Comments in Response to FERC Rulemaking on Regional Transmission Organizations

On May 13, 1999 the Federal Energy Regulatory Commission (FERC) issued a Notice of Proposed Rulemaking (NOPR) on Regional Transmission Organizations (RTO). The purpose of the NOPR is to seek comments on proposed regulatory rules that would encourage transmission system owners to participate in regional transmission organizations. Such organizations would manage various aspects of the operation and expansion of the nation's high voltage electric transmission system to support developing competitive wholesale and retail electric generation service markets that rely on these transmission networks. Regional integration of transmission systems is thought to be required to manage more effectively transmission network operations, to internalize various network externalities, and to facilitate the development of competitive electricity markets. Four non-profit Independent System Operators (ISOs) have already been created from the three existing tight power pools covering the Northeastern states and in California. However, the development of similar RTOs in other parts of the country has been slow. The FERC initiative aims at speeding up the development of such regional organizations. My comments focus primarily on the future structure of the regulatory framework that governs how transmission owners and operators will be compensated for providing transmission service. I also present a framework for evaluating the benefits and costs of not-for-profit ISOs that operate transmission facilities owned and maintained by others vs. for-profit Independent Transmission Companies (Transcos) that own, maintain, and operate their own transmission facilities. The success of the ongoing restructuring of the nation's electricity sector and its reliance on decentralized competitive generation service markets depends heavily on the existence of a robust transmission network that operates efficiently. Indeed, the new decentralized industry structure with a large number of economic agents pursuing their own self interests requires a more robust transmission network and enhanced operating capabilities than was the case during the era of vertically integrated regulated monopolies. Recent historical evidence suggests, however, that resources devoted to maintaining, operating, and expanding the nation's transmission networks are declining rather than increasing in relative terms. Continuing to rely on FERC's historical transmission regulatory framework is not likely to foster the kind of robust transmission networks that are required to support efficient competitive electricity markets. Traditional transmission regulatory procedures pay too much attention to the direct costs of transmission (capital and operating costs) and too little attention to the indirect costs of transmission (congestion, ancillary services, and local market power mitigation costs). It is very important for the FERC to adopt new regulatory mechanisms that provide transmission owners and operators with powerful economic incentives to operate transmission networks efficiently and to invest the resources necessary to expand their capabilities efficiently. These incentives should be an integral component of a performance-based regulatory (PBR) framework for the regulation of transmission rates that rewards transmission owners for achieving these objectives and penalizes them for failing to do so. There is a growing debate over whether RTOs should be non-profit ISOs or for-profit Transcos or some combination of the two organizational forms. This debate raises important issues, though the signal to noise ratio that has characterized this debate has not been very high. There are potentially significant costs resulting from the separation of ownership and maintenance decisions from transmission operating decisions, as is the case with ISOs. On the other hand, there are potential benefits associated with independence of the transmission operator from generation and marketing activities and the internalization of significant regional loop flow and related network externalities within a single organization. There are significant incentive issues that must be addressed both for non-profit ISOs and for-profit Transco monopolies. Viewed properly, it is not so much a choice between a not-for-profit ISO and a for-profit Transco, as it is a choice about the distribution of responsibilities between them.