Here's where FERC should have started with its transmission incentives review, except it got so excited by proposals for new incentives, the existing incentives ended up at the back of the rack as a mere afterthought. While not as exciting as FERC's proposals for new incentives, these still require a look because they are the source for all the "FERC candy" comments, and have driven many bad transmission ideas that are bankrupting consumers and causing increased opposition to bad projects.
ROE Adders for Transmission Only Companies: This incentive adds 50 points to a transmission company's return on equity. In people-speak, that equates to an additional half a percent of interest on a company's rate base. Rate base is the cost of projects that have not yet been repaid by consumers. When a project is completed, its total cost goes into the rate base and it is repaid to the transmission owner over the useful life of the asset (approximately 40 years for transmission). With transmission projects costing multiple billions, that extra half a percent interest on a balance that slowly depreciates over 40 years can add up to big bucks. So, the Commission wanted to give an incentive to independent transmission owners, who perhaps it felt needed a leg up to compete with incumbent utilities. Independent transcos also should not have any interest in generation or distribution companies that may cloud their thinking about what to build, nor compete for parent company investment dollars. Sounds good on the surface, but guess what happened when FERC put this into practice? Suddenly all the incumbents created spin-off companies that were supposedly "independent" in order to win that extra interest. These spin-offs enjoy parent company benefits, such as being able to borrow money at a low rate to finance the project, then collect extra interest on their borrowed "equity." If a parent can borrow at 3%, then use that money to inject "equity" into their transmission-only spin-off, they can earn maybe 10% (or more) on that money, while only having to re-pay the loan at 3%. That extra 7% is gravy for the parent company.
ROE Adders for Transmission Only Companies: This incentive adds 50 points to a transmission company's return on equity. In people-speak, that equates to an additional half a percent of interest on a company's rate base. Rate base is the cost of projects that have not yet been repaid by consumers. When a project is completed, its total cost goes into the rate base and it is repaid to the transmission owner over the useful life of the asset (approximately 40 years for transmission). With transmission projects costing multiple billions, that extra half a percent interest on a balance that slowly depreciates over 40 years can add up to big bucks. So, the Commission wanted to give an incentive to independent transmission owners, who perhaps it felt needed a leg up to compete with incumbent utilities. Independent transcos also should not have any interest in generation or distribution companies that may cloud their thinking about what to build, nor compete for parent company investment dollars. Sounds good on the surface, but guess what happened when FERC put this into practice? Suddenly all the incumbents created spin-off companies that were supposedly "independent" in order to win that extra interest. These spin-offs enjoy parent company benefits, such as being able to borrow money at a low rate to finance the project, then collect extra interest on their borrowed "equity." If a parent can borrow at 3%, then use that money to inject "equity" into their transmission-only spin-off, they can earn maybe 10% (or more) on that money, while only having to re-pay the loan at 3%. That extra 7% is gravy for the parent company.
Q 57) Does the Transco business model continue to provide sufficient benefits to merit transmission incentives? What information should an entity seeking a Transco incentive provide to demonstrate sufficient benefits?
Q 58) Should the Transco incentive remain available to Transcos that are affiliated with a market participant? If so, how should the Commission evaluate whether a Transco is sufficiently independent to merit an incentive?
Q 59) Should a Transco incentive be awarded on a project-by-project basis?
Q 60) Should the Transco incentive exclude assets that a Transco buys, rather than develops?
Another gravy-maker is the RTO/ISO membership incentive. Sec. 219 tasked FERC with developing incentives for transmission companies that JOIN an RTO/ISO, figuring that membership provided benefits to consumers. Can't change this now, it's in Sec. 219. The incentive FERC developed for this instance was another 50 points on the ROE. However, FERC interpreted Sec. 219 incorrectly in order to award the incentive to every transmission company that IS a member of an RTO/ISO. Therefore, companies that have been members for years are routinely awarded that extra interest just for maintaining their membership, something they were most likely going to do anyways. Providing extra interest isn't going to make or break RTO membership, except maybe in the case of a new entrant. In addition, the incentive may be awarded to multiple spin-offs and projects of the same parent company, based on one membership. The incentives for continued membership simply have to stop. It's a misinterpretation of Sec. 219 that costs consumers billions they wouldn't spend otherwise.
Q 61) Should the Commission revise the RTO-participation incentive?
Q 62) Should the Commission consider providing incentives other than ROE adders for utilities that join RTO/ISOs, such as the automatic provision of CWIP in rate base or the abandoned plant incentive for all transmission-owning members of an RTO/ISO? If so, what other types of incentives would be appropriate?
