Will tomorrow's transmission be privately funded, with the first-class seats reserved for investors?
The six o'clock news has locked its radar on California's power market meltdown, and rightly so. But that's no reason to overlook the nation's heartland, where a utility coming late to the game has set the pot boiling.
I'm thinking about Entergy, which hasn't really been on the cutting edge since the mid-1980s. That's when, under its former name of Middle South, it rocked regulators in Arkansas, Louisiana, and Mississippi with its cost allocation scheme for the Grand Gulf nuclear plant. Energy's multi-state plan threatened to place the local power infrastructure under federal control. That fight offered a stage to crusading politicians, including the young Bill Clinton. He worked to protect the state's rate-setting authority against encroachment from the Federal Energy Regulatory Commission. He should have been governor of California.
Now, Entergy is in the limelight again, and not just for its planned merger with Florida's FPL Group. Faster than FERC Chairman Curt Hébert can say, "Incent and they will come," Entergy has proposed an ambitious plan to award huge premiums to grid investors. It has included the incentives in the rate design it proposes for its stand-alone, for-profit transmission company, or "transco," filed with the FERC as part of a hybrid regional transmission organization with the Southwest Power Pool.
The case is complicated. Some want to know why requests for transmission line-loading relief are rising in Entergy's region. Should today's service quality form the benchmark for Entergy's proposed scheme for performance-based transmission rates? Others have used the case to attack Entergy's source/sink disclosure rule. The FERC approved it a year ago, but it's still on appeal in federal court (). They say the rule has reduced liquidity in power markets in the region. Yet Entergy's proposal may reveal where transmission is heading.
Among other ideas, Entergy proposes that certain transmission expansion projects should be funded privately by individual investors, such as power producers. They would then keep all, or nearly all, of the rights and benefits. Think of how they reserve the box seats for members of the Opera Guild, and you start to get the picture.
"PAY RANSOM TO TERRORISTS?" asks attorney Robert McDiarmid, representing municipal utilities in Mississippi and Louisiana, who oppose Entergy's grid gambit. McDiarmid argues that Entergy has built a dominant position in the generation sector, even as it has let its transmission network go to seed. That has required a crash program of wires expansion, he says, that Entergy will fund through its high rates.
"As a result of this failure to construct," says McDiarmid, "the Entergy area of Mississippi, Louisiana, Arkansas, and Texas may be thought of as one huge load pocket." That poses problems for state-sponsored retail choice, he adds.
"Two of the states in question, Arkansas and Texas, have already passed restructuring legislation. ... By contrast, there is frequently zero import capability into Energy. ... As a practical matter, the failure of Entergy to build new transmission has led to a situation in which restructuring is bound to fail."
McDiarmid also rails against Entergy's proposed 16 percent return on equity for regional expansion projects-a 13 percent rate, plus a 3 percent incentive bonus.
"[T]his filing proposes a 13 percent return on equity," adds McDiarmid, plus an "entirely unsubstantiated additional 3 percent, or 16 percent return on equity when the transco ... has to wake up and actually do something to justify its existence. ... The motto seems to be, 'Bribe Me.'"
Many others dislike Entergy's proposed 16 percent ROE. They question other parts of the rate design-many more features than can be described here. Such features include the performance-based rate adjustments for service interruptions and voltage fluctuations. The proposal also calls for a three-year initial period of carte blanche cost recovery (the so-called "exact recovery mechanism"). Entergy says its needs the ERM because it lacks a track record for transco operations, making it difficult to construct a baseline to guide regulators in reviewing expenses.
But for me, the most interesting aspect of Entergy's rate plan is the notion of privately financed transmission expansion. Entergy's tariff calls them "participant-funded investments." And the investors would retain benefits, subject to a 5 percent commission paid to Entergy. That's better than getting naming rights for a new sports stadium. In his testimony filed at the FERC, consultant Michael Schnitzer explained the concept behind privately funded grid expansions.
"THE BASIC CONCEPT IS THAT PARTIES WHO VOLUNTARILY CHOOSE TO FUND GRID EXPANSIONS RECEIVE, IN RETURN, ALL THE LONG-TERM RIGHTS." According to Entergy and Schnitzer, the scheme is necessary because of the way some grid expansions may devalue certain congestion management hedges, or generation at certain specific locations.
"Participant-funded expansion, where possible, is more likely to produce the 'right' level of transmission investment," says Schnitzer. "With respect to generation, FERC policies in most instances favor having these key judgments made by market participants, risking their own capital."
Schnitzer explains how Entergy would take back a 5 percent cut as compensation, which it could distribute to other grid users:
"Entergy will be proposing an incentive on participant-funded expansions. This will take the form of a share of the value of the rights created by the expansion, or, where appropriate, a development fee. The 'shared value' incentive will provide [the Entergy transco] with up to 5 percent of the transmission rights created by the expansion. [The] transco will not hold these transmission rights, but will auction them off."
As I see it, with generation a merchant business, the power producers certainly will demand control over all elements of production. That includes transmission capacity, which can dictate locational power prices and market values for generating plants.
In fact, when the economists first toyed with locational marginal pricing for generation, I'm sure they never dreamed they were sewing the seeds for a privatized transmission grid, but that result now appears inevitable.
"There is nothing inherently wrong or bad," adds Schnitzer, "about this interaction between transmission expansion and generation value-it is a fact. But it does mean that ... investors in competitive generation—existing and new—have a legitimate interest in transmission expansion policy."
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