FTC Staff Comment Before the Federal Energy Regulatory Commission Concerning Long Term Transmission Rights in Markets Operated by Regional Transmission Organizations and Independent System Operators

Before the
United States of America
Federal Energy Regulatory Commission
Long Term Transmission Rights in 	)
Markets Operated by Regional Transmission 	) 	Docket No. AD05-7-000
Organizations and Independent System 	)
Operators 	)
Comment of the
Staff of the Federal Trade Commission*
August 8, 2005
* These comments represent the views of the staff of the Federal Trade Commission.
They do not necessarily represent the views of the Federal Trade Commission or any
individual commissioner. The Commission, however, has authorized the staff to file
these comments.

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Before the
United States of America
Federal Energy Regulatory Commission
Long Term Transmission Rights in 	)
Markets Operated by Regional Transmission 	) 	Docket No. AD05-7-000
Organizations and Independent System 	)
Operators 	)
Comment of the
Staff of the Federal Trade Commission1
I. 	Introduction and Summary
The Staff of the Federal Trade Commission (FTC) appreciates this opportunity to
comment on the Federal Energy Regulatory Commission’s (FERC’s) initiatives to reduce
entry impediments in wholesale electricity markets that may stem from long-term risk in
obtaining transmission services.2 Currently, wholesale electricity customers and their
generation suppliers face substantial risk in the acquisition of long-term transmission
access in markets operated by FERC-approved regional transmission organizations
(RTOs) and independent system operators (ISOs).3 These risks relate to both the price
and the availability of long-term transmission. FERC already has approved the use of
short-term financial transmission rights (FTRs) in RTOs to mitigate important
1 These comments represent the views of the staff of the Federal Trade Commission.
They do not necessarily represent the views of the Federal Trade Commission or any
individual commissioner. The Commission, however, has authorized the staff to file
these comments.
2 Long Term Transmission Rights in Markets Operated by Regional Transmission
Organizations and Independent System Operators, FERC No. AD05-7-000 (May 11,
2005) [hereinafter Notice]; FERC Staff, Long-Term Transmission Rights Assessment
(May 11, 2005) [hereinafter FERC Staff Paper].
3 For convenience, this comment will refer to RTOs and ISOs collectively as “RTOs.”

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components of short-term transmission risk.4 Although these short-term FTRs appear
likely to improve the competitiveness of these markets and improve their efficiency,
practicable means to address long-term transmission risk are limited.5
This comment offers three insights on why FERC's initiatives in this area are
important. These suggestions are grounded in principles of competition policy and
economic efficiency. We respectfully suggest that American consumers will be well-
served if these principles form a primary basis for FERC's policymaking efforts.
* * * * *
The FTC is an independent agency of the federal government responsible for
maintaining competition and safeguarding the interests of consumers through
enforcement of the antitrust and consumer protection laws and through competition
policy research and advocacy. In the electric power industry, the FTC often analyzes
regulatory or legislative proposals that may affect competition or the efficiency of
resource allocation and reviews proposed mergers involving electric and gas utility
companies. In the course of this work, as well as in antitrust and consumer protection
research, investigation, and litigation, the FTC applies established legal and economic
principles and recent developments in economic theory and empirical analysis to
4 FERC Staff Paper, supra note 2, at 3-4.
5 Currently, merchant entities that undertake transmission investments receive long-term
transmission rights. A transmission investor that voluntarily supplements the grid with
merchant transmission investment generally obtains long-term priority in using the
transmission assets that it adds to the grid. Scale economies in transmission may make
transmission investments impracticable for individual transmission customers, and there
may be uncertainty and costs associated with organizing a large enough group of
customers to make such investments at an efficient scale. With the exception described
above and a brief period of experimentation in the New York ISO with long-term FTRs,
long-term transmission rights are not generally available.

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competition issues. As part of its competition advocacy program, the FTC has released
two Staff Reports on electric power industry restructuring issues at the wholesale and
retail levels.6 In addition, the FTC and its staff have filed numerous competition
advocacy comments on electricity restructuring efforts with FERC and the states. The
FTC staff also contributes to competition filings with international competition
organizations.7
II. 	The Ability to Reduce Long-Term Transmission Risk May Be Critical for
Efficient Generation Entry in Areas with RTOs
A. 	Overview
The Notice is directed at long-term transmission rights in general, but many of the
issues discussed in the FERC Staff Paper focus more narrowly on questions involving
long-term FTRs.8 From a competition policy perspective, it is less important to focus on
the specific policy instruments used to reduce long-term transmission risks. Rather,
FERC may wish to focus more generally on the availability of some practicable manner
to address this important element of long-term risk facing potential generation entrants,
6 FTC Staff Report: Competition and Consumer Protection Perspectives on Electric
Power Regulatory Reform (July 2000), available at http://www.ftc.gov/be/v000009.htm
(compiling previous comments that the FTC staff provided to various state and federal
agencies); FTC Staff Report: Competition and Consumer Protection Perspectives on
Electric Power Regulatory Reform, Focus on Retail Competition (Sept. 2001), available
at http://www.ftc.gov/reports/elec/electricityreport.pdf.
7 The FTC and the Department of Justice participate as delegates from the United States
in a number of international organizations, such as the Organization for Economic
Cooperation and Development. As part of this process, the FTC staff contributes to the
United States’ “country reports” on competition topics. When requested by the
Department of State, the FTC staff also contributes to U.S. comments on proposed
regulatory reforms in other nations.
8 FERC Staff Paper, supra note 2, at 4-19.

