Promoting Transmission Investment Through Pricing Reform, 43294-43341 [06-6495]

Agencies

• DEPARTMENT OF ENERGY
• Federal Energy Regulatory Commission

[Federal Register Volume 71, Number 146 (Monday, July 31, 2006)]
[Rules and Regulations]
[Pages 43294-43341]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 06-6495]



[[Page 43293]]

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Part II





Department of Energy





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Federal Energy Regulatory Commission



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18 CFR Part 35



Promoting Transmission Investment Through Pricing Reform; Final Rule

Federal Register / Vol. 71, No. 146 / Monday, July 31, 2006 / Rules 
and Regulations

[[Page 43294]]


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DEPARTMENT OF ENERGY

Federal Energy Regulatory Commission

18 CFR Part 35

[Docket No. RM06-4-000; Order No. 679]


Promoting Transmission Investment Through Pricing Reform

Issued July 20, 2006.
AGENCY: Federal Energy Regulatory Commission, DOE.

ACTION: Final rule.

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SUMMARY: In this Final Rule, pursuant to the requirements of the 
Transmission Infrastructure Investment provisions in section 1241 of 
the Energy Policy Act of 2005, which adds a new section 219 to the 
Federal Power Act, the Federal Energy Regulatory Commission 
(Commission) is amending its regulations to establish incentive-based 
(including performance-based) rate treatments for the transmission of 
electric energy in interstate commerce by public utilities for the 
purpose of benefiting consumers by ensuring reliability and reducing 
the cost of delivered power by reducing transmission congestion. This 
Final Rule is intended to encourage transmission infrastructure 
investment.

DATES: Effective Date: This Final Rule will become effective September 
29, 2006.

FOR FURTHER INFORMATION CONTACT: Jeffrey Hitchings (Technical 
Information), Office of Energy Markets and Reliability, Federal Energy 
Regulatory Commission, 888 First Street, NE, Washington, DC 20426, 202-
502-6042.
    Sebastian Tiger (Technical Information), Office of Energy Markets 
and Reliability, Federal Energy Regulatory Commission, 888 First 
Street, NE, Washington, DC 20426, 202-502-6079.
    Andre Goodson (Legal Information), Office of the General Counsel, 
Federal Energy Regulatory Commission, 888 First Street, NE, Washington, 
DC 20426, 202-502-8560.
    Tina Ham (Legal Information), Office of the General Counsel, 
Federal Energy Regulatory Commission, 888 First Street, NE, Washington, 
DC 20426, 202-502-6224.
    Martin Kirkwood (Legal Information), Office of the General Counsel, 
Federal Energy Regulatory Commission, 888 First Street, NE, Washington, 
DC 20426, 202-502-8125.

SUPPLEMENTARY INFORMATION: 

 
                                                               Paragraph
                                                                 Nos.
 
I. Introduction.............................................          1.
II. Background..............................................          1.
III. Overview...............................................         10.
    A. The Need for New Transmission Facilities.............         10.
        1. Background.......................................         10.
        2. Comments.........................................         11.
        3. Commission Determination.........................         14.
    B. The Need for Incentives..............................         15.
        1. Background.......................................         15.
        2. Comments.........................................         16.
        3. Commission Determination.........................         19.
    C. Summary of the Nature and Applicability of Incentives         21.
     Adopted by the Final Rule..............................
    D. Effective Date and Duration of Effectiveness For              30.
     Incentives.............................................
        1. Background.......................................         30.
        2. Comments.........................................         31.
        3. Commission Determination.........................         34.
IV. Discussion..............................................         37.
    A. Standard for Approval of Incentive-Based Rate                 37.
     Treatments.............................................
        1. The Final Rule Applies to the Recovery of Costs           37.
         Incurred to Ensure Reliability or to Reduce
         Transmission Congestion, or Both...................
        2. Other Criteria For Approval of Incentives........         44.
        3. Rebuttable Presumptions..........................         57.
        4. Applicants Seeking Incentive-Based Rates Will Not         59.
         Be Required To File A Cost-Benefit Analysis........
        5. Procedural Requirements for Obtaining Incentive-          66.
         Based Rate Treatments..............................
    B. Incentives Available To All Jurisdictional Public             84.
     Utilities..............................................
        1. ROE Sufficient to Attract Capital................         85.
        2. Construction Work in Progress (CWIP) and Pre-            103.
         Commercial Expenses................................
        3. Hypothetical Capital Structure...................        123.
        4. Accelerated Depreciation.........................        135.
        5. Recovery of Costs of Abandoned Facilities........        155.
        6. Deferred Cost Recovery...........................        168.
        7. Other Incentives--Single-Issue Ratemaking........        179.
    C. Incentives Available to Transcos.....................        194.
        1. Definition of Transco............................        194.
        2. Transco ROE Incentive............................        206.
        3. Accumulated Deferred Income Taxes (ADIT).........        242.
        4. Acquisition Premiums for Transco Formation.......        251.
        5. Merchant Transmission............................        259.
    D. Performance-Based Ratemaking.........................        263.
        1. General Comments.................................        263.
        2. Comments Proposing Performance Tests and                 273.
         Competitive Bidding................................
    E. Advanced Technologies................................        280.
        1. General..........................................        280.
        2. Case-by-Case Review..............................        294.
        3. Whether To Require A Technology Statement........        300.
        4. Risk Sharing.....................................        303.
        5. Other Technology-Related Issues..................        308.
    F. Transmission Organization Incentive..................        312.
        1. Background.......................................        312.
        2. Comments.........................................        314.
        3. Commission Determination.........................        326.
    G. Recovery of Prudently Incurred Costs to Comply with          334.
     Reliability Standards and Recovery of Prudently
     Incurred Costs Associated with Transmission
     Infrastructure Development.............................
        1. Background.......................................        334.
        2. Comments.........................................        336.
        3. Commission Determination.........................        343.
    H. Public Power.........................................        349.
        1. Background.......................................        349.
        2. Comments.........................................        350.
        3. Commission Determination.........................        354.
V. Reporting Requirement....................................        358.
    A. Background...........................................        358.
    B. Comments.............................................        360.
    C. Commission Determination.............................        367.
VI. Other Issues............................................        377.
    A. Rate Related Issues..................................        377.
        1. Rate Related Issues..............................        377.
    B. Section 35.34........................................        395.
        1. The Proposal to Eliminate Section 35.34(e).......        395.
VII. Information Collection Statement.......................        406.
VIII. Environmental Statement...............................        410.
IX. Regulatory Flexibility Act Certification................        411.
X. Document Availability....................................        412.
XI. Effective Date and Congressional Notification...........        415.
Appendices..................................................
 


