Electricity Markets

Who really benefits from transmission incentives?

The Federal Energy Regulatory Commission is currently considering changes to its policies for awarding electric transmission rate incentives. In March, the Commission issued a notice of inquiry (NOI) that asked interested parties to weigh in on a broad range of incentive rate topics. The last round of comments was filed on August 26, and now the wait begins to see what, if anything, FERC will do.

The last time FERC revised its transmission incentive policies was in 2012, when it issued a policy statement that made it harder to get incentives, responding to concerns that the Commission had been too generous in awarding rate incentives, particularly return on equity (ROE) adders. While not perfect, the Association was generally pleased with the 2012 Policy Statement and grateful for the Commission’s willingness to revisit its incentive policy at the time.

The robust pace of transmission development over the past decade indicates that there is no need for FERC to loosen the incentive purse strings now to get transmission projects built. In fact, certain aspects of FERC’s incentive policies remain overly generous to transmission owners and in turn overly costly to consumers – such as the all-but-automatic ROE adders awarded to transmission owners in regional transmission organizations (RTOs) and independent system operators (ISOs).

The Association strongly supports transmission development that benefits consumers. Prudently planned and constructed transmission facilities can increase supply options, reduce congestion-related costs, integrate renewable resources, and promote grid reliability. But incentives should be reserved for cases where they have a meaningful influence on the decision to build a project and achieve those benefits for consumers.

Some have argued that, even though transmission investment has been at record levels in recent years, the Commission should revise its transmission incentive policy to promote the right types of projects. It is certainly important to pursue the most beneficial transmission investments, but this is what transmission planning is for. If the regional and interregional transmission planning process is not identifying the most beneficial and cost-effective projects, then that is a problem with the planning process — and FERC should not try to fix it through its incentives policy.

If FERC chooses to revisit its transmission incentive policy, then we want to make sure that the policy actually supports building beneficial transmission – and won’t just provide a windfall to transmission owners. If reconsidering the policy leads to relaxing the requirements for incentives, then it threatens to raise electricity bills for customers without yielding any benefits.

How we got here

Before 2005, inadequate transmission infrastructure caused many problems for public power utilities — lack of long-term transmission rights in RTO regions and exposure to congestion costs, difficulties in designating new network resources under Open Access Transmission Tariffs, and exposure to the potential exercise of transmission and generation market power.

Congress responded in the Energy Policy Act of 2005 by adding section 219 to the Federal Power Act (FPA), which required FERC to issue rules providing for certain kinds of transmission incentives. Section 219(a) makes it clear, however, that transmission incentives granted by FERC can only pass muster if they lead to consumer benefits in the form of enhanced reliability and/or lower power costs. Section 219 also provides that all incentive rates granted under the statute must meet the FPA’s just and reasonable rate requirements.

FERC adopted regulations implementing FPA section 219 in its Order Nos. 679 and 679-A, issued in 2006. FERC identified a number of different incentives that transmission owners could request for particular projects. The incentives fall into two categories: risk-reducing and return-enhancing. The risk-reducing incentives (such as allowing full recovery of costs associated with projects that are abandoned through no fault of the developer) promote transmission development by easing project financial risk. Return-enhancing incentives (such as ROE adders) can, in theory, help encourage investment in particularly challenging or risky projects.

FERC’s regulations require evidence that a transmission project will provide reliability or cost savings benefits to be eligible for incentives. Importantly, the rules also require utilities to show that the total package of requested incentives is tailored to address the demonstrable risks or challenges faced by the applicant in undertaking a project. This requirement to show that the incentives are actually designed to address project risks and challenges is crucial because it establishes a nexus between the incentives and the particular investment decision. Without such a “nexus” requirement, an incentive could end up being, as FERC put it, simply a “bonus for good behavior” that does not actually benefit consumers.

However, in practice, the Commission’s application of the nexus test for project-specific incentives ended up being too forgiving. In particular, companies were frequently awarded ROE adders for relatively routine projects. In early 2011, the Association joined with numerous other entities — including state commissions – in preparing a white paper that proposed improvements to FERC’s incentive policy. When FERC issued a notice of inquiry later in 2011, initiating a broad examination of its transmission incentive policies, we filed lengthy comments with a large group of fellow commenters, including many state commissions and consumer advocates.

