First Refusals, Least Regrets


What California can teach FERC about transmission planning.

Fortnightly Magazine - December 2010

Last month, speaking at an industry conference, the rookie regulator Cheryl LaFleur tabbed FERC’s current rulemaking on transmission planning and cost allocation as likely the most important she would see during in her term at the commission.

In that proceeding FERC proposed for the first time to mandate regional planning for grid expansions, fully transparent and open both to incumbent utility transmission owners (TOs) and private grid developers, and to ground this new planning process not only on traditional needs to assure reliability and ease congestion, but also to meet so-called “public policy” goals laid down by federal and state laws and regulations, such as energy efficiency targets or mandatory portfolio standards for renewable resources. (See, Notice of Proposed Rulemaking, Docket RM10-23, June 17, 2010, 131 FERC ¶61,253.)

But while it would place new burdens on utilities, FERC’s initiative has become known more for what it would take away—the so-called “right of first refusal,” or ROFR. This right, entrenched in FERC’s pro forma transmission tariff, gives utility TOs the option within their defined service territories to build and own new lines approved through the planning process. Seen as a corollary to the duty to serve, and to the backstop obligation that utilities take on to extend network transmission service to new load and new generating plants, the right of first refusal stands as a thorn in the side of merchant developers and independent transmission companies (ITCs), who would relish the opportunity to bid on any and all projects, regardless of design or purpose.

And so what might appear at first sight as an exercise in engineering and cost-benefit analysis has morphed into a political process of picking winners and losers. What FERC’s planning initiative really means is deciding who builds the new projects—who captures the revenue stream from what surely stands as the last fully regulated and low-risk opportunity in the electric utility sector for growing rate base.

In fact, even as the transmission service sector has remained the last fully regulated corner of the electric utility industry, the transmission construction sector has exploded. Blame this turn of events on the growth in wind energy and the rate incentives created by the FERC Order 679 and the Energy Policy Act of 2005. Especially in regions rich with renewable energy potential, developers can been seen literally falling over one another in a race to lock down key markets and rights-of-way.

One of these new developers is Pattern Transmission, a subsidiary of Pattern Energy Group LP, which in turn was formed only in June 2009 by Riverstone Holdings LLC, a private equity firm that claims approximately $17 billion under management across six investment funds.

In fact, Pattern Transmission stands as lead developer, financer and builder of the Trans Bay Cable, a 53-mile, 400 MW high-voltage DC submarine transmission line which, when tied in to PG&E’s Potrero substation and placed in commercial service, will be capable of supplying approximately 40 percent of the power needs of the city of San Francisco and the surrounding peninsula.

And FERC might well learn a thing or two from Pattern’s California connection. That’s because in June of this year, a good six weeks before FERC’s rulemaking made news, California’s independent grid system operator (CAISO) had proposed a new grid planning regime of its own, remarkably similar to FERC’s vision. Like the feds, CAISO had proposed to plan for so-called “policy” grid upgrades, designed to accommodate California’s ambitious renewable energy goal of 33 percent by 2020, as endorsed by Governor Schwarzenegger in November 2009 in Executive Order S-21-09. (See, Revised Transmission Planning Process, FERC Docket ER10-1401, filed June 4, 2010.)

CAISO insisted that FERC could approve the new California planning rule even before the federal rule was finalized. However, because CAISO had proposed to retain ROFRs for certain categories of grid upgrades, FERC decided in July that the California tariff might not be just and reasonable. Thus it suspended CAISO’s RTTP tariff until Jan. 3, 2011, to give FERC staff enough time to conduct a technical conference (held this past August) and to explore CAISO’s ideas. (See, Order Suspending Proposed Tariff, Docket ER10-1401, July 26, 2010, 132 FERC ¶61,067.)

