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Holding RTOs Accountable
GUEST EDITORIAL
Joshua Z. Rokach
Holding RTOs Accountable
I. Background In March of this year, the Federal Energy Regulatory Commission (FERC) received comments on its proposal to establish performance standards (metrics) for regional transmission organizations (RTOs), the transmission grid operators the agency regulates.1 FERC’s request responds to recommendations in a report from the Government Accountability Office (GAO), which found the benefits of RTOs difficult to determine and their costs difficult to control. FERC’s action comes
Joshua Z. Rokach, a member of the Editorial Advisory Board of The Electricity Journal, worked as a partner in the energy and appellate practice groups at Balch & Bingham LLP from 2001 through 2009. Before entering private practice he served for 27 years in the federal government, 23 of them with the Federal Energy Regulatory Commission. At the Commission, he served for nine years each as an adviser to two commissioners as an attorney in the Solicitor’s Office. He graduated from Yale Law School and City College of CUNY. His occasional commentaries on deregulation issues solely reflect the author’s opinions.
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more than five years after a staff report, which tried to rebut criticism at that time that RTOs wasted money. FERC staff calculated the costs of forming and operating a basic RTO and recommended accounting changes for greater transparency. In 2005, FERC Order No. 668 imposed the staff’s recommended new accounting rules on RTOs. FERC’s current effort to promulgate performance standards for RTOs marks a major improvement over the approach the agency took in Order No. 668. Adopting specific requirements for RTOs addresses the problem of accountability more directly and forcefully than amending the Uniform System of Accounts. Some of the proposed metrics would accurately measure performance and have the potential to make RTOs efficient. owever, other proposed standards might prove detrimental to effective performance. Most important, FERC fails to ensure that RTOs will, in fact, perform efficiently. Nowhere does the proposal reward RTOs for meeting or exceeding the standards. Neither does FERC propose to penalize RTOs for falling short. Finally, FERC neglects to rank
H
each of the performance categories in order of importance. The agency could remedy these flaws and ensure that RTOs perform to the highest standards by adopting the innovations FERC promulgated in Order No. 2000. That landmark order created RTOs and sought to establish them as successful stand-alone transmission businesses.
II. FERC’s Proposed RTO Metrics In its request for comments, FERC explained that it acted on the recommendations of a GAO report to the Senate Homeland Security and Government Affairs Committee in the fall of 2008. Actually, the issue of RTO performance dates back to the creation of RTOs a decade ago, to the time of Order No. 2000. The problem became acute when the not-for-profit Midwest Independent Transmission System Operator spent freely and missed deadlines in trying to organize its operations. States complained and utilities petitioned FERC to withdraw from the organization. In response, FERC’s staff investigated a representative
1040-6190/$–see front matter # 2010 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2010.03.007
The Electricity Journal
sample of RTOs to determine the capital costs needed to establish an RTO and the annual expenses in running a basic market. The staff found that overhead ranged between $38 million and $117 million, with annual expenses ranging between $35 million and $78 million. The report concluded that these expenses had a minimal effect on customers’ energy bills. The staff recommended that FERC amend its accounting rules, to make the public aware of the reasonable nature of the costs of establishing and running RTOs.2 FERC mandated that RTOs create new accounts for investment and operating expenses. In doing so, the agency mistakenly sought to use disclosure as the means of controlling RTO costs. Order No. 668 stated, ‘‘The Commission expects that these changes in accounting and financial reporting will [provide] increased assurance that the costs [of RTOs] are both legitimate and reasonable. . . .’’3 Disclosure, however, can accomplish only so much. FERC’s accounting rules make public the expenses that the RTOs have incurred. Although sunlight is the best disinfectant – as Justice Louis Brandeis remarked – prevention works more effectively to keep costs in check. Performance standards provide RTOs incentives to spend wisely. Standards ensure periodic and accurate regulatory review of RTO spending. Publicizing costs through accounting does not. he GAO report laid the groundwork for reform. The
T
April 2010
report criticized FERC for failing to review RTO expense filings, for never conducting an empirical analysis of RTO benefits and for adhering to the view that the agency need not adopt performance standards to assure that RTOs serve the interests of their customers. As the GAO Report pointed out4: By developing standard performance measures . . . FERC could, over time, develop a more thorough
In mandating that RTOs create new accounts for investment and operating expenses, the agency mistakenly sought to use disclosure as the means of controlling RTO costs. empirical understanding of RTO performance and whether and to what extent RTOs have provided benefits to the industry and consumers. This could help FERC in evaluating its decision to encourage the creation of RTOs . . . Measures may also help FERC determine . . . where its RTO policy and RTOs themselves could . . . improve.
