February 09, 2021

Swallowing the Rule: Why FERC’s “Immediate Need Exemption” Frustrates Competitive and Climate-Smart Electricity Sector Transmission Planning under Order No. 1000

Philip Killeen

Introduction

On October 17, 2019, the Federal Energy Regulatory Commission (FERC or the Commission) initiated a section 206 proceeding to consider whether ISO New England Inc. (ISO-NE), PJM Interconnection, L.L.C. (PJM), and Southwest Power Pool, Inc. (SPP) were improperly using the exemption for immediate need reliability projects (the Immediate Need Exemption) permitted under Order No. 1000’s requirement to eliminate a federal right of first refusal for electricity transmission infrastructure projects. In theory, this exemption was designed to balance the Commission’s obligations to provide reliable and low-cost service to customers by allowing incumbent transmission providers to avoid competitively bidding for transmission projects in limited circumstances where necessary to avoid delays that could endanger reliability. In practice, however, the Immediate Need Exemption has effectively negated the Commission’s efforts to eliminate the right of first refusal, resulting in non-competitive bids from incumbent transmission providers winning the vast majority of new transmission infrastructure projects in ISO-NE, PJM, and SPP. An important consequence of this trend is that certain transmission resources capable of reducing greenhouse gas (GHG) emissions in the electricity sector are being underutilized.

In this paper I argue that the Immediate Need Exemption is inconsistent with the Commission’s duties under the Federal Power Act (FPA) to ensure just and reasonable, and not unduly discriminatory, rates and practices in interstate transmission markets. Because, as implemented, the exemption foregoes substantial consumer savings, unnecessarily restricts nonincumbent transmission developers from participating in competitive project solicitations without demonstrable reliability benefits, and frustrates the Commission’s intent to facilitate states’ legitimate policy preferences for reducing electricity sector GHG emissions, its use should be significantly circumscribed. This could be done either by shortening the time frame denoting project “immediacy,” focusing on a project’s in-service date rather than its need-by date, or removing the exemption altogether.

Background

Congress enacted the FPA in 1935, vesting the Federal Power Commission—the Commission’s predecessor—with authority to regulate the wholesale sale and transmission of electricity in interstate commerce. Pursuant to this authority, the Commission was tasked with ensuring that all rates received by public utilities for the transmission or sale of electricity under its jurisdiction (and all regulations affecting such rates) be “just and reasonable” and not “grant any undue preference or advantage” or “maintain any unreasonable differences in rates, charges, service, facilities . . . between localities or . . . classes of service.”

Initially, the Commission fulfilled this mandate in partnership with state and local public utility commissions, which granted electrical utilities monopoly franchises to generate, transmit, and distribute electricity to a captive customer base in return for a guaranteed rate of return based on their cost of service. A significant drawback to this approach was that utilities had a strong incentive to unnecessarily maximize investments in grid infrastructure to ensure a higher guaranteed rate of return based on their cost of service. Recognizing this trend, the Commission introduced a series of orders beginning in the late 20th century, predicated on the understanding that elements of the electricity sector could achieve more efficient (and therefore more “just and reasonable”) outcomes for consumers by introducing new technologies and competition.

One such example is Order No. 1000, which reformed the Commission’s transmission planning and cost allocation requirements for public utility transmission providers. The rule introduced three new requirements for transmission planning: (1) each public utility transmission provider must join a transmission planning region that proactively identifies the need for transmission on a region wide basis; (2) such transmission planning regions must identify and plan for transmission needs driven by public policy, including the climate-related priorities of the states in which the individual utilities are located; and (3) neighboring transmission planning regions must “coordinate” with each other to evaluate whether interregional transmission facilities could more efficiently or cost-effectively address identified transmission needs. Acknowledging that nonincumbent transmission developers may be more capable of providing these solutions than incumbent utilities, the Commission also stipulated that public utility transmission providers must remove from their tariffs any “federal right of first refusal,” which grants an incumbent utility the right to build any new transmission facilities called for in regional transmission planning. In so doing, the Commission explicitly sought to foster competition between incumbents and nonincumbents in soliciting bids for transmission infrastructure projects called for in regional planning.

Discussion

The Commission’s effort in Order No. 1000 to introduce competition into transmission markets is laudable and consistent with its gradual recognition of the benefits of competition in electricity generation markets. Unfortunately, however, these benefits are undermined by the Immediate Need Exemption—an exception threatening to swallow the rule prohibiting federal rights of first refusal for transmission projects, along with any associated economic and environmental benefits.