In fact, the stakeholder discussions at the California conference identified serious concerns about the CAISO proposal—concerns that could undermine the FERC’s rulemaking, as they involve features common to both the California and federal proposals:

• Policy Builds & Cost Control: Traditional grid projects aimed at reliability or congestion come with their own built-in cost controls. But as these objective standards are lacking for public policy upgrades, worries emerged in California that policy upgrades would lead to over-building—a concern that FERC’s rulmaking seems to have overlooked.

• Ad Hoc vs. Holistic Planning: Both FERC and CAISO want to minimize ad hoc, single-project planning, which occurs when generators seek interconnection rights for a new plant, in favor of more holistic planning that looks across broad regions and timeframes. However, in California, stakeholders learned that utility TOs can bypass the holistic in favor of ad hoc, by shoe-horning what are essentially public policy projects into the large generator interconnection process (LGIP), created by FERC Order 2003. The federal initiative would seem vulnerable to this stratagem, yet FERC doesn’t propose to revisit Order 2003 in its rulemaking.

• Category Shopping for Stealth ROFRs: If one theme dominated any other at the California conference, it was this: CAISO’s proliferation of categories of grid upgrades, each with its own set of rules, and especially the public policy category, often seemed indistinguishable from one another. With different categories conveying different rights, developers feared that incumbent utility TOs could engage in category shopping to preserve de facto ROFRs, or to shut out independent developers from bidding on the right to build. While FERC’s rulemaking contains fewer categories, the policy upgrade might still invite gaming behavior.

Back in California, in written comments it offered on CAISO’s proposed grid planning tariff, Pattern questioned why, given the competitive nature of the transmission construction sector, an incumbent utility TO should see its obligation to serve as a burden that would justify a right of first refusal:

“Preferences cannot be justified,” Pattern wrote, “as the necessary corollary to an incumbent transmission owner’s obligation to build.

“The obligation to build is in reality a privilege, allowing the successful transmission owner the opportunity to collect the costs of the project … as well as a reasonable return of and on capital.”

Moreover, if a developer is successful in building a project approved in the regional plan, then that developer eventually becomes an incumbent as well, with its own obligation to build, as Pattern readily admits.

“Yet that obligation,” it adds, “does not seem to be discouraging many developers … from pursuing project development opportunities.”

A Fundamental Recasting

The CAISO proposal turns California’s grid planning process upside-down. Instead of taking specific proposals from would-be project sponsors and then addressing them one by one, the RTTP puts the ISO to work first in gathering assumptions and then forming a plan that contains various grid upgrade elements. Then, after approving projects needed for reliability, generator interconnections, and to preserve the simultaneous feasibility of long-term financial congestion rights, the ISO will open the floor for developers to bid and compete for the right to build the “economic” (congestion-easing) and policy-driven (to meet RPS laws) upgrades already defined and approved in the plan.

According to the California Municipal Utilities Association, this new format marks “a fundamental recasting” of CAISO’s grid planning process, and an “important improvement.” (Comments and Protest of CMUA, FERC Docket ER10-1401, filed June 30, 2010.)

The RTTP also should prove more efficient, as CAISO itself explained:

“It would be highly inefficient to allow parties to submit economically driven and policy driven projects in a request window prior to the ISO’s determination of a need for such projects …

“With a process that confers a first-in-time right to parties who submit proposals, project proponents would have incentives to submit numerous proposals in order to establish rights to build and own projects …

“This would result in a planning process where the ISO’s efforts are focused on evaluating individual projects on a case-by-case basis whether they are needed or not.” (Answer to Protests, FERC Docket ER10-1401, filed July 15, 2010.)

Yet problems still remain, as pointed out by the California Wind Energy Association.

For reliability upgrades, such as to relieve thermal overloads or stability violations, planners use NERC reliability standards as guideposts for least-cost solutions. Cost-benefit tests keyed to wholesale power prices also can reveal whether an economic upgrade is warranted to relieve congestion. But as CalWEA notes, “such objective tests are not directly applicable to policy-driven upgrades to integrate renewable energy supplies into a transmission grid that already meets NERC reliability criteria, particularly if the cost of the renewable energy exceeds the cost of energy produced using other fuels.”