Q 63) If the Commission continues to provide ROE adders for RTO/ISO participation, what is an appropriate level for an ROE adder?
Q 64) Should the RTO-participation incentive be awarded for a fixed period of time after a transmission owner joins an RTO or ISO?
Q 65) Should the RTO-participation adder be awarded on a project-specific basis?
Q 66) In Order No. 679, the Commission found that “the basis for the incentive is a recognition that benefits flow from membership in such organizations and the fact that continuing membership is generally voluntary.” Should voluntary participation remain a requirement for receiving RTO/ISO incentives?
Transmission companies can also request an additional 50 points for using "advanced technology" in their transmission project. However, requests for this incentive have been few and far between. What exactly defines "advanced technology," and for what period of time is this technology actually "advanced" before it becomes routine? FERC created an impossible task of defining "advanced technology," and besides, transmission owners are a pretty staid bunch, preferring to use "technology" that would be recognized by Thomas Edison. More Tesla, less Edison.
Q 67) Why have few transmission developers sought transmission incentives for the adoption of advanced technology?
Q 68) Do NERC reliability standards affect the willingness of transmission developers to enhance existing transmission facilities by deploying new technologies because of concerns these technologies may increase the risk of standards violations?
Q 69) Are there any types of transmission incentives that could better encourage deployment of new technologies? If so, please describe them.
Now let's move on to the non-ROE incentives, incentives that do other financial things other than increase a transmission owners' ROE.
FERC's jammed several things into a topic called "Regulatory Asset/Deferred Recovery of Pre-Commercial Costs and CWIP". Pre-Commercial costs consist of a company's expenses that happen before FERC grants incentives and recovery of a transmission project's costs. So, that could include everything from the moment some transmission genius rolls out of bed with an idea for a new transmission proposal, and FERC rate approval (including all costs to seek that approval in the first place). This incentive allows the company to recover all these costs, plus interest, from consumers, generally over the first 5 years of rate recovery.
CWIP stands for "Construction Work In Progress," which is basically a holding account for the capital costs of building a transmission project. FERC's CWIP in Rate Base incentive allows the company to include its CWIP account in the Rate Base number upon which it earns a yearly return. Even though a transmission project has not yet been built, or completed, a company can earn a return on its investment. CWIP doesn't depreciate because the project has not yet gone in service, so this balance continually builds until the project's in service date, then it begins depreciating.
It's helpful to think of transmission finance sort of like a home mortgage you're familiar with. ROE is interest, and depreciation is principal. You pay interest for 30 years while your principal is slowly paid off during the term of the loan.
FERC doesn't ask many questions about these combined incentives... perhaps because they don't intend to change them at all, just expand them?
FERC's jammed several things into a topic called "Regulatory Asset/Deferred Recovery of Pre-Commercial Costs and CWIP". Pre-Commercial costs consist of a company's expenses that happen before FERC grants incentives and recovery of a transmission project's costs. So, that could include everything from the moment some transmission genius rolls out of bed with an idea for a new transmission proposal, and FERC rate approval (including all costs to seek that approval in the first place). This incentive allows the company to recover all these costs, plus interest, from consumers, generally over the first 5 years of rate recovery.
CWIP stands for "Construction Work In Progress," which is basically a holding account for the capital costs of building a transmission project. FERC's CWIP in Rate Base incentive allows the company to include its CWIP account in the Rate Base number upon which it earns a yearly return. Even though a transmission project has not yet been built, or completed, a company can earn a return on its investment. CWIP doesn't depreciate because the project has not yet gone in service, so this balance continually builds until the project's in service date, then it begins depreciating.
It's helpful to think of transmission finance sort of like a home mortgage you're familiar with. ROE is interest, and depreciation is principal. You pay interest for 30 years while your principal is slowly paid off during the term of the loan.
FERC doesn't ask many questions about these combined incentives... perhaps because they don't intend to change them at all, just expand them?
Q 70) Should the Commission continue to provide regulatory asset treatment and CWIP as incentives? Should these incentives be granted automatically to certain types of transmission projects? If so, how would the Commission determine what types of transmission projects?
Q 71) Should the costs of unsuccessful Order No. 1000 proposals be recoverable through regulatory asset and deferred pre-commercial cost recovery incentives? If so, what costs are appropriate for recovery?
