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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

make the perfect the enemy of the good.

Incentive 5 (creation of regulatory assets) would be available in those situations where a valid state order otherwise would preclude the passthrough of the new owner's transmission charges, most often due to a retail rate freeze that applies to the retail rates of a bulk transmission service customer.

Finally, incentive 7 ( Mobile-Sierra language) would be available to a new owner that desired a certain stream of revenues for a defined period of time. The purpose for this incentive is the expectation that certain investors might purchase the assets with a pre-determined investment horizon. We expect that certain stakeholders will decry any policy that would facilitate the entry of financial interests with relatively short-term investment horizons. Under normal circumstances, such objections would require careful consideration. Capital intensive industries such as the electric industry undeniably have benefited from long-term, stable capital sources. However, the present situation is not typical. There is a genuine need for expanded investment and valid policy reasons to create independent control. Under these circumstances, investors with short-term return objections can align their interests with valid regulatory objectives.

Performance-Based Ratemaking

Above, we mention a special kind of inducement to relieve congestion. The principle is simple: The regulated company proposes delivery of a measurable level of improved service in exchange for higher rates or a prescribed addition to the allowed equity return. Typically, the return on equity incentive is achieved by moving the allowed return to the upper end of the zone of reasonableness. If the promised level of performance is delivered, the company retains the rate incentive. If the promised delivery improvement is not produced, the rate increment is returned to the ratepayers through retroactive or prospective rate adjustment. Performance-based ratemaking typically requires that the company also accept a downside risk, requiring a refund below the otherwise allowable return if performance falls below a predetermined level. 23

The example described is predicated on a reduced level of incurred congestion costs, but other performance targets also could be used, such as reduced maintenance time or lower forced outage rates, both of which should reduce congestion-related generation costs.

FERC has had virtually no success in obtaining proposals for performance-based rates. The reasons for this are not clear, but part of the problem may be that reduced congestion costs could entail a net loss to the current integrated utility transmission owner, if it is the owner's generation that benefits from out-of-merit order dispatch. An ITC will have no motivation to perpetuate historical congestion patterns, especially if the ITC directly is compensated for reducing congestion and out-of-merit order dispatch costs. The current state of bifurcated jurisdiction over transmission and the absence of adequate investment incentives both appear to have a major role in discouraging transmission investment. We believe that the promotion of ITCs remove a major disincentive to develop performance-based rates.

The policies we advocate are all about making the most of FERC's somewhat defensive regulatory posture. Current holders of wholesale transmission rights certainly will object that any increase in present rates is but a windfall