[[Page 43295]]

Before Commissioners: Joseph T. Kelliher, Chairman; Nora Mead Brownell, 
and Suedeen G. Kelly.

I. Introduction

    1. Pursuant to the directives in section 1241 of the Energy Policy 
Act of 2005 (EPAct 2005) \1\ which added a new section 219 to the 
Federal Power Act (FPA), in this Final Rule the Commission provides 
incentives for transmission infrastructure investment that will help 
ensure the reliability of the bulk power transmission system in the 
United States and reduce the cost of delivered power to customers by 
reducing transmission congestion. The Rule does not grant outright any 
incentives to any public utility, but rather identifies specific 
incentives that the Commission will allow when justified in the context 
of individual declaratory orders or section 205 filings by public 
utilities under the FPA. A number of these incentives reflect 
departures from what the Commission has permitted in the past and a 
willingness to consider much greater flexibility with respect to the 
nature and timing of rate recovery for needed transmission 
infrastructure. While the Commission in recent years has permitted 
higher rates of return and deviations from past ratemaking practices in 
a few individual transmission infrastructure cases,\2\ we here 
determine generically that these types of ratemaking options and others 
should be considered on a broader basis for those applicants that can 
demonstrate that their infrastructure proposals meet section 219 
requirements.
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    \1\ Energy Policy Act of 2005, Pub. L. No. 109-58, 119 Stat. 
594, 315 and 1283 (2005).
    \2\ See Western Area Power, 99 FERC ] 61,306, reh'g denied, 100 
FERC ] 61,331 (2002) (Western), aff'd sub nom. Public Utilities 
Commission of the State of California v. FERC, 367 F.3d 925 (D.C. 
Cir. 2004); Michigan Electric Transmission Co., LLC, 105 FERC ] 
61,214 (2003) (METC); American Transmission Company, L.L.C., 105 
FERC ] 61,388 (2003) (American Transmission); ITC Holdings Corp., 
102 FERC ] 61,182, reh'g denied, 104 FERC ] 61,033 (2003) (ITC 
Holdings).
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    2. In reaching our determinations in this Final Rule, we have 
considered comments that reflect widely divergent views with respect to 
whether and when utilities should receive incentives and what they must 
demonstrate in order to receive particular incentives. As noted, the 
Rule does not grant incentives to any public utility but instead 
permits an applicant to tailor its proposed incentives to the type of 
transmission investments being made and to demonstrate that its 
proposal meets the requirements of section 219. Further, under the 
Rule, the Commission will permit incentives only if the incentive 
package as a whole results in a just and reasonable rate. For example, 
an incentive rate of return sought by an applicant must be within a 
range of reasonable returns and the rate proposal as a whole must be 
within the zone of reasonableness before it will be approved.
    3. An important component of this Rule is the willingness to 
provide procedural flexibility, including the use of expedited 
declaratory orders on permitted ratemaking treatments, to help with 
financing and up-front regulatory certainty for project investments. We 
are particularly attuned to the need for flexibility to support long-
distance interstate projects that significantly reduce the cost of 
delivered power by reducing transmission congestion on the interstate 
grid.
    4. The Final Rule provides incentive-based rate treatments to any 
public utility transmitting electric energy in interstate commerce that 
meets the requirements of section 219 and this Final Rule. The 
Commission will not limit an applicant's ability to seek incentive-
based rate treatments based on corporate structure or ownership. In 
addition, the Final Rule provides additional incentives, to the extent 
within our jurisdiction,\3\ to any transmitting utility or electric 
utility transmitting electric energy in interstate commerce that joins 
a Transmission Organization.\4\ Finally, as explained below, to the 
extent our jurisdiction allows, we encourage public power entities to 
take advantage of the incentive-based rate treatments outlined in the 
Final Rule.
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    \3\ With regard to non-public utilities, although the 
Commission's regulatory authority is bound by statute, such entities 
could be covered by a public utility's incentive rate proposal by a 
separate agreement between the public utility and a non-public 
utility. See Bonneville Power Administration, et al. v. FERC, 422 
F.3d 408 (9th Cir. 2005).
    \4\ Transmission Organization is defined in 18 CFR 35.35(a)(2) 
of this Final Rule as ``a Regional Transmission Organization, 
Independent System Operator, independent transmission provider, or 
other transmission organization finally approved by the Commission 
for the operation of transmission facilities.'' Electric Utility is 
defined in section 3(22) of the FPA as ``any person or State agency 
(including any municipality) which sells electric energy; such term 
includes the Tennessee Valley Authority, but does not include any 
Federal power marketing agency.'' 16 U.S.C. 796(22). Transmitting 
Utility is defined in section 3(23) of the FPA as ``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.'' 16 U.S.C. 796(23).
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    5. Some commenters have argued that few or no incentives are needed 
to encourage new transmission investment. We reject these comments as 
fundamentally inconsistent with section 219. Section 219 reflects 
Congress' determination that the Commission's traditional ratemaking 
policies may not be sufficient to encourage new transmission 
infrastructure. Although section 219 does not permit approval of rates 
that are inconsistent with section 205 or 206, section 219 nonetheless 
constitutes a clear directive that ``the Commission shall establish, by 
rule, incentive-based * * * rate treatments * * * for the purpose of 
benefiting consumers by ensuring reliability and reducing the cost of 
delivered power by reducing transmission congestion'' (emphasis added). 
We therefore cannot simply rely on existing ratemaking policy to 
faithfully implement section 219. This Final Rule therefore identifies 
a non-exclusive list of ratemaking reforms and requires applicants to 
tailor their proposals to fit the facts of their particular case.
    6. We do agree, however, with the position of certain wholesale 
customers and state commissions that the Commission should not provide 
incentives that only serve to increase rates without providing any real 
incentives to construct new transmission infrastructure. Section 219(a) 
states that transmission incentives should be ``benefiting consumers by 
ensuring reliability and reducing the cost of delivered power by 
reducing transmission congestion'' (emphasis added). The purpose of our 
Rule is to benefit customers by providing real incentives to encourage 
new infrastructure, not simply increasing rates in a manner that has no 
correlation to encouraging new investment. The Final Rule, therefore, 
makes clear that not every incentive identified herein will be 
necessary or appropriate for every new transmission investment. To 
provide guidance in this regard to potential applicants, we discuss 
below why certain incentives may, as a general matter, be better 
tailored to certain types of investments than others.