FERC has proposed 44 specific metrics within 14 general metrics, under the categories of reliability, market, and organizational effectiveness. Reliability metrics would involve matters such as: The total number of violations of reliability standards, both selfreported and uncovered, and the severity of each violation;
The number of brownouts and blackouts as well as the number of outages for planned maintenance scheduled sufficiently in advance; Variations between actual power flow and scheduled flow; Length of time to respond to interconnection requests from generators; The number of transmission facilities approved for ‘‘reliability purposes’’; The number of transmission facilities actually under construction, and The degree the RTO meets FERC’s open-access planning requirements. xamples of market standards include: The degree to which RTOs adopt locational marginal pricing (minute-by-minute pricing for each connection to a generator); The amount of congestion reflected in surcharges at times of limited capacity; The percentage of demand response (conservation), and The percentage of renewable energy flowing over the lines. Organizational effectiveness standards encompass: Administrative costs and cost overruns; Percentage of satisfied customers, and Billing controls. FERC also asked for comment on performance standards other parties suggested. These include: the dollar amount of fines RTOs paid for violations of reliability standards; the number of times RTOs impose price controls on
E
1040-6190/$–see front matter # 2010 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2010.03.007
93
generators; and the volume of electricity involved in the region or for particular locations.
III. Improving FERC’s Performance Metrics Performance standards for RTOs will work only if FERC adds these elements to its proposal. FERC must develop a mechanism to reward success and punish failure. In addition, the agency must prioritize its standards, in order that RTOs know the relative importance of each. FERC should embrace the forprofit model of Order No. 2000. The for-profit model would reward wise investment and efficient operation, which the not-for-profit has not. Successful companies reward investors, while poor performers induce shareholders to oust management. Experience supports this paradigm. In its second phase of implementing Order No. 2000, FERC decided that RTOs should operate as not-for-profit entities rather than for-profit transmission companies. In so doing, FERC created a situation in which it could not fine any RTOs for violations. That is because not-for-profits lacked the funds to pay meaningful fines. n addition, not-for-profit RTOs gain nothing from achieving
I
94
and exceeding performance standards. They lose nothing from failure. For that reason, in the original Order No. 2000, when FERC proposed innovative rates, including performance-based rates, it could only apply them to for-profit stand-alone transmission companies. Not-for-profit systems operators could not respond to economic incentives that might enrich or impoverish some of their members. Moreover,
FERC should embrace the for-profit model of Order No. 2000, which would reward wise investment and efficient operation, which the not-for-profit has not. not-for-profit entities encompass members with diverging interests. Satisfying one group, such as transmission owners, by spending money to upgrade facilities, would meet with opposition from other members, such as manufacturers, wanting low prices at all costs. Gridlock ensues. The proposed metrics fail to weigh the relative importance of the various categories. Making every standard equally important
dissipates the efforts of RTOs to assign limited resources to each category. Should the RTO focus on the short term ahead of the long term, or vice versa? Failing to give weight to performance standards makes it difficult to prioritize among the metrics and choose between conflicting goals. For example, imposing price controls will satisfy customers, but will create congestion by failing to provide sufficient funds to invest in expansion of facilities. FERC needs to guide RTOs in their choices. The agency should establish clear overall goals with prioritized performance standards. This mechanism will foster ingenuity on the part of the industry to most efficiently fulfill the needs of its customers.& Endnotes: 1. RTO/ISO Metrics, Docket No. AD1005-000 (Feb. 3, 2010). 2. Staff Report on Cost Ranges for the Development and Operation of a Day One Regional Transmission Organization, Docket No. PL04-16-000 (Oct. 2004) at ii–iii. 3. Accounting and Financial Reporting for Public Utilities Including RTOs, 113 FERC ô 61,276 (2005) at P. 4. Electricity Restructuring: FERC Could Take Additional Steps to Analyze Regional Transmission Organizations’ Benefits and Performance, United States General Accountability Office Report to the Committee on Homeland Security and Government Affairs, U.S. Senate (Sept. 2008) at 57.
