The Federal Energy Regulatory Commission (FERC) has proposed substantial changes to its policies for awarding ratemaking incentives for new transmission investment.  The most fundamental change is that FERC would no longer award incentives based on a proposed project’s risks and challenges but would instead award them based on its economic and reliability benefits.  In addition, the incentive for a higher return on equity for project investment would be potentially more generous than under the current policy.  FERC’s proposal should be of interest to utilities, transmission-only companies, market participants who pay transmission rates, customers and investors interested in developing transmission projects.

Background

In 2005, Congress added a new section 219 to the Federal Power Act that directed FERC to provide by rule incentive-based rates for 1) new electric transmission facilities that either ensure reliability or reduce the cost of delivered power by reducing transmission congestion, and 2) for utilities and other transmission providers that join a Transmission Organization such as a Regional Transmission Organization (RTO).

FERC adopted its rule providing for transmission incentives in 2006, observing that the most compelling candidates for incentives are new projects that present special risks or challenges, not routine investments.  In addition to higher ROEs, the incentives available to such projects include (1) recovery of incurred costs if a project is abandoned for reasons outside the applicant’s control; (2) inclusion of 100 percent of costs for construction work in progress in rate base; (3) use of  hypothetical capital structures; (4) accelerated depreciation for rate recovery; and (5) recovery of pre-commercial operations costs as an expense or through a regulatory asset.

FERC has used the above framework for awarding transmission rate incentives since 2006.  The Commission’s recent Notice of Proposed Rulemaking (NOPR), however, observes that the landscape for planning, developing, operating, and maintaining transmission infrastructure has changed considerably and that the types of transmission projects that are needed, and the use of rate treatments to incent them, must evolve to reflect the changes in market fundamentals.

Proposal

FERC proposes to discard the risks and challenges approach for evaluating incentive requests and instead will focus on the benefits of new transmission investment.  FERC notes that all of the RTOs and ISOs use software modeling to identify the benefits and costs of proposed transmission projects, and the Commission can leverage those efforts to better target incentives at transmission projects that demonstrate sufficient economic benefits.  The NOPR says that the proposals should increase certainty for developers; better align incentives awarded with transmission project benefits and costs; increase the precision and transparency with which transmission project benefits are considered by the Commission; and increase the ability, over time, of the Commission to determine whether incentives are effective in spurring development of transmission projects with desirable benefits.

Proposed revisions to specific incentives are as follows:

ROE incentive for economic benefits.  FERC would offer an extra 50 basis points on ROE transmission projects with a benefit-to-cost ratio in the top 75th percentile of transmission projects examined over a sample period and an additional 50 basis points on ROE for projects that demonstrate ex-post cost savings in the 90th percentile of transmission projects.  FERC proposes to measure benefits as adjusted production cost, similar congestion reduction measurements, and other quantifiable benefits.  The NOPR discusses establishing national benefit-to-cost ratios.

ROE incentive for reliability benefits.  Up to an extra 50 basis points on ROE would be offered for projects that demonstrate, through quantitative analysis where possible and qualitative analysis, potential reliability benefits to address specific reliability needs.  Examples of quantitative measures include reduced loss of load probability, reduced unserved energy under various contingencies, reductions in reliability unit commitments, increases in import or export capability, and improvements in voltage stability.

ROE incentive for technology.  Projects that deploy transmission technologies that enhance reliability, efficiency, and capacity or improve the existing facility operation would be eligible for an extra 100 basis points on ROE for the costs of those technologies, as well as capitalizing up to two years of certain initial costs in a regulatory asset on which a return would be earned.

ROE incentive for RTO membership.  FERC proposes to increase to 100 the basis points that would be added to the ROEs of transmitting utilities that turn over their wholesale transmission facilities to an ISO, RTO or other FERC-approved transmission organization.  The current incentive is 50 basis points.  The NOPR discusses the substantial benefits of RTOs and ISOs.

Cap on total ROE incentives.  Currently, FERC limits the total ROE, including all incentives, to the upper bound of what is known as the ratemaking “zone of reasonableness.”  FERC proposes to replace that limit with a 250 basis points hard cap on the total of all ROE incentives granted to a transmission utility.  This proposed policy is expected to be less restrictive.  FERC also asks for comment on removing, on a case-by-case basis, the zone-of-reasonableness restrictions placed on already granted incentives and replacing them with a simple hard cap.

Abandoned plant cost recovery.  For projects abandoned for reasons beyond a developer’s control, FERC would allow recovery of costs incurred from the time the project is selected in a regional planning process.  Currently, FERC only allows recovery of costs incurred from the time this incentive is approved by FERC.

Special incentives for transcos eliminated.  Currently FERC offers a special incentive to stand-alone transmission companies, or “transcos.”  FERC offered this incentive in 2006 based on the promise of the stand-alone structure to invest in transmission.  The NOPR observes, however, that the transco business model has not enhanced the deployment of transmission infrastructure sufficiently to justify incentives beyond those available to all public utilities.  Accordingly, FERC proposes to no longer offer the special incentives for transcos.

Commissioner Glick dissent

Commissioner Richard Glick dissented in part from the NOPR.  A post on the Commissioner’s web site expresses his disagreement with the following aspects of the proposal:

  • Limiting incentives to projects that meet efficiency thresholds or result in significant reliability benefits ignores transmission projects needed to meet public policy goals, such as carbon reduction targets.
  • The proposal doubles the ROE incentive for RTO membership even though there is nothing in the record to suggest that any transmission owner would leave an RTO without the incentive.
  • There is no evidence that rates would be just and reasonable under the new cap of 250 basis points on total ROE incentives.

Comments on FERC’s proposal are due 90 days after the date of publication in the Federal Register.

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Photo of Bud Earley Bud Earley

Bud Earley, a non-lawyer senior advisor, provides analysis and advice on a wide range of federal and state energy regulatory issues, including transaction and rate issues, regional transmission organization (RTO) tariffs and rules, interconnection, retail choice and demand response for electricity customers…

Bud Earley, a non-lawyer senior advisor, provides analysis and advice on a wide range of federal and state energy regulatory issues, including transaction and rate issues, regional transmission organization (RTO) tariffs and rules, interconnection, retail choice and demand response for electricity customers, a natural gas pipelines and hydroelectric facility licenses, and LNG export authorizations.

Working with Covington teams, Mr. Earley has provided expert advice and analysis to investment firms, utilities, independent power producers, project developers, customers, marketers and U.S. and international energy companies,

Prior to joining Covington, Mr. Earley served for over 30 years in various staff positions at the Federal Energy Regulatory Commission (FERC). While at the FERC, Mr. Earley was instrumental in developing and applying policies regarding the transition of the electric utility industry to competition, including policies regarding independent power producers, transmission access, standard generator interconnection procedures, organized electricity markets, mergers and market-based rates.