Regulators Forum: Shifting Winds, Shifting Strategies


State regulators grapple with investments, supply planning, and structural issues.

Fortnightly Magazine - November 2005

Nothing changes the landscape like a hurricane.

As Gulf Coast utilities struggled to recover from the disaster of two major hurricanes striking within weeks of each other, the rest of the country was bracing for shockwaves in fuel prices. After a year of precipitous price increases, projections of even higher natural-gas prices this winter are shedding a different light on state ratemaking and resource-planning priorities.

The opposing challenges of higher gas prices and rising environmental concerns have put utility regulators in a difficult position: How can they bring rate stability while minimizing environmental impacts? At the same time, they are grappling with trends in consolidation, competition, transmission planning, and distribution service quality.

Each state brings a different view of the changing utility landscape. For insight, Fortnightly brought together regulators from several states to discuss their plans and priorities for today and the future.


Life After Katrina

Despite facing colossal challenges in the wake of Hurricane Katrina, Mississippi's utilities successfully restored power to most affected areas within three weeks—a heroic effort by any measure. In the aftermath, however, utility regulators must answer questions they've never considered before—questions about how ratepayers in one of America's poorest states will absorb rebuilding costs that will mount into the billions, and how to help utilities deal with the fact that nearly 15 percent of their electricity loads—and therefore their rate bases—were wiped out in a single blow.

Mississippi PSC Commissioner Michael Callahan took a break from storm-recovery efforts to speak with Fortnightly in late September. Though Callahan paints a bleak picture of the state's utility systems in the wake of Katrina, he also shows remarkable optimism about the possibilities that might emerge from the devastation it left behind.

Q: Tell me about Hurricane Katrina. How were utilities in Mississippi affected?

A: It was utter devastation. For all practical purposes, the whole transmission system was gone. Nobody in southeastern Mississippi had power. For many companies, disaster-response plans A, B, and C all were wiped out. They had no buildings left for staging their response.

Mississippi Power Co. was the hardest hit. They lost all their main offices. Their storm center was Plant Watson, the coal-fired power plant, but they had to evacuate it because the plant was virtually destroyed by the storm surge. It's still physically standing but the storm surge washed through there and damaged a lot of equipment.

For the first three days, the big problem was that there was no way to communicate. And the roads were clogged with evacuees from Louisiana, which made it extremely hard to get around. Then, by Saturday after the storm, we were on the verge of stopping restoration efforts because we were running out of gasoline to fuel our trucks.

That first weekend was a very frustrating and tense time. I knew we were in for rough going when I actually had to separate two of my directors whose tempers had reached the breaking point.

We had to do a lot of things that weren't part of our emergency-response plans. We had to establish telephone services to offices that didn't exist before. And I spent a lot of time finagling $2.6 million worth of gasoline from a refinery to keep our restoration effort going.

At the same time as we were running out of gasoline, we had to divert resources from other things to get the pipelines back up and pumping. In Collins, Miss., there is a pumping station that I've driven past many times. I had no idea it was a matter of national security until we got calls from the vice president and the DOE about getting it back online.

Q: What's the status of the recovery effort now?

A: To get the system back up and running, utilities had to start at the power plants and tie-ins, and essentially build back the entire system. They did all of that, even out to rural areas, in three weeks or less. That is pretty impressive. It was a team effort, with everyone working together and helping each other.

We're still working hard, though, to restore basic services to some devastated areas. We're looking at a couple of years of recovery, when you add everything up.

Q: How much will it cost Mississippi utilities in the end? And how will they pay for it?

A: We have a cost estimate now, but it's not official yet. Let's just say it's staggering-more than I ever imagined it would be.

We will have to wait and see where to go from here. We are working with Gov. [Haley] Barbour and Sen. [Thad] Cochran, as well as President Bush. Everyone has a plan, and different ideas are floating back and forth. We probably will put a special rider on customers' bills to pay the cost of storm recovery.

In addition to cleanup costs, we are using a lot more natural gas now than we were before, and we know what the price of natural gas is doing. When we lost Plant Watson, we lost our cheap power and now we're burning natural gas at $12/MMBtu.

Another problem that we haven't looked at before, and that is somewhat troubling, is what do you do when the utility is ready and able to provide service, but the loads no longer exist? Mississippi Power had 195,000 customers prior to the storm, and when they got everyone back online they were down to 164,000 customers. Now they're up to 170,000, but many big customers aren't ready to come back yet. The casinos on Mississippi's Gulf Coast, and Chevron and DuPont plants won't be back online for months. That's substantial revenue being lost daily, and ratebase is set by the kilowatt-hours you sell.