1. The Immediate Need Exemption is Unjust and Unreasonable Because its Use has Resulted in Few Competitively Awarded Projects and Significant Lost Consumer Savings

In their Order No. 1000 compliance filings, ISO-NE, PJM, and SPP each proposed a “limited exemption for immediate need reliability projects,” whereby a Regional Transmission Organization (RTO) would be given discretion to determine whether there is sufficient time for a transmission project called for in its regional transmission planning to be competitively awarded. In approving these proposals, the Commission sought to create a class of transmission projects to be built by incumbent transmission developers that were exempt from the competitive bidding project solicitation process. In concluding that the Immediate Need Exemption was just and reasonable, the Commission balanced several considerations. On one hand, the Commission recognized that the exemption would necessarily act as a barrier to potentially competitive transmission resources provided by nonincumbent transmission developers and that “it is not in the economic self-interest” of incumbent utilities to expand transmission infrastructure to permit access to competing sources of supply. On the other hand, the Commission recognized potential delays in the competitive bidding process for transmission projects could adversely affect an RTO’s ability to ensure grid reliability.

Eight years of experience with the Immediate Need Exemption demonstrates that the Commission has not appropriately balanced these conflicting interests. Since implementation of the order, FERC-jurisdictional ISOs and RTOs have invested approximately $17 billion per year in transmission investments, with annual growth in investment ranging from 10 to 16 percent. However, as a result of the Immediate Need Exemption, FERC-jurisdictional ISOs and RTOs have only completed thirty-one competitive transmission project solicitations, only twenty-one of which have actually resulted in competitive projects. Put differently, 97 percent of all FERC-jurisdictional transmission investments occur outside the competitive process in which nonincumbent transmission developers may compete. Market research suggests this is not due to a lack of investor interest in nonincumbent transmission projects. Indeed, Commission staff found that nonincumbent transmission developers accounted for 47 percent of all bids in competitive solicitations from 2013 to 2016.

Experience in FERC-jurisdictional ISOs and RTOs suggests that increased use of competitive transmission project solicitations could reduce investment costs by an estimated 25 percent while increasing investment cost-effectiveness. To date, the average cost of transmission project proposals selected in competitive solicitations fell 40 percent below the initial project cost estimates prepared by ISOs and RTOs and the lowest-cost offers from incumbent transmission developers. This downward price pressure reflects the significant interest and participation in competitive processes by unique market participants. Unsurprisingly, then, research suggests ISOs and RTOs could save electricity consumers $8 billion over five years by expanding the scope of competitively solicited processes from 3 to 33 percent of all planned U.S. transmission investments.

Furthermore, unlike projects developed under the Immediate Need Exemption, many proposals selected through competitive solicitations included cost control measures that serve to insulate customers from the risk of cost escalation. While certain cost escalations relating to inflation, routing adjustments, or environmental permitting may be unavoidable for any transmission project, the Commission expects that such escalations will be smaller in competitively solicited projects due to the additional due diligence conducted by bidders.

2. The Immediate Need Exemption is Unduly Discriminatory because its Eligibility Criteria Unnecessarily Restricts Nonincumbent Transmission Developers From Participating in Competitive Project Solicitations without Demonstrable Reliability Benefits

To ensure that the Immediate Need Exemption was used only in limited circumstances, the Commission established criteria limiting a RTO’s discretion to grant the exemption; the most important of which required the project to be needed within three years to resolve the reliability concern. The Commission subsequently determined that the appropriate date to calculate whether a transmission project qualifies for the Immediate Need Exemption is the date that the reliability need must be addressed rather than the date when the project is actually in-service. When narrowly construed to be satisfied only when a project is truly needed in-service within three years of its approval, this criteria could serve a valuable function in ensuring grid reliability. As implemented, however, the three-year time sensitive need criteria has acted as a rubber stamp, allowing incumbent transmission developers to circumvent competitive project solicitations.

This dynamic is most prevalent in ISO-NE, where projects qualifying for the Immediate Need Exemption have been “plagued by significant delays.” Since implementation of Order No. 1000, all thirty of ISO-NE’s completed and ongoing transmission projects were designated as needed for grid reliability within the next three years. Accordingly, each qualified for the Immediate Need Exemption and was awarded to incumbent transmission developers without a competitive solicitation. However, of these thirty projects, twenty-four (80 percent) were not in-service within three years, while half are expected to take at least five years to complete. Similarly, SPP designated a project for the Immediate Need Exemption in 2018 based on its determination that the project was “needed” by 2020, but has an expected in-service date in 2023. Meanwhile, none of SPP’s other Immediate Need Exemption projects have gone in to service, including those with “need-by” dates in the past. Finally, of the thirty-nine transmission projects designated by PJM for the Immediate Need Exemption in 2014, only 72 percent have gone into service within three years of their “need-by” dates.

