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Perspective

Fortnightly Magazine - April 1 1995

or nothing will happen. The policy statement on transmission pricing issued last October by the Federal Energy Regulatory Commission (FERC) marks a hopeful step forward. The contemplation of transmission tariffs not necessarily based on embedded costs and the "nonconforming" proposals of the recent transmission pricing policy statement mark a significant change for an agency so long focused on ensuring cost-based rates. Nevertheless, the FERC's concern over the monopoly power of transmission owners is well placed.

My own experience includes examples of competitive business concerns using any edge to gain an advantage over the marketplace. Yet this search for a competitive advantage is the result of the competitive forces we covet. Regulators must ensure that advantages come only from innovative services and consumer sovereignty (em that regulation does not itself create advantages. In this new world, regulators will be interested less in the cost of service and more in preserving and maintaining a "level playing field." In other words, commissioners will assume the role of "referee." They must disdain the "command and control" ethic of the micromanager.

The FERC inquiry into power-pooling institutions, including the "PoolCo" concepts that have been proposed in the CPUC's own restructuring proceeding, holds the promise of also exploring a radically different industry structure for electric service. The "divested utility," no longer vertically integrated, may provide the answer to many of the seemingly intractable problems regulators, at both the state and federal levels, now face. Concerns over market power are reduced when the transmission and distribution systems are no longer owned by generation interests. We eventually learned that lesson in natural gas.

Nevertheless, the transition will not be quick or easy. These steps, as important as they are, will in time be seen as our first "baby steps" toward the new competitive world. As such, they are tentative, uncertain, wobbly steps open to much debate. Is this the right direction?

Are we doing it in the correct manner? Is there an easier path? Questions like this will occupy the industry for some time. It is important, though, that we all quickly reach agreement on one issue: that the goal of open nondiscriminatory transmission access and a competitive generation "market," is both reasonable and achievable.

Performance-Based Ratemaking

Performance-based regulation (PBR), also referred to as "incentive" or "price cap" or "CPI-X" regulation, is not unique to the electric industry. In California we have used this idea with some success in telecommunications since the late 1980s and, to a lesser degree, in natural gas. The United Kingdom now relies on this approach for its restructured electric industry. While there have been some fits and starts there, PBR has not been seriously questioned. I should admit to being a Commissioner during these explorations of alternatives to cost-of-service in California's telecommunications and natural gas industries; it has been, to say the least, an exciting period.

In general, the idea is to replace cost-of-service ratemaking with an approach oriented more toward rewarding performance. Traditional utility rate regulation ensures compensation to utilities only for the costs they incur. This simple cost-of-service formula obscures the tremendous uncertainty