PUCs could face rate shock if feds push plans for an RTO signup bonus.

State PUCs will surely weigh in on the latest move by the Federal Energy Regulatory Commission (FERC) to work its will on the nation's electric transmission grid. In this case, the item in question concerns a policy statement proposed by FERC that would reward electric utilities for investing in new transmission upgrades and-more importantly-for joining up with a regional transmission organization (RTO).

Certainly, no one suggests that state regulators oppose grid expansion. But if past decisions offer any guide, one can expect that state PUCs will question any new policy that ties incentives for grid expansion to a surrender of rate-making jurisdiction to federal agencies.

In short, the evidence indicates that state PUCs fear a new round of rate hikes if FERC should get its way on grid restructuring.

Meanwhile, recent PUC actions continue to cast doubt on the benefits that might follow from reform of wholesale markets-even though some states still attempt to sound optimistic in the face of paltry progress .

Illinois, an advocate for choice, still complains of lackluster growth in competition and in the number of customers opting for supply choice. Michigan, another booster, reports a modicum of progress, though the numbers seem not too much different than those seen in Illinois. And Pennsylvania, the poster child for electric utility reform, has been forced to fall back and assign customers to suppliers on a random basis, at least in the Philadelphia area, under a regulatory settlement that called for compulsory assignment if not enough individual customers elected competitive suppliers.

The Federal-State Conflict

FERC's new proposed pricing policy for electric transmission services, aired in January, features rate incentives to reward grid investment and the formation of RTOs. The key elements of the plan include:

• RTO Signup. An incentive adder for all public utilities equal to an additional 50 basis points on their return on equity (ROE) for participation in an RTO;
• Asset Divestiture. An additional 150 basis points for divestiture of transmission assets; and
• Investment Incentive. A generic ROE-based incentive equal to 100 basis points for investment in new transmission facilities.

FERC claims that the program will reduce wholesale transmission and transaction costs over the long run by improving grid performance. But at the same time, by allowing utilities to earn additional profit for participating in RTOs or investing in transmission facilities, the move would likely increase retail rates for consumers.

This type of incentive program has been the subject of criticism by state regulators. They cite concern over the possible effect that such a move might have on retail rates. For example, last year the Louisiana Public Service Commission (PSC) cited just such concerns in voting against a proposal whereby Entergy Gulf States would have divested and transferred transmission assets as part of a plan to join the proposed SeTrans RTO in the Southeast U.S. Docket No. U-25965, Order No. U-25965-A, March 19, 2002, 216 PUR 4th 1 (La.P.S.C.)

In that case, the PSC raised concerns over both the effect of the plan on its authority over transmission matters in general and the practical effect of granting incentive returns on transmission investment. The PSC said that the economic impact of such rate hikes on native load customers should be a primary consideration in deciding an appropriate RTO structure. It concluded that rates would go up for native load customers in Louisiana if ratemaking power escapes to the federal level. It explained that Entergy expected to earn a 13 percent ROE under FERC jurisdiction, while it was authorized to earn only 11 percent ROE at that time under state regulation.

The Rush to Incentivize

FERC's rush to incentives comes at a time when its underlying policy-remaking the grid into RTOs or similar institutions-has floundered.

Up till now only two RTOs-the Midwest ISO and the PJM Interconnection-have received final certification, even while FERC Order 2000, an earlier blueprint for transmission market reform, had called for RTOs to be in operation across the nation by December 2001.

To jumpstart that process, FERC's proposal would now reset the deadline for RTO formation to Dec. 14, 2004. And, as if to put PUC worries at ease, FERC insists that the new ROE incentives would fall subject to a cap equal to the top of a range of reasonable ROEs for a proxy group of transmission owners participating in an RTO.

But make no mistake: The new incentives seem designed to rescue a teetering policy.

As FERC explained, "Many of our orders to date on transmission rates have been targeted more toward 'hold harmless' provisions to protect a utility from adverse rate-making consequences due to its transfer of its facilities to an RTO or ITC." In light of the slower-than-anticipated progress toward national grid reform, FERC said it had decided to take the bull by the horns and ensure that transmission owners would receive benefits from RTO formation.

Although rates for transmission services could rise when a utility takes advantage of the incentives, the commission insists that "customers benefit when transmission services are overseen by RTOs, independent of market participants." It explained that RTOs and FERC'S proposed standard market design would eliminate rate pancaking, improve congestion management, more accurately reflect transmission capacity, and provide for more efficient planning for transmission and generation investment. It added that the incentive for RTO formation would be available to public utilities that have already turned over the operational control of their facilities to a FERC-approved RTO but not yet received the 50-basis point incentive.

In some ways, the fight between FERC and the state PUCs over transmission pricing and ratemaking reflects a fundamental disagreement over the very nature of the transmission grid.

In short, the states see transmission as a mature sector that benefits from a hands off, or business-as-usual treatment. By contrast, FERC sees the grid as an emerging market-a fast-changing sector that carries higher-than-normal risk and that demands higher-than-normal rewards.

Rate Case Dichotomy: SoCal Ed and MISO

This dichotomy can be seen in a pair of transmission rate cases decided at FERC during the past several years. The first case, issued more than two years ago, involved Southern California Edison Co. The second case, involving the Midwest ISO (MISO), was handed down in early February, just three weeks after FERC announced its new policy on grid incentives.

