GUEST EDITORIAL

The Missing Piece in the TransmissionPricing Puzzle

Joshua Z. Rokach

I. A Lesson from HealthCare Reform

In his book on the history of

health care reform from FDR

through George W. Bush, David

Blumenthal cites one of several

factors which made the difference

between victory, as in the creation

of Medicare, and defeat, as in the

demise of the Clinton health care

bill.1 President Lyndon Johnson

sacrificed specifics for simplicity, in

order to get the law through

Joshua Z. Rokach, a member of theEditorial Advisory Board of TheElectricity Journal, worked as a

partner in the energy and appellatepractice groups at Balch & BinghamLLP from 2001 through 2009. Beforeentering private practice he served for27 years in the federal government, 23

of them with the Federal EnergyRegulatory Commission. At the

Commission, he served for nine yearseach as an adviser to two

commissioners, as an attorney in theSolicitor’s Office. He graduated fromYale Law School and City College ofCUNY. His occasional commentarieson deregulation issues solely reflect the

author’s opinions.

94 1040-6190/$–see front matter # 2010 E

Congress. President Bill Clinton

neglected practical politics in favor

of a logically consistent, but overly

complex, program. Policymakers

in critical areas outside of health

care should heed this lesson.

By Aug. 30, the Federal Energy

Regulatory Commission will have

received comments on its Notice of

Proposed Rulemaking (NOPR) on

transmission planning and

pricing.2 This proceeding marks

FERC’s latest attempt at solving the

difficult problem of attracting

sufficient investment in

transmission to assure an adequate

electricity grid for the 21st Century.

T o its credit, FERC avoids two

past mistakes. In contrast to

its abortive Standard Market

Design rulemaking, the agency’s

latest proposal allows for regional

differences in pricing schemes.

FERC also turns away from its

longstanding policy that all custo-

mers, even those who do no need

upgrades, must subsidize new

transmission. However, the pro-

posal rejects pricing rules relying

solely on ‘‘participant funding,’’ a

pricing model in which the gen-

erator requesting an upgrade must

pay for it in full. FERC still adheres

to some form of ‘‘beneficiary

pays.’’

lsevier Inc. All rights reserved., doi:/10.1016/j.

FERC’s formula spurns the more

streamlined approach in favor of

the more complex. Participant

funding directly assigns to buyers

the costs of their purchases.

‘‘Beneficiary pays,’’ though

mathematically precise, requires

lengthy proceedings to apportion

benefits. While FERC’s proposed

modifications to a strict

‘‘beneficiary pays’’ pricing policy

would reduce litigation, they

would not eliminate it. The agency

must permit utilities to use the

more straightforward model and

one that would best expedite

construction.

II. FERC’S Rulemarking:Pragmatism, but NotEnough

Traditionally FERC required all

existing users of transmission to

subsidize facilities for new

customers. Utilities charged each

customer its share of the total cost

of the network’s wires and

switches. FERC’s Interconnection

Rule, Order No. 2003, explained

that upgrading an integrated

network improves power flows

over the entire system and benefits

all customers. Even those for

tej.2010.07.004 The Electricity Journal

whom existing facilities provide

adequate service must pay for the

additional benefits they receive.

A s a matter of engineering,

that proves true. However, in

the real world, the policy created

opposition that delayed or thwarted

construction of new transmission.

In a notorious case, the Arizona

Corporation Commission rejected a

line running through its territory

designed to transmit clean energy to

California from points east. The

state commission balked because

customers living in Arizona, situ-

ated within the grid, but neither

selling nor consuming the electri-

city, would have had to pay for a

portion of the line.

Arizona’s rejection scuttled the

project, preventing California and

the nation from taking an

important step toward the new

energy economy. What some saw

as Arizona’s parochialism, the state

viewed as safeguarding the

pocketbooks of its residents. FERC

took note of the consequences and

issued the proposed rule to adapt

pricing policy to the country’s need

for new transmission.

FERC required every region to

form a planning group for projects

within its boundaries. Under the

proposed rule, these planning

bodies would establish pricing rules

for those projects. FERC also

proposes to require two

neighboring regions to form joint

planning groups for projects

crossing regional boundaries.

(Three or more such regions could

plan jointly if they wish.) These joint

bodies would decide how to charge

for transmission projects within

their multi-regional territories.

Aug./Sept. 2010 1040-6190/$–see

FERC proposed principles from

which planners would establish

pricing rules for transmission

projects within or across regions.3

� Beneficiaries of a project

must pay for it. Utilities may not

charge customers who derive no

benefit.

� In determining who benefits,

utilities may consider ‘‘the extent to

which transmission facilities,

singly or in the aggregate,’’

maintain reliability, increase

reserves, reduce costs, relieve

congestion and allow customers to

meet renewable portfolio

standards.