The 2011 NOI resulted in the 2012 Policy Statement, in which FERC “reframed” the nexus test to establish an expectation that applicants would take all reasonable steps to mitigate the risks of a project, including requesting risk-reducing incentives and considering project alternatives, before seeking an incentive ROE based on a project’s risks and challenges.

Section 219 of the FPA also required FERC to adopt rules providing incentives to utilities that join an RTO or ISO. In response, FERC generally awards a 50 basis point ROE adder to each transmission owner that participates in an RTO or ISO. The adder is not limited to specific projects.

Responding to the NOI: Ensuring projects work for customers

The wide-ranging notice of inquiry could potentially result in significant changes to FERC’s incentive rules. A number of the policy changes under consideration would likely result in transmission cost increases without any corresponding benefit.

This is why the Association joined with other industry groups to respond to the NOI. As our comments explain, the Commission’s approach to evaluating project-specific incentive applications is generally sound. The 2012 Policy Statement’s emphasis on risk-reducing incentives has helped to strike an appropriate balance between consumer and investor interests in awarding incentives. We also recommend a number of improvements to the current framework.

Some of the main points included in our comments are described below.

When FERC grants incentives, there has to be some assurance that the project will benefit consumers by ensuring reliability and reducing the cost of delivered power by reducing transmission congestion. That is the cornerstone requirement of section 219.

The Commission’s current requirement to demonstrate that requested incentives are tailored to project risks and challenges is crucial to establishing a nexus between the incentive and the project investment decision. This “risks and challenges” framework helps ensure that FERC does not hand out incentives that are unnecessary and can’t affect investment decisions.

We don’t support changes to FERC’s policies that would award incentives based only on the benefits that a project is expected to provide, such as reduced congestion or increased flexibility, security, and resilience. Demonstrating project benefits is already a prerequisite for awarding incentives under FPA section 219, and evidence of these benefits alone is not sufficient to justify incentives under the just and reasonable standard.

The Association supports elimination of the ROE incentive adder for RTO/ISO members. Again, to satisfy the just and reasonable standard, there has to be evidence that the incentive is actually inducing action. There is not much evidence that the adder is actually affecting utilities’ decisions to participate in RTOs and ISOs. It seems to us that the adder has become much more like the prohibited “bonus for good behavior” rather than a true incentive. At a minimum, the RTO/ISO adder should be phased out over time.

Project-specific ROE adders should generally sunset after 15 years. Nothing in FPA section 219 requires that incentives (particularly ROE adders) remain in place for the life of a project. The passage of time and changing conditions make it difficult to isolate and identify benefits associated with a particular transmission investment to justify ongoing incentives.

The Commission should enhance its existing policy for promoting joint ownership opportunities for public power utilities. FERC has recognized and promoted the benefits of including public power utilities and electric cooperatives in joint ownership arrangements for transmission projects. FERC should strengthen its current encouragement of joint ownership within the current incentive framework by requiring incentive rate applicants to show whether they have considered joint ownership arrangements. Any project for which joint ownership arrangements may have been feasible but were not pursued should face heightened scrutiny in seeking incentives.

The Commission should not award incentives automatically – case-by-case evaluation remains appropriate. FERC should not pursue the idea that some incentives, such as the risk-reducing abandonment incentive, should be awarded automatically to transmission projects considered and approved in a regional transmission planning process. For sure, regional planning process review provides some assurance that a project will be beneficial and also reduces the chance that a developer will take on unnecessarily risky projects in reliance on the abandonment incentive. But case-by-case review of incentives still plays an important role in ensuring that customers will benefit.

I liken this to a daily routine in my house: I trust my 10-year old to pack her own lunch, but that doesn’t mean I can’t check to see what she packed. Local and regional entities should have the opportunity to review incentive applications at FERC, even for projects approved in the planning process, to be able to look under the hood of proposed projects and ensure their customers will benefit.

Although FERC’s notice of inquiry discusses potentially significant changes to the Commission’s policies for project-specific incentives, our advice is “if it ain’t broke, don’t fix it.” The framework established in the 2012 Policy Statement for evaluating project-specific incentives is generally working fine, and transmission is getting built. Focusing on the planning process is likely to be more beneficial than pursuing incentive rate changes.