February 2000

Order 2000: Transco to Go -- Or No?

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2000/02)

FERC’s finalization of the RTO NOPR, as Order No. 2000 substantially along the lines of its initial proposal – open architecture, "voluntary" but "tough love" mandatory requirements and intriguing but hypothetical ratemaking incentives for new acolytes – does not necessarily resolve the business or the legal issues facing power industry players. In fact, it raises some new tactical questions as well. For privately owned transco fans, it may be remembered, indeed, as the Y2K glitch that was.

Here’s how this conundrum happened. The questions FERC faced were:

(1) How to incentivize the expedited new construction of transmission, and overcome the physical and planning constraints necessary to facilitate the knitting together of the national deregulated open access market.

(2) How to prevent the existing wires franchisees from unfairly precluding competition in their service territories, with the result that competition in generation does not reach the levels anticipated from deregulated competition.

FERC had to come up with a way to answer these questions in a power market characterized by three potentially obstructive factors: consolidating in number of players: inability of ISO reforms of Order No. 888 to penetrate certain holding company dominated geographical inaccuracy of traditional powerpools’ boundaries to reflect future merchant and trading power flows.

FERC believes that private transcos are an important part of the way in which Order 2000 will cope with these problems. Some skepticism is in order.

(1) Staff has stated that Order 2000 will result in private transcos which address the need for new transmission construction. The Order requires utilities to present plans to divest ownership and control of assets by October 15, 2000. Utilities can do this by joining an RTO or ISO thereby submitting their assets to not-for-profit governance for no return, or sell the, sale of assets to a for-profit transco which would allow their profit realization. FERC staff assumes that the only options for utilities in response to the NOPR are (1) divest ownership to an independent for-profit transco (e.g. DC-based Trans-Elect); (2) divest control to an RTO which is "independent" under FERC rules (a task to which the FERC found the Midwest’s Transmission Alliance unequal) or (3) come up with something new. It therefore assumes that option 1, which offers short terms earnings growth, will be the one most frequently selected. Its analysis, however, leaves out a few possibilities so often seen in the real world:

• Delay: While intention to join an RTO must be filed by October 15, 2000, transmission owners are not required to give up their assets to an ISO or Transco in which they have only passive ownership until December 15, 2006. Look for challenges to FERC authority and Congressional legislative "fixes" to Order 2000 in the interim. (In its go at deregulation legislation in the last session, Congress was not as enthusiastic about RTO "independence" as is Order 2000.)

• Passive Ownership: Utility non-voting, financial participation in the operations of transferred assets held by qualified RTOs is not restricted in amounts or duration by Order 2000. A passive annuity from a "managed system" RTO may be more attractive to a utility holding T&D assets than the current surrender of the system to a private transco of assets (particularly when the value of these assets in a disaggregated system may be of appreciating value.) It also may represent a better insurance policy for continued operating access to customer markets.

FERC’s private Transco optimism also ignores the fact that private transcos owned by a group of existing regional players seems remote. Order No. 2000 limits active ownership of a Transco by a class of market participants to 15%, i.e., it is designed to prevent local market dominance by utilities through RTOs. The universe of potential private buyers for new transcos therefore may be smaller than anticipated.

In sum, FERC may be overoptimistic in assuming that there will be private transco proliferation which will meet transmission construction needs.

(2) Even assuming RTO transco ownership arrangements can be established in a manner similar to that which it anticipated there is left the question of whether the resulting markets created will be optimal for new generation developers banking on their efficiency. The conflicting views emanating from the left coast between the establishment California Power Exchange (the "PX") which is pro independent non-profit ISO structures (needless to say) and the competing, private Automated Power Exchange (the "APX") possibly is instructive. The APX views the PX as nothing less than a potential monster, i.e. "a state-sponsored monopoly tak(ing) over trading (of) a commodity "with a public mandate as a "not-for-profit"". In support of its position it cites the fact that PX is a private transco in sheep’s closing: It is now seeking to bid as a joint venturer with private companies to serve in other jurisdictions, (just as the Cal ISO is now seeking to expand its scope to embrace more jurisdictions). PX cost structure is bloated, asserts APX reflective in some measure of its expansionist aspirations.

A reasonable concern is that PX-like entities, (whether, in effect, adjuncts of public or private transcos), may proliferate under the new RTO rules. If that is the case, the robustness and attractiveness for merchant plants of deregulated markets may not be as well served as FERC had hoped in its RTO order. Paradoxically, this position may be exacerbated by FERC’s perception that there is efficiency value in requiring RTOs to cover large areas (notwithstanding smothering market competition may be an unanticipated side effect.) The relationship of transcos and PX arrangements is not a subject directly addressed by Order 2000. This may have the affect of slowing private transco development.

Order 2000 will stir up the market for transmission assets and challenge power pricing arrangements. But it will not assure solution of the problems it set out to deal with cited above. Specifically, it does not immutably point the way toward a single new business strategy. At the Power Diner, it is definitely not a FERC fast food order equivalent of "transco to go."

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.