Thus, CalWEA coined an idea it called “least regrets”—a concept that CAISO readily accepted, as a technique to guard against fears that planning for public policy projects would lead to overbuilding.

CalWEA explains:

“Least-regrets planning can be thought of as a critical tool for ‘right-sizing’ the transmission system”—to best adapt to a series of likely scenarios for accessing and integrating renewable energy resources into the CAISO grid.

“The least-regrets analysis,” added CalWEA, “is fundamentally a series of engineering sensitivity analyses to identify which common set of transmission elements are needed in most, if not all, such scenarios.” (See CalWEA comments, June 25, pp. 8-10.)

Nevertheless, this least regrets policy has proved difficult to apply in practice.

Commenting on the least-regrets policy, and on the discussions that took place at the technical conference in August, the City of San Francisco explained further why it can be so difficult to plan for grid expansions that serve “public policy” goals:

“State policies that allow for the extensive use of Renewable Energy Credits, for instance, reduce the need for power to be physically delivered to California and thus reduce the need for new transmission … while state policies that seek to encourage in-state development of renewable energy, by contrast, would tend to favor new transmission projects to access in-state renewable energy zones …

“What is troubling in the RTTP proposal, and still not resolved … is how the CAISO proposes to reconcile these policy options.

“A ‘least regrets’ policy is not a ‘no regrets’ policy, and there is a valid concern that the CAISO could get out in front of state policy makers, committing the state to potentially billions of dollars in new transmission projects to achieve policy goals … that have yet to be resolved by the state’s elected legislative, administrative and executive leadership.”

Grid planners are engineers. Can they be expected to interpret legislative intent—reading between the lines if needed? FERC, are you listening?

The Right to Build

One of the aims of FERC in crafting its rulemaking notice on grid planning involves moving away from ad hoc project review, such as occurs when generation developers seek grid interconnection under the LGIP regime in Order 2003, to embrace a more comprehensive look at the efficiency of the overall regional grid in marshalling and delivering resources to load. FERC explains:

“[A]dherence with this proposed requirement may eventually increase the proportion of transmission network investment that is constructed pursuant to proactive transmission planning processes, thereby reducing the proportion of network upgrades that would otherwise be triggered by individual generator interconnection requests which can be time consuming and inefficient.” (See NOPR, FERC Docket RM10-23, para. 68, p. 39.)

As generator interconnections generally are reserved for incumbent utility TOs, any migration from LGIP upgrades to planning upgrades should also permit greater project participation by merchant grid developers and ITCs —and shift the burden of upfront grid project financing away from generators, as is the case with interconnections under Order 2003, so that grid upgrade costs are recovered through the applicable regional cost allocation formula. For CAISO, that means the ISO-wide transmission access charge, or TAC.

In California, however, a number of stakeholders warn that the LGIP project category could end up swallowing the policy-driven project category, with dire effects for independent grid developers.

That’s because the CAISO RTTP tariff will grant what amounts to a first refusal to incumbent PTOs in the case of grid network upgrade projects associated with generator interconnection requests, allowing the incumbents to push an aggrandized and essentially policy-driven square-peg upgrade through the round hold of the LGIP regime, even if the project in the process becomes much larger than a so-called “but for” upgrade—a grid enhancement that wouldn’t be required but for the request by a generation developer for grid interconnection service.

In fact, these stakeholders, which include Pattern Transmission, Green Energy Express, 21st Century Transmission Holdings, and the so-called “six cities” (Anaheim, Azusa, Banning, Colton, Pasadena, and Riverside), charge that just such a case has arisen with regard to Southern California Edison and the transmission rate incentives it requested for some $1.4 billion in grid projects, including the combined 500-kV Lugo-Pisgah and Red Bluff substation project, costing about $950 million, and the Eldorado-Ivanpah project, costing another $430 to 480 million.