II. Background

    7. Section 219 of the FPA requires the Commission to establish, by 
rule, incentive-based (including performance-based) rate treatments for 
the transmission of electric energy in interstate commerce by public 
utilities for the purpose of benefiting consumers by ensuring 
reliability and reducing the cost of delivered power by reducing 
transmission congestion. Section 219(b) requires that the rule:

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    1. Promote reliable and economically efficient transmission and 
generation of electricity by promoting capital investment in the 
enlargement, improvement, maintenance, and operation of all facilities 
for the transmission of electric energy in interstate commerce, 
regardless of the ownership of the facilities;
    2. Provide a return on equity that attracts new investment in 
transmission facilities (including related transmission technologies);
    3. Encourage deployment of transmission technologies and other 
measures to increase the capacity and efficiency of existing 
transmission facilities and improve the operation of the facilities; 
and
    4. Allow the recovery of all prudently incurred costs necessary to 
comply with mandatory reliability standards issued pursuant to section 
215 of the FPA, and all prudently incurred costs related to 
transmission infrastructure development, pursuant to section 216 of the 
FPA (transmission national interest corridors).
    8. Section 219(c) requires that the Rule provide for incentives to 
each transmitting utility or electric utility that joins a Transmission 
Organization and to ensure that any recoverable costs associated with 
joining may be recovered through transmission rates charged by the 
utility or through the transmission rates charged by the Transmission 
Organization that provides transmission service to the utility. 
Finally, section 219(d) provides that all rates approved under the Rule 
are subject to the requirements of sections 205 and 206 of the FPA,\5\ 
which require that all rates, charges, terms and conditions be just and 
reasonable and not unduly discriminatory or preferential.
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    \5\ 16 U.S.C. 824(d) and 824(e) (2000).
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    9. Congress directed the Commission to issue a Final Rule 
establishing incentive-based rate treatments for transmission 
construction within one year of enactment of EPAct 2005, or by August 
8, 2006. The Commission issued a Notice of Proposed Rulemaking (NOPR) 
on November 18, 2005 seeking comment on the Commission's proposal to 
comply with section 219.\6\ In the NOPR, the Commission proposed to 
amend Part 35 of Chapter I, Title 18 of the Code of Federal Regulations 
by eliminating paragraph 35.34(e) under Subpart F and adding paragraph 
35.35 under Subpart G. The Commission received several hundred pages of 
comments. A list of the commenters appears in Appendix B. As explained 
below, based on the comments filed, the Commission clarifies and adopts 
the proposed regulations in the NOPR.
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    \6\ Promoting Transmission Investment Through Pricing Reform, 70 
FR 71409 (Nov. 29, 2005), FERC Stats. & Regs., Proposed Regs. ] 
32,593 (2005).
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III. Overview

A. The Need for New Transmission Facilities

1. Background
    10. As indicated in the NOPR, investment in transmission facilities 
in real dollar terms declined significantly between 1975 and 1998. 
Although the amount of investment has increased somewhat in the past 
few years, data for the most recent year available, 2003, shows 
investment levels still below the 1975 level in real dollars.\7\ This 
decline in transmission investment in real dollars has occurred while 
the electric load using the nation's grid more than doubled.\8\ 
Further, the record shows that the growth rate in transmission mileage 
since 1999 is not sufficient to meet the expected 50 percent growth in 
consumer demand for electricity over the next two decades.\9\
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    \7\ EEI Survey of Transmission Investment: Historical and 
Planned Capital Expenditures (1999-2008) at 3 (2005).
    \8\ Barriers to Transmission Investment, Presentation by Brendan 
Kirby (U.S. Department of Energy, Oak Ridge National Laboratory), 
April 22, 2005 Technical Conference, Transmission Independence and 
Investment, Docket No. AD05-5-000 (April 22, 2005 Technical 
Conference).
    \9\ Energy Policy Act of 2005: Hearings before the House 
Subcommittee on Energy and Commerce, 109th Congress, First Sess. 
(2005) (Prepared statement of Thomas R. Kuhn, President of EEI).
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2. Comments
    11. Many commenters agree that there is a significant need for new 
investment in transmission facilities. EEI states that, although 
increases in transmission investment are predicted over the 2004 to 
2008 period, the industry still has not reached the optimal level of 
investment.\10\ International Transmission notes that growth in 
transmission capacity has lagged behind the growth in peak demand over 
the last three decades and this trend is projected to continue through 
at least 2012.\11\ International Transmission cites to studies 
estimating the cost of power interruptions and fluctuations to range 
from between $29 billion and $135 billion annually,\12\ the cost of the 
August 2003 Northeast-Midwest blackout to be between $4 billion and $10 
billion,\13\ congestion costs of $4.8 billion in the ISO/RTO markets of 
California, New York, New England, the Midwest and PJM for 1999 to 
2002,\14\ and increases in PJM congestion costs, from $499 million in 
2003 to $808 million in 2004.\15\
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    \10\ 2004 State of the Markets Report, Federal Energy Regulatory 
Commission, Staff Report by the Office of Market Oversight and 
Investigations, June 2005, at p 27.
    \11\ See Eric Hirst, U.S. Transmission Capacity: Present Status 
and Future Prospects, a study prepared for EEI and the U.S. 
Department of Energy Office of Electric Transmission and 
Distribution, June 2004 (Hirst) and Keeping Energy Flowing: Ensuring 
a Strong Transmission System to Support Consumer Needs for Cost-
Effectiveness, Security and Reliability, a report of the Consumer 
Energy Council of America, Transmission Infrastructure Forum, 
January 2005. See also Affidavit of Jon E. Jipping, Exhibit A to the 
Reply Comments of International Transmission (the transmission 
system purchased in Michigan was 2.5 to 7 years behind schedule in 
maintenance on key transmission facilities).
    \12\ Kristina LaCommare and Joseph Eto, Understanding the Cost 
of Power Interruptions to U.S. Electricity Consumers, Lawrence 
Berkeley National Laboratory (September 2004) at xiv.
    \13\ See Final Report on the August 14, 2003 Blackout in the 
United States and Canada by the U.S.-Canada Power System Outage Task 
Force (April 2004) at 1.
    \14\ See Hirst at 8.
    \15\ See 2004 PJM State of the Market Report at 37 (March 8, 
2005).
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    12. Many transmission users and state commissions also agree that 
there is a need for additional investment in transmission 
infrastructure.\16\
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    \16\ E.g., TDU Systems, APPA, and Maryland Commission.
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    13. However, some commenters dispute the need for new transmission 
investment. They assert the Commission has overlooked that investment 
in transmission has increased in recent years.\17\ They also contend 
that investment in transmission by utilities in RTOs and ISOs has been 
significant, citing to the approximately $2 billion of approved 
spending in PJM since 2000. E.ON U.S. asserts that wide-spread system 
shortages have rarely occurred during the past 40 or more years, and 
that there does not appear to be any trend line that would suggest that 
it is becoming a serious problem now.
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    \17\ E.g., NASUCA and Connecticut DPUC.
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3. Commission Determination
    14. The issue of whether there is a need for new transmission 
investment that is sufficient to justify transmission incentives was 
put to rest by section 219. Section 219 mandates that the Commission 
``establish, by rule, incentive-based (including performance-based) 
rate treatments'' and, in doing so, ``promote reliable and economically 
efficient transmission and generation of electricity by promoting 
capital investment in the enlargement, improvement, maintenance, and 
operation of all facilities for the transmission of electric energy in 
interstate commerce'' (emphasis added). If this were not enough, the 
legislative

