Transmission Cost Allocation—What Can We Get for Three-Tenths of a Cent?

Issue 3 and Volume 88.

by Larry Eisenstat, Dickstein Shapiro LLP

The biggest impediment to new transmission construction is the Federal Energy Regulatory Commission’s (FERC’s) lack of a policy regarding network upgrade costs allocation.

Instead, it has approved allocation methods ranging from 100 percent generator-funded to full roll-in depending on the region, voltage level, whether the upgrade is attributable to an interconnection or transmission service request, whether it is required for reliability or sought for economic reasons. This has fostered commercial uncertainty, limited investment in transmission and led to developers’ not pursuing projects that had their overall benefits been fully considered, would have provided ratepayers long-term value.

FERC should reassess whether this patchwork approach works by acknowledging that most approaches used are:

(a) Inconsistent with the nature and usage of the integrated transmission network—i.e., most approaches assign costs to a narrow group of users based generally on the false premise that because only new customers cause the initial need for upgrades, only they can benefit from them and only they should bear their costs.

(b) Entirely and illogically divorced from any consideration of the total extrinsic and intrinsic benefits that would be derived were the proposed facility constructed. At least four facts cannot be ignored.

First, transmission service occurs over a single cohesive network operating as a single piece of equipment available to all network customers at any time. As recognized by the U.S.-Canada Power System Outage Task Force in its April 2004 final report on the 2003 blackout, “The North American power grid is one large, interconnected machine.”

FERC’s policy has been to allocate the cost of transmission service, including new network upgrade costs, among all system users in proportion to their use. Even if a new customer triggered the need for a new system or grid facility, that additional facility constituted a system expansion that should be thought of as having been caused by, and that would be used by, and beneficial to all customers. Rolled-in pricing on a system basis is most reflective of the electrical characteristics of the transmission network and most properly assigns the network upgrade costs to all those who use and benefit from the more robust network resulting from their construction. Ideally, FERC should require that the ratemaking regions be interconnectionwide; if not, they should be limited to a few regions within each interconnection.

Second, no one questions the basis for rolling in the costs of “reliability upgrades.” Important as it is, reliability is just a policy; the degree to which reliability must be maintained is based on our desire that there be disruptions only so often, and no more frequently even in those areas to which we know a cascading contingency could be confined and where only a subset of customers primarily would benefit from the reliability upgrade. So why treat the costs required to fulfill this policy differently from the costs necessary to fulfill some other federal or state policy, e.g., the policy expressed through renewable portfolio standards to build increasing amounts of renewable generation to further our climate and national security objectives?

Third, the price for rolling in the costs of building such network facilities as are required to meet these additional energy policy or security objectives will not cause sticker shock. According to the Energy Information Administration, the nationwide average retail price of electricity in 2008 was 9.7 cents per kilowatt-hour on sales of 4.1 billion MWh. An increase in average retail rates of only three-tenths of a cent per year would generate $12 billion of annual revenue that could be invested in new transmission. This $12 billion increase in revenue requirement would support a capital outlay in the range of $80 billion (based on a levelized annual carrying charge rate of 15 percent). But even if done only regionally, a retail rate increase of three-tenths of a cent per year still would support capital outlays of roughly $15 billion in PJM and $12 billion in the Midwest Independent Transmission System Operator Inc. (MISO) based on 2008 Form No. 1 data.

Fourth, this annual retail rate increase would be offset completely by carbon cost savings alone (assuming that: renewable energy will constitute 15 percent of total generation; coal-fired generation produces 1 metric ton of carbon per megawatt hour at an allowance price of $20 per metric ton; and renewable energy will displace coal-fired generation). This doesn’t consider yet additional offsetting long-term benefits of additional transmission in lower wholesale prices, decreased congestion and a reduced reliance on fossil fuels.

FERC’s cost allocation policy must consider the technical basis for, and the policy objectives that would be furthered by, rolling in the costs of network expansion. Only by including all the extrinsic and intrinsic benefits of new transmission will we have a real chance of ensuring that transmission will be built to any meaningful degree.


Larry Eisenstat is the head of Dickstein Shapiro LLP’s energy practice. Reach him at [email protected] or 202-420-2224.


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