Rule Would Encourage Transmission Investment & Membership in Transcos & Transmission Organizations

In a November 18 notice of rulemaking FERC proposes to implement the incentives mandated in the Domenici-Barton Energy Policy Act of 2005 (EPAct 2005) for investing in electric transmission infrastructure that benefit consumers by increasing grid reliability and reducing the transmission costs caused by congestion.   The rulemaking posits that Transcos "” stand-alone companies that sell transmission services at wholesale or otherwise unbundled from retail electricity sales "” are the preferred vehicle through which transmission investments are made and, accordingly proposes additional financial incentives for forming, participating in, and funding Transcos.  Incentives are also proposed in the rulemaking that would encourage transmission owners to participate in transmission organizations that would operate their systems.  To be considered by the agency, public comments on the rulemaking must be submitted electronically or in hard copy by January 11, 2006.

The transmission provisions of EPAct 2005 and the proposed rulemaking respond to a recent and untenable history characterized by declining investment in transmission infrastructure, on the one hand, and burgeoning demand for electricity service, on the other.  According to industry sources, in order to assure system reliability and support competitive wholesale markets, the current $4 billion level of annual transmission investment in the US must increase to $5 billion annually.  In particular, the rulemaking implements Congress' directives in new Federal Power Act (FPA) § 219 that FERC (1) establish incentive-based (including performance-based) rate treatments to induce investment in new and upgraded transmission systems that improve reliability and reduce congestion, and (2) provide to each transmission owner incentives to surrender operational control of its system to some form of independent operator.

Central to achieving both directives are proposals to allow returns on transmission investments that are at the top end of a zone of reasonableness, recognizing that nothing in EPAct 2005 removes or diminishes the long-standing FPA requirement that all transmission rates be just and reasonable.  This could be achieved not only by authorizing high returns on invested equity but also through the flexible use of hypothetical capital structures in setting returns.  Shortening the depreciable life of transmission investments to 15 years could also be use to accelerate the recapture of investment.  In addition to creamier returns and more rapid depreciation, the rulemaking also addresses investment risks peculiar to electric transmission infrastructure and the tax consequences of spinning off transmission to a Transco.

Aspects of the proposed rulemaking would recognize that long lead times attend designing and constructing new transmission before the new facilities become operational and begin earning revenues, and that unforeseeable things can go wrong in the meantime.  To address long lead times, the rulemaking would (1) allow l00 % of funds spent on transmission construction work in progress (CWIP) into a transmission owner's rate base, and (2) permit the investor to expedite recovery of costs incurred before commercial operations begin by expensing rather than capitalizing those costs.   FERC solicits public advice on what pre-commercial operations costs should be eligible for expensing. 

In the event that occurrences beyond an investor's control cause a transmission investment to be abandoned, the rulemaking would allow complete recovery of those costs.  In the past, the costs of an abandoned project typically have been split between the investor and transmission customers, but under the rulemaking could be recovered 100 cents on the dollar from customers.  FERC points to the recent example in which Southern California Edison was allowed to recover all prudently incurred costs to build transmission to interconnect a proposed wind farm.  FERC reasoned in that case that the wind farm developer's decision to cancel its project would be beyond Edison's control and justified complete recovery of pre-termination investments in transmission.  The rulemaking also addresses the investment deterrent confronting public utilities operating under retail freezes or moratoria.  These utilities would be unable to recover current transmission investments.  To lessen this burden, FERC proposes a deferred cost recovery program under which such a utility would begin recovery of new transmission facility costs in transmission rates as soon as the freeze or moratorium expired.

On top of these inducements, the rulemaking singles out Transcos for even further favors.  The distinguishing characteristic of a Transco is that the entirety of its business is providing transmission services (not coupled or commingled with generation) for which FERC alone sets the price.   In this respect, a Transco stands to benefit from the incentives of the rulemaking more so than an integrated public utility that sells a service of bundled power and transmission that is priced, at least in part, by state regulators.  Moreover, FERC finds in Transcos the preferred vehicle for transmission investments because it would not confront the tradeoffs that a traditional integrated utility confronts when its investment in transmission may well reduce the value of its other investments in generating plant.  Higher equity returns may accordingly be justified for Transcos because they have a history of reinvesting those returns more completely in needed new transmission infrastructure.

The rulemaking proposes also to remove a barrier to Transco formation.  As much of the nation's existing transmission infrastructure that could be spun off to form a Transco has been depreciated to a book value far below its market value, the seller would incur accumulated deferred income taxes (ADIT) on its sizable capital gain.  Under this scenario, the seller can be expected to adjust upward the price it charges for its transmission system to cover these taxes.  FERC proposes in the rulemaking to continue its recent practice of allowing a Transco to recover in its transmission rates the increased purchase price that it pays to cover ADIT.

While clearly less enthusiastic about transmission organizations "” ones with transmission systems still owned and controlled in part by traditional integrated utilities "” than it is about a Transco, the rulemaking proposes to ensure that utilities that join such organizations fully recover the cost of their participation.  The rulemaking also implies and one Commissioner flatly suggested that the returns that transmission organizations earn on transmission investment should be directly proportional to how independent they are from the owners of the transmission systems that they operate.

Lastly, the rulemaking turns itself to the often controversial topic of performance-based pricing of transmission service.  FERC asks for public advice on how performance should be measured and rewarded.  Two noteworthy topics are raised.  FERC first asks whether the participation of public power entities in transmission-investment consortia should be rewarded for the low-cost debt financing they can provide through interest-free bond issues.  Second, FERC asks whether it should ask applicants for performance-enhanced rates for a statement of the innovative transmission technologies that they propose to implement.   [Promoting Transmission Investment Through Pricing Reform, 113 FERC ¶ 61,182 (2005)]