What can we learn from its failure?

That the end of Alliance Company's RTO dreams came swiftly is clear. Whether the denial of regional transmission organization (RTO) status to Alliance means anything outside the Midwest is anything but.

Lurking in the shadows of the Federal Energy Regulatory Commission's (FERC) decision to crown the Midwest Independent Transmission System Operator (MISO) as the RTO for the Midwest is PJM Interconnection. About a month after FERC's decision, PJM and MISO announced plans to form a single energy market. And just prior to that, PJM submitted its application to be the Independent System Administrator for SeTrans, a proposed Southeast RTO.

Strangely enough, Alliance's loss may just turn out to be PJM's gain.

A Reversal of Fortune

When Alliance received its fifth conditional RTO approval in two years from FERC last July, its future looked rosy. It stood poised to be the first for-profit transmission company (transco) with outside investment that would be approved by FERC. Then FERC Chairman Curt Hébert stepped down in August, and was succeeded by Chairman Pat Wood III.

Wood began pushing the idea of four RTOs for the nation. Alliance, whose control area wanders in a curve from Arkansas north to Michigan, then south through Ohio and into Virginia (), hardly fit into the geographic mold that FERC seemed to be favoring. But it wasn't until November, when Wood openly questioned the proper role of a transco in RTOs at a FERC meeting, that Alliance began to suspect its RTO bid was in serious jeopardy, according to Elizabeth Moler, senior vice-president, government affairs and policy at Exelon Corp., who represents Alliance. The company was concerned enough to file papers with FERC, responding to Wood's comments.

It was to no avail. On Dec. 19, the commission rejected Alliance's application for RTO status, ruling that the company lacked sufficient geographic scope to exist as an RTO, and directing Alliance to explore how it could operate as a transco under the umbrella of MISO.

Mixed Market Signals

While Alliance is, according to Moler, "very disappointed," others in the industry think FERC sent the right signal. Reem J. Fahey, director, market policy, Edison Mission Marketing & Trading, says that from the perspective of competitive markets, FERC's decision is a great outcome. With the decision, FERC had a clearer vision than it had expressed before, she says. "Maybe FERC shouldn't have approved Alliance in the first place-it was a lot of wasted resources." Fahey says it is important that FERC has a clear policy and clear direction on RTO formation. "What's critical is to send proper price signals for short and long-term investment. MISO is on the right track to achieve that."

Moler, on the other hand, wonders how the industry will get capital investment in transmission if the RTO isn't a for-profit business model.

Is FERC's sudden reversal on Alliance a bad signal to send to the capital markets? According to Phil Harris, the president and CEO of PJM Interconnection, the answer is no. In addition to the known political risk, Alliance, he says, had many externalities to deal with-Sept. 11, Enron's collapse, and the California market. Those externalities, he says, made it clear to the commission that the issue was markets, not structure. "Alliance was all about structure," he says. What FERC says in the Alliance/MISO decisions, according to Harris, is that there can be independent transmission companies, but not as an RTO. There is plenty of room for large transcos, in Harris' view. As a result of the FERC decision, he says, Alliance's business model will be matured.

Perhaps, as Chairman Wood himself put it, "the hidden big story" of Dec. 19 was not the Alliance/MISO decisions, but rather the approval of International Transmission Co. as an independent transco. At the meeting, Wood remarked that "an independent transmission company . . . is not only possible but very welcome. . . . I think we gave in these orders some very strong guidance that you can move forward into a for-profit model in the context of a broad regional umbrella organization, such as MISO, and set up markets that work and set up a transmission business plan that will try [to attract] capital."

According to Peter Esposito, senior vice-president and regulatory counsel at Dynegy, the issue of investment for transmission goes well beyond the Alliance order. Because there's a lot of uncertainty about where FERC is going, he says, there need to be incentives in capital markets. "If we have uncertainty over revenue stream, then there's hesitation to invest," he says, so that an increased rate of return is necessary to compensate for that uncertainty. It's good that FERC wants to get to establishing RTOs quickly, Esposito says. He doesn't see resolve wavering in either the industry or FERC to accomplish the opening of the transmission market.

Fahey says, "[w]hat's critical is to send proper price signals for short- and long-term investment. MISO is on the right track to achieve that."

James P. Torgerson, president and CEO of MISO, says that MISO didn't do much to persuade FERC to make it the Midwest RTO. "The agency got input from the state [commissions] in November, which basically said they wanted one RTO, and that they liked the stakeholder involvement" that MISO has.

