Post # 2 - FERC and the Smart Grid

Application of FERC Interim Rate Policy for “Smart Grid” Investments

By Gerald Richman

Implementing a true Smart Grid will not come cheap – current estimates suggest a multi-billion-dollar total figure for a truly operational and effective national smart grid system. The question becomes, “who pays?” The average consumer buys retail power from local power companies or retail marketers in transactions subject to regulation by state public utility commissions. At the same time, those retail rates necessarily will reflect the sellers’ wholesale costs: the cost purchasing of power from generators and/or transmitting power from points of generation to points of local distribution. In turn, wholesale power sale and transmission transactions are regulated by a federal agency, the Federal Energy Regulatory Commission (FERC), under the Federal Power Act (FPA).

The states currently are grappling with the degree to which they will allow local power companies to pass along their smart grid investment costs to retail consumers. At the wholesale level, in July 2009 FERC issued an an interim policy by which early adopters of smart grid technologies may recover smart grid costs through their FERC-regulated transmission rates. Then, several months, FERC applied its interim rate policy for the first time. FERC’s action -- involving Pacific Gas & Electric Company (PG&E) -- demonstrates an attempt to balance the agency's statutory duty to ensure non-exorbitant transmission rates with the Congressionally-mandated goal of encouraging smart grid development.

Specifically, in 2007, Congress mandated a multi-agency effort – led by the National Institute of Standards and Technology (NIST) – to coordinate activities by both the government and the private sector to achieve interoperability of smart grid devices and systems. Next, in the 2009 economic stimulus package, Congress authorized the Department of Energy (DOE) to award up to $4.5 billion in smart grid development grants. Congress also directed FERC to develop standards and protocols necessary to insure interstate smart grid functionality.

But Congress also provided that FERC can issue those standards and protocols only after it is satisfied that NIST has achieved sufficient consensus on grid operability standards, which remains a future development. In the meantime, in July 2009 FERC issued a Policy Statement highlighting what the agency considers key elements of smart grid interoperability and functionality: for example, cybersecurity, standardized communication systems, and the development of electric storage. FERC also stated that once the agency has adopted final smart grid interoperability standards, it will consider making compliance with those standards a mandatory condition for rate recovery by utilities of FERC-jurisdictional smart grid costs. However, final operability standards remain a future development, while companies will be hesitant to make present smart grid investments without knowing their future ability to recover those costs. Reflecting that tension, FERC's Policy Statement included an Interim Rate Policy for smart grid investment.

The Interim Rate Policy provides that FERC will accept rate filings to recover the costs of smart grid deployments, provided that the utility can make each of the following showings. First, the utility must show that the proposed investment will advance overall smart grid development. Second, the utility must establish that there will be no adverse impact on cybersecurity or system reliability. Third, the utility must share technological information with DOE’s Smart Grid Clearinghouse. Fourth, the utility must show that it has minimized the possibility that its proposed smart grid infrastructure ultimately will have to be abandoned as incompatible with FERC’s final (and future) interoperability standards – in other words that the utility has minimized the potential for so-called “stranded costs.”

Of course, one way or the other, ultimate retail consumers of electric power can expect to bear costs related to the creation of the smart grid. This is not inherently unreasonable to the extent that consumers will be beneficiaries of smart grid technologies that facilitate reductions in their energy costs. Moreover, the social benefits of smart grid can be fostered by regulatory structures that encourage industry investment in smart grid technology through cost recovery.

As always, however, the question is getting from “here” to “there.” Because of the importance of wholesale power transmission rates, FERC’s application of its Interim Rate Policy will play a major role in apportioning costs between consumers – who potentially can benefit from lower prices that may result from more efficient electric usage – and transmission utilities and related commercial entities that likewise stand to financially benefit from greater efficiency in energy supply and transmission operations. Moreover, there may be concern that some utilities may see smart grid rate recovery as a mechanism to effectively recover costs of prior profitable infrastructure investments that new smart grid technology will arguably “strand” in the future. Thus, stakeholders will carefully watch FERC’s actual application of the policy in particular cases, and the first instance occurred in late 2009 with respect to PG&E’s “synchrophasor” project.

Synchrophasors are devices that use time-synchronized measurements of system parameters to inform operators of potential reliability concerns and identify actions that can address those concerns. Use of synchrophasors can also help a utility to integrate intermittent and energy-limited renewable generation resources. PG&E’s project is part of a regional synchrophasor project undertaken in conjunction with the Western Electric Coordinating Council (WECC). PG&E plans to invest $50 million over the next three years to install or upgrade 25 synchrophasor measurement devices, together with communication infrastructure. The WECC, in turn, sought $25 million in stimulus funding for the project from DOE. In late October, DOE granted the award, which reduces PG&E out-of-pocket investment to $25 million.

In September 2009, PG&E sought a FERC declaration that the company may recover that cost through its wholesale transmission rates. PG&E also sought to recoup 100% of its costs if the project is abandoned for reasons beyond PG&E’s control. The WECC, the California Independent System Operator, and (subject to its own review with respect to retail rates) the California Public Utilities Commission all supported PG&E’s request to FERC. However, other entities (for example, the California Department of Water Resources (CDWR) and municipalities served by PG&E), while not disputing the potential benefit of the project, argued that PG&E’s filing did not contain adequate cost and economic information upon which a meaningful analysis of rate impact can be based.

In fact, while PG&E’s petition discussed the overall regional operational benefits of the synchrophasor project in some detail – and none of the parties seem to dispute those benefits – the filing didn’t provide any breakdown of costs. Similarly, from a stranded cost perspective, PG&E's filing (a) provided no concrete examples of how its synchrophasor equipment could be made obsolete as a result of FERC’s final operability standards and (b) lacked the high level of detail that routinely is required in FERC rate cases.

However, that lack of cost specificity may be less significant than it appeared because, in response to criticism from the CDWR and the municipalities, PG&E made a follow-up filing in which it told FERC that the company will only seek to recover its synchrophasor investment through rates that PG&E only will file after the synchrophasors go into operation. PG&E argued that while the reasonableness of pursuing the synchrophasor project and recovering associated costs will have been determined by FERC in response to the pending petition, both FERC and the various California stakeholders will retain the opportunity to assess the overall justness and reasonableness of those new rates when they are filed with FERC in the future.

In an order issued on December 17, 2009, FERC declared that PG&E may recover the costs of its synchrophasor project through electric transmission rates and also may recover one hundred percent of abandoned plant costs in the event that the project is cancelled for reasons beyond the company’s control. But FERC emphasized that this basic approval under the interim smart grid rate policy treatment under will not free the company from satisfying FERC’s normal standards for rate recovery when PG&E files actual transmission rates covering its synchrophasor costs. For example, PG&E at that time must still satisfy the requirement that only “used and useful” utility investments can be recovered through rates.

Thus, while FERC states that it will continue to review Smart Grid investments outside its normal review of overall utility rate levels, the December 17 order clarifies that once PG&E files rates and seeks actual cost recovery for the synchrophasor project, the California stakeholders will be able to review and comment on both the level of specific costs included in PG&E’s rates and the allocation of those costs. In effect, FERC appears ready to strongly promote smart grid investments in principle, but plans to retain its normal detailed review of the cost underpinnings of transmission rates.