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Fortnightly Magazine - February 15 2000

issuance of RFPs for their construction by the independent system operator. But the Australian experience is indicative of what could happen in the United States.

To reassure regulators, ISOs can conduct a periodic reliability plan and identify upgrades and expansions needed to ensure reliability. This exercise would identify investments that, unless previously proposed by market participants, can be put out for bid by the ISO to ensure their completion. To encourage such investments, ISOs can offer the "carrot" of rolled-in rate treatment into regional transmission rates. This function of the ISO would serve as a "last resort" to ensure that projects that the ISO believes are necessary (and for whatever reason, are not being proposed by market participants) are built.

Why Not Market Prices for Congestion? The question then becomes, how do we implement a market-based system that would provide the necessary reliability signals to encourage such investment? The answer is by implementing a system of locational prices with tradable financial transmission rights. This is where, unfortunately, Boonin and Fernands miss the mark.

Their proposal for ending locational marginal pricing (LMP) would eliminate the necessary price signals and incentives for investment. Without locational prices, the cost of congestion remains hidden. If congestion costs are hidden, generation and transmission project developers will not have clear signals to locate and identify potential investments. The competition that Boonin and Fernands need to serve retail markets will simply not materialize. Contrary to their assertions, LMP is not "an effort to fine-tune the pricing of transmission service." Their assertion that "LMP was not used prior to retail competition" simply continues the assumption that congestion costs can continue to be hidden within a framework of vertically integrated monopoly electric utilities. To follow their logic, by eliminating LMP "the risk of serving particular customers is not increased unnecessarily." On the contrary, the implementation of LMP identifies and quantifies this risk, and the implementation of financial transmission rights provides the vehicle to manage and hedge against this risk.

Auction Off Those Congestion Rights. I suspect that most of the problems that Boonin and Fernands have with locational pricing stem from the structure and allocation of financial transmission rights. There has been a problem in the initial allocation of financial transmission rights to incumbents, as asserted in the article. Fortunately, there is an easy solution for this problem. The initial set of financial transmission rights should be subject to periodic, mandatory auctions. Market participants (whether incumbent or not) can thus have an opportunity to obtain those rights at their perceived value. This is an important detail that will hopefully be incorporated into the frameworks for financial transmission rights being developed in New York, New England and PJM.

José A. Rotger

Manager, Regulatory Strategy

TransÉnergie U.S. Ltd.

Westborough, Mass.

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