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On May 27th of this year, EnergyPulse published my article on the reasons infrastructure investment lags in the electricity industry. Yesterday, the country saw the risks of infrastructure disinvestments. The critical thing is to implement the correct solution.
In the RTOS/ISO industry structure the "owner" of the transmission assets is really the RTO - not the investor. The RTO determines when and how much a grid component will be used. In such a structure the investors will ask for cash flows that look much more like cost of service based structures. In that environment, the RTO should implement an open market bidding structure with a cost of service compensation structure.
Since the RTO has the responsibility for modeling and managing the grid, it has the information necessary to determine the preferable projects for the grid. The system operators in several South American countries - Colombia is one with which I have personal experience – are in the same situation. They have instituted open market bidding systems.
The system operator determines the desired transmission construction projects. The project specifications are published for all industry participants to review. Then the contracts for construction of the lines and the maintenance of the lines are opened for competitive bid. The lowest bidder of acceptable quality is granted the award under the tariff structures included in the bid. Upon completion of the project, the operation of the new facility is folded into the grid operator control.
This structure would work extremely well in the current US environment. It is likely that the review of the events of August 14 will create the impetus for significant transmission investment. The opening of the construction to competitive bidding and the access to a wide range of construction resources would help to assure the lowest reasonable cost and the fastest available construction times.
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If the Regional Transmission Operator orders an installation or upgrade to a specific line, would the capital costs and the operating expenses be shared over all RTO members? I assume that the "owners" were the winning bidders of the auction who would arrange financing based on the cash flow from the contract which is turn depends on the RTO's credit. That will probably roll up to the underlying RTO members somehow and become an obligation against their cash flows. Something similar happened during the PURPA machine boom when the long term contracts by utilities to the PURPA machine developers were held as quasi-debt and a pass-though of the project finance risk. Do buyers of electricity pay the same as generators?
While most agree that transmission investments generally benefit all RTO members, there will be times when specific projects clearly have specific winners and maybe specific losers. Guess what - the losers will scream. Two cases are in the news. First, the Southern Company objects to better transmission links to the Northeast since what Southerner wants a damn Yankee to steal their cheap power? The other case is in Rhode Island where the PSC chairman objects to Rhode Islanders being charged $63 million to improve a link that would primarily (in his opinion) just help neighboring Connecticut. One can similar battles in, say, WSCC when California needs a transmission improvement and those heartless Oregonians object.
It would be easy to see future conflicts where independent power producers overload a link and seek the RTO to pay to bring their power to market. Also, is rapid load growth for one utility is to be subsidized by all RTO members?
Obviously governance of the RTO will be a very touchy subject, just as it was with California ISO when the governor sweep the board and installed his appointees.
Thomas Lord 8.22.03
I agree the conflicts noted above are a major political issue. However, the current call to "upgrade the grid" implies that these issues are resolvable or that it is necessary to override some of these issues with a political mandate. My expectation is that something of this sprt is likely in many instances.
Given that, much has been written and spoken recently about providing incentives to utilities over and above their existing rates or offering tax incentives to get transmission built. The reality is that in most cases the concept implies that the investors would receive something similar to existing cost of service revenue security. The suggestion proposed here pertains to the financing of projects determined to be necessary for "the benefit of the grid" and where revenue security is part and pacel of the project investment. In that case the grid operator should act to ensure that the lowest credible pricing structure should be secured. This is an open market pricing mechanism for the cost of service based pricing.
Volatiltiy Managers works to provide incremental improvements in mechanisms. With the caveats noted above, this is an incremental movement towards using open markets to secure lowest cost services for the grid.
Joseph Somsel 8.22.03
I didn't intend to rain on your parade - the concept has merit and is one of the better notions that have been floated lately.
Transmission lines have the characteristic that first cost is high but O&M is low. Once in operation, there is little or no management lattitude. That means that everything really depends on the construction contract bidding process and in the financing structure. Both are highly competitive industries already and it seems there is little opportunity for improvement. There also seems to be few technical advances on the horizon. Is anyone ready to put up risk capital for an underground superconducting transmission line?
The only possible improvements in the process short-term are in planning and approval process, really, how to appease or overcome the NIMBYs. Maybe the Mafia would be the organization with the competitive advantage.
However, the core issues remain - who owns and runs the New Mega Utilities -the RTOs - and to what end. In some ways you are just substituting the board of directors of the RTO for the state Public Utility Commissioners.
