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Gen Interconnection: Comparability or Common Sense?

Why power plants should pay for grid upgrades.
Fortnightly Magazine - September 15 2002

get around the rule against "and" pricing, which protects transmission customers from having to pay simultaneously for both the network upgrade and use of the existing transmission network.

It should be clear that the new CAISO policy, now officially approved on an interim basis by FERC, is a consistent policy with respect to both short-run and long-run price signals. It aligns costs and benefits, and only as a last resort (backstop) is the ratepayer asked to foot the bill.

Yet even with CAISO's "but for" solution, which assigns some upgrade costs directly to generators, several problems will remain:

  • Financial Capability. Private funding may be prohibitive for an individual generator, yet the upgrade is beneficial to ratepayers.
  • Queue Anomalies. Lower-queued generators may get benefits without paying (the "free rider" problem) since the first generator to interconnect at a specific location (the developer with the highest queue position) is usually the one that contributes all the upgrade costs.
  • Incumbent Bias. New power plants will face costs that existing generators never had to pay, raising a barrier to entry and creating a new version of the comparability problem.

The Likely Result

What happens to energy prices if FERC changes policy and the RTO assigns grid upgrade costs directly to new power plant developers?

Let's reconsider our original example with the two plant sites in California and Arizona. If a new FERC policy prompts the generator to to change plans and instead build the plant in California, where fixed costs are higher, could the generator pass those costs on to the ratepayer by charging a higher-market-clearing price (MCP) for energy?

To answer this question, consider how energy prices are set in a competitive market, and whether generators can influence that price.

In a competitive market, the marginal generator sets the MCP for all generators. A new generator that is more efficient will find that price exceeds their operating costs. Thus, the new generator collects revenues above its operating costs. These revenues help pay the new generator's fixed costs and expected rate of return. But MCP does not change to reflect a change in these fixed costs.

Bid caps present a special case.

Ordinarily, our new generator has no incentive to increase its bid price. However, in a period of constrained resources or excess demand, the generator can charge up to its bid cap (or a "damage control" cap, if one exists). If bid caps do not exist, our new generator can submit bids that reflect the scarcity value ("rent") of the energy. In that case, the price of energy is no longer related to the cost of the product.

Now let's return to our example.

To the extent that our new generator entails higher sunk costs in siting his plant in California, instead of Arizona, those costs will not affect dispatch decisions or the MCP. But the change in siting might still make a difference. For example, if the siting change produces higher operating costs, like paying intrastate gas transmission rates, these costs will affect the bid price, dispatch decisions, and the MCP.

Also, a direct