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The LMP Model: Bottlenecking Merchant Transmission

Locational marginal pricing has not been adequate in providing transmission expansion incentives. Others are needed.
Fortnightly Magazine - April 15 2003

York and New England by increasing energy deliverability between the areas. NYISO has determined that the additional transmission capacity provided by the CSC will increase the limited quantity of capacity import rights from New England to New York, decrease the ICAP locational requirements for Long Island, 3 and potentially reduce NYISO's statewide ICAP requirement by allowing additional sharing of resources across the Northeast. The CSC could provide similar resource adequacy benefits to New England, although as yet no commensurate property rights have been defined or allocated to the expansion.

Since the Cross Sound Cable is a merchant transmission facility, the resource adequacy benefits of the transmission expansion should be collected as a property right and provided to the transmission expander as an offsetting benefit for the investment in the transmission facility.

Market participants in NYISO created UDRs or capacity deliverability rights for the purpose of capturing the resource adequacy benefits of the transmission expansion and allocating them to the transmission expansion. In the case of the Cross Sound Cable, the Long Island locational ICAP requirement will remain unchanged, but the CSC will be allocated approximately 315 MW of UDRs that, when combined with qualified capacity resources in New England, will count toward the Long Island locational ICAP requirement. The CSC UDR is essentially a capacity deliverability right between the two regions. The value of the UDR will approximate the difference in capacity costs between the New England market and the higher-priced, constrained, Long Island market less any transaction costs. UDRs can be used by the transmission expander or sold bilaterally to other customers to be used to meet their locational capacity requirement and allow the valuing of the capacity benefit of merchant transmission. Defining the development of UDRs and their assignment to the transmission expander provides one additional incentive to undertake economic improvements to the grid.

The Future of Merchant Transmission

Merchant transmission can play an important role in improving transmission infrastructure, but merchant transmission expanders should be distinguished from transmission owners with the opportunity to be reimbursed through cost-based rates. Merchant transmission expanders are much more sensitive to market structures and economic price signals than are traditional regulated transmission providers that can average the costs of a transmission expansion along with existing transmission costs into regulated rates. Thus, merchant transmission is particularly sensitive to the underlying market rules and getting the prices right.

Supportive market structures identify areas where merchant transmission adds value, defines property rights associated with this added value and allocates them to the transmission expander, allows for the transferability of these rights, and avoids regional differences that extend old or create new seams issues. Although regulatory certainty cannot be assured, the rights created should be as robust and permanent as possible and incorporated in formal tariff language, with revisions requiring FERC approval. Certainty and stability of property rights and the market rules that support them improves the viability of structural solutions. Transferability of property rights allows parties that have transmission development skills to develop facilities on behalf of other parties who may have a specific need for the