In two recent orders, FERC granted rate incentives for the projects, in part to make sure SoCalEd could meet project milestones necessary to qualify for stimulus funding under the American Recovery and Reinvestment Act. (See, Docket EL10-81, Oct. 29, 2010, 133 FERC ¶61,107; Docket EL10-1, Oct. 29, 2010, 133 FERC ¶61,108.)

The six cities complain first that such shoe-horning allows incumbent utilities to bypass comprehensive planning because CAISO has taken the position that upgrades identified as needed through the LGIP route aren’t to be reviewed through a regional planning process, because they are presumed to be constructed as part of the preliminary assumptions that pre-date planning. (See Comment of Six Cities, Docket ER-1410, Sept. 8, 2010, citing comments of CAISO, FERC Docket EL10-1, filed Aug. 24, 2010.)

The idea also arises that Edison’s strategy allows incumbent utility PTOs to win approval through the interconnection process for what are essentially policy-driven upgrades that should have been let out for bids from private developers, as noted by Pattern Transmission:

“The [then] pending SCE petition in Docket EL10-81 with respect to the Lugo-Pisgah and Red Bluff projects is an example of large network upgrades that should be considered public policy projects under any reasonable definition of that category.”

Many stakeholders, such as the Western Independent Transmission Group, warn that CAISO’s establishment of “multiple, vaguely defined transmission project categories, some with ROFRs and some without, will cause endless gamesmanship and associated litigation.” (See Comments, June 30, p. 7.)

Pattern Transmission, a member of WITG, complains it’s unclear whether, after adopting a completed plan, any policy or economic projects will remain available for bidding by independent developers, after “the three large PTOs” have characterized and claimed projects for their own as reliability driven, for generator interconnections, or for some other project category that pre-empts comprehensive planning, such as projects needed to maintain CRR feasibility, or CAISO’s special project category for generator tie-lines for location-constrained resource interconnection facilities, known as LCRIFs. (See Comments, June 30, 2010, p. 6.)

At the August conference CAISO maintained that category differences exist between policy-driven upgrades and LCRIF tie-lines. Yet many stakeholders found those differences to be far from clear, particularly, noted San Francisco, where new transmission is built out into previously unserved areas.

When he was asked if a gen-tie could later become a network facility, CAISO’s Lorenzo Kristov answered:

“All we’re talking about is timing and potential—we don’t know what’s going to happen in the future.”

Despite FERC’s announcement in its grid planning rulemaking that it intends to do away with ROFRs, Southern California Edison insists that if incumbent utility transmission owners must accept a backstop obligation to step in and build economic or policy-driven transmission projects when private developers fail to follow through on their projects, that it “reiterates its opposition to the obligation to build that is not coupled with the corresponding right of first refusal,” in spite of what FERC might say in its planning NOPR. (See, Comments, FERC Docket ER10-1401, filed Sept. 17, 2010.)

Otherwise, says Edison, it will be faced with cherry-picking and cream-skimming by independent grid developers:

“How will a PTO be financially impacted if it is forced to build only the least desirable projects that independent transmission companies do not believe are sufficiently lucrative to build?

“How will an incumbent utility PTO address the need to reserve balance sheet capacity to cover all required economic or policy-driven projects within its service territory given the risk that other transmission providers fail to complete their projects?” (See, Protest, FERC Docket EL10-76, filed July 23, 2010.)

Perhaps the ROFR dispute is less important for planning purposes, than for what it tells us about the transmission sector as a market.

And representing the Northern California Power Agency, attorneys Robert McDiarmid and Lisa Dowden ask why FERC continues to grant special financial incentives for transmission expansion, as sanctioned under Order 679 and the 2005 EPAct law, when developers and utilities can be seen fighting amongst each other to win the right to build:

“The battle over the proposed removal of the right of first refusal from ISO/RTO tariffs demonstrates that the need for some forms of transmission rate incentives to encourage transmission construction is rapidly passing.”