Commission Watch
T&O Rates: Premature End to A Good Thing?
Solving the dilemma.
April 2004
By John Seelke
The rationale from the Federal Energy Regulatory Commission (FERC) for eliminating through-and-out (T&O) rates while simultaneously imposing a Seams Elimination Charge/Cost Adjustment/Assignment (SECA) is an acknowledgement that FERC is conflicted on a fundamental economic principle: regional transmission organization (RTO) loads use the transmission systems of exporting RTOs; therefore, it is correct for importing customers to compensate exporting RTOs for the use of their transmission systems. It is unfair for importing loads to get "free" transmission service from neighboring exporting RTOs. At the same time, FERC is convinced that T&O rates have a negative impact on electricity markets. As a result, FERC wants to eliminate direct T&O charges while at the same time compensating exporting transmissions systems through inefficient uplift charges.
This view was first expressed by FERC in its Notice of Proposed Rulemaking (NOPR) in 2002.1 FERC proposed eliminating T&O charges, instead charging all customers in an importing region for the exporting region's embedded transmission costs associated with imports. This would be done on an after-the-fact basis based upon the amount of power the region imported. But customers-not regions-import power.
To illustrate, suppose a customer in an RTO has purchased power to save $1.00/MWh in power costs. The exporting region's transmission provider would be paid its embedded transmission cost (say $2.00 per MWh) by all customers in the importing RTO. The cost of one customer's import decision ($2/MWh) would be socialized and disconnected from the purchase decision that caused that cost. How is that economically efficient?
The SECA mechanism is similarly inefficient. It will mean that customers who have historically imported power will continue to bear the cost of past T&O charges during the transition period, whether or not they import power during the transition period.
Is this just and reasonable? Administrative surrogates for direct charges are not consistent with the principles of efficient pricing.
Fortunately, the SECA is transitional. The two-year transition period "is sufficient time for the parties to establish a permanent rate design that efficiently prices transactions for inter-RTO pricing in the PJM/MISO footprint.",2 FERC's action therefore is an interim action to a new, yet undefined, end-state. A permanent solution should also address one of the most vexing problems in pricing inter-regional power transfers: pricing parallel-path flows. In fact, in its NOPR, FERC addressed this problem with an invitation for comments:
"To the extent that the commission adopts a true-up methodology for recovering the costs of through-and-out services, should a similar pricing methodology be applied to parallel path flows? Parallel path flows are comparable because one region benefits by the use of a neighboring region's transmission system. Parallel path flows currently are resolved through cooperation. An alternative method would be to price all uses of the grid. We seek comment as to how cost impacts of parallel path flows across regional borders should be addressed."3
The Answer: Pricing Parallel-Path Flows With T&O Rates
Methods for parallel-path pricing were addressed in the 1997-1999 General Agreement on Parallel Paths (GAPP) experiment, whose results were reported in Final Report: General Agreement on Parallel Paths Experiment, Aug. 31, 1999.4 The GAPP experiment revealed the magnitude of the parallel-path pricing problem for both "through" and "out" transactions.5 The experiment focused on through transactions among four companies that participated for the entire two years: First Energy, Allegheny Power Service Corp. (on behalf of its operating utilities), Southern Company Services Inc. (on behalf of its operating utilities) and Ontario Hydro. Most through transactions were subject to revenue redistribution among participants based upon how much of each transaction flowed on their system. The "through" charges collected by one company-the contract path transmission service provider-were redistributed.
The experiment concluded that under large-scale implementation, 69 percent of revenue would have been allocated to other than the contract-path provider. For "out" transactions, one week of actual transactions were monitored. For this small sample, 41 percent of the power flowed on the direct-connect interface between control areas, with the remaining 59 percent flowing on other system interfaces.