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established independent generators, and the wholesale customers of these electric power
suppliers.9
A useful initial question is why private parties have not developed more extensive
alternatives whereby transmission customers can mitigate transmission risk in RTO
areas. Some explanations may stem from the non-profit status of RTOs.10 Providing
potential generation entrants and other market participants with means to manage long-
term transmission risk is likely to help develop competitive wholesale electric power
markets. In a market economy, entry is a critical factor that contributes to the
development of competitive markets.11 Entry erodes existing market power, provides
more customers with products that closely match their preferences, and brings
9 If FERC determines that the complexities to implement long-term FTRs are too great to
proceed, FERC should consider other approaches that would allow potential generation
entrants and other market participants to address long-term transmission risk.
10 RTOs may not give priority to services that are likely to benefit potential entrants
because potential entrants may not be well represented in RTO governance processes
(since they are not yet market participants) and because RTOs – as non-profit entities –
have little, if any, financial incentive to satisfy the preferences of prospective and actual
transmission customers. See Comment of the Staff of the Bureau of Economics of the
Federal Trade Commission § IV, FERC No. RM99-2-000 (Aug. 16, 1999), available at
http://www.ftc.gov/be/v990011.pdf.
11 Entry generally improves market performance because, for example, it displaces
higher-cost suppliers or undermines incumbent suppliers’ efforts to exercise market
power. “Market power to a seller is the ability profitably to maintain prices above
competitive levels for a significant period of time.” U.S. Dep’t of Justice and Federal
Trade Commission, Horizontal Merger Guidelines § 0.1 (revised Apr. 8, 1997) (Apr. 2,
1992). Entrants that are more efficient than incumbent suppliers may displace existing
suppliers and release resources for other uses in the economy. For example, a generator
using new technology may be able to produce the same amount of electric power with
less natural gas or other fuel. If the new generator displaces an existing, less efficient
generator, the cost of operating the generator will be lower because less fuel is required
and additional fuel that would have been consumed (had the less efficient generator
remained in operation) can be used by other fuel customers.

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innovations that reduce costs to market.12 However, efficient entry may be discouraged
or delayed by high levels of risk (relative to expected returns) that cannot be managed
through long-term supply contracts or other arrangements. Lack of efficient entry may
harm consumers through higher prices, less customer choice, and inefficient production
that wastes real resources. If FERC developed policies to mitigate long-term
transmission risk, potential entrants would be able to address long-term transmission risk
in the same way in which they address other major risks, such as volatile fuel prices.13
B. 	Other Risk Factors Facing Potential Generation Entrants
For a potential generation entrant, transmission price uncertainty is just one of
several risks associated with entry. Generation investments are long-lived and many
entry costs may not be readily recoverable if the entry fails due to higher-than-anticipated
costs over the life of the generation assets. Unanticipated transmission price increases
due to transmission congestion could be the cause of failed entry. A reduction in long-
term risk through long-term contracts (or other means) allows the generator to reduce the
likelihood that it will be forced into bankruptcy (with the attendant costs that it must
bear) during the useful life of the generation assets. Risk reduction also increases the
12 Entry is a key concept in industrial organization economics. The importance of entry
conditions in the analysis of mergers is the focus of Section 3.0 of the Horizontal Merger
Guidelines, supra note 11. FERC has indicated that development of competitive
wholesale electric power markets is the principal goal of its regulatory reform efforts in
the electric power sector.
13 Potential entrants face various sources of risk, many of which stem from volatile input
prices that may cause fluctuations in profits. Transmission is an important input for
generation entrants. Fluctuations in profits may lead to uncertainty about whether the
entrant can cover its financial obligations in all periods of time over the life of the assets,
in turn potentially leading to higher borrowing costs. The use of a supply contract with
predetermined prices to reduce the risk of volatile prices in a spot market or in short-term
bilateral trading is a form of hedging.

