Recent Developments Affecting Investment in New Generation

Richard J. Rudden, Senior Vice President & Managing Director, Enterprise Management Solutions, Black & Veatch Corporation

In the months since the Energy Policy Act of 2005 was passed, several new Final Rules have been passed by the FERC. At the federal level, these Rules implement new transmission pricing provisions, and require ITOs that oversee organized electricity markets to make long-term firm transmission rights available to all transmission customers.

WITH AN EXCESS IN GENERATING CAPACITY and no clear direction on industry structure, it was no surprise that industry participants waited last year with great anticipation for the final passage of the Energy Policy Act of 2005 ("EPAct 2005," or "the Act"). The Act not only provided for greater clarity in policy, but also for incentives that would arguably lead to a greater diversity of fuels to generate electricity and promote investment in the nation's transmission and generation infrastructure.

Of course, the Act passed amidst a cacophony of applause, criticism and controversy. Everyone knew, however, that regulatory initiatives—good, bad or indifferent—would be forged at the Federal Energy Regulatory Commission (FERC). Further, as both a direct and indirect consequence of the Act, state legislative bodies and regulatory agencies were also expected to implement new rules and regulations, designed to provide additional regulatory clarity and economic incentives. There is no doubt that the passage of the Act was a significant development for the industry, but what has happened since this watershed event?

Recent Developments–Federal Level

There have been several recent developments at the federal level that shed light on this question. These include:

• The issuance by the FERC of its Final Rule implementing new transmission pricing provisions.
• The issuance of the FERC's Final Rule pertaining to long-term transmission rights.
• The recent release by the FERC of its Notice of Proposed Rulemaking (NOPR) related to permits for the siting of interstate electric transmission corridors.

FERC's Final Rule Promoting Transmission Investments (Docket No. RM06-4-000; Order No. 679)

On July 20, 2006, the FERC issued a Final Rule relating to transmission pricing, entitled Promoting Transmission Investment Through Pricing Reform, which is aimed at creating new incentives for transmission investment and signals an increasing flexible transmission pricing policy. This Rule specifies incentives that the FERC will consider authorizing based on a case-by-case analysis of individual transmission project proposals. The following are important elements of this new Rule:

1. An incentive return on equity (ROE) for new transmission investment, both for traditional utilities and stand-alone transmission companies (TRANSCOS);

2. Full recovery of prudent construction work in progress (CWIP);

3. Expensing of prudent, pre-commercial operation costs;

4. Full recovery of prudently-incurred costs of abandoned facilities;

5. Use of hypothetical capital structures;

6. The potential to adjust the book value of transmission assets to reflect TRANSCO purchases and sales;

7. Accelerated depreciation;

8. Deferred cost recovery for utilities that were previously prohibited, as a result of retail rate freezes, from passing through the costs of new transmission investments; and

9. A higher return on equity for utilities that join and/or continue to be members of independent transmission organizations, such as regional transmission organizations and independent system operators.

The Rule also provides expedited procedures for FERC consideration of incentive ratemaking proposals.

FERC's Final Rule Pertaining to Long-Term Transmission Rights (Docket No. RM06-8-000; Order No. 681)

FERC also issued another Final Rule on July 20, 2006, entitled Long-Term Transmission Rights in Organized Electricity Markets, requiring independent transmission organizations that oversee organized electricity markets to make long-term firm transmission rights available to all transmission customers. This Rule contains the following elements:

1. A long-term firm transmission right should specify a source and sink, and a quantity of transmission capacity;

2. The long-term firm transmission right must provide a hedge against day-ahead, locational, marginal pricing congestion charges or other direct assignment of congestion costs;

3. Long-term firm transmission rights made feasible by transmission upgrades or expansions must be made available upon request to any party that pays for such upgrades or expansions;

4. Long-term firm transmission rights must be made available with term lengths (and/or rights to renewal) that are sufficient to meet the needs of load-serving entities;

5. Load-serving entities must have priority over non-load-serving entities in the allocation of long-term firm transmission;

6. A long-term transmission right held by a load-serving entity to support a service obligation should be reassignable to another entity; and

7. The initial allocation of long-term firm transmission rights shall not require recipients to participate in an auction.

FERC's NOPR Related to Permits for Siting Interstate Electric Transmission Corridors (Docket No. RM06-12-000)

Once a national interstate transmission corridor is designated by the U.S. Department of Energy (DOE) secretary, under provisions contained in the Act, the FERC has the authority to issue permits to construct or modify electric transmission facilities in such a corridor under certain circumstances. This NOPR, issued June 16, 2006, is entitled Regulations for Filing Applications for Permits to Site Interstate Electric Transmission Corridors. Its purpose is to solicit comments on FERC's proposed filing requirements and procedures for entities seeking to construct electric transmission facilities. This action represents another important step towards addressing barriers to investment in necessary transmission infrastructure that will foster the development of new generation facilities.

Recent Developments–State Level

A number of states have undertaken changes in their regulations, policies and practices to further improve the siting of new generation. Some of these actions actually pre-dated the passage of the federal act. Since these are too numerous to discuss here, we will address only one of the more notable initiatives. In 2005, the Wisconsin State Legislature passed two laws that directly impact the future investment in generation facilities within the state.

On May 2, 2005, Gov. Jim Doyle signed into law Senate Bill (SB) 79, which permits a utility proposing to purchase or construct an electric generating facility to apply to the Wisconsin Public Service Commission (WPSC) for an order specifying, in advance, the rate treatment that will apply to the plant over its economic life. The PSC is permitted to issue such an order if both of the following conditions are satisfied:

1. The order provides a sufficient degree of certainty to the utility, investors and ratepayers regarding future recovery of the facility's costs; and

2. The order is otherwise in the public interest. If the utility accepts the order, the specified rate treatment would be binding on the WPSC in all future rate proceedings, and the order could not subsequently be rescinded or altered; otherwise the WPSC would consider the costs of the facility in all future rate proceedings in a traditional manner.

On August 12, 2005, Governor Doyle also signed Assembly Bill (AB) 441, which modifies the criteria used by the WPSC in granting a Certificate of Public Convenience and Necessity (CPCN) for the construction of electric generating facilities. AB 441 eliminated the statutory provision that prohibits the WPSC from issuing a CPCN until the applicant has obtained all of the required construction permits and approvals. Also, AB 441 modified the criteria for a WPSC determination that an application for a CPCN is complete. Under the new law, if an application is complete in all other respects, the WPSC must determine that the application is complete even if one or more of the following apply:

1. The application includes some, but not all, of the information necessary to evaluate or approve the construction of related transmission facilities that may be constructed by a party other than the applicant;

2. The applicant proposes alternative construction sites that are contiguous or proximate, provided that at least one of the proposed sites is a brownfield site, or is the site of a former or existing facility; or

3. The applicant has not yet obtained all the permits or approvals required for constructing the facility.

Both pieces of legislation are expected to improve the ability of entities to finance new generation facilities within the state of Wisconsin. It will be interesting to see which other states follow Wisconsin's lead in this regard.

Future Outlook

These and other developments are gradually improving the environment in which generating projects must be conceived, planned, constructed, and financed. The combination of the generation- and transmission-related provisions of the Act combined with FERC's recent actions and other developments at the state level bode well for the future. The next 12-to-18-month period should prove illustrative of the real improvements that are possible in the development of future generation and transmission facilities. We remain cautiously optimistic that enhanced regulatory clarity and the removal of institutional barriers will lead to the investments required to meet the growing electric demands of our expanding economy.