Tales of bad faith, cold feet and price manipulation.

Lollipops"/fn1/ and "loopholes." "Islands" and "peninsulas." Utilities have invented a colorful new lexicon to explain what's happening at power pools and regional transmission groups. Yet the basic issue remains familiar: How to gain a competitive advantage.

By early February, the Federal Energy Regulatory Commission was to have held "one or more conferences" with state public utility commissioners to solicit views on how to divide the country into regional districts to develop independent regional organizations to manage electric transmission operations.fn2 The meetings would mark the first step on the way to a rulemaking case to consider the relative merits of "transcos," meaning private, for-profit companies owning and operating transmission lines, versus an independent system operator, or ISO, usually seen as a nonprofit organization managing lines owned by another company.

On Jan. 13 the FERC announced the first round of conferences: Feb. 11 (St. Louis); Feb12 (Las Vegas); Feb. 17 (Washington, D.C.). But the industry was already pressing the question.

On Dec. 21, Minnesota Power Inc. filed a complaint against Northern States Power Co. that could very well force the FERC's hand. In a 200-page package of allegations and affidavits, Minnesota Power brought the ISO-transco debate to a head. It charged that by voting against the ISO proposed for MAPP (the Mid-Continent Area Power Pool) and by announcing an effort with Alliant Energy to form an independent, for-profit transmission company, NSP had breached an agreement signed in 1996 to work toward ISO formation. More importantly, MP suggested that by planning the project in secret, with no collaboration with power producers or transmission owners, NSP would violate a key principle announced by the FERC governing regional transmission groups.fn3

"It came as a complete surprise," said Minnesota Power in the complaint, "when, at the eleventh hour, NSP not only withdrew its support for the ISO, but also actively campaigned to scuttle it."

By Jan. 4, NSP had yet to file a formal answer at the FERC. But when contacted on Jan. 6, the company reaffirmed its faith in the transco idea.

"We're moving forward," said Terry Volkmann, NSP's manager of operational transmission support. "Is it a secret process? I'll tell you what. Any owner of transmission who asks us to present the plan, we're there the next day. We've even been to Minnesota Power to explain to them what we're going to do."

Whatever its merit, the complaint by Minnesota Power forms a knot tying together a set of related debates concerning three regional power markets: MAPP, the Midwest ISO and the PJM Interconnection. First, does a transco initiative satisfy a utility's obligation to form or join an ISO? Second, can voluntary ISOs design transmission rates both low enough to avoid rate shock for customers and yet high enough to entice transmission owners to stay within the group? Third, even where ISOs win acceptance, will they remain vulnerable to a market-fearing backlash?

And one more question adds uncertainty: How much longer will utilities retain the preference for native load? That privilege now appears open to reassessment.

On Dec. 16, in approving the transmission loading relief procedures proposed in June for the Eastern Interconnection by the North American Electric Reliability Council,/fn4/ the commission acknowledged that TLR rules tend to favor native load, since they impose curtailment to relieve congestion only in the case of interchange transactions between control areas. Such transfers don't generally involve native load network service.

To level the field, the FERC asked transmission-owning utilities to file interim TLR procedures by March 1 that would also apply to intraexchange native load transactions. In addition, TOUs not participating in a regional ISO with congestion management programs must file plans by the same date on how they might avoid having to curtail transmission, such as through redispatch procedures. In this way, the FERC's TLR ruling could end up favoring regional markets that follow the PJM design, which allows participants to "buy through" congestion using locational marginal pricing.

Certainly, the vote against the ISO left MAPP to lick its wounds. In December it announced it would ask Hagler Bailly Consulting Inc. to help survey the membership, with results due in early January, to weigh MAPP's next step.

Meanwhile, at the Midwest ISO, the next step appeared aimed simply at survival. Fearing a chilling effect (and defections) from a low profit level in the ISO transmission tariff, MISO participants on Nov. 19 took the unusual step of asking the commission for clues on how it (the FERC) planned to set return on equity.

That move came after a FERC staff witness testifying in November in the NEPOOL rate docket/fn5/ had recommended an ROE of only 8.6 percent - way below the 11.5 percent figure proposed by MISO participants to keep the group together.

Said John Catlin, power system operations manager for the Wabash Valley Power Association, "As a transmission customer of two transmission owners that are sitting on the sidelines - NIPSCO and AEP - I also want those two owners to have some incentive to join.

