Do-nothing regulators scare off investment, raising prospects for yet another large-scale power failure.
Fortnightly Magazine - March 2004


Do-nothing regulators scare off investment, raising prospects for yet another large-scale power failure.

Last summer's blackout is slowly fading from the radar screen. The silver lining that might have moved some to action has now tarnished.

In the first days after Aug. 14, the Department of Energy, the Federal Energy Regulatory Commission (FERC), state regulators, and industry executives all seemed to be heeding President Bush's warnings that the power outages "across the Northeast and Midwest are a 'wake-up call' to the antiquated state of the nation's electrical grid." Under the white-hot glare of the media spotlight, they all promised they would do something.

But eight months later, industry analysts see very little investment in new technology or infrastructure. Are we heading toward yet another disaster?

In fact, many of those I spoke with on the condition of anonymity at Infocast's 2004 Transmission Summit in late January echoed the alarming concern that a large-scale blackout could very well occur this year.

This will come as no surprise to those who have been watching policy development on electric transmission over the last few years. Utilities and potential investors have long said that regulatory uncertainty over regional transmission organizations and reliability policy continues to hinder investment. "Why invest in an asset that we may not own or control?" utility execs ask. "Where is the regulatory clarity?"

Some utilities have just shot themselves in the foot. With their forays into the merchant sector, they have diminished their own financial capacity to spend on infrastructure upgrades. And the sidelining of comprehensive energy legislation that would have aided infrastructure development has just made things worse.

Disagreement continues over how to attract investment in transmission, whether for reasons of reliability or economics. How much should investors be compensated? Who should pay for the cost of the investment? Who should own the grid? Who should manage it?

Any hope that a wave of independent transmission companies would be formed last year was dashed when state regulators opposed FERC's rate incentives for transmission divestiture, concerned that they would increase retail rates and cause a loss in jurisdiction. FERC Chairman Pat Wood was quick to point out that a lack of independence in the transmission sector was inhibiting investment, but many private equity groups at the conference said they stood ready to invest in transmission infrastructure if the rules were clarified.

Certainly, there are very good reasons why transmission policy, and as a consequence, investment, is at a standstill. But if 50 million Americans were to lose their power again, would they be sympathetic to an industry that was recently described by one Infocast panelist as "an aging overstressed muddled beast mired in a swamp of indecision, conflict, and meetings?"

A Return to Central Planning?

Some say regulators may have no choice but to return to the old Soviet-style ordering and planning of transmission. That's where everything seems to be headed, given the current rhetoric from state officials. Furthermore, certain market experts believe some planning is necessary, even if they believe that central planning is not the answer.

At a conference on grid infrastructure held late last year by FERC, Jacob Williams, vice president for generation development at Peabody Energy, said "First of all, we need to look at transmission in a different light. I've heard for the last five years-and I came out of the electric industry-that transmission and generation are interchangeable. That's not true."

Williams believes transmission should be viewed as the ultimate hedge, the longest of "long" positions in the market for electric futures:

"It's an insurance policy against weather patterns, fuel price spikes, market abuse, [and] regulatory and environmental changes," he says.

"I remember when the nuclear units in the Upper Midwest were down back in '96 and '97. What limited transmission we had was the only saving grace we had to serving load. No one would have planned it that way, but a little excess transmission came in real helpful. Otherwise, the lights were out in Wisconsin."

Of course, even Williams admits that power can always be had for the right price:

"There will be no alternative for many parts of the country. They'll just have to run the gas units and pay for the costs. That will hurt both industry, and it will hurt the low-income families."

The answer, as Williams sees it, lies in a re-dedication to system planning:

"I'm not talking about the full-blown integrated resource plans. … But there is some planning of the system that needs to be done because we can't wait until LLPs identify problems and then take seven to 10 years to solve them. We have to see those problems ahead of time and deal with those problems right now."

But planning might lead the industry back down the slippery slope to full-scale, 1970s-style ratebase regulation.

Harvard professor William Hogan is one who warns of such an outcome, especially if regulators cannot decide how to draw a bright line between (A) "merchant" transmission (new lines designed only to link new gen plants to market that are paid for by investors) and (B) "regulated" transmission (lines that remain essential to the overall working of the grid system, and that are added to ratebase.)

In short, Dr. Hogan fears that regulators will take the easy way out and stick it to ratepayers:

"There will be enormous and justifiable pressure on the regulator," he says, "to put generation and demand alternatives on the same playing field of reduced risk and mandatory collection through regulatory mechanisms."

Then it's back to square one:

"The intended modest domain of regulated transmission would expand to include full-blown integrated resource planning. A poor design for transmission investment is a threat to the entire enterprise [standard market design]. The end state could be recreation of the central regulatory decision problems that motivated electric restructuring in the first place."

But Dr. Hogan offers a solution-a possible dividing line between merchant and regulated investment. He says regulated transmission investment would be limited to those cases where the investment is inherently large relative to the size of the relevant market, and inherently lumpy in the sense that the only reasonable implementation would be as a single project, like a tunnel under a river.

"Everything else would be left to the market," he says. "This would be a principled hybrid system."

Also missing from the dialogue is how new technologies that increase reliability on the grid will be introduced and paid for, even as industry experts debate how transmission is going to get upgraded or built. For example, technologies already exist that could allow utilities to more ably control power flows and improve system monitoring, and materials are in development that could increase transfer capability. One state regulator at the conference confessed he really hasn't quizzed utilities during rate cases on their technology spend, but he says he will in the future.

Let's hope the industry spends the money before Mother Nature throws her next pop quiz.


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