REMARKS OF STEWART E. FARRAR,
SOLICITOR GENERAL,
STATE CORPORATION COMMISSION
TO THE SB 1269 LEGISLATIVE TRANSITION
TASK FORCE

July 13, 1999

Update on Significant Commission Activities

A. SCC Proceeding on Regional Transmission Entities

In my last appearance here, I mentioned to you that the SCC had initiated a proceeding seeking comments on questions relating to regional transmission entities. We now have received a number of comments, from the utilities, industrial customers, rural cooperatives, private citizens, the Southern Environmental Law Center, and the Virginia Independent Power Producers. We also were pleased to receive comments from a number of potential new entrants into the electric market in Virginia, including Dynegy Market and Trade, one of the nation's largest independent electric marketers, and the Electric Power Supply Association, which is the national trade association for independent generation competitors. Of course, the comments represent diverse opinions; responsive comments are due July 15.

B. SCC Intervention at FERC in the Alliance Proceeding

The SCC is obligated by the new statute to participate in all FERC proceedings. Accordingly, the SCC on July 7, 1999 filed its intervention with FERC in the proceeding to review the proposed Alliance regional transmission organization.

The Alliance proposal was submitted to FERC by five utilities, including AEP and Virginia Power. It is a proposal to transfer certain transmission functions, assets, or both, to a regional transmission organization.

In its intervention, the SCC raised questions in four major areas. I will touch on each.

1. Geographic Scope and Regional Configuration

The geographical boundaries of the proposed organization are coincident with the corporate boundaries of the five signatories. We noted that these boundaries raised questions concerning reliability and market power.

Concerning reliability, we pointed out that the proposed group would bisect two important reliability regions. SCC Intervention at 3. In this context, we referenced FERC's concern, stated in its recent proposed rulemaking,¹ that an RTO should take into account "existing regional boundaries" and not be "disruptive" to existing useful institutions. RTO NOPR at p.136.

Concerning market power, we noted that the Alliance's territory would lie between, rather than encompass, midwestern and northesastern power markets. SCC Intervention at 3. Some observers have expressed concern that this positioning by the Alliance could deter the economic flow of power between regions. In this context, we noted FERC's concern that "regions [covered by RTOs] should be configured so as to recognize trading patterns, and be capable of supporting trade over a large area, and not perpetuate unnecessary barriers between energy buyers and sellers." RTO NOPR at p.134.

We asked FERC to look closely at these issues of reliability and market power.

2. RTO Structure and Governance

In the electric industry, the regional transmission system is the exclusive highway for commerce. The core question is whether that transmission system will be supervised by an entity which is neutral; or whether system design, planning and operations will be influenced by entities which are, or expect to be, players in the competitive market. Obviously, most companies which own transmission assets also currently own generation and market electricity. It is not clear yet whether the functional separation procedures and code of conduct rules in place at FERC, and those yet to be adopted by various states, will, or can, be fashioned to address sufficiently this vital issue. It is thus important that the RTO structure itself maximize the likelihood of neutral decision-making by the RTO. The practical question posed by the Alliance proposal is whether it grants this new regional transmission organization sufficient power to assure the necessary neutrality, or whether inappropriate powers and functions are reserved to the transmission owners.

Here are four examples of questions the SCC has asked FERC to consider:

1. Some signatories will retain ownership of their transmission facilities; while others will transfer ownership of the facilities to the RTO, but in return receive stock ownership in the RTO. We asked FERC to consider whether those who retain ownership rights - whether ownership of transmission facilities or of RTO stock --might have superior access to RTO officials or their information.

2. Each transmission user would be permitted to own as much as 5 percent of the RTO's stock. Consequently, a few users voting together could control a significant block. FERC has suggested in its general NOPR that the ownership limit should be 1 percent. We asked FERC to examine the implications of deviating from its 1 percent preference.

3. Adding new members to the Alliance would increase the geographic scope, making more markets accessible to Virginia and other consumers. However, under the Alliance proposal, existing members could exclude new members by a majority vote, even if the neutral RTO thought the new member's transmission assets would benefit the region.

4. The Alliance proposal allows transmission owners to divest their transmission assets to the RTO, in return for voting rights. But if the RTO needed to acquire additional transmission facilities to serve the region efficiently or to address market power problems, a Divesting Transmission Owner could block the RTO's acquisition, or the RTO's issuance of securities to finance the acquisition, if such actions would dilute the value of the Owner's stock. We asked FERC to consider whether this veto, as distinct from other means of protecting against dilution, was conducive to the development of an effective regional market.