"If it means that they receive a higher return through the Midwest ISO than they would receive individually, I believe that that would be money well spent that would lower my overall transmission bill."

But will ISOs actually lower bills? That was the issue in PJM, where one energy and transmission customer, the Old Dominion Electric Cooperative, had complained to the FERC on Nov. 4 that prices were going up, not down, ostensibly because of some sort of unfair "gaming" behavior. ODEC insinuated that those owning generation resources within PJM had seized on a loophole in pool rules and were bootstrapping prices to circumvent a FERC-mandated price cap on energy bids by exporting cost-based power outside the pool and then re-importing it for sale within PJM at market prices.

ODEC said that PJM energy prices had increased by more than 23 percent from 1997 during the period from April 1998, right after it had adopted locational marginal pricing, through September, at the close of the summer peak season. ODEC's complaint spawned a raft of denials from PJM members, who submitted an affidavit from star witness William Hogan, the Harvard economics professor and architect of the PJM pricing structure. Hogan chided ODEC for failing to understand LMP pricing theory and the FERC's bid cap.

In a reply filed on Dec. 21, the co-op begged indulgence on the nuances of economic theory. But it renewed its call for the FERC to investigate, appealing to Populist values:

"There is something very, very wrong," the co-op charged, "when the exact opposite from what FERC expected to occur happens under the supposedly 'competitive' market structure that was established to benefit consumers within PJM."fn6

The MAPP Vote: Is a Transco Just as Good?

In a September letter presenting the ISO plan to MAPP, Enron's David Mangskau, chair of the ISO task force, had called the vote "an important crossroads for the MAPP membership." Donald J. Shippar, then senior vice president for customer service and delivery at Minnesota Power, went further: "Without the regional tariff and the ISO, MAPP is in danger of dissolving."

These fears never bothered James Howard, CEO at Northern States Power Co. Writing on Sept. 14 to his counterpart at Minnesota Power, Howard saw a distinction between reliability and the business of operating transmission:

"We believe that MAPP is one of the best, if not the best power pool in the nation. ¼ We believe MAPP can have a successful, effective future as a reliability organization."

But Howard added, "We also believe the proposed ISO threatens the viability of MAPP as a regional reliability organization."

Eventually, on Nov. 6, Northern States Power and Alliant Energy formally announced plans to develop an independent for-profit company to provide electric transmission services to the Upper Midwest. The final blow came on Dec. 22, when Alliant gave formal notice that it would abandon the Midwest ISO, in a letter from Alliant's managing attorney Kent Ragsdale.

Two years earlier, however, when Northern States Power was pursuing the ill-fated Primergy merger with Wisconsin Electric Power Co., it had signed a settlement agreement with Minnesota Power agreeing to work together on forming an ISO if MP would withdraw its opposition to the merger. According to Minnesota Power, that agreement was never made conditional on final approval of the Primergy merger. It is that settlement that underlies MP's complaint of Dec. 21 challenging NSP's transco initiative with Alliant.

Ironically, the complaint from Minnesota Power came even as NSP was busy answering a separate set of charges - in this case filed by Wisconsin Electric Power Co., NSP's would-be merger partner. On Nov. 24, WEPCO charged that NSP operated its transmission system in a discriminatory manner, in violation of its open-access tariff.fn7 In essence WEPCO alleged that NSP gave preference to its own load and curtailed WEPCO transactions on NSP lines by relying on MAPP's TLR rules. The WEPCO complaint focused on NSP's control of the TCEX - the Twin Cities Export Constraint - making it difficult for WEPCO to import cheap power from northern MAPP to serve loads in higher cost areas to the East and South. (This was the same MAPP/MAIN interface that figured in the collapse of the Primergy merger.)

Taken together, these events pose a test case for the FERC under the very worst set of facts: The commission must decide whether a private transco initiative is as good as a collaborative ISO effort, and do so in a case in which the private transco would own and control a critical transmission bottleneck.

Testifying in support of the Minnesota Power complaint, consultant Mark Frankena (now at Economists Inc. and the former deputy director for antitrust at the Federal Trade Commission) noted that "utilities in northern MAPP have no alternative to [the] use of NSP's transmission system to carry power to the East and, to a large extent, the South." He added that between May 12 and Oct. 31, 1998, NSP called for line loading relief on 70 occasions, of which 73 percent involved the TCEX and 20 percent involved the constrained interface between Minnesota and WUMS, the Wisconsin/Upper Michigan division of MAIN (Mid-America Interconnected Network).