The simplicity of the revenue redistribution approach used in the GAPP experiment is that it required no change in the business format for transmission service. The contract-path provider was the seller of transmission service, charging its posted transmission rates. However, its collections were redistributed based upon flows.6 In cases where a transmission provider was not the contract path provider, it would receive revenues based upon the flow impact of specific transactions on its facilities. In addition, the method used in the GAPP experiment could be implemented throughout the Eastern Interconnection using the NERC Interchange Distribution Calculator.
The experiment tried two revenue redistribution methods, but the final report concluded that an untried third method would work best. This method-referred to as the "1-keep" method-would work as follows:
- The contract-path transmission service provider would retain a fraction of the contract-path revenue equal to the portion of the transaction that flowed on its system. This portion is defined as its transaction participation factor (TPF).
- The remaining non-contract-path transmission service provider (TP) would receive the residual contract-path revenue in accordance with this formula:
[TP Transmission Rate x TP TPF) / Sum of TP Transmission Rate x TP TPF]
The example below shows how the 1-keep method would work for a hypothetical transaction where Transmission Provider B is the contract-path provider (see Figure 1).
Transmission Provider B would receive 35 percent of the revenue, corresponding to its TPF of 0.35. The remaining revenue is distributed in accordance to the formula. TPs with the lower transmission rates would receive proportionately less revenue than their TPFs (e.g., D), while TPs with the higher transmission rates would receive proportionately more than their TPFs (e.g., C).
In today's regulatory environment, transmission service providers may be RTOs (such as MISO and PJM) or utilities affected by RTOs. The method described above would work well with a mixture of providers. If the transmission service provider were an RTO, the revenues it collected would need to be allocated to its customers. For RTOs with zonal rates (such as MISO and PJM) the revenues could be allocated directly to the zones with the affected facilities. Of course, some type of cooperative agreement between transmission service providers would be necessary for this model to work. The GAPP experiment had such an agreement and would be an excellent place to start.
FERC's two-year transition period sets the stage for better pricing methods to be developed. The lessons learned from the GAPP experiment are certainly applicable to this goal. Let the dialogue begin.
Endnotes
- Docket No. RM01-12-000 Notice of Proposed Rulemaking (NOPR), July 31, 2002, paragraphs 179-189.
- Docket Nos. EL02-111-004, et al., Nov. 17, 2003, 105 FERC 61,212, 75
- Docket No. RM01-12-000, op. cit., paragraph 190.
- Available at: ftp://www.nerc.com/pub/sys/all_updl/docs/archives/GAPP_exper_report_1999.pdf. Also filed in FERC Docket No. ER97-697-003, Sept. 1, 1999.
- "Through" transactions involve an intermediate "through" control area connecting the sellers' control area and the buyer's control area. "Out" transactions are transactions between directly-interconnected control areas.
- Ancillary services revenues not redistributed.
John Seelke is vice president, Consulting, with New Energy Associates. He advises clients on RTO and transmission service matters. Contact him at 770-779-2816, or jseelke@newenergyassoc.com.
Background: Why FERC Eliminated T&O Rates
As was reported in the January 2004 issue of Public Utilities Fortnightly ("Commission Watch," pp. 20-30), FERC has ordered the elimination of through-and-out (T&O) rates between MISO and PJM and replaced the rates with a Seams Elimination Charge/Cost Adjustment/Assignment (SECA). The SECA will compensate exporting transmission owners by charging importing loads for their lost revenues over a two-year transition period. Lost revenues will be based upon historical usage: a 2002 test period for the first transition year, and a 2003 test period for the second transition year. Charges to loads will be based on their historical usage derived from NERC tag data. FERC's rationale for eliminating T&O rates is succinctly stated. According to FERC, T&O rates, when applied to transactions sinking in an RTO, would: "(1) violate the fundamental requirement of Order No. 2000 that RTOs eliminate rate pancaking over a region of appropriate scope and configuration; (2) obstruct the realization of more efficient and competitive electricity markets in the region; and (3) result in unjust, unreasonable, and unduly discriminatory or preferential RTO rates."
Docket Nos. EL02-111-004, et al., Nov. 17, 2003, 105 FERC 61,212, paragraph 9.
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