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A Subtle but Clear Preference for ISOs

Fortnightly Magazine - March 1 2000

would operate as the managing member of Alliance Transco.

On reviewing the plan, the commission said the transco plan failed roughly half of the 11 standards for ISOs set down in its Order 888:

* Independence. Failed, because the members could control the Alliance Transco through stock ownership of Alliance Publico and thus veto the addition of new members or facilities. (Also, the board of Alliance Transco would owe fiduciary duties to the member companies as owners.)

* Financial Interest. Failed, because directors, officers and employees of Alliance Publico "may perceive career-preserving value in protecting or preferring the interests of [the Alliance company] stockholders over other market participants."

* Nondiscriminatory Tariff. Failed, because the Alliance plan would perpetuate rate pancaking and maintain a "preference" for the generation resources of transmission owners.

* Relief of Constraints. Failed, because the transco could not facilitate redispatch for new service given the lack of generator obligations to submit bids, coupled with pancaked rates.

* Efficient Administration. Failed, because the transco would have "no prohibition or limitation on . . . contracting with market participants."

* Pricing. Lastly, the transco would fail Order 888's pricing policies for transmission and ancillary services, both as to rate formulas and non-rate terms and conditions.

In the Alliance case, the FERC all but urged the member companies to have their transmission systems run by an ISO. For example, it suggested that "Alliance, Midwest ISO and PJM could negotiate procedures and rate treatments that would eliminate the toll-gate aspect of Alliance's configuration, deal with loop flow issues, and eliminate concerns about reliability impairment." The FERC's suggestion speaks volumes about the relative merits of ISOs and transcos in today's industry.

The Value of the Network

As the FERC recognizes in Order 2000, electricity is a network industry. Efficient transmission embraces more than electric throughput. It is instead a complex service with substantial network interactions, as recognized by Harvard professor William Hogan.[Fn.13] In a network industry the focus shifts from maximizing shareholder value to maximizing the network's value. The profit motive does not drive the network so much as an efficient market design.

Thus, the FERC's final order focuses on optimum development of the network itself rather than profitability of the transmission provider. To this end, it is ISOs, not transcos, that have emerged as network facilitators by enhancing access, promoting short-term spot markets, defining a workable system of transmission rights and thereby encouraging opportunity and innovation.

In his comments on FERC's notice of proposed rulemaking leading to its Final Rule, Professor Hogan refers to complex network interactions in the electric grid that presuppose the existence of an entity, as system operator, able to provide certain critical coordinating services. Hogan cites the various functions that this new entity must carry out:

* Load Balancing. Balance aggregate production and consumption continuously within the limits of the transmission system.

* Ancillary Services. Coordinate and monitor spinning reserve and reactive power support.

* Congestion Relief. Arrange economic (least-cost) redispatch when the grid is constrained, subject to security constraints.

* Congestion Pricing. Apply marginal cost prices for power