In thinking about transmission pricing for a competitive electric industry, we should remember that the fundamental objective of competition is to increase economic efficiency. Improved economic efficiency, after all, leads to better use of resources, lower costs, and long-term benefits for consumers. Competition in the sale of capacity and energy is just a means of fostering efficiency by driving prices to marginal costs.
But getting the right price for power at the generator is not enough. We also need reformed transmission prices that provide economically efficient prices for delivered capacity and energy. That in turn requires transmission prices based on marginal or incremental costs.1
As Alfred Kahn says in his classic text: "The central policy prescription of microeconomics is the equation of price and marginal cost."2 The fact that transmission service remains a natural monopoly neither requires nor justifies a departure from this fundamental principle. Furthermore, building a brave new world of competition that deliberately combines capacity and energy prices based on marginal costs, with transmission prices based on embedded costs, would be incongruous as well as inefficient.
Not Contract Paths
Efficient transmission prices based on incremental costs are possible. But first they require a new understanding about what must be priced.