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A Regulatory Scandal?

John Hanger's picture
Acting Secretary Pennsylvania Department of Environmental Protection

John Hanger is the Acting Secretary of the Pennsylvania Department of Environmental Protection. As Acting Secretary, Mr. Hanger manages an agency of more than 3,000 employees with a mission to...

  • Member since 2003
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  • Sep 19, 2003
Cries that the nation’s transmission system has become "antiquated" or even a "Third World Grid" quickly filled the airwaves after the August 14th blackout. Others screamed that "deregulation" had caused massive under-investment in the grid or had strained the grid by supposedly increasing its use or complexity.

If these charges are true, the nation is looking at a calamitous situation, a regulatory scandal, not a market failure.

There is no market, choice or competition for transmission and distribution of electricity. Dissatisfied customers cannot switch to an alternative transmission company. The transmission grid and electric distribution systems remain legally sanctioned monopolies in every part of the country. This critical infrastructure is also owned by entities controlled by federal and local governments, by non-profit rural electric cooperatives, or by investor-owned electric utilities that are regulated by state and federal boards which largely utilize traditional cost-of-service regulation.

Since there is no choice or competition for transmission and distribution service, public or non-profit owners as well as federal and state regulators replace market forces and regulate the grid to assure reliability and reasonable pricing.

So if critics of the nation’s grid are even close to correct that the grid has fallen into a state of disrepair, questions must be asked.

First, why did the federal and municipal owners of the grid allow under-investment in their portion of it? Presumably they weren’t chasing higher investment returns in generation.

Second, why have the non-profit cooperatives failed to invest in their portions of the grid?

Third, why have federal and state utility regulators with the power and responsibility to ensure reliable grid operations by investor-owned utilities not done so? Have they denied recovery of transmission investments, allowed utilities to siphon off dollars needed for transmission into non-monopoly business adventures, or failed to require needed reliability investments and to compensate appropriately utilities?

But here in Harrisburg, Pennsylvania, in the heart of the PJM grid and power pool, we can say that those questions need not be asked, because critics are wrong about the health of the grid in the Mid-Atlantic.

From the perspective of the certainly world-class PJM, the picture painted by some of a creaking grid like that of Lagos, Nigeria which can’t even power traffic lights looks nutty. Similarly, assertions that the grid suffers from under-investment or is too strained to deliver generation to load, no matter the financial transactions associated with the physical operation of the grid, are false in PJM. Generation flows to load no matter how many or few financial transactions commercial entities complete.

Over the last six years, companies doing business within the PJM power pool have made at least $760 million of transmission investment. Competitive companies which have built more than 6,400 megawatts of new generation and connected it to the grid have made about 60 percent of that transmission investment. Owners of the transmission assets have made the remaining 40 percent of the investment.

PJM has long been an integrated, reliable system

For decades, PJM has been a tightly networked power pool and has provided the model of evolution into an ISO (Independent System Operator), RTO (Regional Transmission Organization), or other acronym. Long before the word “restructuring” was invented, PJM and its member utilities made significant transmission investments to enable the dispatch of least-cost generation available to the system. They planned and built several 500 kV and 345 kV transmission lines, mostly to bring power from the western portion of PJM to the east, which now forms the backbone of the PJM system. The costs of these upgrades were part of Federal Energy Regulatory Commission (FERC) regulated transmission rates and are still passed on to ratepayers. Today, the aggregate annual cost of PJM transmission in rates is approximately $1.1 billion, depending on peak demand.

PJM transmission reliability upgrades

PJM believes that most of the transmission investments needed to protect reliability have already been made, again about $760 million in the last six years for new lines and poles, line upgrades to higher voltage, capacitor banks, transformer and substation upgrades, and phase angle regulators.

These upgrades enable more electricity to flow over the power lines from areas where there is a surplus to areas where there is a deficiency. There is no reason to challenge PJM’s conclusion: PJM has proven that it operates reliably and has the authority to order transmission upgrades to meet the reliability of the transmission system.

To determine when transmission reliability improvements are needed, PJM began the first of many subsequent five-year transmission expansion plans when it began as Independent System Operator. Importantly, the Pennsylvania Public Utility Commission during its electricity restructuring proceedings had “strongly recommended” that this transmission planning process be part of PJM procedures in a restructured market.

Based on accepted criteria, PJM plans various transmission upgrades such as the ones that have been occurring on the Delmarva Peninsula over the past couple of years. These plans are updated on an annual basis with input from the various transmission owners and other PJM stakeholders.

