Bullish for Business
Forced consolidation of RTOs would set transmission owners free to go after profits.
On July 12, the day after the feds dropped the bomb and told transmission grid operators to consolidate their activities, Mirant spokesman Lee "Buddy" Eller sent me a short six-page company study that spelled out the best explanation I've ever seen of power price differentials across the Northeast US.
With fully readable charts and maps showing congestion and pricing zones in the New York and PJM grid regions - plus data for New England, as well - Mirant's white paper fixes a precise dollar value ($440 million) on the various mismatched seams and bottlenecks connecting the three markets. (I don't believe you can find the study on the Mirant Web site, but call me and I'll send you a copy by email, if I can get Mirant's permission first.)
As if on queue, Mirant's study offered the perfect endorsement for the newly invigorated Federal Energy Regulatory Commission (FERC), and for its tranche of nine major decisions issued the day before. In those orders, FERC told the three Northeast grid operators to hold talks to consider merging into a single regional transmission organization (RTO), operating on the PJM model. Second, it also advised GridSouth, Entergy, Southern Company Services and the Southwest Power Pool to form a single RTO in the Southeast. Third, it appealed to industry players out West and in flyover country to form a single RTO in their respective regions. In other words, it recommended only four RTOs under FERC jurisdiction - Northeast, Southeast, Midwest, and West.
The Mirant study is fine as far as it goes, but it obscures an important point.
In reality, the RTO concept implies two revolutions: (1) market formation and reliability assurance through a new regional institution, and (2) the launching of a stand-alone transmission business by the grid owner. Up till now, I believe that revolution #1 has stymied any real progress on revolution #2, by imposing requirements for stakeholder participation and collaborative discourse on the process of raising capital from investors, which can be done better in private. I've been thinking about this idea for quite a while, but consultant Mike Brown, from the Hay Group's National Utility Practice, offered some new insights when we talked a few days after the FERC issued its orders.
A Wall Street View
The business of transmission is business.
June 1, 2001
Mr. Paul Cutler
Dir., Corp. Finance & Banking
FPL Energy Inc.
Juno Beach, Fla.
Dear Mr. Cutler:
You have asked us to summarize our views on what factors the public equity market would assess in valuing an independent transmission company such as Grid Florida LLC ("the Company"). Because the Company is not yet established, this letter is only intended to examine the basis concepts ... Nevertheless, we can provide certain general observations.
There is no simple formula for a successful initial public offering. All investments are examined as a unique set of risks and rewards ...
Since neither the Company nor a for-profit U.S., electricity transmission industry exists today, the Company must initially be able to demonstrate the basic elements of any viable business enterprise. It should have:
- a definable market, preferably growing, with sustained demand for the product or service;
- an ability to demonstrate a revenue/earnings model of framework that will result in [i] a reasonable expected return on invested capital, [ii] some level of earnings predictability and growth, [iii] a sustainable dividend;
- a positive strategic direction with real growth opportunities through internal and external means;
- an articulate management team that can describe and execute their business plan; and
- some actual operating history prior to going public.
As of the date of this letter, the Company also has (1) no operating history; (2) no comparable group of public companies with which to compare; (3) an unidentified, untested management with yet unknown experience; (4) no alternative business other than transmission; and (5) no prior regulatory history. All other things equal, these factors obscure the merits of an investment in transmisison and reduce the ability of investors to make a more precise assessment of the potential opportunities and risks facing the Company. ...
To better attract capital investment, the Company should focus on eliminating as much uncertainty about its future as possible .. .
J. Scott Magrane
New York, N.Y.
Source: Florida Power & Light Co. & Tampa Electric Co., Request for Approval of Transmission Pricing Plan, FERC Docket No. ER01-2205-000, filed June 1, 2001.
"THE FERC HAS CREATED A WINDFALL FOR THE TRANSMISSION OWNERS," said Brown, "though I doubt that the commission or the staff or the utilities realize that yet.
"What they've done," he explained, "is to free the TOs from having to work to set up all those administrative conventions and protocols required for RTO formation - like governance, security, balancing market monitoring and OASIS node management, which don't return any dollars to the utility - and instead free up time in their schedules for the transco business, including marketing, asset management, spare parts control, creative tariff design and employee recruitment.
"The transcos now shed the administrative responsibilities that contributed to overhead. Now they can just run the money-making side of the business. This is a good deal."
To understand more of what Brown is talking about, consider the turmoil in the Alliance RTO process, where state PUCs have complained of little or no stakeholder input.
"The design process remains under the control of the Alliance companies," according to a protest filed in mid June by a coalition of state public utility commissions (PUCs) representing Michigan, Illinois, Missouri, Iowa, Ohio, Pennsylvania, Indiana and Virginia.
The PUCs complain of the "continued haze" surrounding the search for a managing member, but that's exactly the sort of process where collaboration gets in the way. (Of course, it now appears even less likely that the FERC would ever allow National Grid to become managing member of Alliance, as per plan.)
I CONFESS I WAS SURPRISED AT THE FERC'S MOVE. I did not see it coming when I sat in on the FERC's technical conference on RTO seams coordination, held on June 19. Then there was no clear call for consolidation, beyond what I'd already heard. "Forced marriages are bad for everyone," said Nicholas Brown, from the Southwest Power Pool.
Others had suggested that the FERC should certify new RTOs immediately, without waiting for all characteristics and functions to comply, so as to make them jurisdictional and give the commission unquestioned authority to force them to move more quickly, but this idea also saw its detractors.
"We are participating with RTO West, but we don't want to join agreements to which we did not participate in negotiations." said Yakout Mansour, from British Columbia Hydro.
Will the industry now buy in? "I don't know," says Attorney Sheila Hollis, from Duane, Morris & Heckscher, "but we're sure going to be busy. I think the northeast and southeast ISOs "will give it a very serious try to make it work."
Hollis doubts that FERC has created a windfall for utilities, as Brown suggests, but instead finds it more important that FERC has signaled a new way of doing things.
"The most important thing is the human interaction on the commission," she told me, as brought about largely by the presence of the two new Bush appointees. "We're watching the future stretch before us."
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