Recognizing the new reality, the Federal Energy Regulatory Commission
(FERC) declared in Order No. 888 that, with easy entry, plentiful gas
supplies, and competing marketers, new plants could charge market-based
rates. In effect, we deregulated the wholesale generation market, over
which FERC has jurisdiction, on a prospective basis. States, in charge
of retail sales, began passing laws rescinding the monopolies of utilities
and offering customers the opportunity to change suppliers periodically.
When retail choice finally emerges, both ends of the electricity market,
the production entrance and the consumption exit, will stand ready to
benefit from restructuring. Regional Transmission Organizations (RTOs)
provide the missing link, transmitting the power from the generator to
the consumer. That makes RTOs the linchpin of restructuring.

FERC Order No. 2000 and RTOs

Cost of service regulation ensured that transmission became the “stepchild”
of generation. Utilities made more profit from costlier plants than from
transmission. As a result, thinkers saw the potential for owners to stifle
competition, by shutting out competing suppliers from access to the grid.
Order No. 888 took a small remedial step. It required public utilities
to file open access tariffs and to “buy” transmission under it, even for
their own retail customers. Open access required a lot of regulation and
engendered disputes over allegations of abuses by integrated utilities,
real and imagined. FERC saw the need to go further.

These efforts culminated in Order No. 2000, which established a more
ambitious goal for a regulatory agency. FERC defined a new utility, the
RTO, an entity that represented “a viable, stand-alone transmission business.”
FERC declared that the RTO could operate as a for-profit company or a
not-for-profit institution, or a combination. Order No. 2000 gave the
RTO a business plan, four characteristics, and eight functions, as follows:

Four Characteristics of the RTO Business Plan

• Independence from market participants, namely, sellers of electricity.
  A for-profit transmission company may allow integrated utilities to
  retain passive ownership interests (a strictly financial stake) in
  the RTO without restriction. FERC placed some restrictions on active
  (voting) ownership – a safe harbor (no questions asked) of 5 percent
  for an individual, a benchmark of 15 percent for a class and a presumption
  of a five-year duration. The benchmark allows for different results
  in individual cases, and the presumption permits more if the public
  interest requires it. Passive owners may retain special rights to
  protect the integrity of their capital investment. FERC indicated
  it would audit independence first, after two years, and every three
  years later. Aside from mentioning independent governing boards, FERC
  gave no guidance to not-for-profit institutions.

• Scope and Regional Configuration to show a potentially viable market

• Operational Authority over the grid

• Short-term reliability

Eight Functions of the RTO Business Plan

• Tariff administration and design to ensure that the RTO controls
  the rates that customers see, and, in that way assure proper price
  signals

• Congestion management, preferably through market means, including
  expansion to prevent inefficient allocation of resources

• Parallel path flows to ensure the transmission customer pays for
  its use of the system

• Ancillary services, reserves and the like, as a provider of last
  resort

• OASIS, including information for prospective customers to enable
  transactions to occur. Again, a for-profit company would have to handle
  this.

• Market monitoring, either itself of through a contractor to ensure
  that competition works

• Planning and expansion of the system, including ordering construction
  when necessary. Here, again, a for-profit company would have to undertake
  this function in order to remain a going concern.

• Inter-regional coordination with other RTOs and utilities to ensure
  smooth passage for electricity across the grid. Coordination includes
  standards for technical and communications issues. A for-profit company
  has every reason to succeed here.

The novelty in Order No. 2000 arises from the decision to offer incentives
for RTO formation, rather than mandate the result. FERC understood that
the market, not regulatory fiat, would ensure the viability of stand-alone
transmission businesses. FERC also understood that cost of service regulation,
which made sense at a time when policy makers thought they needed to regulate
a natural monopoly, hindered the development of competition. Order No.
2000 stated that FERC stood ready to grant these eight price reforms:

Eight Price Reforms

Rate moratoria that freeze prices (effective until January 1, 2005)

• Rate moratoria that assume a static capital structure (effective
  until January 1, 2005) even if the company leverages toward more debt

• Higher rate of return to reflect increased risk of stand-alone (no
  longer diversified) business

• Rate of return that changes according to a pre-determined formula

• Shorter depreciation, such as the life of the contract, for a new
  plant

• Favorable changes in depreciation – to straight line away from accelerated
  – for existing facilities integrated into an RTO

• Incremental pricing in the form of a surcharge added to the access
  charge for customers that need new facilities

• Performance-based rates with internal or external indices.

FERC also said that RTOs may request any other reform upon a showing
of benefit through a cost-benefit analysis, and needed to meet the goals
of Order No. 2000, a viable, stand-alone transmission business. The preamble
discusses the possibility that for-profit companies may seek a new method
of calculating return and may ask for acquisition adjustments. FERC would
not use the RTO Rule as a vehicle for generic reform of the current discounted
cash flow method for calculating return. On acquisition adjustments, Order
No. 2000 restated current policy that allows revaluation of the rate base
to match purchase price, rather than the original cost, if the utility
shows a “demonstrable public benefit.”

