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In Search of... Transmission Capitalists

Facing a cash crunch, transmission owners look for new funding sources.
Fortnightly Magazine - April 1 2003

There is a blizzard of regulatory change taking place that affects transmission, but with regard to encouraging transmission investment, the picture is decidedly mixed. FERC's intent is that the formation of regional transmission organizations (RTOs) and the implementation of SMD will help address the shortfall in transmission in the process of fostering more competitive wholesale markets. RTOs are expected to encourage appropriate transmission investment in at least five ways: ensuring open grid access; objectively calculating available and total transmission capacity; conducting interconnection studies for new generators; sending nodal pricing signals; and working to reduce congestion and increase the flow of power across regional "seams." SMD, if implemented, would be a substantial catalyst for new transmission, since it would put in place a resource planning process to identify what mix of resources, including transmission, should be added, and conduct competitive bids to put that mix into effect. Thus, RTOs and SMD could have a substantial impact on transmission investment, but the impact of these changes will take time and will roll out only in selected areas in the next few years.

Regulation also can provide a financial boost. For example, on Jan. 15, 2003, FERC issued a pricing policy for transmission that would grant incentives for several activities: 50 basis points in return on equity (ROE) for joining an RTO; 100 basis points for new transmission investment approved as part of an RTO planning process; and 150 basis points for forming an ITC. This policy, if adopted, would raise the return on equity for transmission to between 14 and 15 percent using traditional leverage, and to the high teens with a more leveraged investment, a level that can appeal to a new class of investor. FERC has offered sweeteners on specific transmission deals before, but not in a generic manner. This positive step toward encouraging transmission needs to be fine-tuned, but it sends the correct signal that FERC recognizes the need to encourage transmission investment as a market facilitator, and capital from non-traditional investors.

Also, some RTO-specific decisions are encouraging transmission investment. In its Dec. 19, 2002, decision approving PJM as an RTO, FERC required PJM to evaluate merchant transmission on a co-equal basis with utility-based investments in its planning, thus opening a door to new sources of equity. Further, that decision-for the first time-specified that RTOs must consider commercial factors just as much as reliability in deciding what resources should be added. This departure from the traditional focus on "keeping the lights on" is a critical shift. Taken together, these are two important precedents that FERC will likely impose on other RTOs as they form.

So, will regulatory changes lead to the right level of investment in transmission? In each region, the utilities, NERC, and the fledgling RTOs and ITCs are in the process of identifying the specific lines and other transmission investments required to meet the new market requirements. However, there are a lot of details to work through before we know whether FERC's regulatory vision will be effective in getting sufficient transmission built. If we rely only on the evolving