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<title>February 2003: Transmission: The Next Unintended Consequence?</title>
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<p align="left"><font face="Arial"><strong><small>About The Author:<br>
<br>
</small></strong><span lang="X-NONE" style="color: black"><font size="2">
ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon
Markets Group has practiced law related to the finance of environmental and
energy projects and companies for 40 years. In particular, he has analyzed
and executed a wide variety and substantial value of project financings. He
chairs the American Bar Association’s Committee on Carbon Trading and
Finance, serves on the Board of the American Council for Renewable Energy,
and has been a senior official in the Federal Energy Administration. He is
a graduate of Brown University, Yale Law School and Harvard Business School.</font></span></font></p>
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<img src="../images/feldman.gif" alt="Washington Viewpoint by Roger Feldman" border="0" width="375" height="75"><p><b><u><br>
February 2003</u><br>
</b></p>
<p><font size="6">Transmission: The Next Unintended Consequence</font></p>
<p><strong>by Roger Feldman -- Bingham, Dana L.L.P.<br>
</strong><font face="Arial" size="2">(<em>originally published by PMA OnLine
Magazine: 2</em>003/06/14)<br>
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<p>Federal regulation of the electric power industry in the past
quarter-century might be called "The Law of Unintended Consequences." PURPA
brought forth a little deregulation and a lot of PURPA machines at giddy,
avoided-cost prices. Deregulation spawned a trading industry that sometimes
preyed upon the flaws implicit in an overall electric system where market
power was present.</p>
<p>With SMD, we have arrived at an effort to fix what is broke in
deregulation by overturning market abuses through intense Federal
re-regulation. A FERC White Paper is in the offing. The issuance of the
"Proposed Pricing Policy for Efficient Operation and Expansion of
Transmission Grid" (P2 03-1-000) marks a much more focused effort to use
rate incentives to cause market players to join RTOs and independent
transmission companies (ITCs) within RTOs. </p>
<p>A carrot instead of the stick, Order 2000 originally represented a new
milestone event in terms of offering a Federal incentive in exchange for a
desired private action. (The last really was affording market-based rates
for new facilities whose owners had nominally ceded open access to their
grids.) It also may serve to deal with the greatest substantive deficiency
in the current power system: the insufficiency of new generation and the
unsuitability of the configuration of the national power grid to the new
patterns of energy flows contemplated by deregulation.</p>
<p>Perhaps the Pricing Policy also should be acknowledged as a telling
acknowledgment by FERC that if deregulation/SMD is now to be perceived as a
public policy that yields public benefits, it must rely on something more
than economic theory: "While significant benefits from competition are
expected to result from RTOs and ITCs, these benefits will be shared among
end-use customers and generators, among others. To assure that transmission
owners receive benefits from RTO formation, we believe that it is reasonable
to allow an adjustment to be applied to the rates of transmission owners
participating in an RTO, or in an ITC within an RTO… (as well as) certain
new transmission facilities that will be under operational control of RTOs…
(or otherwise expand) new transmission facilities that will be under
operational control of RTOs."</p>
<p>The incentives briefly may be summarized as follows:</p>
<ul>
<li>An entity that transfers operational control of transmission
facilities to an RTO receives a 50 basis point adder on its ROE;<br>
</li>
<li>ITCs that participate in RTOs (and are not otherwise market
participants) qualify for an additional ROE incentive equivalent to 150
basis points, applied to book value of facilities at the time of
divestiture;<br>
</li>
<li>Innovative new transmission facilities, found appropriate pursuant to
an RTO planning process, would receive an ROE-based incentive equal to 100
basis points. </li>
</ul>
<p>These ROE incentives are not in lieu of innovative rate mechanisms that
hold utilities harmless. (It isn’t every day that an investor can pick up
300 basis points on its ROE.) </p>
<p>The Proposed Pricing Policy represents a significant movement away from
the earlier Order No. 2000 formulation that called for a case-by-case review
and approval of each specific proposed innovative pricing proposal. To date,
transco proposals under the Order have struggled with the burden of "one
off" justification. </p>
<p>Market participants with even passive ITC ownership interests cannot
avail themselves of the right to rate incentives. </p>
<p>The Proposed Pricing Policy is a paean to the potential of ITCs, because
of their for-profit nature, to bring about improved physical asset creation
and greater market competition. Where will it lead?</p>
<p> While some analysts have expressed skepticism as to whether it will
lead to much of anywhere until the SMD and operational role of RTOs is
settled, there already has begun to be motion in the market: </p>
<ul>
<li>DTE Energy’s sale of its transmission unit to a major private equity
firm; <br>
</li>
<li>Independent Trans Elect’s successful acquisition of the transmission
systems of two utilities whose prior owners were cash strapped;<br>
</li>
<li>Creation of specialized, independent transmission links for
specialized purpose;<br>
</li>
<li>Accelerated development of pooled transmission, cf. TransLink and the
proposed new Grid America (Ameren, FirstEnergy, and Northern Indiana
Public Service Co.).</li>
</ul>
<p>It is reasonable to foresee further momentum to the trend as smaller
utilities decide that it makes more sense to buy access to transmission,
rather than to maintain their own transmission systems.</p>
<p>Larger utilities may either directly or through third party transactions
seek to grow as well. There are many positive possible consequences to the
transmission system of this development. </p>
<p>But there also is one potential unintended consequence to which FERC
might give some forethought. Transmission ownership already is more
concentrated than generation. It is likely to grow more so as the utility
merger boom proceeds, and as the ITCs expand and themselves cede management
control to a few large operating firms working with the ITCs and the RTOs,
cf. National Grid for Grid America. As it retips utility asset ownership
balances once more through its new proposals, FERC should consider whether
market power consolidation is desirable, harmless, or a potential threat
with real market power consequences.</p>
<p>The lesson of "Jurassic Park" was the inability of science to predict all
consequences – even of carefully controlled scientific experiments. Perhaps
in the power deregulation world, that was the lesson of California and
Enron. Transmission is the "next big thing" – particularly financial
transactions involving existing systems during the next few years. Perhaps
early attention to the unintended consequences of the new industry structure
being promoted would be a valuable undertaking for the Commission. </p>
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<span lang="X-NONE" style="color: black">ROGER FELDMAN, Co-Chair of Andrews
Kurth LLP Climate Change and Carbon Markets Group has practiced law related
to the finance of environmental and energy projects and companies for 40
years. In particular, he has analyzed and executed a wide variety and
substantial value of project financings. He chairs the American Bar
Association’s Committee on Carbon Trading and Finance, serves on the Board
of the American Council for Renewable Energy, and has been a senior official
in the Federal Energy Administration. He is a graduate of Brown University,
Yale Law School and Harvard Business School.</span></font></p>
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