1040-6190/$–see front matter # 2010 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2010.03.007
The Electricity Journal
Joshua Z. Rokach
Holding RTOs Accountable
I. Background In March of this year, the Federal Energy Regulatory Commission (FERC) received comments on its proposal to establish performance standards (metrics) for regional transmission organizations (RTOs), the transmission grid operators the agency regulates.1 FERC’s request responds to recommendations in a report from the Government Accountability Office (GAO), which found the benefits of RTOs difficult to determine and their costs difficult to control. FERC’s action comes
Joshua Z. Rokach, a member of the Editorial Advisory Board of The Electricity Journal, worked as a partner in the energy and appellate practice groups at Balch & Bingham LLP from 2001 through 2009. Before entering private practice he served for 27 years in the federal government, 23 of them with the Federal Energy Regulatory Commission. At the Commission, he served for nine years each as an adviser to two commissioners as an attorney in the Solicitor’s Office. He graduated from Yale Law School and City College of CUNY. His occasional commentaries on deregulation issues solely reflect the author’s opinions.
92
more than five years after a staff report, which tried to rebut criticism at that time that RTOs wasted money. FERC staff calculated the costs of forming and operating a basic RTO and recommended accounting changes for greater transparency. In 2005, FERC Order No. 668 imposed the staff’s recommended new accounting rules on RTOs. FERC’s current effort to promulgate performance standards for RTOs marks a major improvement over the approach the agency took in Order No. 668. Adopting specific requirements for RTOs addresses the problem of accountability more directly and forcefully than amending the Uniform System of Accounts. Some of the proposed metrics would accurately measure performance and have the potential to make RTOs efficient. owever, other proposed standards might prove detrimental to effective performance. Most important, FERC fails to ensure that RTOs will, in fact, perform efficiently. Nowhere does the proposal reward RTOs for meeting or exceeding the standards. Neither does FERC propose to penalize RTOs for falling short. Finally, FERC neglects to rank
H
each of the performance categories in order of importance. The agency could remedy these flaws and ensure that RTOs perform to the highest standards by adopting the innovations FERC promulgated in Order No. 2000. That landmark order created RTOs and sought to establish them as successful stand-alone transmission businesses.
II. FERC’s Proposed RTO Metrics In its request for comments, FERC explained that it acted on the recommendations of a GAO report to the Senate Homeland Security and Government Affairs Committee in the fall of 2008. Actually, the issue of RTO performance dates back to the creation of RTOs a decade ago, to the time of Order No. 2000. The problem became acute when the not-for-profit Midwest Independent Transmission System Operator spent freely and missed deadlines in trying to organize its operations. States complained and utilities petitioned FERC to withdraw from the organization. In response, FERC’s staff investigated a representative
1040-6190/$–see front matter # 2010 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2010.03.007
The Electricity Journal
sample of RTOs to determine the capital costs needed to establish an RTO and the annual expenses in running a basic market. The staff found that overhead ranged between $38 million and $117 million, with annual expenses ranging between $35 million and $78 million. The report concluded that these expenses had a minimal effect on customers’ energy bills. The staff recommended that FERC amend its accounting rules, to make the public aware of the reasonable nature of the costs of establishing and running RTOs.2 FERC mandated that RTOs create new accounts for investment and operating expenses. In doing so, the agency mistakenly sought to use disclosure as the means of controlling RTO costs. Order No. 668 stated, ‘‘The Commission expects that these changes in accounting and financial reporting will [provide] increased assurance that the costs [of RTOs] are both legitimate and reasonable. . . .’’3 Disclosure, however, can accomplish only so much. FERC’s accounting rules make public the expenses that the RTOs have incurred. Although sunlight is the best disinfectant – as Justice Louis Brandeis remarked – prevention works more effectively to keep costs in check. Performance standards provide RTOs incentives to spend wisely. Standards ensure periodic and accurate regulatory review of RTO spending. Publicizing costs through accounting does not. he GAO report laid the groundwork for reform. The
T
April 2010
report criticized FERC for failing to review RTO expense filings, for never conducting an empirical analysis of RTO benefits and for adhering to the view that the agency need not adopt performance standards to assure that RTOs serve the interests of their customers. As the GAO Report pointed out4: By developing standard performance measures . . . FERC could, over time, develop a more thorough
In mandating that RTOs create new accounts for investment and operating expenses, the agency mistakenly sought to use disclosure as the means of controlling RTO costs. empirical understanding of RTO performance and whether and to what extent RTOs have provided benefits to the industry and consumers. This could help FERC in evaluating its decision to encourage the creation of RTOs . . . Measures may also help FERC determine . . . where its RTO policy and RTOs themselves could . . . improve.