Hypothetical Capital Structure -- Since rate setting begins before a transmission project is built and operational (remember, that guy rolling out of bed with an idea), FERC must set a capital structure long before it actually happens. It's hypothetical. A transmission owner's capital structure determines how much of the cost of the project is equity (money contributed or invested by the company out of its own funds) and how much is debt (money borrowed by the transmission owner to use to build the project). Defining this is necessary because equity earns the "Return on Equity" or ROE interest rate set by FERC, and debt earns at the rate the money is borrowed. Since the transmission company probably hasn't even borrowed the money, or set any real capital structure when rates begin, FERC has to guesstimate. A basic rule of thumb is that 50% of the cost of the project will be equity, and 50% will be debt. That is, half of the rate base earns at ROE rate, and half earns at debt rate. However, a transmission owner may request a different split of equity/debt, such as 60% equity to 40% debt. Obviously, this capital structure makes more money, right? FERC can grant an incentive allowing return at this higher rate before actual capital structure is set by the borrowing of money.
Q 72) Should the Commission continue to utilize hypothetical capital structures as a transmission incentive? If so, what entities should be eligible to apply for a hypothetical capital structure?
Q 73) Have hypothetical capital structures been effective in reducing the overall cost of debt by rendering the capital structure more predictable? Q 74) In what circumstances, if any, should hypothetical capital structure incentives granted to an entity also be authorized for that entity’s yet-to-be formed affiliates?
Q 75) Under what circumstances, if any, should hypothetical capital structures extend beyond the construction period?
Q 76) Should the Commission provide a consistent hypothetical structure (e.g., 50 percent debt and 50 percent equity)? Alternatively, should the Commission cap the equity percentage at some upper limit (e.g., 50 percent)?
Abandoned plant incentive. This one is a particularly bitter pill for ratepayers to swallow, where they end up paying for a transmission project that never actually gets built... and we're talking in the hundreds of millions of dollars, plus ROE over a set recovery period. FERC's abandoned plant incentive guarantees that the transmission owner can recover its sunk costs if the transmission project is cancelled through no fault of its owner. How does this happen? When a project is "ordered" by an RTO/ISO and later found not to be needed at all. This should be a very rare occurrence, but it's not. It's happening with more frequency, as RTOs stick their necks out ordering the unneeded projects proposed by their members. What happens to unneeded projects? They're opposed by affected communities. And what happens if the opposition is successful (and this also is happening with more frequency)? The project does not receive state siting and permitting approvals and is cancelled by the RTO, causing the transmission owner to abandon its project through no fault of its own. Nobody's at fault, nothing to see, pay the money and let's move on. What??? The only way to stop the proposal of bad projects is to make their owners responsible for their own failure. Instead, FERC makes ratepayers responsible for the faults of transmission owners and RTOs, when the ratepayers have been the voice of reason all along. This is truly absurd.
Q 77) Should the Commission grant the abandoned plant incentive automatically, rather than on a case-by-case basis? Under what circumstances might an automatic award of the abandoned plant incentive be appropriate?
Q 78) How, if at all, could the Commission grant the abandoned plant incentive without encouraging transmission developers to pursue unnecessarily risky transmission projects or take unnecessary risks in transmission development? Could such behavior be reduced if the developer shared some risk associated with the abandonment, e.g., 10 percent of abandonment costs? If so, what level of developer risk is appropriate?
Q 79) How should the Commission evaluate whether the costs of an abandoned facility were prudently incurred?
Accelerated depreciation -- Essentially, this allows the transmission owner to recover its costs quicker than the traditionally used "life of the project." If a transmission line is supposed to last 40 years, then its total cost is broken down into re-payment over 40 years (plus interest). Each component of a transmission project has a determined "life" of how long it's supposed to last before needing replacement. This sets a transmission line's depreciation schedule, the rate at which principal is paid back. But say a transmission owner wanted to recover the cost of a 40-year transmission line over a period of 20 years? Sure, the transmission owner would get its money back faster, but it would earn a lot less interest. This incentive has never been popular. Can you guess why?
Q 80) Should the Commission continue to consider accelerated depreciation as an incentive?
Q 81) Does the accelerated deprecation incentive provide meaningful benefits to transmission developers?
Q 82) Should the Commission grant an accelerated depreciation incentive with a generic depreciation period or continue to determine such a period on a case-by-case basis?
For the last in this series, we'll tackle the dregs of FERC's inquiry -- the mechanics and implementation of incentives. Coming soon....
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