The fact that so many transmission projects in these regions qualify as time-sensitive yet are not sensitive enough to actually be built on time, suggests that incumbent transmission developers are not actually using the Immediate Need Exemption to ensure grid reliability, but rather as an anticompetitive measure to erect barriers to the participation of nonincumbent transmission resources. The urgency of these projects is further undermined by the RTOs’ repeated assertions that their grids continue to operate reliably with existing transmission infrastructure.

3. The Immediate Need Exemption Frustrates ISO-NE, PJM, and SPP States’ Legitimate Policy Preference for Low Emissions Electricity Generation

Order No. 1000 requires RTOs and ISOs to proactively identify and plan for region wide transmission needs driven by public policy. This, the Commission concludes, will help ensure that the rates, terms, and conditions for wholesale sales and transmission of electricity are just and reasonable and not unduly discriminatory against stakeholders unrepresented among incumbent transmission developers. Many states are seeking to reduce electricity sector greenhouse gas (GHG) emissions by implementing renewable portfolio standard (RPS) policies that seek to transition from fossil fuel to renewable-based electricity generation. In ISO-NE, each constituent state has implemented RPS policies, with 2020 targets ranging from 10 to 59 percent of electricity supplied from renewable energy. Washington, D.C., and ten of the thirteen states comprising PJM’s membership have implemented RPS programs. Finally, nine of SPP’s fourteen member states have also implemented RPS programs.

In practice, eliminating the federal right of first refusal serves states’ RPS policies because it forces RTOs and ISOs to consider proposals from nonincumbent transmission developers that provide ancillary environmental benefits. The Commission’s definition of “nonincumbent transmission developers” includes entities that propose transmission projects outside of their existing retail distribution service territory or that lack a distribution service territory altogether. A transmission project developer from a neighboring RTO or ISO and an owner of battery storage infrastructure that is capable of providing transmission services would therefore both qualify as “nonincumbent transmission developers.” Accordingly, by prohibiting a federal right of first refusal, Order No. 1000 encourages regional interconnection of transmission systems and investment in battery storage technologies.

Regionally interconnected transmission networks and battery storage technologies are particularly important for variable renewable energy resources because they transmit electricity between different markets and help diversify a region’s resource mix, helping address some of the challenges associated with intermittency and curtailment. Indeed, studies indicate that, with a nationally interconnected grid, the United States could reduce power sector GHG emissions by 80 percent relative to 1990 levels through renewable energy and natural gas without the need for battery storage or an increase in the levelized cost of electricity. Most importantly, regionally interconnected transmission markets allow states to source in-state electricity consumption from renewable energy, and thereby meet RPS targets, when intrastate generation facilities are otherwise insufficient. Because the Immediate Need Exemption has substantially frustrated the ability of non-incumbent developers to participate in planned transmission investments in FERC-jurisdictional RTOs and ISOs, it effectively negates the Commission’s intent in Order No. 1000 to facilitate state public policy goals in the electricity sector.

Conclusion

As poignantly put by Phil Sharp, former chairman of Congress’ Energy and Power Subcommittee, “reliability is the last refuge of scoundrels.” Lacking robust and objective criteria for project urgency, the Immediate Need Exemption has become susceptible to misuse by incumbent transmission developers seeking to corner out competition. This misuse has foregone substantial consumer savings, unnecessarily restricted non-incumbents from participating in transmission markets, and frustrated states’ legitimate policy preferences for reducing electricity sector GHG emissions. Accordingly, the Immediate Need Exemption is inconsistent with the Commission’s duties under the FPA to ensure just and reasonable, and not unduly discriminatory, rates and practices in interstate transmission markets.

Nonetheless, it remains important to reserve flexibility for grid operators to address urgent and unexpected reliability threats. In such situations, incumbent transmission developers may be better positioned to quickly and affordably provide needed infrastructure than nonincumbents. Therefore, aside from eliminating the Immediate Need exemption entirely, the Commission should also consider whether the exemption would be more appropriately used if the time frame denoting project “immediacy” was shortened from three years or if projects were selected on the basis of their in-service date, rather than their need-by date.

    Philip Killeen

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    Philip Killeen is a 3L at American University Washington College of Law who will work for the Energy & Infrastructure Projects practice at Skadden, Arps, Slate, Meagher, & Flom LLP after graduating.