PBR – A Window of Opportunity for Transmission Owners

Performance-based ratemaking (PBR) provides an opportunity for transmission owners in the new competitive era to maximize return on assets and increase shareholder value. FERC Order 2000 offers the PBR mechanism to entice transmission owners to join Regional Transmission Organizations (RTOs) and invites creative proposals for evaluating-and rewarding or penalizing-performance based on measurable industry benchmarks. Properly designed, PBR establishes clear targets for reliability, customer service, efficiency and other objectively measurable criteria. In addition, PBR loosens regulatory oversight requirements and provides incentives for transmission owners to improve performance. By assuming greater risk through their obligation to perform, transmission owners are afforded a new opportunity to enhance return on assets and shareholder value.

Historically, transmission-owning utilities provided all aspects of transmission service including planning, designing, obtaining necessary approvals and constructing new transmission facilities, as well as operating and maintaining existing facilities. Under the new electric power industry structure, transmission-owning utilities are handing over control of their transmission assets to RTOs. The transmission-owning utility’s role has been significantly reduced, principally to that of an asset manager. Although a transmission owner still has a role in planning, that role will be limited, and construction will most likely be contracted out under competitive bidding. As a result, it will be critical for transmission owners to pay particular attention to their existing assets in an effort to maximize return and provide greater shareholder value.

There are a number of means available for transmission owners to increase asset value; however, under the current rate-of-return or cost-of-service regulation, there is little incentive for them to do so. Existing regulations allow transmission owners to pass through prudently incurred costs at a rate of return reflecting minimal risk, providing little reason to pursue efficiency gains.

FERC Order 2000 indicates that FERC will consider offering incentives to transmission owners that join RTOs. FERC encourages RTOs to submit proposals for PBR and other incentives such as return on equity, levelized rates (significant for RTO participants with substantially depreciated systems), and accelerated depreciation and incremental pricing for new investments. All of these incentives present opportunities for transmission owners to increase asset value.

PBR is a “carrot” that FERC is offering to transmission owners in exchange for joining RTOs. An RTO’s PBR proposals must include both rewards and penalties based on known and measurable performance benchmarks. These incentive proposals will be reviewed by FERC on a case-by-case basis, and they represent a desirable form of regulation for transmission owners because they are “light-handed.” In other words, the regulatory agency will have much less control and interaction.

Under PBR, a utility’s price or revenue is capped, providing incentive to improve efficiency and reduce costs to increase profit margins. Utilities are rewarded for good performance through higher profits and penalized for poor performance through lower profits. Performance indicators usually relate to reliability, power quality and customer service. Under cost-of-service regulation, a regulated rate of return on transmission assets might be 9 percent. However, under PBR, if a utility can implement effective cost-reduction schemes and maintain performance in the upper quartile of its peers, it may be able to increase returns by an additional 1 or 2 percent.

A PBR scheme for transmission owners generally would include a revenue cap, adjusted annually to account for input price increases (often set at the consumer price index), and productivity improvements. The adjustment for productivity ensures that consumers share in a portion of the benefits derived by the transmission owner. In addition to the input price and productivity adjustments, there is generally a factor that allows for the direct pass-through to consumers of costs over which the transmission owner has no control, such as costs incurred due to tornadoes, hurricanes, ice storms, etc.

The other part of the PBR equation relates to performance criteria such as customer service, market efficiency, reliability and power quality. Typically, performance indicators might include such things as frequency of delivery point interruptions, system minutes of unsupplied energy, one-hour restoration commitment, 24-hour restoration commitment, and market efficiency performance measures including transmission system unavailability. Rewards for meeting the performance indicators should be based on costs the transmission owner would incur in meeting the targets.

The additional benefits and returns resulting from PBR come at a price, generally reflected by increased risk. The onus will be on the transmission owner to perform. Increased use of automated schemes and supervisory monitoring and control will be be necessary for a transmission owner to succeed. The following will be of particular interest to transmission owners:

  • Substation automation, including voltage/VAR monitoring and control (automatic capacitor bank switching and transformer tap control); protection; and addition of intelligent electronic devices to enable expanded visibility of real-time conditions.
  • Real-time monitoring and control of network devices, including security analysis (static, voltage collapse assessment and dynamic security); remedial control; loss minimization; and improved restoration time.
  • FACTS (flexible A/C transmission system) and other network control devices.

The objectives of these schemes include improving reliability, customer service and market efficiency by reducing costs and increasing productivity.

In summary, FERC has opened the door for transmission owners to increase returns and shareholder value under Order 2000. It is up to the transmission owners to seize this opportunity by submitting PBR schemes to FERC through their RTO and, following approval, to pursue the innovation offered by various automation schemes to enhance financial and operational performance.

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Doug Bowman is an executive consultant with KEMA Consulting, an international corporation that provides technical, management and training service to the electrical power industry worldwide. Mr. Bowman has 23 years of electric power industry experience. His prime areas of expertise include power sector restructuring, power market analysis, regulation, tariff design and pricing. Mr. Bowman can be reached at 703/631-6912 or dbowman@kemaconsulting.com.

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