Connecting The Dots In Transmission

If we want a robust and reliable grid, then we have to think about how to manage and operate transmission. This question has been a core component of restructuring debates over the past four years, and disagreement over the organization of transmission operations continues to be extreme. But transmission is crucial to the development of robust, healthy wholesale markets.

The organization of transmission operations is very complicated and not particularly transparent. Currently most transmission is owned by regulated public utilities, though federal agencies and other entities own a large chuck of transmission, especially in the West. In the northeastern United States and in California, the transmission is managed by an independent transmission provider (RTO or ISO), in the rest of the United States the local monopoly utility company manages most transmission.

Most transmission service is regulated by FERC, a federal government agency (but, paradoxically, FERC does not regulate transmission owned by other federal agencies). A great deal of transmission was built by local monopoly utility companies to serve ratepayers in their “home” service territory, under terms approved by state utility commissions.

Most reliability rules, governing a great deal of the terms of transmission operation and the costs involved, are established by NERC and implemented in conjunction with 12 regional reliability councils. In regions with RTOs/ISOs, that organization usually acts as reliability coordinator. The reliability coordinators oversee control area operators. The control area operators are the “front line” system operators with the job of keeping the interconnected grid up and running.

The Midwest region is much more complicated than most of the country, and the explanation takes all of a half-page sidebar on page 14 of the blackout report. In the Northeast, the ISOs typically cover one or two control areas; the Midwest ISO “provides reliability coordination for 35 control areas in the ECAR, MAIN and MAPP regions and 2 others in the SPP region.” PJM now oversees 9 control areas, but most of these are in the Midwest region, too.

This complex organizational structure to control reliability arose out of the 1965 blackout, which occurred at a time when wholesale power transactions were few, and not much trade crossed control area lines. Now, with power flows crossing between reliability coordinators and through multiple control areas, things have changed. Any lack of clarity or transparency – about who is responsible for system status, about information flow among control areas, or about funding of reliability investment – becomes problematic as trade increases and the quest for efficiency shines light on these worn out, opaque institutions.

Investment in transmission has been lagging for years, and the regulatory response has been to offer more incentives and more assurances that cost recovery is available. Just yesterday at FERC’s open meeting, that Commission issued a policy statement on reliability that again assured transmission owners that prudent reliability costs could be passed along in transmission rates. It is more of the same regulatory approach, and maybe this time it will work….

A recent paper by Paul Kleindorfer, a professor at the University of Pennsylvania, offers a different vision for promoting investment in the grid: treat transmission service as a commercial, for-profit business. He argues that “the complexity and interdependence of the power grid … [makes it] difficult for distributed owners to come to grips with who should pay for reliability.” Kleindorfer points out that existing transmission ownership and operation do not have the transparency and clarity of rules and rights that are crucial to commercial ventures and provide proper incentives and a stable institutional framework for trade.

His discussion focuses on four commercial principles that he argues would make transmission a forward-looking venture that would attract investment in, among other things, reliability. First, transmission entities (let’s call them RTOs for brevity) have to face performance standards and be accountable for their achievements and failures. This is the role that capital markets and shareholders play in for-profit companies. Second, RTOs should focus on customers. Third, operations and planning in RTOs must integrate the engineering of the system with its economics. Finally, the RTO governance structure must be responsive and decisive.

FERC’s current “ideal” organizational structure for transmission, in which transmission assets from several companies are combined and turned over to a independent organization to manage, just doesn’t connect the economic dots well enough to inspire the commercial creativity necessary to motivate capital markets to pony up.

In a presentation hosted by the Progress & Freedom Foundation, Kleindorfer observed that the underlying structural issues may not just be vague, but even actively harmful: incumbent transmission owners may face economic incentives contrary to overall system quality and performance. A paper on the economics of networks by Jacques Cremer, Patrick Rey, and Jean Tirole makes the essential point: the benefits of network quality improvements may go disproportionately to the creative upstarts in the industry, but the quality of the network is largely determined by the investment decisions of larger, established firms. If you are the established firm, how much do you want to pay in order to throw the door open wide to your new competitors? (See Journal of Industrial Economics, December 2000) An excellent paper by Amitai Aviram, “Regulation by Networks,” hidden away in the BYU Law Review (2004), examines the Cremer-Rey-Tirole paper and a number of broader issues.

The current regulatory/administrative approach to transmission planning and operations has, along with a substantial dose of regulatory uncertainty, given us the current mess in the transmission business. The solution may be to treat the transmission business, as more of a business.

One thought on “Connecting The Dots In Transmission

  1. New Investments in Generation, Demand Response, and Transmission

    Competing participants in existing and new investments face a myriad of incentives (disincentives), overlapping jurisdictions, and changing paradigms. New tensions exist between the emerging reliability-based model and the competition-based model with respect to the incentives for investment in facilities (generation and transmission) and demand-response. Demand response reduces the need for new facilities but faces strong resistance, particularly from those with major investments in existing facilities. Proposed market reforms (CAISO’s MDO2) offer refinements to locational marginal pricing (LMP), which are superior to prior muted (averaged) market pricing but are still lacking. Investment impacts of LMP seem limited given emerging investment constraints and the diminished investment response from competition.
    In the current setting, competition appears to provide less generation and transmission investment than expected. Generation reserve margins are forecasted to be tighter and use of transmission loading relief (TLR) is expected to increase. The siting of new facilities is strongly opposed in most areas (NYMBY), while jurisdictional authority has become more complex among investors, owners, regulators. The need for reliability suggests regional consolidation of facilities, which raises competitiveness questions, particularly the no harm to competition standard. At the same time, reliability places a high value on the quality of power service but comes at a large cost. Because of large differences among consumers’ willingness to pay for reliability and the lack of demand response programs, demand-based pricing of reliability has been used very little. In this environment, federal and state regulators are expected to open investigations into deficiencies in facility investment.
    It appears that existing and new market participants have to developed strategic responses to new investment. Rational owners of existing investments oppose new entrants and have develop at least a loose strategic coalition to respond in like kind to administrators and regulators. New entrants seem to overreact in stating that the existing market structure bars new investment. Thus, market administrators and regulators should not expect to hear candid views, the real story, from either side about ways to increase competition or reliability. Rather, each investment group (e.g. existing transmission and generation owners) is likely to oppose other investment groups that have different technology to increase competition and reliability. This is textbook response in organizational theory (J. Tirole 1988) and competition (M. Porter 1985). Regulation’s response to reliability needs can severely undercut competition. While competition, with its deficiencies to date (Woychik and Carlsson 2004), seems inadequate to provide reliability. In this light, what kind of analytic framework will best provide informed decisions that reconcile opposing participant investors in competition and reliability?

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