Economic transmission investment

At this point a lot of new transmission investment in PJM is for economic reasons, to improve the efficiency of the system. Although transmission has not been deregulated, the competitive generation market has improved the reliability of PJM.

PJM experienced a massive investment in new generation —about 6,465 MW — from January 1999, when restructuring began, through the end of 2002. When a generator wants to build in PJM, the generator, not the transmission owner or utility, is usually required to upgrade the surrounding transmission facilities. For example, in order to be classified as a capacity resource, new generation owners must upgrade the transmission system as needed to enable the new generation to be deliverable to the system during peak hours. These transmission upgrades conservatively total hundreds of millions of dollars, and are estimated to comprise as much as 60 percent of all incremental investments in the transmission system since 1999.

In the old days, these investments would have been made by the public utility, with the cost and a return on the investment passed on to all consumers through regulated rates. Now, the new generation owner must bear these costs and the risk of obtaining compensation through generation sales. In other regions of the country without a strong central network like PJM, more generation tends to be “islanded” and is not deliverable to load when it’s most needed.

In PJM and some other regions operating under restructured Independent System Operators, Locational Marginal Pricing provides a strong incentive to build generation in those parts of the system with the highest cost (the eastern part of PJM), which reduces the need to flow as much power from the west to the east and reduces congestion. Thus, besides generator investment in new transmission facilities, new generation closer to load actually reduces the need for new transmission facilities.

Transmission remains fully regulated

All transmission remains fully regulated by FERC, although states, mostly through public utility commissions, have substantial influence, especially when it comes to siting new facilities. Public utilities still have a legal obligation to provide reasonable transmission service. FERC, and to some extent public utility commissions, also have the ability to order improvements but such orders are not common. In PJM, the system itself identifies and makes most needed improvements. Moreover, the politics of regulation rarely support aggressive intervention to mandate new transmission investment.

Transmission owners, mostly the former monopoly utilities, remain responsible for keeping their portion of the transmission system reliable. Each year, regulated customers pay more than $1.1 billion to utilities for transmission infrastructure and ongoing maintenance, with rates currently paid to utilities based on the costs of the system in 1996.

Is there a disincentive to invest?

Since the blackout, some have argued that the incentive for transmission investment must be increased above normal returns. Regulation currently provides returns of between 9 percent and 12 percent on transmission investment. Indeed, returns on transmission in the last couple of years have been much greater and safer than returns on generation investment.

Regulatory commissions have the job of setting transmission rates. They must consider many factors, including of course the cost of capital, operating expenses, transmission volumes that typically have increased, and new transmission revenues from Fixed Transmission Rights (FTR), a PJM system that since 1998 has compensated utilities and their customers for prior investment in transmission. This year, the value of FTRs was $345 million. If all factors are weighed properly and appropriate rates set, no disincentive to invest in transmission will exist.

Who decides what

PJM works closely with transmission owners to plan system improvements. Although PJM can and does order transmission owners to build upgrades, siting approval remains a state decision and rate recovery remains a FERC decision.

The need for siting approval often provides an opportunity to cancel proposed transmission improvements, mostly because states or their citizens don’t want new transmission built in their backyard. This problem can be worse when the transmission improvement would increase reliability or efficiency to the benefit of others more distant.

Yet changes to siting law must be approached cautiously. Protections against the state taking of property or development that will reduce the property value of other owners serve important economic and environmental functions. Alternatives to new transmission capacity may also exist.

Rules and incentives

PJM has most of the rules in place to maintain a reliable electric system. That’s not true in many parts of the country which don’t have modern planning, control and communication networks like PJM. Yet, with competitive markets, it often is the infrastructure of incentives that makes reliance on mandates less important.

Up to this point, PJM hasn’t had the authority to substitute a better or less expensive generation or demand-response solution for a transmission upgrade solution. But there are currently proposals in PJM committees to encourage more economic solutions instead of regulated transmission improvements. For example, building a small generator at a substation or increasing demand responsiveness or improved energy efficiency can be much lower-cost solutions than building new transmission facilities, and less likely to run into NIMBY problems. So far, such alternatives have not been able to compete fairly with the regulated transmission upgrade.

PJM is currently considering an auction mechanism that would allow all solutions to be evaluated and the lowest overall system cost solution to be accepted.

