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Transcos Reborn

Recent attrition raises the question: Consolidation or death spiral?

Fortnightly Magazine - July 2005

a stand-alone transco based in Reston, Va. “I think we’ve established the value of independent transmission, regulators are supporting us, and the industry in general has accepted transcos.”

What remains to be seen is whether the barriers before the transco business will diminish and allow the industry to grow beyond three companies.

Strategic Transmission

For many U.S. lawmakers, the August 2003 Northeast blackout was a wake-up call alerting them to the need for new transmission-system investments. Regulators and executives in the utility industry, however, needed no such wake-up call. They’d known for years that transmission investments were falling short. In September 2000, consultant Eric Hirst wrote in the pages of this magazine, “If the nation’s electric transmission network continues as it has, failing to expand enough to keep pace with growth in demand for electricity, then within a few years today’s problems could become a crisis” (“Transmission Crisis Looming,” Fortnightly, Sept. 15, 2000).

Hirst’s words proved prophetic when the Northeast was cast into darkness three years later. Yet today the industry still faces a shortfall in transmission investment, caused by a host of complicated factors. Those factors begin and end, however, with disincentives that keep investor-owned utilities (IOUs) from investing in transmission systems as much as most experts agree is necessary to maintain a reliable and efficient grid over the long term.

“The only way to allow recovery of transmission investments has been through a retail rate case,” says Doug Jaeger, vice president of transmission with Xcel Energy in Minneapolis. “Transmission investments, while large, don’t substantiate revenue requirements large enough for a rate case by themselves. What happens is you make significant investments over time, and don’t recover costs for three to six years.”

Along the way, transmission projects encounter many major hurdles, including local siting opposition and jurisdictional disputes. As a result, such investments represent significant risks for transmission owners. The rewards, however, might not be commensurate with the risks—at least not when compared with other investment options available to utility shareholders. This internal competition for capital creates dilemmas that have dogged integrated utilities ever since FERC issued Order No. 888 in 1996.

Order No. 888 effectively prohibits inegrated IOUs from using transmission assets to advance their strategic positions. In fact, transmission owners are required to provide open access for wholesale competitors to trade power in a free market. Thus, integrated utilities not only must accept front-loaded risks for rate-regulated transmission investments, they also must accept that such assets may be used against them in deregulated markets. It comes as no surprise, then, that executives and shareholders in integrated IOUs understandably have shied away from such investments.

Many of the dilemmas and uncertainties arise from the way IOUs in general are regulated, and the way transmission systems in particular are planned, financed, and built.

For example, conflicting policies between state and federal agencies have put the squeeze on utilities investing in transmission systems. Rate-of-return incentives that the federal government provides to encourage transmission investments can be taken away by state regulators seeking to minimize rate impacts on consumers. Moreover, IOUs