[[Page 43297]]

mandate of section 219 is supported by abundant evidence, as discussed 
above, including the fact that transmission investment in real dollars 
terms is lower today than it was in 1975 when the load was 
significantly smaller and that, even with the transmission additions of 
recent years, the industry still incurs significant congestion costs 
due to inadequate transmission.

B. The Need for Incentives

1. Background
    15. In section 219(a) of the FPA, Congress directed the Commission 
to establish incentive-based rate treatments to foster investment in 
transmission facilities.
2. Comments
    16. Several commenters argue that incentive-based rates are not 
necessary to encourage transmission construction or that incentives 
will not accomplish the intended goal.\18\ Others assert that reliance 
on incentives may increase the price of electricity without any real 
benefit.\19\
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    \18\ E.g., APPA, TAPS, NECOE, E.ON U.S., NARUC, and New Jersey 
Board.
    \19\ E.g., Connecticut DPUC, NASUCA, NECPUC, Delaware 
Commission, Missouri Commission, and New Mexico AG.
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    17. Commenters urge the Commission to limit the scope of any 
incentive-based treatments or to adopt mechanisms to ensure that they 
have their intended effect. For example, the New Mexico AG and TAPS 
assert that the Commission may implement an incentive-based mechanism 
by penalizing utilities or RTOs that fail to make investments necessary 
to ensure the reliability of the transmission grid. The Delaware 
Commission contends that providing incentives without assessing 
penalties for failure to meet obligations violates the just and 
reasonable standard. NASUCA states that it is unfair to provide 
incentives that increase utility profits but do not hold applicants 
accountable for performance. The Missouri Commission proposes that the 
Commission implement a process that determines performance-based return 
on equity. Other commenters recommend that the Commission make approval 
of any incentives conditional on the applicant showing a need for the 
incentive or that the facility would not have been built absent the 
incentive.
    18. In contrast, a number of commenters, including EEI and a large 
number of utility and Transco commenters, argue that incentives are 
needed to foster investment in transmission facilities. EEI asserts 
that incentives are needed to stimulate planning and investment in 
national interest electric transmission corridors. NU states that the 
many risk factors associated with transmission investments, such as 
considerable time delays, negative public opinion of transmission 
construction, state siting uncertainties and recovery of project costs, 
justify incentives.
3. Commission Determination
    19. Here again, the fundamental issue raised by certain 
commenters--whether transmission incentives are necessary to encourage 
new infrastructure--was put to rest by the plain language of section 
219(a), which requires the Commission issue a rule that adopts 
``incentive-based * * * rate treatments.'' Certain commenters urge the 
Commission to adopt ``penalties'' in this rulemaking for entities that 
do not build sufficient transmission. We decline to do so here.
    20. Other commenters do not oppose incentives outright, but rather 
are concerned with the extent to which incentives may increase rates to 
consumers. Those concerns are premature. The Final Rule does not grant 
incentive-based rate treatments or authorize any entity to recover 
incentives in its rates. Rather, it informs potential applicants of 
incentives that the Commission is willing to allow when justified. 
Before adopting any incentive-based rate treatments for a particular 
company, the Commission will need to determine that the applicant has 
justified its specific incentive request. In addition, although the 
Commission intends to provide flexible procedural mechanisms by which 
an applicant may obtain an early determination of which incentives it 
may receive (e.g., through an expedited declaratory order proceeding), 
before recovering any incentives in its rates, specific rates must be 
approved under section 205 of the FPA.

