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Merchant Transmission Redux

Financial transmission rights and regulated returns have not induced needed construction. Presenting an alternative model.

Fortnightly Magazine - September 2006

processes that forecast growth, solicit generation and transmission, and set project queues. Adding it as an option will have no impact on the process of calculating nodal prices or other aspects of LMP as currently implemented.

As FTR policies continue to evolve, RTOs will remain free to innovate or not innovate as they wish. Since there is only one way to calculate nodal prices, the sponsor’s recovery under RICC and its liabilities to the RTO, TO, and LSE will remain unchanged as institutional changes like these take place.

Increasing Competition and Reallocating Risk

Because RICC encourages transmission investments that might not otherwise have been made, it increases the competitiveness of markets and widens their scopes, while posing no threats of market power. RTO rules and FERC regulations ensure that sponsors will be unable to withhold capacity, and a price cap at nodes that are adversely affected ensures that they cannot profit from any incidental congestion their projects cause.

Because RICC offers a new alternative, it will limit further the abilities of vertically integrated utilities (even under an RTO) to exploit system weaknesses that favor their own generation and allow discrimination of access. But competition is more than just a lack of abuses due to market power. Implementing RICC would promote entrepreneurship in an area that has seen little of it. It would motivate the expeditious construction of new lines and upgrades. The winning sponsor would be the first entity that believes it can earn an acceptable return by building it. RICC also rewards more efficient upgrades and better-located lines that are consistent with reliability. If a project can have several configurations, competition for RICC income can incentivize a search for designs that maximize the difference between its costs and benefits.

RICC also reallocates transmission risks as the shift from rate-base plants to non-utility production did for generation risks. Traditional regulation thrust the risks of both onto captive ratepayers, while utility investors enjoyed secure (but relatively low) returns. Today investors in independent power bear the risk that their plants will not pass a market test. Competition both limits their returns and offers the prospect of large rewards for efficient choices. There are limits to competitive transmission that do not exist in generation, because the benefits of a new or upgraded line usually are maximized by building one facility. Unlike generators, competing transmission owners will not enter a market to cut the profitability of existing ones and transfer more of the savings to customers. Economists sometimes say that regulation ideally attempts to bring about a competitive allocation of resources when the market will not provide one. Until now the market has offered few such opportunities in transmission. Behind RICC is the idea that some degree of competition is possible even in transmission, and that it is worth trying.

The nation’s transmission system is closing in on engineering limits that threaten its reliability and economic limits that render it less able to move power on demand through an ever growing set of markets. Regulated rates of return on transmission appear insufficient to attract investment, while