� A region or regions may not

impose a benefit-to-cost ratio as

threshold for payment higher than

1.25 without FERC approval.

� Even if other customers

benefit, only those within the

planning groups, whether in single

or multiple regions, would pay for

the project.

� In their pricing rules, regions

may not use ‘‘participant funding’’

(requester pays) as the sole

criterion because it would violate

the agency’s transmission pricing

principles.

In the real world,the policy createdoppositionthat delayedor thwartedconstruction of newtransmission.

front matter # 2010 Elsevier Inc. All rights re

III. What Else We Need

FERC’s policy has improved

since the days of Pennsylvania

Electric Company, 58 FERC � 61,278

(1992), when the agency found

illegal any pricing arrangement

under which customers requesting

service paid in full for their

transmission. Order No. 2000 and

the Energy Policy Act of 2005 had

allowed that practice under certain

conditions. The Notice of Proposed

Rulemaking makes further progress

toward sound transmission pricing.

However, FERC should encourage

– at a minimum not block –

participant funding.

The market economy uses that

model. Incremental pricing

allocates new capital or labor costs

to the customer on whose behalf

the business incurs the expenses,

even though other customers may

‘‘benefit’’ from the expenditure.4

Making each customer bear its own

costs promotes efficiency by

placing on the buyer the full

economic impact of a proposed

transaction. That principle

underlies the Administration’s

climate change policy

M oreover, FERC’s objection

to participant funding does

not apply in the real world. The

NOPR states in several places that

participant funding will cause

customers to delay asking for

improvements. Parties needing

transmission would assume that

someone else will pay for a project

that will also take care of the needs

of the first group. Theoretically,

customers could do that. However,

losing money or otherwise suffer-

ing from an insufficient supply of

served., doi:/10.1016/j.tej.2010.07.004 95

electricity in the absence of a

needed improvement in the hope

that someone else (also wise to that

ploy) would pick up the slack,

would amount to cutting off

one’s nose to spite one’s face. In any

case, FERC sites no evidence to

support the existence of such a

problem.

A dmittedly, letting some

existing customers enjoy

added collateral improved service

for free results in imprecise

matching of costs and benefits.

However, FERC’s own pricing

principles create imprecision.

FERC would exempt beneficiaries

located outside a planning group

from paying for the project. The

proposed rule also allows a

benefit-to-cost ratio threshold of up

to 1.25. This would excuse some

beneficiaries even within a

planning group from paying for

improved service.

FERC proposed both limitations

for good practical reasons.

Limiting payment to customers

within a planning group would

avoid a situation such as Arizona’s

veto of California’s clean energy

transmission line. The cost-to-

benefit ratio threshold would

appease marginal beneficiaries

and lessen opposition to new

projects.

This same pragmatism dictates

allowing regions to adopt

participant funding. Pricing

96 1040-6190/$–see front matter # 2010 Els

according to customer requests has

the advantages of support in

economic theory and practicality in

application. Participant funding

would expedite construction of

facilities. No need would exist for

measuring elusive benefits.

Neither would opposition arise

from customers having to shoulder

costs they would not have incurred

but for the new market entrant.

Each customer would pay its own

freight.

IV. Conclusion

FERC’s laudable goal of

expanding the transmission grid

requires a sound pricing policy. A

good planning regime with poor

pricing will not attract

investment. A good pricing policy

will. Just as President Johnson

took politics into account in

steering Medicare through

Congress, FERC must take

Pricing accordingto customer

requests has theadvantages of

support in economictheory and practicality

in application.

evier Inc. All rights reserved., doi:/10.1016/j.t

practicality into account when

establishing transmission pricing

rules. Charging those generators

who request new transmission

rather than those customers who

benefit from upgrades or new

lines has the virtues of feasibility

and simplicity.

Using a ‘‘beneficiary pays’’

standard may make sense from an

engineering point of view.

However, the lengthy process of

identifying beneficiaries and the

complex exercise of quantifying

benefits makes that approach

uneconomic and unworkable.

Requiring customers to pay for

facilities other parties require

breeds litigation.

The nation’s electricity needs

cannot wait. FERC must allow

regions to price transmission

through participant funding, even

at the cost of the mathematical

precision ‘‘beneficiary pays’’

offers.&

Endnotes:

1. D. BLUMENTHAL, THE HEART OF POWER:HEALTH AND POLITICS IN THE OVAL OFFICE

(Univ. of California Press, 2009).

2. Transmission Planning and CostAllocation by Transmission Owning andOperating Public Utilities (NOPR) 131FERC � 61,253 (2010).

3. NOPR at PP. 164, 168, 174, 175 n.173.

4. P. SAMUELSON, ECONOMICS, 9th Ed.(McGraw Hill, 1973), at 449–62.

ej.2010.07.004 The Electricity Journal