3. RTO Operational Activities

Another aspect of the importance of neutrality appears when considering the area of RTO operational activities and the need for constant use of discretion in conducting those activities. For competition to develop, this operating discretion must be in neutral hands; that is, the operational decisions must be made independently of the strategic preferences of market competitors. To ensure this neutrality, FERC has stated in its NOPR, p.115, that an RTO must acquire certain minimum functions from the existing transmission owners. These minimum functions should include establishing requirements for operational control, market monitoring, and congestion management.

We asked FERC to look closely at certain features of the Alliance proposal to see if they are consistent with these principles. Here are two examples:

1. The Alliance proposal would allow transmission owners to continue to operate their control areas, and perform certain physical functions, subject to the RTO direction. We pointed out that the proposal would therefore leave existing transmission owners with significant discretion, and asked FERC to consider this issue.

2. If a Transmission Owner acquires transmission facilities not identified in the original filing, the RTO cannot gain functional control of those facilities unless the Transmission Owner consents.

4. Pricing

Present regional transmission pricing is afflicted with something known as pancaking. As FERC has said, pancaking results when a transmission customer pays "separate, additive access charges every time its contract path crosses the boundary of a transmission owner." FERC has explained that pancaking leads to a "balkanization" of electric markets, forcing consumers to pay more than they otherwise would. RTO NOPR at pp. 56­57.

The Alliance proposal would include pancaking of charges during a six­year transition period. Under some circumstances, the pancaking effect could be eliminated; but the Alliance proposal makes no guarantee of this. And, it is possible that someone could seek an extension of the pancaking after the first six years.

We have asked FERC to look closely at this issue as well.

Some final comments on the Alliance proceeding at FERC: Under Virginia statutes, including provisions included in the 1999 Restructuring Act, a proposal by APCO or Virginia Power to transfer control or ownership of its facilities to a third party, including an ISO, must come before the SCC for approval. For this reason, we did not take a final position on the issues before FERC in the Alliance proceeding. We did, however, raise a number of questions in the areas just discussed, and asked FERC to resolve these questions after a hearing. We are informed that other parties, including the Indiana Commission and other state commissions having jurisdiction over the signatory utilities, have raised similar questions.

We expect that as a result of the questions raised by the SCC and others, we and the Alliance companies will have future discussions aimed at resolving those questions. We will keep the Task Force informed.

C. Finally, a general comment on this issue of regional transmission policy.

In the area of regional transmission policy, there are at least three uncertainties:

1. market uncertainty, because no one is sure who will be buying from which generators as competition develops;

2. regulatory uncertainty, because FERC, Congress and the various states are still formulating policy; and

3. legal uncertainty, because the Courts are still sorting out the boundaries of FERC and state jurisdiction.

As an example, a recent decision of the U.S. Court of Appeals for the Eighth Circuit changed many observers' understanding of the boundary between state and federal jurisdiction. The Court held that FERC, in its application of Order No. 888, acted beyond its jurisdiction when it required a transmission owner, in its provision of transmission service to unbundled transmission customers, to use curtailment procedures which are comparable to those which the transmission owner uses for its native load customers of bundled retail service.²

The decision has at least two important implications for Virginia as a state and for our new statute. First, it underscores the uncertainty of the boundary between the FERC and the state commissions.

Second, it also underscores the wisdom of the General Assembly's decision to grant the SCC substantial authority in this area of regional transmission policy. If the SCC did not have clear authority to take actions relating to transmission, an action like the Eighth Circuit's could leave a state commission in a position of needing to act ­­ because the Court has foreclosed FERC from acting -- but unable to act ­­ because the state commission lacked appropriate authority under state law.

The Virginia Electric Restructuring Act authorizes the SCC, in the area of formulating regional transmission policy, to take all actions necessary up to the point of preemption, leaving it up to us, the parties, FERC and, perhaps, the courts to sort out where that point it. This flexibility will prove vital to Virginia's effective implementation of competition.

¹Notice of Proposed Rulemaking, Docket No. RM99­2­000 (hereinafter, "RTO NOPR").

²Northern States Power Co. v. FERC, __ F.3d __ (8th Cir. Mar. 8, 1999), 1999 WL 301458 at 4­5 (finding that the indirect effect of Order No. 888's curtailment procedures, as interpreted by FERC, constituted an attempt to regulate the curtailment of transmission service to retail customers, thus transgressing its Congressional authority which limits its jurisdiction to interstate transactions).