For its part, NSP argues that its TLR curtailments of WEPCO transmission did not discriminate in favor of its own transmission: "In each instance this summer in which NSP curtailed WEPCO and was required to curtail native load by its [NSP's] open-access transmission tariff, NSP did so by curtailing native load transmission via redispatch. Thus, [we] complied with the open-access requirements without shedding [our own] firm customers."

As NSP points out, the FERC expressly approved that bifurcated strategy for NSP last summer.fn8 It adds that its strategy of TLR plus redispatch would pass muster under the FERC's December TLR order: "NSP has been doing since June 29, 1998, that which the commission ordered all other utilities to do by March 1, 1999."

The MISO Quandary: Like a Gas Pipeline?

The Midwest ISO case presents the FERC with another challenge: How to keep transmission tariffs low enough to avoid the sort of rate shock that led the Indego ISO to fail (when public power agencies balked at paying transmission rates four to seven times higher than under existing contracts), and yet provide the type of profit incentive needed to attract all transmission owners in a given region? The commission must solve this problem to avoid ISOs in which the members are noncontiguous. FERC commissioner William Massey often has called this phenomenon the "Swiss cheese" ISO.

Testifying on Dec. 4 for the Midwest ISO participants in support of the request for policy guidance on how the FERC might eventually rule, José Delgado, vice president of electric system operations for WEPCO, set out the problem:

"The 11.5 percent rate of return on equity filed in this proceeding is conservative when compared to state returns. ¼ I believe that sooner or later all transmission service will be unbundled from retail rates and provided through FERC-approved tariffs. If MISO rates are much lower than retail rates, the companies will face a significant reduction in earnings when they join the ISO."

Delgado noted that a MISO ROE discounted 100 basis points below the 12.2 percent ROE authorized by the Wisconsin Public Service Commission would imply a $1.2 million cut in annual transmission revenues for WEPCO. And he added that WEPCO was atypical: "Unlike most utilities, which have 10 to 15 percent of their plant in the transmission function, Wisconsin Electric has only 7 percent of its plant booked to transmission. Further, [our] transmission plant is, on the average, older and therefore more depreciated."

Moreover, Delgado was speaking only of return on investment - not capital for new construction in a state facing transmission constraints.

"Wisconsin faces very limited capability across its western interface with MAPP utilities. ¼ [T]ransfer capability into Wisconsin from Illinois is also much more limited than it used to be just a few years ago. Consequently, while Wisconsin has long been an electrical 'peninsula,' it has recently taken on the attributes of an electrical 'island.'"

The issue of return on equity in the MISO case is set for hearing before an administrative law judge in June. Nevertheless, any interim negative event might spook the fragile core of MISO participants. Accordingly, the MISO has asked for a set of four instructions, ensuring that the ISO equity return will be high enough to:

(1) offer incentives to join the ISO;

(2) avoid penalizing participants, compared to what they would receive in bundled rates without joining the ISO;

(3) encourage and facilitate construction of new transmission facilities; and

(4) be comparable to returns earned by other transmission-only companies, such as interstate natural gas pipelines.

Consumer advocates in Ohio, Indiana, Pennsylvania and Missouri oppose the MISO request: "Although not stated explicitly, the apparent purpose of the motion is to obtain ¼ a rate of return higher than that actually necessary.

"Whether gas pipelines are enterprises which have similar risks to the Midwest ISO is a question of fact. ¼ It is not the sort of question appropriate for decision through a 'policy instruction' without any evidence being taken."

PJM: Who's Gaming Whom?

The complaint filed by Old Dominion Electric Co-op paints a different picture. In PJM, a competitive market supposedly is already up and running. The pieces are in place. Yet something has gone wrong, says Old Dominion, a fault it lays to market "gaming" strategies made possible by well-intentioned restrictions imposed on a temporary basis by the FERC.

Could it be the commission itself that is the culprit?

ODEC charges that the PJM restructuring has led to sudden, unexplained energy price increases in PJM. It suggests that the blame lies with a "price cap" imposed temporarily by the FERC on generation within PJM. It argues that this "price cap" has led PJM resource owners to export their power outside the interconnection, where it can take on the guise of an import through a loophole and then bypass the FERC's price cap. As a remedy, ODEC asks PJM to recall these power exports for sale inside PJM at cost-based rates, to keep the PJM price down. It would also have the FERC investigate the price runup.