C. Summary of the Nature and Applicability of Incentives Adopted by the 
Final Rule

    21. The incentives adopted by this Final Rule are properly 
understood only in the context of the traditional regulatory principles 
they seek to further. The longstanding rule is that utility rate 
regulation must adequately balance both consumer and investor 
interests. It is not enough to ensure that investors are properly 
compensated, and it is not enough to ensure that consumers are 
protected against excessive rates. Our policies must ensure both 
outcomes and, in doing so, strike the appropriate balance between these 
twin objectives. In striking that balance, the courts have recognized 
that there is no single formula for establishing a just and reasonable 
rate. Rather, the test is whether the ``end result'' is just and 
reasonable.\20\
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    \20\ See FPC v. Hope Natural Gas Co., 320 U.S. 591, 602-03 
(1944).
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    22. The traditional policies that we re-examine here reflect both 
fundamental precepts: the need to balance investor and consumer 
interests and the recognition that there is no single formula for doing 
so. For example, in ensuring that rates produce adequate returns for 
investors, we do not set a single return on equity for all public 
utilities, nor do we presume that there is only one return on equity 
that is appropriate for any individual utility. Rather, our precedents 
require the establishment of a range of returns and we select an ROE 
within that range that reflects the facts and circumstances of a 
particular case. Similarly, our policies regarding the recovery of 
Construction Work in Progress (CWIP) seek to balance investor and 
consumer interests by allowing, in the typical case, 50 percent of CWIP 
in rate base. This policy balances investor and consumer interests in 
the ordinary case by permitting investors recovery of some construction 
costs on a current basis while also protecting consumers against full 
rate recovery before a particular facility is placed into service.
    23. Our procedural regulations respecting rate recovery also seek 
to balance investor and consumer interests. For example, we allow 
public utilities to determine, as a general matter, the timing and 
frequency of when to seek a rate increase, which ensures that investors 
can file a rate increase when current rates are no longer adequate 
(e.g., when the utility is undergoing a large construction program). 
However, we also typically require a utility seeking a rate increase to 
expose all of its costs to review and therefore do not generally permit 
``single issue'' rate filings (selective rate adjustment).
    24. Section 219 requires the Commission to re-examine these and 
other policies to determine whether they continue to strike the 
appropriate balance in encouraging new transmission investment given 
the significant need for new transmission infrastructure in the Nation. 
We do so in recognition of the unique and substantial challenges faced 
by large new transmission projects. Siting major new transmission lines 
is extraordinarily difficult, given the environmental and land use 
concerns associated with obtaining and permitting new rights-of-way. 
The

[[Page 43298]]

experience of American Electric Power Corp. in taking 16 years to 
complete construction of a new high-voltage transmission line from 
Wyoming County, West Virginia to Jackson Ferry, Virginia represents an 
extreme example, but it is illustrative of the significant risks and 
challenges associated with siting large new transmission projects.\21\
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    \21\ Although new section 216 of the FPA improves the siting 
process for certain new projects, it does not eliminate all risks 
faced by such projects nor does it address the risks faced by other 
projects that do not reside in a national interest transmission 
corridor.
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    25. These challenges and risks are underscored by the fact that, in 
many instances, new transmission projects will not be financed and 
constructed in the traditional manner. New transmission is needed to 
connect new generation sources and to reduce congestion. However, 
because there is a competitive market for new generation facilities, 
these new generation resources may be constructed anywhere in a region 
that is economic with respect to fuel sources or other siting 
considerations (e.g., proximity to wind currents), not simply on a 
``local'' basis within each utility's service territory. To integrate 
this new generation into the regional power grid, new regional high 
voltage transmission facilities will often be necessary and, 
importantly, no single utility will be ``obligated'' to build such 
facilities. Indeed, many of these projects may be too large for a 
single load serving entity to finance. Thus, for the Nation to be able 
to integrate the next generation of resources, we must encourage 
investors to take the risks associated with constructing large new 
transmission projects that can integrate new generation and otherwise 
reduce congestion and increase reliability. Our policies also must 
encourage all other needed transmission investments, whether they are 
regional or local, designed to improve reliability or to lower the 
delivered cost of power.
    26. To address the substantial challenges and risks in constructing 
new transmission, the Final Rule identifies instances where our 
regulatory policies may no longer strike the appropriate balance in 
encouraging new investment. The Final Rule identifies several policies 
that should be adjusted, where appropriate on the facts of a particular 
case, to encourage new transmission investment or otherwise remove 
impediments to such investment. Although each reform adopted by the 
Final Rule constitutes an ``incentive'' as that term is used by section 
219, this label has caused some confusion in the comments. It is true 
that our reforms adopted in the Final Rule provide ``incentives'' to 
construct new transmission, but they do not constitute an ``incentive'' 
in the sense of a ``bonus'' for good behavior. Rather, as we explain 
below, each will be applied in a manner that is rationally tailored to 
the risks and challenges faced in constructing new transmission. Not 
every incentive will be available for every new investment. Rather, 
each applicant must demonstrate that there is a nexus between the 
incentive sought and the investment being made. Our reforms therefore 
continue to meet the just and reasonable standard by achieving the 
proper balance between consumer and investor interests on the facts of 
a particular case and considering the fact that our traditional 
policies have not adequately encouraged the construction of new 
transmission.
    27. A few examples will illustrate this point. The Final Rule 
permits higher returns on equity for certain transmission investments. 
This may be appropriate in several contexts, such as where the risks of 
a particular project exceed the normal risks undertaken by a utility 
(and hence are not reflected in a traditional discounted cash flow 
(DCF) analysis) and where necessary to encourage creation of a Transco 
or participation in a Transmission Organization. However, this does not 
mean that every new transmission investment should receive a higher 
return than otherwise would be the case. For example, routine 
investments to meet existing reliability standards may not always, for 
the reasons discussed below, qualify for an incentive-based ROE.
    28. The Final Rule also adopts incentives that are designed to 
reduce the risks of new investments. For example, the Final Rule 
provides that the Commission will provide assurance of recovery of 
abandoned plant costs if the project is abandoned for reasons outside 
the control of the public utility. Although this qualifies as an 
``incentive'' under section 219, it is perhaps more properly 
characterized as reducing a regulatory barrier--the potential lack of 
recovery of costs-- to infrastructure development. Moreover, this 
reform adequately balances consumer and investor interests because it 
is available only when a project is abandoned for reasons beyond the 
control of the public utility.
    29. Our Final Rule also adopts certain reforms that affect the 
timing of recovery of new transmission investments. Given the long lead 
time required to construct new transmission, and the associated cash 
flow difficulties faced by many entities wishing to invest in new 
transmission, the Final Rule provides that, where appropriate, the 
Commission will allow for the recovery of 100 percent of CWIP in rate 
base. Here again, we seek to remove an impediment--inadequate cash 
flow--that our current regulations can present to those investing in 
new transmission. We also will permit, where appropriate, the recovery 
of the costs of new transmission through a single issue rate filing 
without requiring the public utility to re-open all its transmission 
rates to review. We do not, however, suggest that such selective rate 
adjustments will be appropriate in all cases, as discussed in more 
detail below. Rather, as with each incentive adopted by the Final Rule, 
an applicant must show that there is a nexus between its proposal to 
make a single issue rate adjustment and the facts of its particular 
case.