We have case law going back many years that says utilities cannot recoup lost revenues from a storm outage, and that's appropriate. But we need to maintain our infrastructure, because those customers will be back. We have to wrestle with this and figure out how to handle it. We are looking at some heavy cost numbers, heavier than anyone would ever want to see.

Q: What lessons were learned from this storm?

A: The first thing you see is that the grid really is interconnected. We've always argued in the Southeast that we'd like to stay by ourselves, in terms of our power market. But what happens 100 miles away will affect other plants and substations. When Plant Watson went down it caused a spike in the grid that shut down a SNEPA coal-fired plant in Purvis, Miss.

So we are interconnected, and we need to do a better job of ensuring in situations like this, in a Katrina-type storm or a terrorist attack, that we have the right communications systems and people in place to make the right decisions and do what needs to be done to restore the grid as quickly as possible.

Some regulatory requirements have made communication more difficult. The FERC [Federal Energy Regulatory Commission] has put firewalls in place [to prevent self-dealing and cross-subsidies]. But when you deal with a disaster of this magnitude, your first priority is to get the grid online without getting someone killed because they haven't been told the grid will be hot in five minutes. Restrictions on communication can make for dicey problems.

Q: What does the future hold for Mississippi? What improvements are needed to make the system more survivable?

A: You can't bulletproof everything. If the good Lord wants to tear something down, he's going to do it. The casinos were supposed to handle 200-mph winds, but the winds weren't that great and they still moved 100 yards inland.

But in dealing with the pipeline issues up in Collins, there are things we can do to better protect things that are vital for national security, to make sure they come online quicker. The local folks just need to know if something is in the national interest, so we can work with the federal government to protect that asset.

In the big picture, based on the growth we have in this country, we will rebuild from Katrina and Rita, and we will make the Gulf Coast better and stronger. The great thing about a storm is that when everything you have is knocked down, you can explore your options.

As we move forward, we will need power. With the high price of natural gas, we have to find alternative fuel sources to produce electricity. We are exploring clean coal and nuclear power, as well as efficiency and demand response. Our role at the PSC is to support our companies in innovating and making prudent investments in technology.

We are all in this together. With cooperation between companies and regulators, a lot of great things can happen.

New Jersey

Thinking Green

One might argue that as one of the country's wealthiest states (from a per-capita income perspective), New Jersey can afford to pursue idealistic goals, including satisfying all of its future power demand growth by using efficiency and renewable resources. But on the other hand, New Jersey residents also pay living costs that are among the highest in the country. And with its large base of industrial energy users, New Jersey cannot afford dramatic rate increases.

Despite all that, the state already is almost halfway toward the goal of serving new load via more efficiency and renewables, and auditors say the state will suffer only "negligible" economic impacts by implementing its plans, according to Jeanne Fox, president of the New Jersey Board of Public Utilities. In a conversation in late September, Fox explained the state's policy priorities.

Q: What are the big issues on the BPU's agenda right now?

A: We have the Exelon/PSEG merger petition, which obviously is huge for us. But we also have the impact of increasing natural gas prices as well as other fuels. Hurricane Katrina adds to that situation, but fuels already were rising before that. As of last spring, we already had natural gas prices rise 300 percent in the past five years.

We asked companies to hedge against price increases, and 60 percent of our supply is hedged. That's good, but prices still are going up. We are contemplating whether we will allow utilities to raise rates by more than 5 percent in December and February.

I set up a task force on fuel, focusing on what we can do to help residential customers, especially lower-income people. We have a concerted effort on conservation among the lowest-income, highest-load customers that is working very well.

Q: What are your policy priorities in the long term?

A: Clean power, renewable energy and efficiency are very big priorities for us. New Jersey is one of two leading states for renewable energy. California has been at it a lot longer and has more money to put into it, but our policies are the best. We are pushing hard.

We set a goal of having 20 percent of our energy come from renewables by 2020, and 4 percent by 2008. Any increase in energy demand will be met by energy efficiency and renewable energy. We're not quite halfway there yet, but we think we can get there. Rutgers did a study for us, and said that our RPS goals through 2020 were economically feasible, and would impact electricity costs by less than 2 percent over 20 years.

We have been stressing photovoltaics (PV). At least 2 percent of our power will come from PV in the future. Four years ago there were six PV installations in the state, and now there are 750, and we have a couple of hundred applications pending. Putting in solar will reduce peak load and that will benefit everyone.