Here, though, ODEC becomes its own worst enemy. Its complaint confuses the meaning of terms and definitions used in the PJM market structure. Two key terms are "locational marginal pricing" and the so-called "price cap."

In truth, however, locational marginal pricing is not an energy pricing formula. Instead, it operates as a method for setting prices for transmission congestion. Technically speaking, LMP-based transmission prices respond to energy prices - not the other way around. In fact, no congestion pricing was seen in PJM at the times of high energy prices cited by ODEC. These observations came in an affidavit filed by PJM pricing architect William W. Hogan, the Harvard University professor, and Dr. Scott M. Harvey, a director in the economic consulting firm of Putnam, Hayes & Bartlett Inc. Hogan and Harvey also explained how the FERC had not imposed a cap on energy prices, but only a cap on bids by resource owners, designed to prevent power producers from gaming the market by withholding capacity:

"Cost-based bid caps do not necessarily cap prices. ¼ The purpose of a bidding cap is not to cap prices but to avoid the possible exercise of market power through [a] de facto limitation of the output of generators."

Nevertheless, there remains the problem of the PJM internal memo that appears to admit the possibility of the type of gaming of which ODEC complains.

That memo, "Operation of the PJM Market Such That No Member Has Undue Influence," was sent to members of the PJM energy markets committee in preparation for a conference call set for Aug. 10. In it, Kenneth W. Laughlin raises the possibility that PJM members might manipulate capacity to boost prices:

"FERC may not have fully considered the possibility of a PJM participant creating a scarcity situation, and possibly exercising market power, by permitting off-system sales of internal [PJM] resources, while simultaneously allowing market-based bids to set the PJM price. FERC probably assumed that market-based bids would be called upon [only] after all 'cost-capped' internal PJM resources were loaded."

Laughlin suggested a fix: Allow PJM to recall sales of internal PJM capacity to outside buyers, so as to bid such resources at cost within PJM, before loading any market-priced supply bids from outside the area. The committee rejected that proposal, but questions persist.

Most intervenors oppose any new bidding restrictions. Sithe Energies notes that ODEC's worries, whether valid or not, will soon disappear, "as vertically integrated utilities sell off generating assets [and the] acquirers ¼ obtain market-based pricing authority." Says PECO Energy: "ODEC completely distorts the ¼ letter circulated by Kenneth Laughlin."

Nevertheless, some intervenors believe that ODEC might be on to something. Electric Clearinghouse, the PJM industrial customer coalition, and Public Service Electric and Gas appear to favor at least a FERC investigation, even if ODEC has failed to identify the precise cause for high prices.

Have any PJM companies engaged in price manipulation? Laughlin remained circumspect in his now-notorious memo:

"Situations could arise on PJM (although PJM is not suggesting that the situations have arisen), that are similar to the ¼ oil industry when loopholes in the regulations permitted 'old oil' to be sold at 'new oil' prices. PJM is not suggesting that this is occurring, and PJM has not investigated whether or not such things are occurring, but the ability exists to make such things occur."

Bruce W. Radford is editor of Public Utilities Fortnightly.

Taken by Surprise? The ISO collaborative that wasn't.

The Agreement:

"Applicants agree to work cooperatively for the purpose of forming a regional ISO. ¼ [A]pplicants and MP&L agree [that] MAPP has the background expertise, experience ¼ and ¼ credibility ¼ to expeditiously implement an ISO."

Settlement agreement whereby Minnesota Power & Light Co. (as Minnesota Power Inc. was then known) agreed not to oppose Primergy merger if Northern States Power Co. and Wisconsin Electric would work to form an ISO. Filed Oct. 4, 1996, FERC Docket EC95-16-000.

The Squabble:

"Recently, representatives of Northern States Power have stated that NSP intends to vote against the proposed MAPP ISO and regional tariff; NSP is now publicly campaigning other MAPP members to vote against ¼

"Minnesota Power believes such actions by NSP can be viewed as a violation of its FERC-filed ¼ Settlement Agreement."

Letter, Sept. 10, 1998, from Donald J. Shippar, then senior vice president, customer service and delivery, Minnesota Power, to Anthony Schuster, director and vice president of transmission systems, Northern States Power Co.

