More than a decade ago, working at the energy laboratory at the Massachusetts Institute of Technology, the late Fred Schweppe devised a novel scheme for pricing electric transmission. His solution? Do nothing. Simply ignore transmission. Or, for those of you old enough to remember what utilities used to say about open access, "Just say node."

What Schweppe discovered, as told by Sally Hunt and Graham Shuttleworth in their recent book, Competition and Choice in Electric (John Wiley & Sons, Ltd., 1996), was that any attempt at transmission pricing is largely "redundant." The costs don't matter (except, perhaps, for line losses in a condition of zero constraints.) Instead, you simply estimate the price of generation at each and every busbar, or "node," in the grid. All else equal (no undue "market power"), the difference in energy prices at nodes A and B should give you the true price of transmission from those two points.

Schweppe eventually refined his ideas in the landmarks study, Spot Pricing of Electricity (Kluwer Academic Publishers, 1988), with co-authors Michael C. Caramanis, Robert E. Bohn, and Richard D. Tabors. That work forms much of the basis for today's "poolco" proposals. Today, a decade after the idea was born, the FERC is at last taking arguments on locational pricing for electric transmission.

A Slush Fund?

The case at the FERC involves the Pennsylvania-New Jersey-Maryland Interconnection. PJM member companies have filed an interconnection agreement, a tariff and a transmission owner's agreement governing wholesale trades in the new PJM power pool (see FERC Docket Nos. OA97-261-000 and ER97-1082-000).

At issues is PJM's "Locational Marginal Pricing" model, proposed by the so-called "supporting companies" (seven members of PJM). The LMP plan is championed by Professor William Hogan of the Harvard Electricity Policy Group, who claims it's the best way to "get the price right." As I understand the LMP idea, PJM would collect transmission charges based on nodal energy prices and then rebate those costs among buyers and sellers, reflecting ownership and market value of Firm Transmission Rights. PJM would award FTRs only to owners of generation dedicated to firm or network transmission service. FTRs would function as a price hedge--a financial right to move power from one node to another. Settlement would occur after the fact, when the pool tallies power transactions and distributes rebates. But all FTRs are not equal. Some long-distance FTRs crossing transmission constraints could prove quite valuable, earning a high rebate. On the other hand, an FTR for a generating plant serving only local load might carry no value at all.

Hogan sees no discrimination in the rebate process: "Congestion rebates are set up so that no one will be any worse off than if they had to serve their own load entirely with their own resources."

Nevertheless, many oppose PJM's LMP plan. Notable opponents include PECO Energy and the Coalition for a Competitive Electric Market, which includes a group of power marketers. PECO reportedly argues for a single-system access charge (a postage-stamp rate) with a uniform uplift fee to recover redispatch costs. CCEM advocates zonal pricing--a variant of LMP that includes separate capacity rights in transmission sold by auction, plus market-based energy pricing. The point: to create separate unbundled commodity markets in energy and transmission. At this writing, it was anticipated that all parties would file a new set of documents at the FERC on or before May 31, to reconcile or defend their various proposals.

Ironically, while PJM's LMP plan follows directly on the work of Schweppe, so does the CCEM model, which was developed primarily by Schweppe's co-author Richard Tabors, of Tabors, Caramanis & Associates, also of Cambridge. CCEM claims its model is better adapted to the real world. Indeed, Tabors would boil down the problem to some five zones, each containing groups of hundreds of nodes with similar prices characteristics.

"PJM intends to replace the market with computers," complains John Hughes, director of technical affairs at the Electric Consumers Resource Council.

Don't be fooled, however, this no academic debate. Some investor-owned utilities see themselves as winners. Other don't. And then there's the power marketers, who do not own generation, and will receive no FTR allocation.

"[We] would have no role to play," says Enron's Eric Van Der Wilde.

"As [PJM] added more detail, I became more pessimistic," adds Robert A. Levin, v.p., New York Mercantile Exchange. "I think it will discourage a lot of parties from getting into this market."

Kathy Patton, regulatory counsel for Electric Clearinghouse, agrees: "Locational pricing might ultimately make sense, but only if there was no market power. It will give a monopoly to the ISO and the rest of us will be restricted to buying and selling paper."

David J. Pratzon, of PECO Energy, pulls no punches. At a technical conference held at the FERC on May 9, Pratzon likened PJM's LMP plan as not much more than a "a slush fund"--a rebate program offering windfalls to a lucky few.

"Hung Out" on Transmission

From what I see, the critics don't begrudge LMP as theory. Instead, they cringe at the thought of a market they can't see: 1,600 different prices and delivery points, with final prices held hostage to an after-the-fact cost settlement engineered by computer software. Here's a short list of a dozen common objections:

• Too complicated for real world;

• Costs more than a physical redispatch;

• Bundles energy with transmission;

• Hinders forward and secondary markets;

• Misallocates transmission rights;

• Discriminates against utilities with plants close to load (FTRs hold little value);

• Bad for power marketer (won't receive FTRs);

• Discriminates against municipal utilities (who can't designate plants to earn FTRs under purchased power contracts);

• Price signal is ineffective (after the fact);

• Impossible to audit;

• Won't encourage new transmission; and

• Violates FERC policy against "and" pricing for transmission.

PECO's Pratzon claims that redispatch in PJM (to accommodate constraints) only costs $4 million annually, while PECO's computer modeling runs indicate that LMP would involve $100-150 million annually in collections and congestion rebates.

Randall J. Falkenberg, an Atlanta consultant with J. Kennedy & Associates, Inc., suggests that this high cost may actually make transmission constraints appear too important, giving false incentives to encourage transmission improvements where none are needed. Yet others see the opposite problem: Transmission owners who receive FTRs with high rebate values might conspire against transmission improvements that would relieve constraints.

At Old Dominion Electric Co-op., J. Bertram Solomon says LMP would produce "and" pricing for transmission. "Even though there is a netting of overcharges through rebates, we're concerned that the scheme would allow the regional transmission owners to extract monopoly prices. There is a mismatch between how the FTRs are allocated [individual noncoincident peaks] and how the rebates are allocated [hourly]. ODEC would be put in the worst possible situation. [We] would get no FTRs and would have to pay two pancaked transmission charges to get access to PJM."

Kathy Patton, of Electric Clearinghouse, gets the last word on how the PJM plan would bundle energy and transmission prices, forcing traders to play one against the other:

I can't buy or sell power into or out of PJM. I must reserve my transmission by 10 a.m., but I don't make my energy bid until 12 noon. So, if my bid doesn't succeed, I'm hung out on transmission.

Editor

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