FERC has proposed 44 specific metrics within 14 general metrics, under the categories of reliability, market, and organizational effectiveness. Reliability metrics would involve matters such as: The total number of violations of reliability standards, both selfreported and uncovered, and the severity of each violation;
The number of brownouts and blackouts as well as the number of outages for planned maintenance scheduled sufficiently in advance; Variations between actual power flow and scheduled flow; Length of time to respond to interconnection requests from generators; The number of transmission facilities approved for ‘‘reliability purposes’’; The number of transmission facilities actually under construction, and The degree the RTO meets FERC’s open-access planning requirements. xamples of market standards include: The degree to which RTOs adopt locational marginal pricing (minute-by-minute pricing for each connection to a generator); The amount of congestion reflected in surcharges at times of limited capacity; The percentage of demand response (conservation), and The percentage of renewable energy flowing over the lines. Organizational effectiveness standards encompass: Administrative costs and cost overruns; Percentage of satisfied customers, and Billing controls. FERC also asked for comment on performance standards other parties suggested. These include: the dollar amount of fines RTOs paid for violations of reliability standards; the number of times RTOs impose price controls on
E
1040-6190/$–see front matter # 2010 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2010.03.007
93
generators; and the volume of electricity involved in the region or for particular locations.
III. Improving FERC’s Performance Metrics Performance standards for RTOs will work only if FERC adds these elements to its proposal. FERC must develop a mechanism to reward success and punish failure. In addition, the agency must prioritize its standards, in order that RTOs know the relative importance of each. FERC should embrace the forprofit model of Order No. 2000. The for-profit model would reward wise investment and efficient operation, which the not-for-profit has not. Successful companies reward investors, while poor performers induce shareholders to oust management. Experience supports this paradigm. In its second phase of implementing Order No. 2000, FERC decided that RTOs should operate as not-for-profit entities rather than for-profit transmission companies. In so doing, FERC created a situation in which it could not fine any RTOs for violations. That is because not-for-profits lacked the funds to pay meaningful fines. n addition, not-for-profit RTOs gain nothing from achieving
I
94
and exceeding performance standards. They lose nothing from failure. For that reason, in the original Order No. 2000, when FERC proposed innovative rates, including performance-based rates, it could only apply them to for-profit stand-alone transmission companies. Not-for-profit systems operators could not respond to economic incentives that might enrich or impoverish some of their members. Moreover,
FERC should embrace the for-profit model of Order No. 2000, which would reward wise investment and efficient operation, which the not-for-profit has not. not-for-profit entities encompass members with diverging interests. Satisfying one group, such as transmission owners, by spending money to upgrade facilities, would meet with opposition from other members, such as manufacturers, wanting low prices at all costs. Gridlock ensues. The proposed metrics fail to weigh the relative importance of the various categories. Making every standard equally important
dissipates the efforts of RTOs to assign limited resources to each category. Should the RTO focus on the short term ahead of the long term, or vice versa? Failing to give weight to performance standards makes it difficult to prioritize among the metrics and choose between conflicting goals. For example, imposing price controls will satisfy customers, but will create congestion by failing to provide sufficient funds to invest in expansion of facilities. FERC needs to guide RTOs in their choices. The agency should establish clear overall goals with prioritized performance standards. This mechanism will foster ingenuity on the part of the industry to most efficiently fulfill the needs of its customers.& Endnotes: 1. RTO/ISO Metrics, Docket No. AD1005-000 (Feb. 3, 2010). 2. Staff Report on Cost Ranges for the Development and Operation of a Day One Regional Transmission Organization, Docket No. PL04-16-000 (Oct. 2004) at ii–iii. 3. Accounting and Financial Reporting for Public Utilities Including RTOs, 113 FERC ô 61,276 (2005) at P. 4. Electricity Restructuring: FERC Could Take Additional Steps to Analyze Regional Transmission Organizations’ Benefits and Performance, United States General Accountability Office Report to the Committee on Homeland Security and Government Affairs, U.S. Senate (Sept. 2008) at 57.
1040-6190/$–see front matter # 2010 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2010.03.007
The Electricity Journal