D. Effective Date and Duration of Effectiveness For Incentives

1. Background
    30. Congress directed the Commission to issue a rule establishing 
incentive-based rate treatments no later than one year after enactment 
of EPAct 2005, or by August 8, 2006.
2. Comments
    31. Certain commenters urge the Commission to apply the rule to 
investments made before August 8, 2005 while others ask the Commission 
to apply the rule to investments made after August 8, 2005.\22\ Certain 
commenters argue that the Commission should not approve incentives for 
facilities that are pending at the time the Final Rule becomes 
effective, while others request that the Commission not allow 
incentives for investment in facilities that an applicant already has 
committed to build or for Transcos that already exist.\23\
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    \22\ E.g., Progress, NEMA, and PG&E.
    \23\ E.g., PG&E, Connecticut DPUC, NASUCA, TDU Systems and TANC.
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    32. Several commenters argue that, once the incentives have been 
granted, the Commission should not eliminate them, or should do so only 
under very limited circumstances.\24\ In contrast, others argue that 
the Commission should grant incentives for a specific time period or 
retain the flexibility to change or review any incentives if it is 
found the incentives provide no customer benefit.\25\ The California 
Oversight Board requests that any

[[Page 43299]]

authorized incentives be subject to refund.
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    \24\ E.g., Progress, NEMA, EEI, Trans-Elect, and National Grid.
    \25\ E.g., TANC, Snohomish, Municipal Commenters, and TDU 
Systems.
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    33. KKR explains that, under certain circumstances, investors in 
transmission assets may need favorable rate treatment for a sufficient 
period of time to ensure an appropriate return on their capital, i.e., 
for a 15 to 30-year period.\26\ KKR recommends that public utilities 
requesting incentive treatment for an extended period into the future 
propose criteria that can be used to evaluate that entity's performance 
during periodic evaluations. KKR notes that applicants may not always 
be able to meet certain proposed metrics due to circumstances beyond 
their control. For example, a transmission owner should not lose its 
incentive rate treatments if it does not succeed in meeting desired 
reductions in congestion because the applicant may not have complete 
control of the factors affecting congestion, such as generation 
additions, changes in load location and operation of neighboring 
systems, and RTO policies. KKR emphasizes that the Commission should 
retain the flexibility to assess an applicant's proposal as the facts 
and circumstances will vary case-by-case. Finally, KKR recommends that 
applicants be required to file a report on their performance every 
several years and that the Commission may initiate a proceeding to 
review incentives only if the criteria are not met. KKR explains that 
frequent reviews run the risk of distorting results due to the 
``lumpiness'' of capital investment and the long time periods to make 
capital additions and for capital additions to have effects. Further, 
KKR states that frequent reviews will make long-term investments more 
uncertain and, hence, less likely. In supplemental comments, KKR 
asserts that higher ROEs are of material value for Transcos only when 
long-term. KKR cites International Transmission as an example, noting 
that it is only able to invest in excess of every dollar it earns back 
into its system due to the certainty afforded it by its rate compact, 
which is long-term, formula-based, and includes a reasonable ROE. The 
certainty and long-term horizon of International Transmission's rates 
give debt and equity investors in International Transmission comfort 
that they will ultimately receive an adequate return on their capital.
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    \26\ See also National Grid and EEI.
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3. Commission Determination
    34. Section 219 of the FPA became effective on August 8, 2005. 
Codification of section 219 on that date and the requirement for a rule 
authorizing investment incentives provided notice to the industry that 
Congress intended that the Commission provide incentive-based rate 
treatments promptly. Thus, the Final Rule will become effective 60 days 
after publication in the Federal Register. However, we clarify that any 
investment made in, or costs incurred for, transmission infrastructure 
after August 8, 2005 that ensures reliability or lowers the cost of 
delivered power by reducing transmission congestion will be eligible 
for incentive-based rate treatments under this Rule. Applicants seeking 
incentive-based rate treatments for investments made or costs incurred 
after August 8, 2005 will need to satisfy the requirements of this Rule 
to obtain and recover any incentives and will need to make an 
appropriate filing under section 205.
    35. The fact that a proposed expansion was in a utility's expansion 
plan as of August 8, 2005 does not disqualify the project for incentive 
treatment. Inclusion of a facility in a plan does not mean that a 
project can or will get built. Even where a project already has been 
planned or announced, the granting of incentives may help in securing 
financing for the project or may bring the project to completion sooner 
than originally anticipated. Congress's directive that the Commission 
issue a rule within one year of enactment of EPAct 2005 shows that 
Congress intended for the Commission to take steps to bring new 
transmission on line expeditiously.
    36. With respect to the issue of how long an incentive-based 
proposal should remain in effect, the Commission recognizes that it may 
be necessary to authorize incentives that may extend over several years 
in order to support investment in long-term transmission. It can be 
important to investors making long-term investments in long-lived 
facilities to be assured that a ratemaking proposal adopted prior to 
construction of those facilities will not later be altered in a manner 
that undermines the basis for the financing of those facilities. The 
Commission will therefore allow applicants to propose specific time 
periods by which their incentive-based proposals will not be ``re-
opened'' in a manner incompatible with the nature of the initial 
approvals. However, to ensure that ratepayers are also adequately 
protected, we will require any applicants seeking such a fixed term for 
its plan to explain how ratepayers can be assured that such a plan is 
delivering the benefits that formed the basis for the Commission's 
initial approval of it. For example, an applicant may propose periodic 
progress assessments with appropriate metrics to measure how well the 
project is progressing and whether the proposed investment in new 
transmission is improving reliability or reducing congestion. Such 
metrics would provide the Commission a means to determine whether and 
how the applicant is providing the anticipated benefits and thus that 
the approved incentives need not be revisited. Because the scope and 
size of each project will differ, any applicant seeking incentive-based 
rate treatments may propose metrics for its project as well as the 
frequency for review of those metrics.\27\ An applicant may include its 
proposed metrics and any timetable for review in its section 205 rate 
filing seeking recovery of incentives.\28\ Where such metrics are found 
to be needed and are approved by the Commission, an applicant would be 
required to submit information filings to the Commission consistent 
with the approved metrics and timetable. We clarify, however, that the 
metrics reviews will not be opportunities to re-argue the issues 
addressed in proceedings granting the incentive-based rates; they are 
for the purpose of measuring whether the plan is being implemented as 
initially approved.
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    \27\ The information may include, as well as supplement, 
information provided in FERC-730, discussed in section V below.
    \28\ An applicant has the option to include metrics proposals in 
a declaratory order proceeding, but would also need to include them 
in the subsequent section 205 rate filing.
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IV. Discussion

