FERC had been moving toward opening up transmission access for independent power producers since the mid-1980s, with the blessing of the Reagan and Bush administrations, but proceeded cautiously due to a lack of authority to require transmission providers to allow access by third parties. The passage of the Energy Policy Act of 1992 (EPAct 1992), with its open-access provisions and the increased freedom of action for IPPs, gave new impetus to FERC actions to open up wholesale markets.
Prior to EPAct 1992, FERC had no authority to order utilities to provide transmission service or to require utilities to build power plants or transmission facilities to provide wholesale power or transmission service. As a result, regulatory authority for utility investments, operating costs, and prices lay primarily with individual state regulatory agencies. However, in practice, FERC used its discretionary authority to encourage open access. FERC imposed open-access transmission terms as a condition to approval of “market-based” rates under its general rate regulation authority, contained in sections 205 and 206 of the FPA. FERC initiated this policy with a flexible pricing experiment in bulk power transactions known as the Southwest Experiment.1 Four utility companies proposed in December 1983 to conduct a two-year experiment to see whether competition could develop in a market in two bulk power commodities: economy energy and block energy. The utilities would make transmission services available for trading among them in the two commodities, and the Commission would allow pricing flexibility for these transactions and permit the utilities to retain some portion of the profits from sales.2
The Western Systems Power Pool (WSPP) experiment took the concept of wholesale bulk power markets a step further. WSPP proposed to permit flexible pricing not only for bulk power sales but also for transmission service. The WSPP Experiment involved utilities in ten states with approximately 12 percent (82,000 MW) of the total electric generating capacity of the United States. Membership was opened to all utilities connected to the existing members. Energy prices were to be capped based on the costs of the highest-cost participant. The WSPP Agreement provided for transmission service on a voluntary basis, at the cost of new transmission. The WSPP would utilize an “electronic bulletin board,” a computer to facilitate the daily exchange of buy and sell quotes among Participants.3
Pacific Gas & Electric (PG&E), on behalf of the other WSPP participants, petitioned FERC in 1991 to allow the Pool to operate permanently. FERC had expressed uneasiness over the possibility that sellers of services under the Pool Agreement could wield market power, especially with regard to the WSPP's transmission-dependent utilities. FERC specifically requested that the Pool address issues of transmission access and market power. In response, the WSPP application proposed the so-called Exhibit C transmission principles, requiring member utilities to provide transmission services to other members on reasonable terms. On April 23, 1991, FERC accepted the WSPP's application with major modifications. While Exhibit C did not go far enough in opening access to transmission lines, FERC noted that ordering more stringent transmission access requirements would jeopardize the continued existence of the Pool because of its members' opposition to such commitments. Accordingly, the Commission developed and published uniform energy and transmission rate ceilings.4
FERC also used its merger approval authority to develop transmission policy on a case-by-case basis. FERC began this process in the 1980s, requiring access to transmission as a mechanism to alleviate potential market power concerns.5 FERC consistently imposed “open access” transmission terms as a condition to its approval of mergers under section 203 of the FPA. In Utah Power & Light,6 FERC specifically conditioned merger approval on opening transmission. FERC required that the merged utility wheel power for competitors in order to remedy the merger's likely adverse effect on competition.7 Similar conditions were imposed on the merged utility in Northeast Utilities Service Co.8 In the rehearing of Northeast Utilities, the Commission detailed the incremental-cost approach for recovery of transmission expansion costs. Only those costs that are additional to those required to satisfy native load requirements can be assigned to the third party requesting service.9
The courts confirmed FERC's authority over wholesale transactions, requiring that state regulation of the purchasing utility respect FERC-approved “filed rates.” The “filed rate” doctrine, which had been implied in Montana-Dakota Utilities,10 was set forth formally in Hall11 and confirmed in Natahala.12 The FPA preempted any state commission investigation into wholesale rates, as the FPA gave exclusive jurisdiction to the FPC, leaving no room for state action. The Supreme Court also made it clear that “States may not alter FERC-ordered allocations of power by substituting their own determinations of what would be just and fair. FERC-mandated allocations of power are binding on the States, and States must treat those allocations as fair and reasonable when determining retail rates.”13
These decisions opened the way for utilities to purchase power from power pools and in bilateral arrangements, secure in the knowledge that as long as they followed FERC tariffs, they could pass those costs along at the retail level. It also prevented state commissions from imposing their judgment of the proper allocation of joint costs of power pools or integrated utility systems in setting retail rates, forcing subsidization of in-state consumers at the expense of utility shareholders or customers in other jurisdictions. Utilities still had to perform due diligence to ensure that those power purchases were economic, since a state commission retained the power to rule a purchase to be imprudent, even at a FERC-approved price, if lower-cost power could be obtained elsewhere.14 While regulators allow utilities to earn a return on their investments in plants they own, utilities were not allowed to earn a return on power purchased from nonutility generators, with the costs generally passed directly to consumers. This limited utilities' incentives to rely on purchased power to situations where they considered building generation too risky of an alternative.