While for-profit RTOs have a need for price reforms to increase efficiency
in the grid and could apply the eight listed in Order No. 2000, a not-for-profit
system operator could not make the showing or apply these reforms. In
the latter case, the money would flow to integrated utilities, as the
transmission grid’s owners, the very group FERC concluded had the incentive
to hold back the march toward competition.

RTOs and Restructuring

In any competitive market, companies reduce costs to increase earnings.
With the incentives FERC promises in Order No. 2000, so will for-profit
RTOs. Just as in any market, pleasing the customer creates more business
and higher profit, so, too, in transmission. This will most likely occur
in the for-profit context, with its lack of complex checks and balances
among competing interest groups and heavy-handed regulatory oversight.
Order No. 2000 allows the profit motive to work its magic. The RTO must
please the sellers of electricity, whether generators or marketers, as
the integrated utilities no longer control the grid. The stand-alone transmission
business depends for success on generators connecting to the grid or marketers
seeking to transmit to customers. The integrated utility, in contrast,
deals mostly with the diffuse class of ultimate retail consumers, except
for wholesale sales that account for about 10 percent of revenue.

Using Order No. 2000, transmission companies can prevent congestion problems
from arising in the first place by working with generators and consumers.
With incentive rates to guide them, for-profit organizations will better
maintain their facilities to reduce breakdowns. For-profit RTOs will more
likely expand the grid and help generators make the right decisions about
location.

Moreover, if congestion does occur, for-profit RTOs with proper incentives
offer more efficient and innovative solutions. These include inducing
customers to shift consumption to off-peak times or to reduce demand altogether
during peak hours. For-profit RTOs would create a more hospitable environment
for distributed generation. Rather than viewing it as competition, for-profit
RTOs will look favorably on fuel cells and mini-turbines as tools to improve
resource allocation.

With the company dependent for its earnings on market criteria, not cost
of service, the customers and the utility acquire common interests. These
or similar benchmarks for for-profit RTOs create the same mind set among
managers. Increases in volume over the transmission grid mean more profit
when increases prove economical. Because the for-profit RTO is not a generator,
it has no reason to restrict the flow of electricity. Integrated utilities,
on the other hand, protect earnings from their own generation by restricting
transmission capacity for other generators. Three of the indicators point
that way: throughput, reliability and price. Meeting or exceeding targets
on throughput and reliability mean more megawatts flow over the grid and
fewer outages. Lower prices also lead to greater volume.

The for-profit RTO, therefore, has every reason to create conditions
of plenty rather than scarcity. Other means of managing congestion include
reducing peak demand by paying customers to switch off just as the airlines
pay customers to leave overbooked flights. For-profit RTOs can also time
maintenance work to ensure peak operation during peak demand. The for-profit
RTO will invest in necessary technology, expand the grid when feasible
and otherwise try to accommodate customers, generators, and marketers.
Customer satisfaction also counts toward the for-profit RTOs profitability.

In the end, however, stand-alone transmission businesses can remain viable
under performance based rates. The more effective plans, such as the plan
I instituted in Mississippi, use internal criteria. Possible measures
include: volume of electricity flowing over the wires, length or percentage
of outages, customer satisfaction and percentage of requests granted.
The reward comes from enacting a price cap and allowing the RTO to earn
above its cost of service. The RTO would share the proceeds with customers.
The RTO would bear losses in the same way. The plan could include periodic
audits, but, in any event, eventually the RTO would have to return to
FERC for a rate case.

As easy as it sounds to recite the concept of performance based rates,
we admit the difficulty lies in the details. Setting the proper categories
of performance for the RTO requires thought. Setting the benchmark for
profit and loss requires deliberation. Establishing the sharing mechanism
and procedures for auditing requires an effort, as does establishing the
term of the plan. The need for finding the right answers gives the incentive
to include customers, meaning the sellers of electricity, as well as consumers.
The “stake holder process,” about which the backers of not-for-profit
institutions boast, belongs in the for-profit RTO as well. The difference
arises from the goal of the process. With the not-for-profit entity, it
is left to a debating society to decide lofty issues of plans and needs.
With the for-profit RTO the procedure establishes the basis for transactions,
the actual transmission rates and the expectations of the market.

We urge customers and consumers to negotiate with the for-profit RTO.
FERC conducted conferences to help the industry and customers form stand-alone
transmission businesses. These meetings should continue, once the for-profit
RTO forms and decides to operate under performance-based rates. This type
of rate program, that does nothing more than replicate the market, offers
the chance for sellers to discuss performance-based rates and criteria
and establish plans that will help sellers make sales, for RTOs to make
a profit and for the consumer to benefit from the promise of restructuring.