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Profit Without Costs

An analysis of participant funding in natural gas and electricity markets.
Fortnightly Magazine - August 2004

pipelines or their captive customers. As a result, it no longer fits well with an industry that is increasingly characterized by competition between pipelines.

The current pricing policy (rolled-in) sends the wrong price signals, as some commenters have argued, by masking the real cost of the expansions. This can result in overbuilding of capacity and subsidization of an incumbent pipeline in its competition with potential new entrants for expanding markets. The pricing policy's bias for rolled-in pricing also is inconsistent with a policy that encourages competition while seeking to provide incentives for the optimal level of construction and customer choice. This is because rolled-in pricing often results in projects that are subsidized by existing ratepayers. Under this policy the true costs of the project are not seen by the market or the new customers, leading to inefficient investment and contracting decisions. This in turn can exacerbate adverse environmental impacts, distort competition between pipelines for new customers, and financially penalize existing customers of expanding pipelines and of pipelines affected by the expansion.

Under existing policy, shipper's rates may change for a number of reasons. These include rolling-in of an expansion's costs, changes in the discounts given other customers, or changes in the contract quantities flowing on the system. As a customer's rates change in a rate case, it is generally unable to change its volumes, even though it may be paying more for capacity. This results in shippers bearing substantial risks of rate changes which they may be ill equipped to bear. 31

Our new model is completely consistent with our traditional model except that it now permits pricing grid service on the higher of the grid's average or incremental costs. The result is that the transmission customer pays for all grid facilities at a price equal to or higher than the native load. In the context of our traditional cost-of-service model, this is the equivalent of allocating to the new transmission customer the transmission revenue requirement sufficient to compensate the utility for the expansion of the system. Simply put, it is part of the "cost allocation" process. Thus, by requiring that the new transmission customer pay a rate which is the higher of embedded cost (i.e., a rolled-in rate including the expansion cost) or incremental cost (i.e., expansion cost revenue requirement divided by the new customer's units of service), the new transmission customer is paying an amount that is at least equivalent to a pro rata share of the sum of the cost of the existing grid and the cost of expansion facilities. There are no existing facilities which are being used free of charge and there can, therefore, be no subsidy.

The Commission believes that, to ensure fully comparable treatment of all Generating Facilities, transmission rates should not include the costs of Interconnection Facilities. As stated in the NOPR, this policy is consistent with the Commission's current treatment of generation step-up transformers, appropriately assigns the costs of Interconnection Facilities to the generation customers using them, and ensures that the Transmission Provider's own Generating Facilities and those of its competitors are treated