A. Standard for Approval of Incentive-Based Rate Treatments

1. The Final Rule Applies to the Recovery of Costs Incurred to Ensure 
Reliability or to Reduce Transmission Congestion, or Both.
a. Background
    37. Proposed Sec.  35.35(d)(1) specifies that the Commission will 
authorize incentive-based rate treatments for investment by public 
utilities, including Transcos, in new transmission capacity that 
reduces the cost of delivered power by reducing congestion or promotes 
reliability, as demonstrated in an application to the Commission.
b. Comments
    38. Many commenters urge the Commission to be flexible in applying 
the incentives.\29\ Southern and the Nevada Companies assert the 
Commission should not require that facilities both improve regional 
reliability and reduce congestion to be eligible for an incentive ROE. 
They

[[Page 43300]]

argue that the guiding factor should be to provide incentives that 
improve regional reliability and/or reduce transmission congestion. AEP 
urges the Commission to adopt a functional approach to determine 
whether a project qualifies for incentives. For example, AEP suggests 
that projects that connect newer technology generation or renewables be 
eligible for incentives. Upper Great Plains contends that incentives 
should be available for projects that support the development of new 
electric generation in recognition of the expected growth in electric 
consumption and the need for additional investment to keep pace.
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    \29\ E.g., FirstEnergy, Southern, Nevada Companies, AEP.
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    39. Several commenters urge the Commission to establish criteria 
for transmission projects to demonstrate that they achieve Congress' 
goals before projects receive an incentive.\30\ The New York Commission 
asks the Commission to convene a technical conference to develop the 
criteria.
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    \30\ E.g., AEP and New York Commission.
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    40. The Maryland Commission supports incentives that are forward-
looking and targeted to support electric reliability, competitive 
markets and diversity in fuel sources, including renewable resources, 
in the short and long term.
c. Commission Determination
    41. The purpose of section 219 of the FPA is to benefit consumers 
by promoting transmission capital investments that result in reliable 
and economically efficient transmission and generation. Congress did 
not enact section 219 in isolation. Section 219 is a part of a larger 
statutory framework in which Congress directed the Commission to take 
steps to address reliability of the bulk power system as well as to 
remedy the adverse effects of transmission congestion. For example, in 
new section 215 of the FPA Congress enacted a regulatory regime under 
which the Commission will, for the first time in its history, approve 
and enforce mandatory reliability standards for the nation's power 
grid.\31\ In new section 216, Congress directed the Secretary of Energy 
to identify areas of the nation in which transmission congestion 
adversely affects consumers (national interest electric transmission 
corridors) and gave the Commission certain permitting authority to 
ensure timely construction of transmission facilities to remedy 
transmission congestion in those corridors. In section 1223 of EPAct 
2005, Congress directed the Commission to encourage the deployment of 
advanced transmission technologies that increase the capacity, 
efficiency and reliability of an existing or new transmission facility. 
In enacting these provisions of EPAct, Congress made clear that it was 
equally concerned with reliability as well as the adverse impacts of 
transmission congestion and that the Commission should take steps to 
address both issues. New FPA section 219, which is complementary to 
these other EPAct provisions, directs the Commission to provide rate 
incentives for the purpose of ensuring reliability and reducing 
transmission congestion. However, nowhere in section 219 does the 
language say that the Commission may provide incentives only to 
applicants that propose to both improve reliability and reduce 
congestion. In fact, we believe it would be contrary to the intent of 
the new provisions, taken together, to limit incentives this way.
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    \31\ See Order No. 672, Rules Concerning Certification of the 
Electric Reliability Organization; and Procedures or the 
Establishment, Approval, and Enforcement of Electric Reliability 
Standards, 71 FR 8662 (Feb. 17, 2006), FERC Stats. & Regs. ] 31,204 
(2006).
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    42. Consistent with the overall goals of Congress in EPAct 2005, 
and in particular its focus on reliability improvements and relief of 
transmission congestion, we interpret section 219 to promote capital 
investment in a wide range of infrastructure investments that can have 
either reliability or congestion benefits rather than investments that 
have both reliability and congestion benefits. The alternative to this 
reading would be to apply section 219 in a manner that would deny 
incentive-based rate treatments to a transmission facility that 
significantly enhances reliability but does not reduce the cost of 
delivered power by reducing transmission congestion. This would be 
contrary to a fundamental goal of EPAct 2005 to improve reliability of 
the interstate transmission grid. We do not consider such an 
interpretation to be reasonable. In any event, we expect there will be 
few transmission projects that provide one type of benefit but not the 
other.
    43. Commenters seeking a narrow reading of section 219 are 
primarily concerned with the impact of any incentive-based rate 
treatment on an applicant's rates. These concerns are premature. Before 
the Commission will permit any applicant to recover incentives in its 
rates, the Commission will evaluate the rate impact under section 205 
or 206 of the FPA. Interested parties may raise any rate concerns at 
that time. Further, our case-by-case approach ensures that the 
incentives granted will be tailored to particular circumstances. 
Finally, except for the rebuttable presumptions addressed below, we 
will not at this time establish more detailed criteria an applicant 
must meet to be eligible for incentive-based rate treatments. 
Establishing criteria now would limit the flexibility of the Rule or 
improperly pre-judge which projects are acceptable for incentives. The 
Commission will, on a case-by-case basis, require each applicant to 
justify the incentives it requests. Because these proceedings will 
provide ample opportunity for parties to comment on any incentive 
proposal, we do not see the need for a technical conference or detailed 
criteria now. This notwithstanding, we provide certain guidance, as 
described below, regarding the types of projects that may be 
particularly well suited to certain incentives and others that may not.
2. Other Criteria For Approval of Incentives
a. Comments
    44. Numerous commenters seek additional conditions to be considered 
in the grant of incentives. Some argue that the number of incentives 
should be limited while others recommend additional criteria that an 
applicant must satisfy \32\ or that the incentives be limited to 
certain types of facilities. For example, TDU Systems assert that the 
Final Rule should specifically identify other incentives that will be 
considered under Sec.  35.35(d)(viii) and specify the parameters for 
eligibility for the incentives. EEI, however, contends the Commission 
should allow individual companies to propose any incentives on a case-
by-case basis because the individual companies are in a better position 
to understand the efficacy of particular incentive mechanisms. 
Similarly, National Grid requests clarification that the incentives are 
not mutually exclusive and transmission owners should be free to 
propose customized rate packages that include one or more of the 
incentives in combination.
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    \32\ E.g., East Texas, TANC, and TAPS.
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    45. With regard to additional conditions, some commenters argue, 
for example, that the Commission should authorize incentives only for 
proposals that recognize regional differences, that are the product of 
an open and inclusive regional transmission planning process, increase 
network capacity, or that respond to specific reliability or congestion 
concerns. TANC argues that the Commission should limit qualification 
for the incentives to those transmission projects that are 200 kV and 
above. NECOE argues that incentives should be provided to

