial mission. We are dedicated to developing policies to help the industry to grow and to continue to provide affordable and reliable electricity to the country.

I really do believe in Thomas Edison's statement. "Restlessness and discontent" may be challenges, but they signal progress—indeed, they are necessities. This is the time to turn those challenges into opportunities. The ability to meet growth needs, to make markets work, and to restore investor confidence demand it.

© 2008 Edison Electric Institute