Merchant transmission returns unclear in U.S. market

By Dana Bacciocco, Associate Editor

Returns based on a competitive market may not outweigh the obstacles to implementing merchant transmission. Currently, there is no such project in full operation in the U.S., although two projects have been announced and approved by the Federal Energy Regulatory Commission (FERC) this year.

“Generation expansion at one time went hand-in-hand with transmission expansion. This is no longer the case,” according to Kristina Sepetys, Senior Consultant at National Economic Research Associates (NERA). “Transmission upgrades and expansion have not kept pace with demand, particularly peak load growth demand. Not only are there transmission constraints and shortages, there is currently a lack of incentives for expansion and new construction,” she added.

Merchant transmission is an offshoot from traditional transmission projects built by utilities and approved by regulators on a cost-plus, rate-of-return basis. Neptune Regional Transmission System (Neptune), which plans to connect New Brunswick, Nova Scotia, Maine, Boston, New York City, Connecticut, Long Island and New Jersey, recently announced dates for open season auction of transmission rights. Seeking approval for a similar venture, the Cross Sound Cable Project (to cross Long Island Sound and connect electricity systems of Long Island and New England), Transàƒâ€°nergie filed with FERC requesting market-based rates. FERC granted essentially the equivalent based on what they consider opportunity cost pricing, according to David Clement, Associate Director of the North American Electric Transmission Service at Cambridge Energy Research Associates (CERA). This approach assumes that there is a natural cap for transmission provider charges, based on market prices in the interconnected regions. FERC also granted market-based pricing since none of the assets go into regulated rate base, i.e. the project is at risk to the market, said Clement.

According to Chuck Hewett, CEO of Neptune, FERC made it clear that daily operating decisions would be made by a regional transmission organization (RTO), helping avoid some market power issues concerning FERC. FERC approved the Neptune project and the sale of transmission capacity rights July 25-the decision followed FERC’s directive for the formation of a Northeast RTO.

No one seemed to be speculating on the potential returns of a merchant transmission project in the United States, beyond loose comparison to that of merchant generation or any competitive project. With no operating projects, analysis is at the stage of potential pricing and market effects. According to Sepetys, both the Transàƒâ€°nergie and Neptune projects have proposed selling long-term (15-20 years) contracts at auction to cover the systems’ capacity. Further, added transmission may influence the market differential, so long-term contracts can lessen price risk for the transmission developer, noted Clement.

Clement also said that although North America’s balkanized transmission system offers a wide range of price differentials inviting merchant transmission, generation could be a partial substitute, depending on location. “Locating generation near a transmission constraint can help alleviate that constraint,” said Clement. Developers must monitor existing and planned generation projects, as well as other potential or planned transmission upgrades and interconnections.

Merchant transmission siting and projects, because they are interstate transactions, are subject to state approvals as well as FERC approvals. “State and local approval and permitting processes have proven to be some of the larger hurdles for merchant transmission projects,” said Sepetys. “Some merchant plant developers have argued that because they do not provide retail services to end-use customers, that they should not be subject to regulation as an electric distribution company,” added Sepetys. “In some states we’ll be classified as a utility, in other states, we won’t,” said Hewett.

Assuming a competitive market, risks and returns balance in the long run, said Clement. “Since merchant transmission companies will not face the fuel price risk or the same degree of electricity price risk that a merchant generator would face, I would expect that as the market matures, on average, returns may be somewhat lower for merchant transmission than for merchant generation. That may not be the case today, since the market is still in its infancy and the type of returns earned are going to be project specific,” said Clement.

Kristina Sepetys specializes in energy environmental and public policy analysis consulting at National Economic Research Associates (www.nera.com), a global economic consulting firm focused on the practical application of economics to complex business and legal issues.

Cambridge Energy Research Associates (CERA) is an independent firm providing insight into the energy future. CERA (www.cera.com) offers comprehensive, in-depth research and thought leadership on energy markets, industry dynamics, technology, economics, politics, and investment strategy.

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