November 1998

MERCHANT CHAMPION

by Roger Feldman  --   Bingham, Dana and Gould, P.C.
(originally published by PMA OnLine Magazine: 11/98)

The feasibility of merchant plant development and the attractiveness of redeveloping existing utility sites which have been acquired are impacted significantly by the rules governing transmission access and responsibility for the cost of transmission upgrade. The rules will be set in different governance environments, e.g. ISO vs. transco. Different sets of rules may be established by different governing mechanisms. In such variety may lie confusion and investment impedance. There needs to be what the reinvention of government folks call a "champion" of regulatory coherence.

New England, characterized by a tight powerpool, significant asset divestiture, and a constrained market likely to be characterized by substitution of efficient new capacity for old capacity – has been a leading test case of how well deregulation will work. The significance of FERC’s recent decisions in the Champion International case (EL 98-69-000) and its accompanying Order with respect to the New England Powerpool ("NEPOOL") (ER 98-3853-000) thus is not only its major contribution to the rationalization of that market, but also its precedential character for transactional developments under other forms of system governance in other regions. In effect the process of developing a "case law" under Order 888 for transmission access management is begun.

It’s absolutely necessary. New England rules, for example, were effectively bottlenecking real new merchant plant applications behind ones which existed only on paper. NEPOOL was, in effect, tipping the balance in favor of companies acquiring existing generation and against developers of new capacity that needed access. Not surprising, given the new T&D emphasis of its traditional utility members. Other regions will have analogous competitive problems, reflected in the specific rules which their powerpools adopt. Following are some extrapolations of the new FERC decisions as they may relate to future project development throughout the country.

- The System Impact Study ("SIS") procedures were predicated on NEPOOL’s "full integration requirement"; a new generator’s request for capacity was to be considered to have an "adverse impact" on the NEPOOL system in any instance where an existing generator had a consequent reduced ability of any amount to serve load anywhere on the NEPOOL Grid for any amount of time. Another key assumption in the SIS was that all existing generators on the NEPOOL system would never be displaced, and that while existing generation could be redispatched in lieu of adding system capacity, this was not permitted to be the case for existing generation. FERC struck down as unrealistic the notion that prospective new generation would only serve new load. It removed requirements to interconnection related to local service, when all that was intended and required for particular new generators was access to Pool Transmission Facilities ("PTFs").

This NEPOOL principle that each planned generator must be guaranteed an exclusive and unconstrained firm transmission path to reach every load serving entity in the system similarly was rejected, and its consequence – system oversizing – was highlighted by FERC. So too was the NEPOOL’s correlative notion that interconnection studies might be completed, but no interconnection could be implemented physically, until a new congestion management system was put in place.

Under FERC’s new formulation, analysis is limited to examination of reliability, stability and operating conditions. There will be no delays in implementation. While the specific queuing procedure of NEPOOL was not addressed by FERC at this time, the operative pressures of the former NEPOOL program are reduced significantly by the FERC approach.

Consequently, as a general matter, it may be expected that in the future ISO or Transco rules which can be shown to not correspond to operational realities, or to have been structured to constrain timely new entrants, will be subject to rigorous and skeptical FERC examination.

Pending receipt of the NEPOOL Congestion Management System, FERC has shied away from the decision whether merchant generators should pay rolled in or incremental costs for necessary additional transmission. Two observations by FERC are, however, encouraging in this regard. First, that new generators should have the option of paying redispatch costs in lieu of expansion costs, consistent with the FERC pro forma tariff. Second, that it is important that the NEPOOL rules’ siting incentives mesh with the incentives to be provided by the congestion management plan, i.e. the expansion cost pricing and congestion pricing proposals need to be considered together. Several other important aspects to the FERC Order are also supportive of merchant project development.

As a general matter, therefore, it may be expected that when FERC reviews pricing rules in the future it will be in a manner to take into account their ramifications for future competitive generation.

While the FERC Opinion is notable for its pragmatism, it is notable too for the extent to which it leaves flexible discretionary administrative powers in the entities which emerge to govern different regions. Transmission pricing approaches, for example, apparently may assume different forms depending on different approaches taken by these bodies, to congestion pricing. Congestion pricing likely will reflect the characteristics of the regional transmission system. The significance of transmission costs consequently likely will vary among regions. In effect, even were open access pricing to be mandated Federally, there would still be issues as to the pricing of merchant generation sold in different parts of the country.

Since merchant generation ultimately is the key to competition, it seems reasonable to suggest that FERC should not treat transmission with such unlimited flexibility. Hold the loving sighs over Champion. The well deserved welcome which private power has extended to FERC’s recent decision should not be construed to mean that the agency has become the champion of merchant power in all respects, and indeed that unwittingly it could deter its progress.

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.