Thomas Lord 8.22.03
Absolutely true on the last point. I wrote a white paper for the Center for Advancement of Energy Markets (www.caem.org) looking at the differences between cost of service and open market structures. It is true that the RTOs look like "self-regulating" entities with authority delegated by the FERC (as opposed to PUCs). The commendable point is that - as you noted - the transmission cost structure is a much lower volatility price regime versus the fuel and other costs associated with generation. Therefore, the reality of the RTO acting as a monopoly buyer for transmission is likely to have much more favorable results than when the PUCs were monopoly buyers of a byndle or transmission and generation.
The referenced white paper pointed out why transmission is higly unlikely to be a viable investment in an opern market pricing structure - it really does require a cost of service based structure. The suggestion in this piece just accepts that as a starting point.
Barry Johnson 8.26.03
Analyses that consider transmission in isolation of fuel, generation, distribution are hampered by "myopic tunnel vision" because the electric system costs are a bundle of all the preceding components which are more interdependent for the majority of customers than most FERC wholesale constituents would like to recognize. For example, an RTO may make decisions based on a set of assumptions about where the power "is" versus where the load "is" based on the generating assets (and attendant fuel sources) in place. RTO's are going to have a real challenge accurately predicting where the "market" is going to place future generating assets and the sizing. The problem with that type of decision is that an RTO may frequently make a different choice for transmission investment if it understood where the next segments of least cost generation might be sited due to lower cost of fuel, construction, and O&M that ultimately results in lowest cost of generation. But the open market generators can't easily place a resource where the RTO's transmission system won't support its capacity to deliver the most low cost generation. Integrated utilities used to be responsible for looking at the whole picture with regulators reviewing their decisions and balancing the needs of all constituents. With deregulation, this analysis and decision making has been fractured amongst various parties without access to the whole picture because some of the information is proprietary to market players who don't want to cede the value of that information. The end result is the proposal for regulatory/market systems that appear to optimize a certain sector of the electric system while making it more difficult to optimize the whole bundle as an integrated system. I've been inside an IOU for 15 years watching the transformation of the industry from various assignments as a generation site evaluator, generation designer, fuel buyer, regulatory witness, and occasional legislative lobbyist. The 'new' system has created mostly chaos with few 'winners' (i.e. industrial customers, environmentalists, risk management practitioners) and many 'losers' (retail customers, stockholders, operating employees). Now the US is overdependent on natural gas fired generation, refuses to implement the technology to use its largest fuel resource, is naively depending on a future where renewables will save the day, and has a overly strained transmission system and an under-funded distribution system according to many outside industry analysts. I'm not impressed with deregulation as a customer, a stockholder, or an employee, in that order. I understand the logic of your system for transmission in isolation (even granting the political challenges for an RTO) but I contend that your proposed solution is one among many and not necessarily optimal for the US economy.
Joseph Somsel 8.26.03
While free markets have many advantages, they don't always work in every situation. We certainly don't leave national defense to the lowest bidder nor do we allow a market in sex in most jurisdictions. It's a case of "horse for course" and electricity needs, based on the physics of electricity and the technology of its generation and distribtion, central integration, planning, and control.
A major shortcoming of electricity markets is in accounting for externalities, both positive and negative. As Mr. Lord has cogently pointed out in prior pieces, someone must pay for reliability or we all pay for the unreliability. If the system develops a reputation for unreliability, if trust in electricity fades, then the social costs soar. Another major blackout (after California and now the Northeast), and major money will flow to backup generators and fuel oil storage tanks. Worst, productive investments in the US will flee to locations with better reliability.
Better to think of our electric infrastructure as a internal cost of doing business subject to management discipline rather than an independent marketplace depending on Adam Smith's "invisible hand" to keep the power lines humming. After all, it fails to meet one major assumption of a free market - the ability to withdraw. The users of electricity have few choices, especially with air pollution rules that limit fuel combustion. The suppliers are certainly not able to defer production, especially when supplies are tight. In California, high state officials where threatening prison to power generators who decided to not generate or who decided to sell out-of-state. If our past internal infrastructure management has slipped, and the former industry structure looks like the good ole days to most people, then the answer is do a better job of management.
