THE PRICING TURMOIL THAT STRUCK MIDWEST POWER markets during the week of June 22, with allegations of price gouging and calls for a wholesale price cap imposed by the Federal Energy Regulatory Commission (see Docket EL98-53), made for good copy but has obscured what's really going on.

"In the pleadings to FERC, I saw no evidence of price gouging," says attorney Jeffrey Watkiss, who represents power marketers who have asked the Commission for wholesale market reform.

"To the contrary, short-term prices seemed to behave as one would expect in a competitive market for a scarce commodity that cannot economically be stored. It spiked briefly and then returned to stable levels."

Markets go up and down, but the real story concerns the transmission network and the rules that govern both access to the lines and relief from line-loading congestion. These questions resound especially in the Midwest, where individual utilities operate the control areas, and where utilities are locked in a battle between supporters of two competing proposals for grid management.

Some utilities are looking beyond the traditional independent system operator, to other structures, such as transcos, gridcos and independent transmission companies. These terms all refer to the idea of an investor-backed, for-profit company that would both own and operate the transmission grid. Transco supporters insist that ISOs serve only as a transitional half-measure on the road to the end game.

Thomas M. Lenard, senior fellow and director of regulatory studies at The Progress and Freedom Foundation, observes: "The transco model is attractive precisely because it permits the owner of transmission assets to be the system operator. Users never transmit power across the network. You don't define transmission at all. You simply sell power at some nodes and buy at others."

And with gas-powered turbines offering cheap onsite power, the grid seems poised to go competitive. Lenard adds, "Gas-turbine generation technology makes the natural gas pipeline network a potential competitor of the electricity grid. In the language of economists, the grid is becoming 'contestable.'"

Off the Beaten Path

On June 5, three weeks before prices exploded, the North American Electric Reliability Council asked the FERC to certify that its transmission loading relief procedures comply with the FERC's pro forma transmission tariffs. In particular, the TLR rules permit the curtailment of transmission service to relieve the impact of parallel (loop) flows on grid systems that are not located directly on the contract path of the curtailed transaction. The FERC took the matter under consideration, but in its routine notice announcing the NERC filing, it advised that utilities could apply the TLR rules within the Eastern Interconnection pending a final decision, in light of the "serious reliability problems that could result if the ... TLR procedures were discontinued during the current summer period" (Docket No. EL98-52).

Soon afterward, Detroit Edison intervened, protesting both NERC's TLR proposal and the Commission's interim approval. It attacked the "off-path" rule as premature under NERC's own procedures and injurious to Michigan electric systems: "The Michigan systems and others are affected by significant parallel flows around Lake Erie that can result from transactions nominally taking place hundreds of miles away. Virtually any transaction engaged by a system around Lake Erie can have flow impacts. Detroit Edison may be particular vulnerable."

Detroit Edison explains that many firm purchased power contracts no longer identify specific resources, thus making it impossible to anticipate particular contract paths or loop flow effects.

Attorney Sara Schotland, representing the Electricity Consumers Resource Council, explained the significance of the TLR dispute in a memo issued to ELCON members on June 26: "NERC's TLR procedures -- prematurely blessed by FERC in an order [the notice] issued June 12 -- have seriously affected several member companies and imposed curtailment ... triggering in-fighting among the IOUs."

As of July 14 several other parties had intervened in the off-path case, including Constellation Power Source Inc. (a power marketing affiliate of Baltimore Gas & Electric) and the Transmission Access Policy Study Group. Wisconsin Electric Power Co. weighed in on the side of NERC. PECO Energy supported Detroit Edison, explaining that under NERC's off-path TLR proposal, "the grid actually may be less reliable, because the TLR policy transforms a local transmission reliability problem into a regional generation resource adequacy problem -- not due to insufficient resources, but the inability to deliver them."

A Smoke Screen?

Even as the FERC considers NERC's "off-path" proposal for transmission service curtailment, it is studying the relative merits of nonprofit ISOs vs. for-profit transcos (Docket PL98-5). The debate has become particularly important in the Midwest, site of pricing turmoil, as evidenced by the competing proposals of supporters of the Midwest and Alliance ISOs.

John Procario, vice president of electric system operation at Cinergy and chairman of the Midwest ISO management committee, touts a single grid operator for much of the region. "We believe only one ISO should operate in the combined MAIN and ECAR regions." However, his comments reveal a desire to permit individual transmission-owning utilities to maintain a degree of control: "Merging control areas in this region for economic dispatch and generation balancing purposes is unnecessary and will add tens of millions of costs."

Procario adds, "We are concerned that the ISO vs. transco debate is a smoke screen. The development of a transco of sufficient size and governance structure, which would provide similar benefits to an ISO, would be complicated and require substantial time."

The Alliance ISO would operate as a transco. FirstEnergy, an Alliance booster that figured prominently in the recent pricing blowout when it lost three transmission lines, sees the Midwest ISO as a step backward: "To a large extent, the ISO represents a compromise to the commission's goals in that it does not require the ISO to divest transmission facilities."

Kathryn Patton, regulatory counsel at Dynegy, sees the California ISO as the "price police." She wants utilities to break all financial ties to the grid.

What does the FERC think? At a regional conference on May 29, Commissioner Massey noted: "Just two years ago there was very little hint that utilities would actually be willing to spin off their transmission assets. If there was that hint, we didn't pick up on it. We thought its was actually fairly bold to be encouraging formation of an ISO that allows utilities to retain ownership of their transmission assets."

Unfortunately, however, the FERC probably lacks legal authority to force investor-owned electric utilities to form transcos, as Massey suggested: "There is no hostility that I can detect at all toward the concept of [a transco]. As a matter of fact, there are economists that believe that should be the ultimate end game. For the FERC, I think there's a real question about whether we could somehow make that happen, though."

Nevertheless, many foresee more trouble ahead unless the industry can evolve from ISO to transco. Certainly Wall Street thinks so, as indicated by Caren Byrd, a principal with Morgan Stanley Dean Witter: "Once the FERC gave the signal that it could be responsive to the concept, we could start moving in that direction. And the time frame to create transcos would be relatively short."

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