December 1998

NEAR BEER ON PIKE'S PEAK

by Roger Feldman  --   Bingham, Dana and Gould, P.C.
(originally published by PMA OnLine Magazine: 12/98)

By ordinary economic logic the Midwest should be an important "emerging market" for private merchant power; that would certainly be the lay non-conspiracy interpretation of the price "spike" of the past summer. The Midwest business opportunity should be the beneficiary of all of the institutional market-shaping work that has whipped the New England market into a booming state.

However, whether this will in fact be the case will be a function of the extent to which a regulatory "transition gulch" which precludes new investment development can be avoided while the new market is structured there. Far from being a replication of the New England debates, the Midwestern transmission issues are of a new second generation order, reflecting unresolved old arguments and new private project sponsor thrusts.

Key questions remain to be answered:

• Has FERC properly assessed the causes of the price spike?

• How important is the push toward introduction of retail markets?

• Are ISOs or private transcos the best way to foster necessary market transmission growth and stability?

Two key data points in accessing the situation are a recent critique of the FERC Spike report in Public Utilities Reports, and the emerging ISO/ Transco debate currently swirling over the Midwest.

The first data point relates to problem definition. Writing in the Nov. 15 issue, Judah Rose challenges the hypothesis that the Midwest price spikes were an aberration. While accepting the main hypothesis that there was no price manipulation associated with them, his bottom line is: "The region is... close to having future blackouts next summer – so close that regulators and others should make it a primary concern to remove all impediments to deregulation and take proper steps to manage generation reliability during the transition to full deregulation." Unlike New England where NEPOOL planning, designed to assure reserve margins sufficient to protect end users and enforced by clear penalties, is in place, the Midwest has looked to open market operations to achieve market equilibrium. Market reliance, of course, carries with it the potential for rolling generation shortage-caused blackouts, especially in urban areas. The basic problem in the Midwest states, Rose asserts, is that utilities are unwilling to build new plants when the pattern of deregulation is so much in a state of limbo.

The second data point relates to market response. Recently the members of the MidContinent Area Power Pool (MAPP) rejected a proposal by the reliability council to establish an independent systems operator (ISO) in the region. The stated reasons of objectors to the proposal was its lack of incentive for construction of necessary transmission. Some companies (like those in Wisconsin which are required to join an ISO by June 2000), may be pushed to join the Midwest ISO. Other ISO possibilities are still presented. But the tide seems to be moving toward mechanisms which provide market incentive for transmission provision.

The implications of the new initiative away from ISOs and toward independent transcos in the Midwest needs to be given greater attention by private power. Alliant Energy has now joined Northern States Power in a proposal for an independent transmission company, which would be spun off as a publicly traded independent company. It would offer an open access tariff. Meanwhile, American Electric Power has announced that it is joining First Energy and Virginia Power in a proposal (the "Alliance") for a regional transmission entity. It would be a competitor of any Midwest ISO. It is contemplated to have both ISO features (e.g. member inclusiveness) and also be a "transco lite."

For those more into Bud and Amstel, more information is useful as to what kind of "near" beer in a rose tinted bottle is transco lite. It does not own all the wires; it operates them all. It makes a profit on its operations. Presumably its therefore motivated to de-congest transmission (at a price). Its rates are set at auction: when the market is ready to pay for more transmission, presumably it will provide it. Anybody can join ("munis and coops too); but presumably ownership reflects transmission asset contributions. In the new Alliance proposal, the three founders own 34,500 miles of transmission lines and serve 17 million people in 9 states. Question for other would-be players: care to up the ante?

The juxtaposition of uncertainties as to the cause of the Midwest price spike and the impact of the impending Midwest Transco revolution is this: Are the developments consistent, in the short run and the long run, with fair opportunities for new regional private power developers? Spike is driven by generation (and perhaps to a lesser extent transmission) capacity shortage Lite is driven by desire for reward for transmission development (and just possibly for generation hegemony as well). In principle, in the long run, all free market initiatives should produce a consumer friendly market clearing initiative. In the near term, Lite could present a constraint to realization by generation capacity of the economic rewards it desires for its development. In the long term, in principle, open access will be available to all for all generation opportunities. In the near term (and conceivably into the future), private transcos could provide de facto market power to their ultimate owners, and deregulated utility gencos could enjoy unfair market power. The Justice Department has expressed this concern.

The essence of the matter, in my mind, is that there is ultimately only one economic rent in play –for both new generation capacity (if, as many think is the case, it is needed) and for providing transmission in a constrained transmission environment. The pattern of allocation of that economic rent will be a function of the transmission management debates. This is not necessarily the best backdrop for merchant plant development.

The issue is gaining momentum, if not clarity before the FERC, whose own views are in transition. Commissioner Massey recently announced he is joining Commissioner Hebert in favoring transcos. Chairman Hoecker still supports ISOs. Commissioner Bailey and Breathitt are undeclared.

Atop the Midwest spike’s peak then, a battle is shaping up, as the transco lite brigade sweeps toward the crest. It is no longer a matter of classic regulation vs. deregulation rhetoric debate. It is an issue which will govern how – and whether – private power can benefit through deregulation. A time to find out what "proof" transco lite really can offer.

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.