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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
  1. a defined recovery period for amortization of the regulatory asset; 18
  2. Use of a formula rate for bulk transmission service; 19 and
  3. Inclusion of Mobile-Sierra language prohibiting either the transmission owner or transmission customers from seeking to change the approved rate for a defined period of time. 20

These rate options could afford direct and quantifiable benefits to investors, not to mention a meaningful opportunity to reduce congestion by adding new transmission capacity. Congestion fragments service areas with often deleterious, temporal effects on the level of competition within the resulting sub-markets. FERC will need to ensure that new investment addresses this problem.

By now, it is apparent that the mere suggestion of "innovative rate treatments" in Order No. 2000  has elicited neither universal RTO participation nor sufficient transmission investment. The required showing of a cost-and-benefit analysis to support these "innovative rates" invariably are subjective and invite litigation over the adequacy of the supporting evidence, creating uncertainty and undercutting the incentive purpose of the policy. This is not to say that the FERC automatically must authorize all of the above incentives to any applicant that can satisfy the independence criterion. Incentives 1, 2, and 6 should be available presumptively to any such applicant, but the availability of incentive 1 would be subject to a demonstration that the company is eligible for a FERC-approved return on equity on the assets. FERC could provide additional certainty by establishing a baseline return on equity that need not be independently proved and to which the 100 basis premium would be automatically applied. For incentive 2 (use of a hypothetical capital structure), FERC could set a hypothetical capital structure that would apply for a certain number of years. For instance, a 50/50 structure based on the incentive return on equity and the actual cost of debt could be used and guaranteed to be available for five years. 21 Incentive 6 requires no justification; FERC long has accepted formula rates that accurately reflect the elements of FERC ratemaking policy as just and reasonable rates. A notable variation on the usual formulation is that used by ATC, which employs a projected test year with an after the fact true-up of the projected to the actual costs experienced during the year. The use of such a formula is especially valuable to a utility with a heavy construction budget, like ATC.

The use of formula rates provides significant benefits both to the regulated utility and to its customers, with a significant reduction in rate-case expense, regulatory lag, and regulatory uncertainty, which has beneficial effects on cost of capital. The Midwest Independent System Operator (ISO) provides in its tariff a Formula O methodology for pre-approved use by its transmission-owning members. FERC recently encouraged PJM Interconnection to adopt a similar approach.

FERC previously authorized utilities to use CWIP in rate base when heavy capital requirements have threatened the ability of a utility to raise capital on reasonable terms. ( See 18 C.F.R. § 35.25 , which authorizes a utility to include 50 percent of CWIP in rate base under very specific circumstances and subject