Knowledge Problem

Transmission, Congestion Charges, and the Smart/Modern/Intelligent Grid

Lynne Kiesling

Mike beat me to it in commenting on David Cay Johnston’s NYT article from Wednesday about grid congestion. My thoughts are somewhat different from Mike’s, for what it’s worth.

Johnston hits on one of the most pressing problems in electricity restructuring, although I’m going to frame it differently from how he does: technological change and economic dynamism have changed the underlying environment in ways that make it more valuable/more efficient/less costly to move away from the vertically-integrated, government-granted service territory monopoly that we have had for a century. This is particularly true in generation and is seen in the estimates of value creation (new benefits, cost savings, etc.) from the liberalization of wholesale electricity markets. It is also true in retail provision of energy services to end-use customers, although we have less evidence of that because of the perpetuation of the bundling of the energy commodity sale with the wires rental from the point of view of the customer. The pesky network/”natural” monopoly (although I think it’s becoming quite unnatural) portion of the value chain is the wires. So as we liberalize generation and move toward liberalizing retail, the physical wires remain the part of the value chain that still has some economic justification for the continuation of regulation (although that justification will wither over time, as distributed generation and active demand response make those wires contestable).

Thus one part of this phase transition is that wires investment, particularly transmission investment, can get lost in the shuffle. This was particularly true toward the end of the 1990s, when the regulated rate of return on such investments was unattractive relative to average rates of return in other investments. Resources flow to their highest-valued use, and by having regulators determine the “reasonable” rate of return, that means relying on their estimate of the value of transmission investment instead of the interaction of many, many potential investors and owners and customers. In other words, regulator-determined rates of return on transmission investments are not adaptable and do not adjust to reflect changing opportunity costs over time (FERC has recently done some adjustments to this rate of return process, but it’s still inertial and non-adaptive). Regulatory determination of this rate of return also has a political economy problem, because of the effect of the political process on determining that rate of return; for example, regulators have to weigh the pros and cons of transmission investment against the political backlash that can arise from increases in rates to pay for such investments.

In brief, the process through which transmission investment is supposed to occur is currently a mess: too politicized, not sufficiently transparent, and not adaptive to changing conditions.

Johnston does offer the “official story” about transmission investment and how congestion charges have increased over the past decade as demand has increased and transmission capacity has not. Here are three important other points to consider as you read his analysis.

First, always remember that prices help resources flow to their highest valued use, and that congestion charges are prices that make the relative scarcity of transmission capacity more transparent to both consumers and transmission owners. So in the example he uses of Chambersburg, Pennsylvania, the increase of congestion charges is an important signal, communicating to those customers that something involved in the process of providing them with energy service is relatively more scarce than before. That is a signal to them to evaulate the value to them of using the amount of electricity that they do. If they are more sensitive to these prices, they will reduce their use to the extent they can. Similarly, these congestion charges are an investment signal (more on that in a second).

Second, transmission capacity is not congested to the same degree over the entire day; it’s more congested at some times and less congested at others. Unfortunately, though, that fact is not communicated transparently to end-use customers, because they pay a flat-rate transmission charge regardless of when they consume power. If the transmission prices that customers actually saw had more granularity, i.e., were able to reflect those changes in scarcity, then customers could see the real effect that their consumption choices had on the network as a whole, and they would have a real incentive to shift their use to non-congested periods.

Third, the way investment occurs in most industries, and the way it has occurred in most markets throughout human history, is through entry. One of the biggest problems with the current structure of electricity transmission is that the transmission owners receive those congestion charges, but they are the only ones who are legally capable of building new transmission capacity. If they did that, the congestion charges they receive would diminish or disappear, and all they would get in return is the regulated rate of return on the new investment. But because of the government-granted monopoly treatment of the wires, new transmission entry is illegal. Thus the natural dynamic by which new suppliers can come in and compete away those congestion charges is stifled by regulation.

One final point on which I cannot really fault Mr. Johnston, but I can fault myself and all of us who are working in grid modernization: his article says nothing, and I mean NOTHING, about using digital technology and interoperability to modernize the grid, make it adaptive, responsive, self-healing, and more automated all the way from generator to customer. That is the most effective way to deal with the grid congestion challenges facing us, because bits are cheaper than iron, and digital technology is not prone to the same NIMBY challenges that new wires are. There are lots of us working on this challenge: