MIT professor Paul Joskow asks the FERC how its rulemaking will help consumers.
By Aug. 23, the electric industry had filed over 150 separate comments - nearly 4,000 pages - telling the Federal Energy Regulatory Commission what it thinks about regional transmission organizations.
All other stories pale in comparison. The commission's proposed rulemaking on RTOs would reinvent the electric transmission business. The case gives economists a once-in-a-lifetime opportunity to instruct a government agency how to design and build a market from the ground up. For utilities (and state regulators, too) it's life or death. The transmission business marks the only thing left that utilities can still call their own. And even if the wires stay regulated, the FERC will capture most of that turf from the state public utility commissions, which hardly knew what to do with it anyway.
WHO'S FILING COMMENTS? WHO'S SAYING WHAT? If you take a moment to look, you'll see the usual suspects (ELCON, EPRI, NERC and NARUC), but also some new faces, such as the New York, New England, Midwest and PJM independent system operators, and even the Arizona Independent Scheduling Administrator. At least half the state PUCs offered opinions, with nine PUCs from the Midwest joining on one comment. Throw in some local color (the cities of Anaheim, Calif.;Tallahassee, Fla.; and Cleveland each filed - don't ask me why) plus some earnest individuals (Eric Hirst, Mark Lively, Hyde Merrill), and you've got a fairly wide swath of opinion. Enron and Con Ed were strangely silent, but NYMEX and The Fertilizer Institute each weighed in. Go figure.
If you're like me, and don't fancy the notion of reading everything, you'll want to graze the comments for the best ideas. In that case, you could do worse than to download and read the comments filed by professors William Hogan (Harvard University), Paul Joskow (MIT), and Charles H. Koch Jr. (College of William & Mary), each representing himself and no other client. Each professor lays out his own compelling theory of what must be done, presenting his ideas with the care and precision of a peer-reviewed journal author. In fact, the piece submitted by Koch will soon appear in Florida State Law Review.
For Hogan, everything rests on efficiency of dispatch. He dismisses the transco-ISO debate as a distraction, and tries to avoid using either term: "With deference to Alfred Kahn, who popularized the practice when referring to a term of art that has become politicized, let us call the entity that provides these [grid] services a 'banana,' and explore what must be done."
If nothing else, Hogan insists that the banana must coordinate generation prices with market interference caused by transmission constraints, in the way that the PJM region combines the power exchange and the ISO in one agency, with locational marginal pricing to allocate congestion rights. Do that, says Hogan, and everything falls into place, including the mystical debate between the transco and ISO models. He sees FERC's role as imposing the efficiency that's lacking when property rights are ambiguous.
By contrast, Koch thinks like the lawyer he is: Is the grid really a monopoly? If so, how should the FERC respond? Efficiency takes a back seat to control of market power under a legal analysis. Choose the model - ISO or transco - by how well it deflects anticompetitive conduct and how easy it is to regulate. In fact, Koch acknowledges that while transcos may appear more market-friendly, the efforts involved in controlling them eventually may spur more bureaucracy.
"The transco model," says Koch, "can honestly be seen as furthering a strong national commitment to private ownership and control. ¼ Still, whereas the transco will be privately owned and operated, it will require an active role for government regulation and disappoint pure deregulation."
But I think I was most taken with Joskow's fresh approach. He asks a question I haven't heard much, if at all: Do RTOs help make consumers better off?
"Transmission regulatory reform," says Joskow, "should not be viewed primarily as a 'carrot' ¼ to entice reluctant utilities to form and participate in RTOs."
IN THE MIDWEST ISO, UTILITIES ARE FIGHTING with the FERC over the allowed return on equity. That fight provides a good example of what's at stake in the RTO docket and why Joskow thinks consumers are being overlooked.
A settlement a few months back between MISO and the FERC staff OK'd an ROE floor of 10.5 percent, with room to grow to 11.5 percent, but the MISO members say the higher figure still won't save them from revenue losses when the MISO tariff eliminates rate pancacking, and when they lose the higher returns earning on transmission assets through bundled retail rates approved by state PUCs.
In a brief filed Aug. 2 (Docket No. ER98-1438), the MISO utilities said Cinergy would lose $8 million a year (a one-third drop in transmission revenues) on joining the ISO. They offered testimony by José Delgado (vice president for electric system operations at Wisconsin Electric Power), showing how, under state PUC regulation of bundled retail rates, ROE averaged 12.7 percent for MISO members. He argued that 100 basis points (up to 11.5 percent) would boost transmission rates by only 4 cents per kilowatt-month, a mere fraction of the 74 cents saved by avoiding a pancacked charge from even the lowest-priced tariff for any MISO member, and thus certainly not burdensome on consumers.
Consultant Charles Olson (H. Zinder & Associates) argued further that if the FERC should insist on its discounted cash flow ROE method, with the two-stage procedure for factoring in short- and long-term dividend growth, without using a risk-premium method as a counterbalance, then at least the commission should select interstate gas pipelines as proxy companies for the MISO utilities. After all, the utilities would function much like transmission-only pipelines after ISO formation. Olson's method would yield a DCF-derived ROE of between 11.87 percent and 15.37 percent.
(Note: It was the staff's strict selection of electric utility proxy companies, and its refusal to consider using a risk-premium method, that led to the now-famous ruling of March 31 by administrative law judge Michel Levant (Docket ER97-2355) that rejected a proposed 11.7 percent rate and set a 9.68-percent ROE for transmission assets for Southern California Edison, and which is eliciting protests from Edison Electric Institute and others that if the FERC insists on low returns for transmission, its RTO efforts are doomed to failure.)
JOSKOW OFFERS A DIFFERENT TAKE ON ROE. He notes that transmission revenue represents only about 4.5 mills per kilowatt-hour (about a half a cent), or about 6 percent of the average customer's bill. And ROE on transmission investment (net of taxes) is less than 1 mill.
"Regulators," Joskow notes, "will not be doing consumers any favor at all if the small price reduction they receive in the short run as a result of cutting a couple of points off the expected rate of return ¼ destroys the transmission owner's incentives to invest."
But even if the FERC should cave and offer higher ROEs, as the industry wants, Joskow still warns against putting too much faith in ROE incentives as a way of enticing grid expansion:
"Indeed, proceeding under the assumption that, at the present time, 'the market' will provide needed transmission network enhancements is the road to ruin.
"There is abundant evidence that market forces are drawing tens of thousands of megawatts of new generating capacity into the system [but] there is not evidence that market forces are drawing ¼ entrepreneurial investments in new transmission capacity."
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