While FERC was establishing policy through adjudication, it also engaged in rulemaking efforts to encourage competition. In 1985, FERC initiated proceedings to investigate how its regulatory policies ought to reflect the changes in the bulk power marketplace.15 In 1986, President Reagan nominated Martha Hesse to be chairman of FERC. Hesse was a DOE official, and her candidacy was supported by Energy Secretary John Herrington. Together with two other commissioners – Charles Stalon, an economist, and C. M. Naeve, an attorney – Hesse laid the groundwork for bringing more competition into the electric power industry. Her staffers held a series of public inquiries into issues concerning the generation and transmission of wholesale electric power.16 On September 4, 1987, twelve electric utility chief executive officers sent a letter to all five FERC commissioners to endorse Chairman Hesse's effort to craft rules bringing more competition into the wholesale electric power industry.17 Within a few weeks, the utilities that signed that letter formed an ad hoc coalition called the Utility Working Group. They were opposed to complete decontrol but welcomed the opportunity to obtain additional revenues from sales of surplus power.18
In 1988, FERC issued a series of NOPRs addressing concerns raised in the earlier conferences and leading to the development of standards for approving market-based generation sales on a case-by-case basis. The rulemakings addressed competitive bidding,19 avoided costs,20 and IPPs.21 FERC had become concerned that many utilities had adopted a very conservative strategy with respect to building new capacity. The Commission felt that it had an obligation to create a regulatory environment that ensured that needed capacity investments would be made in a timely and efficient manner. The Commission recognized that its cost of service rules and other regulations placed onerous burdens on IPPs, discouraging entry and development of new power plants. Cost-of-service regulation was fundamentally incompatible with IPPs who lack market power. Regulatory burdens include the administrative costs of complying with regulations, delays inherent in the regulatory process, and interference with the firm's decision-making. Traditional cost-based regulation policies discouraged investment by passing on to ratepayers much or all of the gains from innovative technology and efficient production. In setting rates for short-term purchases, the Commission allowed departures from seller's costs, accepting rates that recovered incremental costs plus equitable sharing of the trade gains, usually capped at 50 percent. The adders provided an incentive for sellers to make power available. The Commission began accepting rate filings for voluntary coordination transactions.22
In January 1989, the Office of Technology Assessment (OTA) issued a report in response to a request from the House Committee on Energy and Commerce to evaluate the technical feasibility of increased competition in the electric utility industry. The OTA report found no specific reason why competition could not be made to work. However, the OTA warned that insufficient analysis had been done to determine whether benefits outweigh costs. Five scenarios were presented, ranging from the status quo to complete disaggregation into generation, transmission, and distribution functions.23
A new coalition, formed in September 1990, urged Congress to amend PUHCA. The coalition included the Utility Working Group, the IPP Working Group, the Cogeneration and Independent Power Producers Coalition of America, the Natural Gas Alliance for the Generation of Electricity, the National Independent Energy Producers, and the Ad Hoc Committee for a Competitive Electric Supply System (a group of industrial consumers). The coalition urged Congress and the administration to support a change to PUHCA to lift restrictions on the ability of utilities and IPPs to locate their facilities where they might be needed. The group could not agree on whether PUHCA legislation should include transmission.24
