By Robert Mullin

VANCOUVER, Canada — With three RTOs advancing competing efforts to extend their services into the West, the region’s utility regulators last week took a timely crash course on the legal implications of allowing their utilities to join organized markets.

It was a bracing — and invaluable — session, according to some industry stakeholders attending the spring joint meeting of the Western Interconnection Regional Advisory Body and the Committee on Regional Electric Power Cooperation.

Scott Hempling, an attorney specializing in public utility law, provided a compressed but comprehensive 90-minute primer of the statutes, regulations and case law governing the functioning of RTOs, beginning with their origins in FERC Order 2000, which encouraged — but did not require — utilities to form or join an RTO.

“The primary purpose was to end discrimination by transmission owners,” Hempling said. “One of the methods of discrimination before Order 2000 was to keep secret the availability of transmission.”

Hempling explained the four “minimum characteristics” of RTOs required by FERC: independence; appropriate scope and regional configuration; operational authority; and exclusive authority over short-term reliability.

In addition, RTOs must fulfill eight “required functions,” including tariff design and congestion management. “Understanding those 12 things is crucial to understanding what’s getting turned over to the RTO,” he said.

Hempling clarified that a transmission-owning utility legally becomes a customer of an RTO once it joins the RTO and turns over its transmission assets. It also becomes FERC jurisdictional. “When your utility joins an RTO, it no longer provides transmission service,” he said.

“Let me put it bluntly: you lose jurisdiction over transmission costs” when a utility joins an RTO, Hempling told the audience of commissioners. As a result, any state commission that has approved RTO membership cannot “logically disallow” a utility from including in retail rates the costs of becoming a customer of the RTO.

“Once FERC determines that the rate charged by the RTO to the transmission owner is prudent, the state must pass that cost on” to customers, Hempling said.

And while a transmission-owning utility does receive a pro rata share of the revenues the RTO generates from all transmission customers, the resulting credits don’t always make retail ratepayers whole. “You’d think the retail charges and credits would be a wash, but that’s not necessarily the case,” Hempling said.

One commissioner asked if FERC made distinctions within RTOs between how it treats investor-owned utilities on the one hand and rural cooperatives and municipal power systems on the other.

Hempling noted that the Federal Power Act exempts publicly owned systems from FERC oversight — unless they are TOs and join an RTO. “Co-ops and munis join RTOs by contract. Now if they’re transmission owners, are they subject to FERC jurisdiction? The answer is ‘yes.’” Based on FERC’s reciprocity rule, “if you want to take transmission service and you own transmission, then you’re going to need to provide transmission service,” Hempling said.

FERC ‘Controversies’

Hempling turned to key areas “where FERC finds itself resolving controversies” related to the nation’s RTOs.

Chief among the agency’s concerns: return on equity for transmission investments.

“There is a great deal of controversy over what is the ‘fair return on equity,’ and it’s not just about profiteering,” he said. “We’re talking about hundreds of billions of dollars in necessary transmission investment, and that money is going to have to come from somewhere and get paid off over a certain period of time. So return on equity matters, both from the customer standpoint and the investor standpoint.”

Hempling pointed to the differences between administering general rate cases (FERC’s past approach) and formula rate cases (its current approach).

“A formula rate’s a spreadsheet, and I guess the word is that you ‘populate’ the spreadsheet with the numbers — as opposed to a general rate case, where everybody and their brother and father and mother and sister gets into the case and everybody fights over what the ultimate [regulated rate of return] should be,” Hempling said. “For years, FERC set transmission rates with a general rate case, but now it prefers to set them by formula. But just because it’s a spreadsheet that you populate across doesn’t mean that FERC goes to sleep and just asks that you include whatever you want to put in there.”

Hempling expressed his respect for FERC, calling the agency “very, very professional — even in the current political environment.” But he cautioned state commissioners about the agency’s limitations in judging the reasonableness of transmission project expenditures, another area of focus for the agency.

FERC “does not disallow costs very often. … There is a question whether an agency whose authority is transmission [has] competency in looking at alternatives,” he said, adding that FERC “does not do integrated resource planning.”

Hempling also pointed to FERC’s role in overseeing RTO transmission cost allocation.