Ultimately we have to decide if the $50 to $100 billion needed for upgrading our transmission system is a better investment than the social and economic disruption that a degenerate, unreliable system will yield. It's like a house with a leaky roof - fix it now or spend a fortune repairing water damage and living in fear of a rain cloud.
Thomas Lord 8.26.03
I wrote a white paper for the Center for Advancement of Energy Markets (www.caem.org) that looked at cost of service and open markets as transaction environments. I agree that the 1940-1970 period of cost of service regulation had massive social benefit to the country. HOWEVER, cost of service regulation requires a regime of low price volatility for the entire economy - not just electricity but also fuels, construction costs, labor costs, debt costs, etc. The paper examines why the cost of service regime becomes untenable in times of high price volatility for the INPUTS to the system. I agree that restructuring - not deregulation - has been a failed model because a.) everyone ignored that cost of service was a trading regime and did not examine the cause for its breakdown and how to manage those issues and b.) the underlying transactions for investment and operaiton of the system were not adequately laid out. This latest go around started by the Giga-NOPR may be the last chance to solve the problem. Volatility Managers has proposed solutions but the common response is that they are too complex or too expensive. The reality is that there is no "silver bullet" but rather a complex system that requires a dynamic and flexible system of managing the market.
David Robbins 8.26.03
It is an absolute necessity we find a feasible solution in a timely manner. This process must recognize the unique qualities of electricity as a product/commodity and the externalities that exist in its generation, transmission, and distribution. I am a free marketer, but I don’t want my national defense left to a company that is the low bidder. And when externalities exist, players will always try to find ways to get others to pay those costs. Decision makers, including congress, legislators, regulators, and interest group advocates must recognize the realities and near-term shortcomings a totally free market in electricity has and will produce. If the political reality is that we will not tolerate near-term market adjustments such as the California debacle, or another August 14th, we must manage (regulate) the process.
Mr. Lord’s use of RTO’s to solve the infrastructure problems is worthy of debate, but I believe regional interests well cause this option to languish. Technology can solve many or all of the problems but investors must have a reasonable level of return and reliability or that return.
One big factor that has hampered the electric industry in recent years is the fact that many regulators don’t feel obligated, morally, ethically, or legally, to abide by or recognize previous “commitments” amongst the players. If existing regulated utilities would be assured their investments in improving the infrastructure would be protected (at least being able to recover the cost of improvements) I am confident the industry will step up to the plate.
TERRY MEYER 8.27.03
Mr. Lords article raises some questions, which is great if it gets people thinking.
My first question is about changing ground rules. SOMEone will be on the hook for construction costs, right? Why would anyone want to take such a risk in this environment of every cost's having a full blown investigation or being disallowed completely? How can a business model be developed when revenue is unknowable? When voters see how much a fair rate of return will cost them, what’s to stop Big Government from throwing armies of lawyers at the risk taker (at taxpayer expense) until the risk taker settles for half a $Billion loss out of court rather than risk losing billion$ at trial? Who would do such a thing when there’s billion$ to be MADE in, say, consumer credit at quantifiable risk? Call me David Robbins, but look at all the money left on the table of cancelled power plant projects. Who, oh, who would take on a huge transmission project in such an environment?
Joseph Somsel brings up some interesting questions. Please excuse my post-8/14 negativity (yeah, it only started then, that’s the ticket). >>…would the capital costs and the operating expenses be shared over all RTO members?<< Of course not. Proportionally large political contributors will not pay their share. EVERY Reregulation scheme is cooked up purely to steal from the poor and give to the rich.
>>Do buyers of electricity pay the same as generators?<< Only if they have the same political clout. Buyers for corporations larger than AEP will pay less than generators. The rest of us will pay more than generators will.
>>California…governor sweep the board and installed his appointees.<< The ISO board that had 3 generator members but only one retail consumer rep and prices quadrupled and the lights still didn’t stay on? Dey oughtta recall da guy.
[Actually we DO leave national defense to the lowest bidder…unless one of President Cheney’s oil baron buddies wants the contract. Is everyone really okay with energy policy that can’t stand the light of day and has to be wonked in secret?]
If a power line builder could freely take it out of service without risk of condemnation, only then could she capture competitive prices. Couldn’t this be a start to a “cost of service” model? Years ago I heard of a company that wanted to build a transmission line along the Rockies almost from Canada to Mexico FOR FREE as a demonstration of their “few technological advances” (composite towers for one) but Big Brother would have nothing of it because the company wanted freedom to operate the line and charge market based rates. Don’t forget California’s plan to replace the Pacific AC Intertie with underground cables. Yeah, right. After the underground was in place I can just see them tearing down the overhead. NOT.
