by Tanya Bodell, FTI Consulting
Traditionally considered a natural monopoly, transmission is coming into its own as a dynamic segment of the electricity supply chain. With billions of dollars in capital required to extend and upgrade the high-voltage lines that cross the U.S., new entrants are entering the space with new business models, many of which borrow from other segments of the industry and other industries.
Business innovations include independent transmission, transmission project financing, merchant transmission with anchor tenants, and real estate investment trusts.
Since 2006, nearly one-quarter of new transmission lines placed into service have been built by independent transmission companies. Established as a viable business model in 2002 when an independent transmission company purchased the Consumers Energy transmission system in Michigan, Trans-Elect’s subsequent construction of the Path 15 Upgrade in California established a role for independents in greenfield development.
The initial business construct mimicked that of regulated utilities, securing cash flows through a regulatory order with a defined return on equity recovered through cost-of-service rates. In contrast with utilities that rely on public debt and equity markets to finance their projects, however, independent transmission has favored nonrecourse debt and private equity through project financing vehicles.
Project financing vehicles allow banks to loan against the projected cash flows of a specific transmission project and can be used when revenue streams are secured through regulatory or contractual arrangements. One of the most common structures funding independent transmission is the limited liability corporation (LLC). Adapted from the precedent set in independent power, LLCs can be established on a project-by-project basis, creating a financing structure that maintains title to the assets but can vary equity ownership in the business entity.
The LLC structure also creates a favorable tax structure and can allow for additional leverage at the parent corporation. Even regulated utilities with commercial transmission businesses, such as Electric Transmission America, have adopted the LLC structure for individual transmission projects, enabling greater flexibility concerning partnerships and financial arrangements.
Whereas transmission tariffs provide regulated return on investment, merchant transmission projects recover their costs through market-based contracts. Not to be confused with merchant generation that earns revenues from the spot market, merchant transmission tends to be supported with long-term contracts for capacity. To comply with the Federal Energy Regulatory Commission’s (FERC’s) open access requirements, capacity traditionally has been allocated through a competitive bidding process referred to as an open season auction. Examples of merchant projects that subscribed capacity using competitive solicitation and market-based prices include Cross Sound Cable, Neptune, Cross-Hudson, Great Basin Transmission, Montana-Alberta Transmission Line, the Wyoming-Colorado Intertie and Linden VFT. Relaxing open access rules associated with merchant transmission, FERC has approved bilaterally negotiated agreements with anchor tenants that cover 50 percent of the available transmission capacity. Subsequent filings have pushed this precedent further, requesting higher levels of capacity and allocation to affiliated entities.
The most recent business model for transmission and distribution assets is a real estate investment trust (REIT) structure. In 2007, the Internal Revenue Service (IRS) issued a private letter ruling defining transmission and distribution assets as real estate for purposes of meeting the requirements of REITs.
In November, Hunt Power, Marubeni Corp., John Hancock Life Insurance, TIAA-CREF and OPTrust Private Markets Group announced establishment of two separate REITs to invest up to $2.1 billion in electricity and gas transmission and distribution assets. Conceptually, an REIT structure allows access to a different source of capital (e.g., public and private REIT investors) and greater opportunity for management control. There also may be preferred tax implications depending on the specific situation.
Transmission is breaking ground with new investors and business models. If acquiring or developing transmission, think through the business implications of the structures available and whether alternatives better fit your project’s characteristics. The industry has shown a keen willingness to consider new business models for one of the most traditional segments of the power sector. Use that to your advantage.
Tanya Bodell is a managing director at FTI Consulting and co-founder of the Electricity Consulting Group. Reach her at firstname.lastname@example.org.
“Bad idea: laughing at business models instead of investing”
Headline of Nov. 22, 2010, Fortune magazine article
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