Industrial customers started to advocate for electric industry restructuring in the early 1990s in states where average utility rates were high due to the costs of nuclear units and QF contracts. These customers pointed out that if they could obtain generation directly from new gas-fired combined-cycle units, they might be able to obtain power for 3–4 cents per kWh, not the 5–8 cents per kWh they were currently paying. High electricity prices were discouraging location of heavy industry in some states, which prompted measures to lower costs to industry to prevent the loss of manufacturing employment.25 These high prices also encouraged a growing chorus of voices calling for deregulation of the bulk power market, encouraged by the apparent success of deregulation efforts in other industries.26 The smaller group of observers counseling caution were generally ignored.27
The Bush administration initially made noises about developing a new energy strategy based around environmental concerns, but Bush's credibility was limited given his close ties with the Texas oil industry. However, when Iraq President Saddam Hussein, on August 1, 1990, invaded Kuwait, world oil prices shot up and Congress was suddenly amenable to a new energy bill. The proposed White House energy blueprint called for stimulating domestic oil production, including drilling in the Arctic National Wildlife Refuge (ANWR) and consolidation of nuclear licensing procedures. The administration proposal would also eliminate FERC as an independent commission and fold it into DOE as the Natural Gas and Electricity Administration, headed by a presidential appointee whose nomination would be subject to Senate confirmation. The idea for shutting down the Commission came from Vice President Dan Quayle's Council on Competitiveness. Wholesale generators would be exempted from the PUHCA provisions, permitting businesses to own or invest in generating plants in more than one geographic area. However, state regulators would have to approve certain transactions between a utility and its subsidiary. PURPA's exemption for power produced from geothermal, solar, wind, or waste sources would no longer be limited to plants of less than 80 megawatts in states that require a competitive bidding process for utility electricity purchases.28
The plan did not receive overwhelming applause on the Hill. Environmentalists criticized it as a “drain America first” policy, with no provisions for increasing conservation. In the Senate, Energy and Natural Resources Committee chairman Bennett Johnston (D-LA), working with the committee's ranking Republican, Malcolm Wallop, put together a bill combining drilling in ANWR with higher CAFE standards. The Committee's Democrats opposed many of the Johnston-Wallop bill's provisions, including the opening of the Alaska wildlife refuge to drilling and easing regulation of the nuclear industry. The bill was reported 17–3 after a final markup session on May 23, adding provisions deregulating the wholesale electricity business.29
Philip Sharp (D-IN), chairman of the Energy Subcommittee of the House Energy and Power Committee, began hearings on energy policy. However, with the end of the Iraq war, energy quickly faded as a hot-button issue, and the Subcommittee on Energy and Power did not begin to mark up legislation until the middle of July 1991. The subcommittee voted out a bill that included electricity generation deregulation, with provisions to protect consumers and to require free access to transmission networks. The bill exempted wholesale power producers from PUHCA and provided FERC with the authority to order utilities to give independent producers access to their transmission lines. The bill provided that federal regulators review power sales by new wholesale producers to ensure they would not hurt consumers. Another provision banned utilities from building an affiliated, independent power plant and then selling the electricity to itself. The House bill that passed on May 19, 2002, included the Sharp electricity deregulation provisions.30
The electricity provisions became a contest between proponents of deregulation and retail wheeling, including the Electricity Consumers Resource Council31 and environmental and consumer groups, and the defenders of the status quo, the investor-owned utilities, represented by the EEI, and a new lobby organization, the Electric Reliability Coalition.