Q: Those are aggressive goals. How will the BPU help utilities achieve them?

A: We do everything with a very transparent process, with the industry involved every step of the way. It is simple and easy to understand, although there are a lot of acronyms.

Our renewable portfolio standard (RPS) is part of our basic generation service (BGS) auction. The suppliers that bid into the BGS auction have to provide renewable energy or buy renewable energy credits (RECs), which are traded using PJM's general attribute tracking (GAT) system. Suppliers are bearing the risk as they bid into the auction process, and so far it seems to be bearable.

In addition to the RPS, we have rebates for installation of renewable energy, covering approximately 65 to 70 percent of the cost of installation. And now we are looking into energy-efficiency portfolio standards, which Pennsylvania is considering as well. We're not there yet, but it makes sense and we are working on it, talking with Pennsylvania and working in various forums to set up a renewable and energy efficiency certificate.

Our goal is to transform the marketplace so rebates for renewables won't be necessary; in 10 years the costs of manufacturing will fall enough to eliminate the need for rebates.

Q: How do you view consolidation trends now that PUHCA has been repealed?

A: The BPU probably will implement some regulations to replace parts of PUHCA that were eliminated federally. Specifically we may require structural separation between the utility and its affiliates, and limitations on diversification.

We are doing discovery now on the Exelon/PSEG merger. We are concerned that FERC didn't address the market-power issue adequately. FERC came up with a virtual divestment plan, with long-term contracts for some plants. Where I come from, long-term contracts aren't market-power mitigation. We will appeal if FERC doesn't really look at it. PSEG is one of the oldest companies in the state, serving a large share of our energy users. Both PSEG and Exelon are big, so it's important to get it right.


Crossroads and Crucible

Ohio represents a great American crossroads. It's the state where the East meets the Midwest, where Appalachia meets the Great Lakes, where coal fields meet cornfields. Likewise in the utility business, Ohio looks to the East, with American Electric Power participating in the PJM market, and to the West, with Cinergy in the Midwest Independent Transmission System Operator (MISO). And with the August 2003 Northeast blackout having begun in FirstEnergy's network, Ohio also found itself at the nexus of the reliability controversy.

From his vantage point as chairman of the state's Public Utilities Commission (PUCO), Alan Schriber talked to recently about the challenges and issues utility regulators face at the Ohio crossroads.

Q: Ohio utilities are involved in some major mergers and acquisitions. What are your thoughts and concerns about the consolidation trend, now that the Public Utility Holding Company Act of 1935 (PUHCA) has been repealed?

A: If companies can demonstrate there are net benefits to ratepayers, I am an advocate of consolidation. In addition to potential cost benefits, consolidation helps to ameliorate some concerns, with respect to transmission issues, for example.

We have a very good laboratory in which to check out whether RTOs and ISOs are working. RTOs have benefits in terms of market monitoring, security, and the exercise of state estimators. But the more RTOs become involved with generating capacity, the more confused I become with distinguishing between capacity and energy. The MISO has charted out a very interesting course with its energy-only market, whereas PJM has embarked on a capacity project. It is quite an interesting contrast, and it reinforces what I've always thought-it's not easy to define what capacity is.

There also is a lack of logic to some RTO footprints. In Ohio we've got four companies interconnecting to each other, but operating in separate ISOs. Something doesn't quite compute.

It could lead to a misallocation of resources, and higher costs than might otherwise be the case, and allocations that are inconsistent with the cause of the costs. Whether it's transmission or spreading the cost of capacity, I think some states will bear a disproportionate part of the burden that would be thrust upon them by certain projects underway to develop capacity markets.

A more logical geographic footprint, from an economics and technical point of view, would make more sense than what we are seeing now.

Q: How might a more sensible footprint be developed?

A: There are logical consortiums that can come together without it being mandatory. If it doesn't make sense for someone to participate in an RTO, they shouldn't.

Frankly, I think a lot of this can be transcended by [a] for-profit transmission organization. As long as they don't abuse their market power, to the extent they have it, I don't see any problem. It just requires oversight.

Q: What are your ratemaking and regulatory priorities on the distribution end of the business?

A: We've gotten to the end of what was intended to be our market-development period, prior to going to markets with electricity. In the absence of a fluid secondary market, we extended everything with what we called the rate-stability plan, where utilities were to continue with stable rates adjusted only for fuel cases coming in. Now that will [be] pretty significant, given the increases in fuel costs.

