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Grid Investment & Restructuring: Two Challenges, One Solution

FERC must align the immediate self-interest of profit-maximizing entities with its own view of what is in the public interest.

Fortnightly Magazine - August 2005

The utility industry is operating amidst a hodgepodge of market and non-market regulatory arrangements, but these quasi-competitive circumstances, even if politically tolerable, will prove economically inefficient and therefore detrimental to consumer interests. How can real markets promptly and responsibly be advanced? We see two main challenges.

The first challenge is to reverse a long-term underinvestment in transmission infrastructure. Although the nation's high-voltage electric transmission network properly is viewed as a "public good," investment in the grid is, and long has been, in trouble. The current uptick in construction of (mostly small) transmission projects and recent studies announcing that investor-owned utilities plan to ramp up transmission investments in the next few years 1 do not alter that fact. Grid investment fell further and further behind the pace of growth in electricity demand during the past two decades 2 —a potentially costly threat to the digital economy and the American standard of living. This infrastructure deficit has direct implications for the possibility of liquid wholesale power markets and reduced congestion costs, continued high levels of reliability, any prospect of achieving stable market institutions and regulatory arrangements, and least-cost economic dispatch of generation across the board. 3

The second challenge is to improve upon the uncertain legal and regulatory environment within which the first problem must be solved. FERC's lack of success in inducing transmission investment with higher equity returns is part of a larger failure of federal law to more clearly delineate the appropriate scope of state and federal authority over the delivery of power and to set policy accordingly. Notwithstanding the Supreme Court's unequivocal support of FERC's authority over interstate transmission, 4 about 90 percent of transmission revenues remain subject solely to state rate decisions. In other words, the bundling of transmission as an undifferentiated component of the delivery of electric energy to the end user effectively insulates most transmission usage from direct federal oversight and the potentially positive effects of federal rate policies. FERC's incentive returns simply do not have the intended effect on the investment decisions of integrated utilities whose facilities primarily serve native load.

Vertical integration of utility functions affords companies at least the opportunity to grant preferential treatment to their own energy marketing interests, contrary to FERC's decade-long campaign to de-monopolize the industry and introduce competition into wholesale power sales. Recognition of this potentiality may be ample justification for going beyond mere functional unbundling of transmission.

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