PJM has also established the infrastructure to support economic transmission projects that reduce generation costs but can also contribute to reliability or avoid the need for reliability improvements. PJM has outlined specific revenue rights for these projects, such as Generation Interconnection Rights, Financial Transmission Rights, and Transmission Withdrawal Rights.

Projects worth tens of millions of dollars of potential investment have been proposed. Various alternating current (AC) and direct current (DC) projects are in the development and/or implementation phases:

  • Three projects at Sayreville 230 kV for 790 MW of capability (DC)
  • Linden 230 kV for 300 MW and 230 kV for 1,000 MW (DC)
  • Hope Creak 500 kV – Cedar Creek 230 kV (AC)
  • Kenney Transformer 230/138 kV (AC)
  • Cheswold Transformer 138/69 kV (AC)
  • Sewaren 230 kV for 790 MW Capability (DC)

The economic backstop
Long before August 14, PJM began developing an “economic backstop” mechanism in the event that merchant solutions aren’t built and the regulatory mandate doesn’t work. On August 25, PJM filed more detailed rules with FERC to require transmission owners to construct economic upgrades. Specifically, PJM added a new section to the Operating Agreement describing each step in the economic planning process, stating the types of data that will be made available to market participants through PJM's website, describing the analyses that PJM will undertake as it evaluates congestion on the system, and performing cost-benefit evaluations of alternative transmission solutions to unhedgeable congestion.

The PJM proposal is a good start in allowing the market to respond while at the same time reasonably expanding the transmission system. Limited portions of the PJM system have been harmed by Locational Marginal Pricing, and this solution provides a cap to the amount of congestion that a group of customers must accept. Yet the approach looks first to market-based solutions and gives that market every opportunity to resolve the problem.

This PJM proposal, however, can be improved in at least two ways: by forecasting areas of future congestion and by providing a level playing field for resolving congestion with non-transmission solutions.

There is no regulatory scandal in this region. Both the rules and incentives in PJM have successfully developed a reliable transmission system that simply doesn’t need massive new investment or structural changes. Restructuring in PJM has been a key part of the success, and other states, regions and the federal government would do well to replicate much of the PJM model.

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Ravinder Singh's picture
Ravinder Singh on Sep 18, 2003
Dear Friends, You are right- there is no problem with the grid. Let me add. grids are always overdesigned. Transmission lines can carry many times more load than average- TL are designed to deliver electricty at under 1% loss per 100km.

South England blackout exposed human factor behind the blackout. SE was served by 4 HT lines. Two were down for service at peak time. Third gave warning signal and the operator swithed it off. The fourth had undersize fuse and tripped. You cannot find such a massive blackout of Human Intelligence.

Deregulation reduced accountability, electricity is being delivered through multiple agencies, trading on short term basis made the system vulnerable to human failure. Insead of innovate projects to save $1000 b in 10 years, you have handed over power system to traders and speculators. Instead of engineers, clerks run the business of electric supply. --Ravinder Singh

Len Gould's picture
Len Gould on Sep 23, 2003
A strong counter-argument to the "market bashing" commonly seen elsewhere. I agree that "market forces" are required for most societal functions to operate efficiently, but haveing seen (willing to notice) too many failings of unrestrained markets, I tend to prefer systems with a healthy dose of "help thy neighbor" / "long range plan based decision making" / "moral ethics" / "philosophy according to Christ / Mohamed / Budda / Confucious / {add yours here}" also thrown into the mix. Your discussion of how market forces couldn't have been responsible for the blackout fails to acknowledge things like e.g. when Ontario Hydro went private (or was preparing to) enormous numbers of experienced engineers were declared redundant, many very senior who may never find another job, and many more who took buyouts because they were very good and had no fear of learning to fit into another industry, obviously leaving (some) others less confident behind. My observation of other industries indicate that in times of cutback, it id very rare for the decisionmakers to consider those affected as other than "warm bodies".
John Sheppard's picture
John Sheppard on Sep 25, 2003
When engineers ran utility systems, reliability was not a problem. When the MBA's and the economists calculated all the massive profits that could be made by opening the markets, reliability suffered. Under economic theory, the market will find a solution to congestion. Unfortunately, in real life, the other influences can not be ignored, like line routing, environmental considerations, right-of-way procurement, and political influences. In theory, resources don't necessarily have to be geographically located near loads. In engineering theory, they must be located near enough for practical purposes.

Why don't we simply assume a transmission super highway, similar to the internet, and get on with the open markets. Market forces will find a solution, even if it's in the dark. Ha! Ha!

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