I know the engineering types don’t want to hear about politics, but, hey, that’s the realm into which electric power issues have been placed. Third party marketers brought us to this political place when they couldn’t shoehorn their way in any other way. Now they get a free ride on others’ transmissions lines and free voltage support and free frequency control and free oxygen for their plants and electric rates soar for the little guy.
Why can’t people realize that there is a limit to what small consumers WANT to pay for reliability. If Big Business needs a gold-plated grid, let THEM pay for it.
The future? When the voters finally get tired of this stagnant economy caused by our borrow-and-spend government they’ll elect tax-and-spend types who will build a grid at my expense, then turn it over to Big Business the same way that interstate highways subsidize the trucking industry. Whether it is paid for by middle class taxes or retail electricity, when the bill comes due the voters will oust the tax-and-spenders and elect the borrow-and-spenders who will neglect the whole system until we’re back where we are now.
Also, the grid will be built on a boom-and-bust basis – built on overtime with scarce (premium priced) materials, leaving many without careers when it’s “done” instead of being built economically and steadily with the efficiencies of an ongoing enterprise.
I can already sense eyes glazing over just like they did 20 years ago when I predicted this mess, so I’ll quit typing now.
Lloyd Weaver 8.27.03
Town health boards used to recruit individual private doctors to meet a town’s health care needs with large gaps in service and no accountability or continuity of records a common occurrence. Now we have a multi-town rural health center model and permanent facilities and medical records and regional board structures. It should be no surprise to anyone that this health care model was sponsored by the Federal Government, and it works.
It is definitely time for something more responsible as regards to regional grid investment and management, compensation for existing structures confiscated notwithstanding. The state PUC’s and existing grid control structures will consolidate and lose management control for the betterment of the whole just as town health boards lost control of meeting health care needs and doctor recruitment to new regional boards. This is what is going to happen because regional populations will not settle for anything less. Massive regional blackouts are not acceptable performance, period. And existing grid management structures have more than amply demonstrated they can’t solve the problem. Therefore, they will be replaced, and new, better, more logical management structures that can get the job done will take their place.
Patrick Burdett 8.27.03
It is clear that the really sticky question is who should pay for improvements.
But I am not so sure that market-based systems will not eventually work if locational marginal pricing schemes become widespread. Why won't the cost of congestion revenue rights send appropriate price signals to load centers and trigger transmission (or local generation) investment when it makes economic sense? We may be a long way from that kind of market efficiency today, and NIMBYism may be a wrench in the works, but in theory shouldn't the market self-correct?
Joseph Somsel 8.27.03
Maybe we should start using the word that really conveys the true meaning of separating generation, transmission, and distribution - DISINTEGRATION.
Thomas Lord 8.27.03
No, Patrick, LMP doesn't work for infrastructure investment. I hate to sound like a broken record but the white paper I wrote for CAEM (go to www.caem.org and look for White Paper for the Energy Infrastructure, Invetment and Incentives Forum - as of this morning it was linked from the banner on the right side of the home page) goes through the problem. Also, on the Volatility Managers web site (www.volatilitymanagement.com) and go to the NEWS page, there is a link to a presentation I made at the Alstom User's Group in June regarding why LMP doesn't work for grid infrastructure investment - I believe this is not just for transmission but is also for the NEXT required cycle of generation investment. Please feel free to contact us about further discussion as to why LMP works to dispatch the real options that are the Operation of the grid assets but not for the real options that are the investment in grid assets.
Jack Sprat 9.2.03
There have been hundreds of power engineers who tried to warn the industry, Congress and FERC that deregulation was leading to disaster as it was formulated. The engineers were ignored and often told to shut up or be fired. In frustration I wrote a book in an attempt to educate the American public. In the book "Power to the People" I predicted a wide-area blackout on the east coast before 2005 due to over stressing of the transmission system by deregulation. It took only two years from the publication date for the August 14 blackout to come to pass.
Now the powers will stack the deck with politically correct investigators to say that transmission is problem not electric power deregulation. Technically, they will be correct in saying that transmission failure was the cause of the blackout, but that's like saying that no one dies of aids, that they die of some kind of infection.
