March 2004

Grid Poker

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2004/04/24)
 

We must look beyond the poker games being played now to where the great pots will be in the future. Grid poker is the future.

It has become clear that the continued momentum of restructuring and the competitive model has stalled. The commonly accepted wisdom is that we are re-entering the era of re-regulation of vertically integrated utilities, overseen by regulators re-focused on integrated resource planning. In effect, the commonly accepted wisdom is that we are entering the age of the policy rollback. It is a very Newtonian notion: for every revolution there is a counter-revolution. The New Order giveth way the Old.

But this overlooks two realities, one political and one corporate. For consumers and voters – and therefore ultimately regulators and legislators – what the power business is “really” about are blackouts, national security concerns and support for domestic economic competitiveness. As a technological matter, what that common sense perception translates into is the need for a “smarter” electrical system that is interactive, secure and self healing in emergencies.

The Newest Order not only needs to be, but possibly will be, a pragmatic focus on “distributed energy”: operating the grid better and smarter in the future to alleviate the shortcomings which deregulation revealed in the system infrastructure (notably T&D), and to control future generation needs and costs through measures as diverse as demand response, load management and technologies meant to operate the grid better and smarter in the future. This is not just a shift in attention from one end of the integrated system, generation, to the other transportation. Nor is it an effort to reign in “Big Power” by focusing on conservation not production. It is a measured embrace for basic scientific reasons of a new approach toward keeping our power system up with our computerized society.

Right now the high rollers are in the private room buying and selling existing generation assets. Buying and selling wires is a secondary game. Of course it is recognized that what assets will be worth will be a function of the grid to which they are interconnected. Regulatory attention therefore already is on rationalizing grid system regulation.

But the future is not simply about congestion pricing and the allocation of embedded transmission costs. Grid poker is increasingly about finer grain T&D issues: (1) interconnection of large and small generators; (2) distribution generation applications; and (3) renewable energy delivery on wires and through trading mechanisms. It is about system reconfiguration and improvement through distributed energy initiatives.

FERC has promulgated a rule for large generators (over 20 MW) and proposed a separate rule for small generators. The thrust of the large generator rule was to alleviate an important practical obstacles to hook-ups by new facilities seeking to compete with local utilities in a reliable manner. It was part of deregulation through standardization: notable provisions are: (1) one set of standardized interconnection procedures and a standard interconnection agreement throughout the nation, designed to reduce the time and cost burden of case by case negotiation; and (2) delineation of responsibility for interconnection costs: upgrades to new generation initially to be “participant” funded by generators, subject to full refunds to ISO/RTOs’; distribution system upgrades paid entirely by the generator. But while this Order struck a blow for open access, observers of the prospects for a vital responsive grid remained skeptical. They perceived lack of sustained momentum for the traditional grid regulation/business model, including lack of continued impetus for major existing transmission system improvement –in the absence of an intense focus on whether the existing network with strategic DG add-ons, demand side management and demand response initiatives, could run more efficiently.

FERC has not been oblivious to the potential of enhancing the transmission system by adding distributed energy resources at key points on the system. What better response to the blackout threat than to minimize reliance on widely diffused power-grid than to promote the deployment of DG closer to load on a “plug-and-play” basis. But in its small generator interconnection rules, FERC became embroiled in old style controversy, notably over Federal-State jurisdictional issues with respect to the regulation of interconnection of DG on local distribution systems and FERC’s alleged premature presumption of Standard Market Design, even though it did not prevailed nationally.

Gridlock over transmission reform and SMD has already left the public wondering how the clear near-term need for transmission and distribution (T&D) system upgrades (with an estimated $30-100 billion cost over the next decade) will be met. How will congested load centers be served? How will interregional seams be traversed?

Increasingly, it is recognized that the issue is one of mobilizing “distributed energy” techniques without penalizing existing utilities’ distribution systems in the process. Even-handed regulatory approaches, new technology applications and “smart” distribution systems, including layered control systems; protection systems for two-way power flows; improved communications and rapid ability to realign configuration and operations, are all receiving greater attention.

Renewable resources that produce electricity intermittently, especially wind and solar, will be used more extensively if customers can rely on the traditional utility system to eliminate deficits and to absorb excesses from on site generation. Protections against discrimination for long-distance transmission from remote sites to load centers will help them further.

To deal with situations where wires do not facilitate sales, state initiatives have focused on “constructive” movement of energy are coming into focus. Renewable Portfolio Standards, (mandatory green-sourced power purchase requirements for distribution companies); the creation of “green tags” (or “credits”) associated with but separable from green power, which may be sold by its generators to distribution companies and used by them to meet these purchase requirements; the facilitation of the trading of these green tag rights among parties, and experimentation with government sponsored markets for certain derivative products-based upon the trading of these “greenstream products” are all state initiatives. So too are “cap and trade” programs for “emission reduction credits,” which are earned by reducing carbon emissions through substitution of non-carbon generating technologies for carbon polluting generation sources (an approach being pioneered in EU countries under Kyoto) may a similar “constructive” power movement effect.

Revision of grid poker’s rules will mesh with several primary interests of the capital markets. They are an integral piece of the fabric of free trade in electric power. They promote a healthy grid system, which provides technological innovation with respect to the wires system which, in turn, benefits national security, consumers, and fundamental regulatory stability. They also add a wild card to the deck: of monetizable “legal assets” which can be factored into the complex financing equation of certain assets. A chance, perhaps to be “future studs”. The best players of grid poker will be future studs.

ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.