The Breakup:

"Dear Donald:

"By now I'm sure you are well aware of our position on the proposed MAPP ISO and regional tariff. ¼ We are voting against ¼ because we think the ISO concept itself is fundamentally flawed.

"We've been working on what we think is a better proposal. ¼ Development of an independent transmission company has been under way for more than a year. [W]e believe it is gaining acceptance in many circles. We are recruiting partners and intend to file our application with FERC in 1999.

"I would be happy to discuss these concepts with you to determine whether the ITC can accommodate your needs."

Letter, Oct. 14, 1998, reply from Anthony G. Schuster to Donald Shippar.

Strung Along?

"I have since learned that NSP was actively working on the development of an ITC ¼ beginning in the fall of 1997. NSP's ITC activities were kept secret. In fact, I believe NSP's representatives on the MAPP committees were taken by surprise by the company's sudden repudiation of ISOs."

Affidavit of Stephen D. Sherner, senior vice president, energy sourcing, Minnesota Power Inc., filed Dec. 21, 1998, FERC Docket EL99-20-000.

Loss Leader? Cinergy sees revenues falling as a member of Midwest ISO.

Excerpts from testimony of Jon C. Procario, vice president, electric operations, Cinergy Corp., filed Dec. 8, 1998 in FERC Docket ER98-1438, supporting MISO request for 11.5 percent return on equity:

Q.

Please describe the financial risks associated with joining an ISO.

A.

There is a substantial risk of the loss of millions of dollars of transmission revenues.

Q.

Have you calculated a potential impact on Cinergy of joining the Midwest ISO?

A.

Yes. [T]he most likely figure is ¼

$8 million dollars [during the initial six-year transition period].

Q.

Are there other financial risks?

A.

Yes. Cinergy may be required to construct [transmission] facilities and will not receive full recovery of those costs from the ISO during the six-year transition period. ¼ [S]tate commissions may be reluctant to burden their ratepayers with the costs of facilities which largely benefit customers in other states.

Q.

Doesn't Cinergy face these risks today?

A.

Not to the same degree. Cinergy [is] not obligated under its [current] transmission tariff to construct transmission facilities to relieve problems arising on other transmission systems.

Q.

How should these risks be considered in establishing a return on equity for the Midwest ISO?

A.

The Midwest ISO filing includes an 11.5 percent return on equity. ¼ [T]his was the return agreed to by the diverse group which negotiated the Midwest ISO documents.

Q.

Has experience shown a need to provide some reward for joining

an ISO?

A.

Yes. ¼ The ISOs that are up and running today are from tight power pools or California, which has state

legislation. ¼ ISO efforts in areas without tight pools have had problems. For example, Indego in the Northwest collapsed after lengthy negotiations. MAPP recently voted down an ISO proposal.

Q.

Is a reasonable return important for the Midwest ISO?

A.

It is of particular importance. ¼ Many Midwestern utilities remain

on the fence.

1 The term "lollipop pricing" refers to the two-part transmission tariff that would have applied if the members of MAPP had voted to approve formation of an ISO. The "pop" element sets a price for service in the zone where the load is located, at that zone's net revenue requirement. The "stick" portion denotes the price for service required to transmit power to the "pop," or outside of MAPP, based on a cost-based formula for firm service (giving higher weight to high-voltage transmission lines) and a megawatt-mile, distance-based formula for nonfirm service.

2 Notice of Intent to Consult Under Sec. 202(a), FERC Docket No. RM99-2-000, Nov. 24, 1998.

3 Complaint and Motion for an Order to Show Cause, EL99-20-000, Dec. 21, 1998.

4 Docket No. EL98-52-000, Dec. 16, 1998, 85 FERC ¶61,353.

5 See Direct Testimony of Staff witness David R. Penkrot, filed in FERC Docket OA97-237, calculating a weighted average return on equity for NEPOOL members of 7.88 percent, and recommending an 8.6 percent ROE for the NEPOOL ISO. (According to answer filed in the Midwest ISO case by the Ohio Consumers' Counsel, the Indiana Utility Consumer Counselor and the Pennsylvania Consumer Advocate.)

6 See Complaint for Modification of PJM Open Access Tariff, filed Nov. 4, 1998; and Request for Leave to File Answer, filed Dec. 21, 1998, FERC Docket EL99-9-000.

7 FERC Docket No. EL99-12-000, filed Nov. 24, 1998.

8 See No. Sts. Pwr. Co., June 29, 1998, 83 FERC ¶61,338.

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