Deregulation was an ill-conceived plan that, as formulated, totally ignored the design of the transmission system. The political powers and FERC were warned but they chose to turn a blind eye to the coming problems.
Now the coverup begins.
I retired September 1, 2003 after 30 years as a professional engineer with the Federal Energy Regulatory Commission (FERC) and its predecessor the Federal Power Commission (FPC). I retired so that I might freely speak out against stupidity in the marketplace that masquerades as power engineering.
Jack Duckworth, CEO Expert Systems Programs and Consulting, Inc. and author of "Power to the People, Electric Power Deregulation, an Expose."
Thomas Lord 9.2.03
Thomas Lord 9.2.03
Let me try again.
Open market pricing for the transmission investment a viable solution in myopinion. The RTO structure makes a great deal of sense for creating regional deicsions, shared cost and engineering efficiency. The generation investment structure is actually efficiently handled as FAR AS RUNNING the plants with an LMP structure. An option market that allows existing generators, potential investors and end users to participate to determine the price that they are willing to pay for and provide energy to the grid also makes sense. I am not advocating - as someone once put it - "competitive regulation". Rather it is importanjt to recognize those components of the infrastructure system that have inherently long lead times and low cost volatility (transmission) and are therefore are more amenable to cost of service regulation and those components with short lead times and high cost volatility (generation and fuels) and manage them in an open market environment.
So your statement "deregulation was an ill-conceived plan that ... totallly ignored the design of the transmission system" would, in my opinion, be more aptly phrased "restructuring was a system that did not recognize the inherently different structures of the transmission and generation investment decisions. As currently instituted, restructuring can not create the investment necessary for a stable transmission grid. Furthermore, incentive structures and other systems that do not recognize the fundamentally different structures of the transmission and generaiton investment structure will, at best, waste a significant amount of money and, at worst, will not correct the problems."
Thomas Lord 9.2.03
One last try - the forst sentence should read "Open market pricing for the transmission investment is not a viable solution in my opinion."
Joseph Somsel 9.4.03
We all need to understand that in an electric system, generation, transmission, distribution, and end use are ALL highly inter-related and inter-dependent - in real time and over decades.
Economic theories taken from other commodities and applied to the electric system as presently instituted have not worked very well. The suspicion is growing amongst the voters that most of this theorizing has been at the service of special interests, bent on exploiting the commonwealth's existing infrastructure for corporate advantage or for ideological power (for the environmentalists.)
I'm as much a general free market believer as the next Republican, but I think I see the limits of markets in the case of electric power. Mr. Lord seems to be coming to the same conclusion for transmission, at least. There will be some economic innovation applicable to electricity supply but so far those sucesses have been few and far between. I will admit that political oversight of electricity has had its problems too but I would chose the devil we know over the one we know not.
Let's stop running social science experiments on our vital electricity supply - the risks outweigh the expected benefits for society.
Len Gould 9.23.03
Terry Meyer makes a good point which I don't see anyone talking about in this or any other forum. <>. It is certainly my experience that in Ontario since de-regulation and free market electricity (and gas), that my homeowner rates have gone up almost triple in less than 3 years. (I am, by luck, contracted to the CHEAPEST supplier choice). And I am expected to make rational multi-year choices between competing contract suppliers for a comodity I am in no way equiped to evaluate, and I used to manage the electric bills and systems at a large industrial plant.
Ontario uses very little natural gas to generate (1/3 nuke, 1/3 Hydro, 1/3 coal/oil/gas) so the huge rise in nat. gas prices I've seen on my heating bill shouldn't be the problem. Which rise, I suspect, has been caused by generation companies building all new additions as natural gas turbines instead of something which won't run out in ten or fifteen years. If the generator owners are not benefiting from the rate increase then it must be the <> who have the political clout to implement this stupid system. Here we taxpayers are stuck with paying off a huge stranded debt from the generation plants (difference between debt and "market" value at day of sale) while our per unit costs are going thru the roof.
I know that in "the good old days" the taxpayer was subsidizing the utility bill for the little guys, and much of the taxes are paid by big business. But I still think the old (government monopoly) way of running thing was a lot better, cheaper, reliable and sensitive.
The one problem, i guess, is that Ontario has to compete for industry with the US, so if the US looks we gotta jump. Right into the (soon freezing) lake.