Transmission Expansion: Risk and Reward in an RTO World
Some thoughts on who should take the lead and how to set up financial incentives.
One of the most interesting questions that arises from federal restructuring of the electric grid, with regional transmission organizations (RTOs) and a standard market design (SMD), concerns the risk of building transmission in an RTO environment.
In the traditional setting, without RTOs, and with utilities controlling generation, transmission, and distribution, state regulators are involved in both the permitting and the rate making. If development costs should become stranded for a lack of permits before construction begins (NIMBY comes to mind), the utility can recover its sunk costs on showing a good-faith effort to obtain the necessary authorizations. And once construction begins, a tracking account (AFUDC-allowance for funds used during construction) will allow the utility to accrue a return on investment until such time as the asset qualifies as "used and useful" and is added to the rate base.
By contrast, investors lack a proven road map in the case of RTOs, where transmission is unbundled and the case lies within the jurisdiction of the Federal Energy Regulatory Commission (FERC). Utilities might well harbor concerns that transmission development costs could end up stranded.
Nevertheless, a careful look at the risk involved reveals a hint of policy taking shape in a variety of novel cases.
Construction Costs: Proof of Reasonableness
FERC has provided a strong signal about reasonable transmission construction costs, in a dispute over Sempra's $2 million expansion of California's import capacity. Approximately 900 MW were proposed, but the state of California objected on the basis that the costs incurred were not reasonable.
Of course, it is nothing new for regulators to conduct a review of reasonableness of costs at the time a new asset is placed in service. Yet the case is notable, as FERC dismissed the state's objections as unsupported, and signaled how it will weigh evidence in these types of cases. FERC's assessment of the costs and benefits is important, and provides much needed guidance.
In fact, FERC went so far as to encourage additional expansion, providing an advance opinion, that stated further tie expansion with Mexico was virtually a "no brainer."
Larger RTO-driven projects present far greater dollar disputes, and the added potential of state regulators pushing a single project's costs across service boundaries. If the project had involved $2 billion and more local jurisdictions, as it might under an RTO, continued uncertainty about the strictness of FERC's review standard could chill development. The Sempra case involved unfortunate political dynamics, but FERC's resolution of the dispute goes a long way to dispel investor concerns. 1
Socializing the Costs: Proving System-wide Benefits
An RTO decision for an upgrade likely will affect the rate and risk structure of the transmission owner's investment. For example, the owner's risk may depend on the subjective determinations an RTO makes about whether the new investment has system-wide benefits.
If the RTO makes such a finding, it may be argued that the costs should be "rolled into" regional embedded costs, as are upgrades that enhance stability and must-run contracts with