Everyone is always interested in rates and prices, but I think we need to re-emphasize the obligation to provide high-quality service. We need to renew that covenant, which is actually not a covenant in Ohio but a law. It needs revisiting.

Expenditures on O&M [operations and maintenance] have shrunk, and I'm not saying you can't get along with less; the technology has changed. But whatever it takes, service quality needs to get back to what it was, which historically was pre-eminent, irrespective of rates. People understand they will have to pay more occasionally because things wear out.

Q: What supply options are most promising for Ohio? I know AEP has a proposal to build an IGCC (integrated gasification combined-cycle) facility.

A: It's easy to talk about the virtues of an IGCC plant, but you can't just do it at any cost. We figure there may be an opportunity for the company to go forward, but the burden will fall upon them to demonstrate the cost-benefit analysis will pay off, and that includes clean-air standards and whatever employment revenue the state will generate.

We are going to move toward clean-coal technology, but also we have to revisit nuclear power. People say the problem is storing the spent fuel. But the only way to get something done is to move into a crisis mode. If there is enough spent fuel out there to paint an ominous picture, a solution will open up really quickly.

The biggest obstacle is not waste storage or even capital cost. It's cultural. Rightly or wrongly, nuclear power generates a lot of paranoia along with its electricity. That is something we'll have to overcome.


Meeting Tomorrow's Demand

California is America's largest power market, and it also is one of the most progressive. Meeting the state's growing power demand while remaining true to its environmental agenda, however, might prove difficult.

CPUC President Michael Peevey in September explained how the challenges of resource adequacy and reliability are affecting California's long-term policy priorities.

Q: What are the biggest challenges facing California's utility industry? What are CPUC's priorities right now?

A: The biggest challenge in California is resource adequacy-ensuring we have environmentally sound resources to meet the state's energy needs as we grow.

We have made a large commitment to energy efficiency and renewable energy. We've set a policy goal to have the state's utilities depend on renewables for 20 percent of their generation by the end of this decade. That is an ambitious goal that was made more complicated in June when Gov. Arnold Schwarzenegger set forth ambitious goals to reduce greenhouse-gas emissions to year-2000 levels by 2010, and to 1990 levels by 2020-more or less in accord with the Kyoto protocol.

These considerations go into the mix as we look at resource adequacy. Specifically, what is the role of coal in California's future? We've determined there is a role, but it must be as clean as natural gas and the only way to do that is IGCC with sequestration. We are wrestling with this now at the PUC, and our resource adequacy plan will be decided by the time we attend the NARUC annual meeting in November.

Also, California is initiative-crazy. Gov. Schwarzenegger called a special election for November, and one item the consumer and labor groups put there, Proposition 80, would disallow direct access, which we suspended temporarily during the energy crisis. Prop. 80 also would have various other limitations on what the PUC could do, binding us and limiting our ability to act. That creates a certain amount of uncertainty. Until we resolve Prop. 80 and clarify the market structure, it is difficult to predict what will happen. Independent power producers cannot finance plants without signing a 10-year contract for the off-take to utilities, and there is some doubt as to how that will work going forward.

Q: How will California meet those ambitious resource goals?

A: We have a lot of ways to meet our future energy needs. Fortunately this state is blessed with geothermal, biomass, wind, and solar energy. All will play a role.

In our energy action plan, efficiency is our number-one resource. We expect efficiency to offset half of the demand growth in the next 10 years. Demand response will be a big part of that. Then in the loading order comes renewables, and natural gas after that. We will need conventional gas-fired plants, and several are under construction in California right now.

Our utilities haven't invested in renewables directly yet, and I wish they would show as much eagerness to build renewable projects as they do to build CCGTs [combined-cycle gas turbines]. We are giving them a return-on-equity premium to invest in renewables, and over time they will see it's in their best interests to build it themselves.

Q: Where do reliability questions fit into the PUC's agenda?

A: We have a lot of T&D infrastructure that was built in the halcyon days after World War II, and that equipment is coming to the end of its useful life.

Transmission issues are a major component of the reliability question. One lesson learned from the Northeast Blackout in 2003 was that you need a strong, integrated overall system, yet in California we are going through balkanization. The Los Angeles Department of Water & Power isn't part of the California ISO, and now the Western Area Power Administration has left to join the Sacramento Municipal Utility District control area. It's not clear where this will go, and I am troubled by it. I can only decry that has happened, and say that we should be going the other way.