In the recent MISO order, FERC upheld an earlier ruling allowing the Midwest ISO to increase its ROE from 10.5 percent to 12.88 percent, including an upward adjustment of 50 basis points to reward the ISO-participating utilities for turning over operational control of their transmission facilities. The Midwest ISO had asked for new rates based on a 13 percent ROE.

More importantly, however, the MISO case showed FERC's determination to continue to view the transmission grid as an emerging sector, in line with its thinking of two years ago. In particular, FERC rejected calls to set the ROE at a lower level based on theories the commission had long applied while setting ROE for gas pipeline companies. Two years earlier, in the case involving SoCal Edison (which had transferred control of grid assets to the California ISO), FERC had rejected the use of a "two-step" discounted cash flow (DCF) formula normally applied in rate cases for interstate gas pipelines. The commission explained that, unlike the gas pipeline industry, which was nearly through with its restructuring at the time the two-step DCF was adopted, the electric industry was "just beginning a significant new phase of its restructuring." As a result, FERC at that time rejected the 9.68 percent ROE set by an administrative law judge in an initial ruling and granted the company its requested ROE of 11.6 percent. FERC said that the proper application of the DCF for electric transmission service would allow an ROE of 11.73 percent but that a downward adjustment was appropriate to match the award with the company's request. See,

In that light, the MISO case makes it clear that the commission is now committed to rates for transmission service that are sufficiently high to encourage further investment in new facilities and also to encourage a reorganization of transmission system operation. While granting the 50-basis-point award in that case despite claims that the base ROE figure was itself too high, FERC went further and said that it would consider future cases providing a larger upward adjustment for greater levels of transmission system independence. The ruling makes clear that in the eyes of FERC, the rate increase that will naturally follow such adjustments to ROE is well worth the future benefits expected to accrue to both consumers and providers of energy services once a competitive market develops.

FERC goes on to emphasize the importance of independence of the transmission function to market development, stating that dissolving the vertically integrated utility for the sake of independent operation of the transmission system would make the power market "more efficient, fair, trustworthy, and cost-effective."

Whether all players with say over the future structure of the industry will find a common position on the issue remains to be seen.

---

---

The State of Competition: Recent PUC Actions

Three pro-choice states keep a stiff upper lip in spite of discouraging trends.

Illinois

• Lackluster growth in retail competition.
• Gen still highly concentrated.
• Relief perhaps by 2007, when rate freeze ends.

In a recent report to its state legislature on the progress of electric market restructuring, the Illinois Commerce Commission warned that competition has yet to develop either at the wholesale or the retail level.

The commission saw "lackluster growth" in retail competition in most areas of the state. As of Sept. 30, 2002, about 25,000 customers, or only about 6.5 percent of all non-residential customers, had switched to delivery services.

Regulators also found it "uncertain that the wholesale market will produce competitive prices in the foreseeable future or even by January 2007, when the existing freeze on bundled retail rates terminates" under Illinois law. At that time, conceivably, bundled rates could rise from current levels, leaving the currently outmatched alternate suppliers with a chance at gaining market share.

Generator ownership remains highly concentrated in most service areas. Thus, electric utilities were seen having little incentive to encourage diversity by facilitating entry of independent generators or by increasing transmission import capacity.

Michigan

• A doubling of customers opting for choice.
• But number (5,700) and load share (7%) still negligible.
• Growth seen in gen and grid capacity.
• And all utilities join RTOs.

According to its most recent annual report, the Michigan PSC says that competition in the state's commercial and industrial electric markets continued to expand during 2002. (Full open access for all electric customers in Michigan took effect on Jan. 1, 2002.)

The PSC notes that the number of customers now participating in the PSC-guided Retail Open Access Program has doubled over the last year to approximately 5,700 participants, with 7 percent of the statewide peak load now served by alternate suppliers.

Other highlights: (1) the licensing of 12 new alternate electric suppliers in 2002, bringing the total to 25; (2) the start-up of 2,286 MW of new in-state generation capacity; (3) participation of all of the state's investor-owned utilities in regional transmission organizations; and (4) a transmission capacity increase of 2,000 MW.

Yet the PSC warned that competition remained under the influence of national events. It cited the recent economic downturn as well as documented accounting and energy trading scandals, including one involving CMS Energy, corporate parent of Consumers Energy, as contributing to an overall "slowdown in further transition to competitive energy markets."

Pennsylvania

• Poor participation in PECO area.
• Only 7-8% of commercial accounts choose choice.
• Situation forces random assignment of suppliers.

Approximately one-half of PECO Energy's commercial customers may be randomly assigned to alternative electricity suppliers under a plan approved by the state PUC to encourage electric competition in the Philadelphia area. A similar plan will be required for residential customers and is being developed before an administrative law judge. See,

According to the PUC, the "market share threshold" plan is a requirement of PECO's 1998 restructuring settlement. Under that agreement, the company must randomly assign half of its customers to alternative electricity suppliers if less than 50 percent of its customers had selected another supplier as of Jan. 1.

As of the first of the year, other suppliers were serving approximately 7.7 percent of PECO's 152,500 commercial customers, the PUC reported. The approximately 71,800 commercial customers assigned to a new supplier will begin to receive service from that supplier May 1, with the majority of the customers receiving at least a 0.25 percent discount off PECO's price. -P.S.C.

Articles found on this page are available to Internet subscribers only. For more information about obtaining a username and password, please call our Customer Service Department at 1-800-368-5001.