Perhaps FERC also was persuaded by merger plans between MISO and Southwest Power Pool (SPP), which would give MISO a range stretching from Michigan to Louisiana. Torgerson says "the merger with SPP is going to happen."

Both those in favor of Alliance's RTO application, and those who were opposed to it, point to Chairman Wood as the primary reason for FERC's reversal in policy. As Fahey points out, the decision "was primarily predicated on change of chairman. Wood tries to work with state commissions." Moler says that while Hébert was clearly a transco advocate, there's not evidence yet that Wood is one.

Many cautioned against extrapolating the MISO/Alliance decision outside the Midwest. Esposito says, "I wouldn't take the Alliance decision beyond face value. It's a unique situation, with the Midwest split in two, and state commissions arguing strongly for one RTO." Indeed, he says that FERC saw a vehicle in MISO that could achieve FERC's goals.

The survival of MISO at all, let alone its crowning as Midwest RTO, represents a fairly stunning change of circumstance. In January 2001, MISO's future was so cloudy, Torgerson issued an open letter that began, "[r]umors to the contrary, as Mark Twain told the Associated Press, reports of [the MISO's] demise have been greatly exaggerated." Torgerson concedes that last May, MISO had to get cash from somewhere. "We were running out of cash, no doubt about it," he says. Because three companies wanted to leave MISO, the organization had no access to capital markets until those issues were resolved, he says.

Ironically, it was the settlement of that case, in which MISO took $60 million from Alliance in exchange for letting Commonwealth Edison, Ameren, and Illinois Power join Alliance, that may have saved MISO from bankruptcy.

PJM Everywhere?

Now, Alliance must try to work out an agreement with either MISO, SeTrans, or PJM to operate as a transco under an RTO umbrella. If PJM achieves two of its goals, though, Alliance will be dealing with PJM regardless of which RTO it technically operates under.

On Jan. 8, PJM filed its bid to become the administrator of markets, systems, and regional planning for the proposed SeTrans RTO. Two weeks later, PJM and MISO announced that they had executed a letter of intent to develop a single wholesale market for electricity producers and consumers in all, or parts of, 27 Midwest and mid-Atlantic states.

The letter of intent is laden with principles for a single energy market, but has scant specifics. The idea behind the letter of intent, according to MISO's Torgerson, is to have a single marketplace for transmission and for day-ahead energy markets. PJM's Harris says that MISO needs to develop an efficient, common market. That market needs to have the same pricing protocol throughout, with one common interface for traders, he says. Currently, MISO has neither day-ahead nor spot markets.

If the PJM/MISO proposal is approved by FERC, Harris says he hopes to accomplish the single energy market by developing three plans. First, PJM and MISO will ask their customers what projects should have the top priority toward developing the single energy market. Next, PJM and MISO will look at their information technology (IT) plan, to jointly assess the state of their respective technology, and to migrate together to new and upgraded technology, so that there will be no inconsistency or incompatibility between the two. Third, the two organizations plan to do integrative planning together, a cost effective solution, Harris says. Under this integrated planning structure, MISO might perform one task for both RTOs, or vice-versa.

The notion of a PJM/MISO single energy market doesn't necessarily please everyone. Esposito says that the prospect of implementing exactly the market rules PJM has in Midwest troubles him. He says that there are kinks to locational marginal pricing (LMP)-in his view, LMP is set up so that congestion becomes a problem for the shipper to work out-but that PJM is working out the kinks. "LMP plus," PJM's new pricing proposal, might work, in Esposito's view.

In addition, Chairman Wood has announced that he plans to meet with PJM and MISO officials regarding their letter of intent. No specific date has been set, but Wood has said he expects to discuss the proposed market and RTO issues generally.

Right now, Esposito says, there are no incentives in transmission markets to relieve congestion. For example, he says that Dynegy had a deal with an unnamed utility that would have earned the utility $40,000 in one day. As part of the deal, the utility would have had to drop their transmission rate, say from $3 to $1.50. Esposito says the utility turned down the deal. The main reason, he says, was a common problem utilities have-a mechanism in state ratemaking regulation that takes any excess collected above approved transmission rates from another part of the utility's balance sheet. So there's no discounting going on, Esposito says, which is a huge difference between gas and power. Because there's no profit incentive, there are hundreds or thousands of these types of transactions every day that don't happen, he says.

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