“You’re a multistate region — which state’s customers are paying for what? And there are now a variety of court of appeals decisions and FERC decisions that allocate costs among the family members, who at conferences like this are all happy to see each other over pastries, but then they’re happy to hire very expensive lawyers to fight over who’s getting which dollars.”

Power to the States?

Hempling posed a series of hypothetical questions regarding a state’s influence over utilities before and after a decision to join an RTO. His answers, he made clear, were based on his own professional opinion, not settled law.

Can a state order its utility to join an RTO?

Yes, Hempling said. A state commission could find that a utility’s rates “will not be just and reasonable, reliability will be insufficient to satisfy state law unless the utility joins an RTO,” he said. “I also think therefore — and everything I’m saying now is subject to debate — that a state can reject a utility’s request to join, I think for the same reason.”

Can FERC order a utility to join?

“This question, along with all the others, is untested, because if FERC does have the authority to order a utility to join, then that would pre-empt a state that rejects a utility to join. That would be an inconsistency, right? You can’t put a utility between a rock and a hard place,” Hempling said.

“Do I think FERC has the authority to order a utility to join? I think they do. … And in any event, FERC has never said so,” he said. “And that’s why the joining of RTOs by utilities is opportunistic. That’s why they at least get to decide … based on their own self-interest, because FERC has not said it can order a utility to join.” But FERC has conditioned a utility’s request for merger approval on joining an RTO, he noted.

Hempling also posed the possibility of a state requiring a utility to get state permission before proposing to the RTO any new construction of transmission above a particular level. “In my legal opinion, a state can do that, but it has not been tested,” he said.

After the Fact

How can a state pursue its values after a utility joins an RTO?

Hempling noted that legal precedent precludes states from forcing a utility — including an RTO — to submit a tariff change with FERC. Still, a state can circumvent that restriction by persuading the utility or RTO to make a state-sought filing.

“The way the Federal Power Act works is this: If a utility makes a filing at FERC, and that filing satisfies the Federal Power Act standard of ‘just and reasonable’ … FERC is obligated to approve it, even if FERC has a better idea. … It’s a utility-deferential statute,” he said. “Which means if you are a state wanting to say, ‘I’ve got a better idea,’ and so you introduce at FERC a filing, FERC is going to say, ‘I like your idea a lot better, state, but the utility’s idea is just and reasonable.’”

SPP has worked around this situation through the authority granted to its Regional State Committee, which can order SPP to make a filing even if the RTO disagrees with it, Hempling said. “Now SPP can also make its own filing, and they can say, ‘We think the state’s idea is crap,’ but we file it because we agreed to file it. And what happens now is that FERC can actually choose either one. So it puts the states on equal legal footing in terms of the chances of being selected.”

Former California Public Utilities Commissioner Mike Florio, now principal of Florio Consulting, said that California legislators have asked him whether the state can direct an investor-owned utility to leave an RTO.

“My … answer is no, because … it’s a contract that FERC has approved,” Hempling replied. “And that contract is where you go to find out the authority of someone to leave. And because it’s a FERC-jurisdictional contract, a state cannot issue an order that causes a utility to act in violation of the contract. That would be pre-emptive.

“FERC wants the stability about decisions to be in FERC’s hands,” he added.

Utah Public Service Commissioner David Clark said one of his concerns about his state’s utilities joining an RTO is the cost-of-service differential between it and other states in the region — namely, California.

“I know FERC has been concerned that the RTO process maintain status quo benefits and focus on new benefits,” Hempling said. “I think FERC has not had the notion of creating enemies of the RTO process.”

Another commissioner asked: “How do we know we’re protecting our state’s interests?”

Hempling replied with a question: “What is the commonality that we’re trying to pursue through the RTO mechanism when there are so many differences? … Focus on what the commonalities are.

“I was once at a [National Association of Regulatory Utility Commissioners] meeting and there was a Midwestern commissioner who said, ‘Whoa, if we’re not preserving state regulation, what are we here for?’” Hempling said. “And I’m thinking, ‘What you’re here for is something bigger than that. You’re here for efficiencies; you’re here for the customer; you’re here for investors; you’re here for marginal values. You’re here for something. You’re not here for jurisdiction.’

“The mission is not jurisdictional preservation. It’s jurisdictional effectiveness.”