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Transmission Tariffs: Still Pro Forma? Locational Pricing and the Federal Power Act

Fortnightly Magazine - May 1 1996

congestion credits. (Those parties would pay the difference between the prices at the load and source locations.)

At this writing, companies supporting the PJM model were intending to file a comprehensive plan with the FERC by the end of May. The PJM states that its plan should meet the objectives of the Mega-NOPR without pro forma tariffs, which the PJM companies believe should not apply to power-pool services.

Breaking the Cost Link:

Just and Reasonable?

In effect, "locational pricing" will create a free-floating price for the interstate transmission of electricity (em a price wholly independent of the embedded "cost" of providing service. The immediate question, then, is whether locational prices will pass muster under section 205(a) of the FPA, which sets a "just and reasonable" standard for electric transmission rates.

Historically, regulators have closely linked the "just and reasonable" standard with depreciated embedded cost, irrespective of the price the market would attribute to the service provided. Thus, the FERC has traditionally allowed electric utilities to price firm transmission so as to yield annual revenues equal to the embedded cost of the utility's integrated transmission grid. For nonfirm service, the FERC has approved rates reflecting variable costs, plus a charge of up to 100 percent of fixed costs.

Can the law abide rates that ignore costs? Since the advent of utility rate regulation, economists have argued that cost-based rates breed inefficiency. If the sum of the costs do not equal the value society places on the resource, demand will exceed supply (em a phenomenon amply demonstrated by the distorted interstate natural gas market of the late 1970s. Conversely, a surplus will arise if the sum of the costs exceeds the resource value (em a result now amply demonstrated by "uneconomic assets" and excess generating capacity in the electric industry. Unfortunately, this economist's view has not yet prevailed in the courts.

The "just and reasonable" standard is not inherently incompatible with economically efficient rates or ratemaking methods. Indeed, in the celebrated Hope case,7 the Supreme Court held explicitly that the statute does not prescribe any single rate-setting method, but only an end result that qualifies as "just and reasonable." An end result that maximizes economic efficiency and reduces aggregate societal cost should suffice.

Nevertheless, the truth shows utility ratemaking to be infected with a virulent strain of populism. Economic efficiency has long taken a back seat. Instead, regulation has focused on protecting the public from "exploitation" by utilities (em defined as any utility earnings that exceed cost of service plus a reasonable return. Just as Nero watched Rome burn, the Federal Power Commission of the 1970s watched rolling curtailments in the interstate market while it sought to ensure that natural gas producers received no more than cost plus a reasonable return.

Market Pricing:

Controlling the Profits

In the coming debate on locational pricing, the D.C. Circuit's 1984 opinion in Farmers Union Central Exchange8 may offer guidance on whether transmission pricing can ignore costs.

That case remanded a FERC order that relied upon competitive forces to assure that oil pipeline rates would remain "just and