The Johnston bill was derailed by a filibuster over the issues of Alaska oil drilling, electric utility deregulation, and CAFE standards.32 Johnston tried again in January 1992, offering a trimmed-down version of the energy bill, discarding the proposals to open ANWR to drilling and to increase CAFE standards. Conservation and energy efficiency sections were strengthened and environmental protections were restored. The revised bill passed the Senate on February 19, but the only major accomplishment of the bill was the deregulation of wholesale electric power generation. A coalition of utilities vigorously opposed the proposal but received little support in the Senate. An amendment to protect consumers from self-dealing passed, under which utilities could only buy power from an independent affiliate if state regulators approved. Other provisions included exempting wholesale electricity generators from PUHCA, allowing utilities to operate independent wholesale plants outside their service territories, and encouraging independent producers to operate generating plants.33
The major point of contention in the conference negotiations was the lack of guaranteed access by producers to electric transmission systems in the Senate version. Malcolm Wallop, a key author of the Senate bill, was the chief opponent of mandatory transmission access. Wallop said the House transmission proposal would ride roughshod over private utilities and “envisions making FERC the electric utility czar.” Environmental groups supported these changes, believing competition would open up opportunities for renewable-energy producers. Sharp and Johnston cleared the way for the deal by directing their key staff aides to draft a comprehensive proposal. The House accepted the Senate provision to let utilities buy power from independent affiliates as long as state regulators approve the deals. Conferees also agreed to a new provision that would permit utility holding companies to build plants overseas. After a month of haggling, the conference finally came up with a final product on October 1. Tax incentives for conservation, renewable energy, and alternative fuel cars survived the conference, as well as relief for independent oil and gas producers. The conference report flew through both the House and Senate, and was signed by the President on October 24, ending an eighteen-month odyssey.34
The new law empowered FERC to order any “transmitting utility” to provide transmission for wholesale electricity transactions whenever the requested transmission can be provided consistent with maintaining reliability and would be in the public interest. The definition of “transmitting utility” includes “any electric utility, qualifying cogeneration facility, qualifying small power production facility, or Federal power marketing agency which owns or operates electric power transmission facilities which are used for the sale of electric energy at wholesale.”35 FERC could compel a transmission provider to enlarge its transmission capacity where existing capacity is inadequate to provide the requested service. FERC was prohibited from requiring retail transmission to an ultimate consumer of electricity or conditioning any regulatory approval on agreeing to provide retail wheeling.36
As amended, section 212 of the FPA required FERC to set rates, charges, terms, and conditions for wholesale transmission service that permit the transmitting utility to recover all costs “incurred in connection with the transmission services and necessary associated services,” including “any benefits to the transmission system of providing the transmission service, and the costs of any enlargement of transmission facilities.” Rates shall “promote the economically efficient transmission and generation of electricity.” The cost causation principle should be used to allocate costs.37
A new category of utility was created: Exempt Wholesale Generators (EWGs). EWG eligibility was restricted to “persons” (including an affiliate of an electric utility) who are exclusively in the business of owning or operating power generation facilities and selling electric power at wholesale. An EWG was not an “electric utility company” under the PUHCA. In addition, an EWG was deemed not to be “primarily engaged in the generation or sale of electric power” for purposes of the FPA. An EWG is, however, a “public utility” within the definition of the FPA, and is subject to regulation of rates and charges for sales of electricity or leased capacity, tariff requirements, and information reporting.38
FERC authority to require the wheeling of power from these new independent wholesale generators was the next step toward establishing wholesale electricity markets. PURPA had allowed independent power developers to build plants, but restrictions on QFs basically limited them to either cogeneration facilities (which were limited by the population of customers with substantial thermal loads) and fringe plants that were a substitute for IOU generation under state IRPs. EWGs would build merchant plants that competed on price against incumbent IOUs.
