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

Fortnightly Magazine - May 1 1996

the higher of the utility's embedded or opportunity cost. Though not reflective of historic costs, locational pricing arguably calibrates and collects opportunity costs on a nearly real-time basis. However, the courts have concluded that a utility can charge only that rate that holds native-load customers harmless and does not produce excess revenue.14

The control of the ISO arguably should prevent any transmission owners from exercising market power. Moreover, compensating owners for the use of their transmission assets on an embedded-cost method (em with congestion rents paid to holders of TCCs (em should forestall any "creamy" returns.

Congestion Contracts:

Monopoly Rents?

The potential problem concerns the potential enormous value represented by transmission congestion contracts. In essence, the value of a TCC equals the difference between embedded cost and market value. Whereas the market value of transmission may constitute an opportunity cost, there is no correlation between the revenue generated under such contracts and the revenue requirement of the contract holders. This disjunction may prove particularly troublesome if TCCs are first allocated to the distribution function of existing utilities. Those utilities could then write their transmission capacity up to market, while recognizing the economic gain in the distribution function, but retained under the corporate umbrella.

This possibility was actually floated early on in the electric restructuring debate as a way to mitigate stranded costs: Utilities would simply write up transmission assets and mark down generation to match market valuation. However, such proposals were rejected out of hand as impermissible cost shifts. Arguably, TCCs would create precisely the same effect. Will pool allocations of TCCs confer economic value to the distribution function and, if so, should regulators apply that amount as an offset against stranded generating assets owned by the same utility?

Further, can nondiscriminatory transmission access exist where some hold firm capacity rights while others do not? Certainly the "have nots" may pay substantially higher net costs, leading to an anomalous situation in which nonfirm transmission service may cost exponentially more than firm service. How firm capacity is distributed in the first instance may either accentuate or mitigate discrimination under a transmission contract regime. Equal access becomes more problematic if TCCs are allocated to the distribution function at no cost. These difficulties could be minimized, however, if TCCs are allocated by auction, giving existing users a right of first refusal.

The Defining Moment

To the economist, cream-skimming returns issue a clarion call to new competitors, indicating a market that places a higher value on a service than on the cost of production. To the courts, "creamy" returns reveal just the sort of consumer exploitation that warrants a "just and reasonable" ratemaking standard. To economists, "uneconomic assets" arise naturally from that creative engine of destruction, the free market. To utilities and regulators, "stranded investments" mark "prudently incurred costs" that ratepayers should be required to pay.

The TCC concept may frame a defining moment in utility regulation (em that moment when the benefits of economic efficiency finally outweigh the historic aversion to potential profits that constitute the life blood of a competitive market. Coupling TCCs with