[[Page 43301]]

utilities that conform to good utility practice and minimize total 
costs. Also, NECOE asserts that, when more than one incentive is 
requested, the Commission should require the applicant to demonstrate 
why a single, appropriately targeted incentive is insufficient. Several 
commenters urge the Commission to grant incentives for existing 
facilities and for maintenance of existing facilities.\33\ The Southern 
Companies state that the Commission should grant incentives to 
proposals that resolve a significant inter or intra-regional 
constraint, or preclude or mitigate anticipated constraints that may or 
may not arise. Progress asserts that incentives should be granted to 
encourage installation of new software to better manage flowgates and 
calculate Available Transfer Capability values on existing transmission 
facilities. The Steel Manufacturers state that a utility does not 
deserve special rate treatment to maintain or upgrade its facility to 
comply with mandated reliability standards.
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    \33\ E.g., FirstEnergy, PSEG, AEP, EEI, Duquesne and 
MidAmerican.
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    46. Several commenters urge the Commission to condition any 
incentive-based rate treatment on the applicant, among other things, 
divesting the subject facility to a Transco, demonstrating that the 
subject facility solves congestion constraints on a regional basis or 
results in significant new transfer capacity, complying with the 1992 
and 1994 Policy Statements, showing that the facilities would not have 
been built absent the incentives, or showing that the facilities were 
not already necessary to meet NERC reliability criteria or normal load 
growth.\34\ PJM proposes a tiered procedure to determine whether 
incentives are warranted. TDU Systems recommend that incentives should 
be denied to public utilities that have refused to provide requested 
relief from transmission congestion in the form of transmission 
upgrades or otherwise, until such congestion is remedied without the 
incentive rates.
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    \34\ E.g., TDU Systems, APPA, TAPS, NRECA, NARUC, NASUCA, 
Connecticut DPUC, New Jersey Board, WPS.
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    47. Several commenters request that the Commission allow states to 
play a role in the approval or recovery of incentives because states 
may hinder recovery of incentives in bundled rates.\35\ National Grid 
asserts that the Commission and states should have an alignment of 
interests on transmission investment and, therefore, there is no basis 
to believe that the rule will warrant shifts in states' roles.
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    \35\ E.g., CREPC, KCPL, Steel Manufacturers, Montana-Dakota, 
MidAmerican, and EEI.
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b. Commission Determination
    48. Congress has determined that there is a need for incentives, 
and has directed the Commission to issue a rule to provide them. Most 
of the prerequisites and preconditions raised in the comments reflect a 
desire to limit or circumscribe the nature or applicability of 
incentives that may be granted under the rule. We have considered these 
comments and do not believe that any of them should be adopted at this 
time. Some of them are consistent with our overall policy goals (such 
as the emphasis on regional planning) and, to that extent, we explain 
how we will factor those considerations into an analysis of a proposed 
incentive. However, some are inconsistent with the policy goals of 
section 219 because they will only serve to discourage transmission 
investment. Therefore, unless adopted in other sections of this rule, 
we will not require applicants to satisfy the requirements proposed in 
the comments. For example, we reject arguments that an applicant must 
show that, but for the incentives, the expansion would not occur. Those 
arguments are based on commenters' conclusions that the Commission's 
prior issuances (i.e., Removing Obstacles order, the 1992 Policy 
Statement, or the innovative rate proposal in Order No. 2000) required 
an applicant to show need prior to receiving incentives. However, the 
Final Rule is based on a clear directive from Congress that does not 
require an applicant to show that it would not build the facilities but 
for the incentives. This notwithstanding, we do require applicants to 
show some nexus between the incentives being requested and the 
investment being made, i.e., to demonstrate that the incentives are 
rationally related to the investments being proposed.
    49. We also consider our procedures for the approval of incentives 
to be comprehensive and, therefore, will not attempt to establish 
gradations regarding either approval requirements or the amount of 
incentive approved, as recommended by TANC, PJM, Industrial Consumers 
and others. Section 219 does not mandate higher returns for projects 
that are part of independent regional planning processes, nor does it 
require higher standards of review for projects that do not result from 
independent planning processes. As long as the project ensures 
reliability or reduces the cost of delivered power by reducing 
congestion, regardless of where it is located on the nationwide 
transmission grid, the project is eligible for incentive ratemaking.
    50. We will not impose size limits on eligible transmission 
projects. Projects below 200 kV can have a significant impact on 
reliability or reduce congestion, and therefore would qualify for 
incentive treatment. We will also not condition approval of incentives 
on market power findings. Our regulations and penalties on market power 
and market behavior are sufficient inducements to ensure markets are 
not manipulated and, therefore, additional provisions are not 
necessary.
    51. We will not deny incentives to public utilities that have not 
built transmission upgrades requested by transmission customers. The 
scope of this Rule is restricted to implementing the requirements of 
section 219; the appropriate means to address this issue is to file a 
complaint in a separate proceeding.
    52. While the promotion of renewable energy projects supports other 
policy and regulatory objectives, we will not adopt separate rate-based 
incentives for renewable energy projects. Congress directed the 
Commission to issue a rule to ensure reliability or to reduce the cost 
of delivered power by reducing transmission congestion regardless of 
the nature of the energy carried over the new transmission facilities. 
We believe that, by providing incentives applicable to all transmission 
facilities, the Final Rule provides incentives for transmission to 
serve renewable resources and, therefore, additional incentives are not 
necessary.
    53. Because section 219 provides a new directive to the Commission 
to permit greater incentives and does not on its face require an 
individual showing of ne