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likelihood that the entrant will experience an orderly depreciation of its generation assets
over their useful life. If longer-term risk cannot be addressed, a potential efficient entrant
may be faced with an unacceptable level of risk.14 As a result, it may decide not to
enter.15
A potential entrant may be more sensitive to transmission risk than an established
independent generator because an entrant is likely to face different risk/return tradeoffs.
Because a potential entrant has no fixed costs (but only variable costs) before it starts the
entry process, it can readily turn to other investment opportunities without suffering any
14 Tolerance for risk may vary among potential entrants and will depend, in part, on the
levels of risk associated with other investment opportunities available to the potential
entrant. Transmission risk in an RTO area is likely to stem from fundamental
uncertainties about demand and supply conditions in electric power markets.
Transmission can become congested during some periods and in some areas, and the
prices of transmission service in RTOs with locational pricing will increase as a result of
this congestion. Because transmission investment exhibits lumpiness, some degree of
congestion from time to time is likely to be efficient and, conversely, efficient
transmission investments also may result in limited periods in which there is no
transmission congestion. Hence, transmission congestion may occur in competitive
electric power markets as well as in markets that have experienced transmission
discrimination or underinvestment. Under any of these conditions, the level and duration
of transmission price increases are uncertain. This uncertainty can stem from several
sources in an RTO, including the growth and variability of demand for electric power due
to innovation, population growth, or weather patterns; the size and location of future
transmission and generation investments; transmission and generation outages; and
changes over time in the price responsiveness of demand.
15 If there is transmission risk, it is likely to influence entry decisions whether the risk is
officially borne by the entrant or by its wholesale customers. If a customer bears the
transmission risk, this is likely to be reflected either in less willingness to buy from an
entrant or in a decrease in the price it is willing to pay to the entrant. Hence, a potential
entrant will likely be concerned about long-term transmission risk even if its contracts
with customers say that the customer will assume all of the transmission risk. In contrast,
the FERC Staff Paper suggests that independent generators are unconcerned about
transmission risk if the supply agreement indicates that the customer bears that risk.
FERC Staff Paper at 16. An independent generator is indeed less likely to have concerns
about an increase in transmission risk if a supply contract with a “take-or-pay” clause has
already been signed with a customer.

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losses.16 In contrast, an established independent generator, to the extent that its
investment is sunk and unrecoverable if it exits, must cope with unanticipated
transmission price increases as best it can. If the potential entrant cannot contractually
reduce the risk, the firm may be reluctant to enter even if it would (on average) be
profitable to do so, and even if the entrant would prove to be a more efficient supplier
than incumbent generators.
Many of the entrant’s risks associated with acquiring inputs (other than
transmission services) can already be reduced in either the short or the long term through
supply contracts with fixed prices or other provisions that reduce price volatility.17 For
example, short- or long-term fuel supply contracts are commonly available to generation
entrants, either directly from fuel suppliers or through contracts with financial
intermediaries. Alternatively, the entrant may be able to invest directly in fuel sources to
reduce this form of risk. In areas with an RTO using locational transmission prices,
shorter-term transmission price risk can be hedged by purchasing a short-term FTR either
at an auction conducted by the RTO or from an owner of an existing FTR. In the absence
of long-term FTRs or alternative long-term transmission contracts, long-term
transmission price risk may be difficult to hedge.18
16 The paradox is that entrants are more sensitive to these risks, but incumbent
independent generators with sunk costs are more exposed to them.
17 Entrants also may be able to reduce revenue risk by forward-contracting with
customers.
18 Potential exceptions to this problem include (1) the construction of a new transmission
line for which the investor receives a long-term FTR, or (2) finding a financial
intermediary that is willing to undertake long-term transmission price risk for a fee.

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When risk is high and cannot be hedged, potential entrants generally need a
higher expected profit level (to compensate for the increased risk they bear) before they
will enter.19 As observed above, some potential entrants that would have entered, had
long-term methods to reduce transmission risk been available, may not enter because they
find the expected profit level insufficient to compensate them for the higher level of
risk.20 When efficient entry does not occur, existing market power may persist and
efforts by incumbent firms to increase market power are more likely to succeed. If means
to reduce long-term transmission risk were available, customers for wholesale electric
power likely would face lower prices.21
In summary, when an investment – such as electric power generation – is long-
lived and entails costs that are unrecoverable if the entrant later decides to exit the
market, contracts for necessary inputs whose terms match the expected useful life of the
assets may be important for efficient entry to take place. FERC can increase the
likelihood of efficient generation entry by promoting means to reduce long-term
19 Electricity investments generally compete with investments in other segments of the
economy with respect to their risks and returns. If a new generation project carries a
higher risk than an investment with similar expected returns in another segment of the
economy, the latter is more likely to attract investors.
20 The fixed-price supply contract will include a premium to compensate the supplier for
accepting the risk that the buyer would otherwise bear. As a result, an entrant’s
calculation includes tradeoffs between higher costs (lower profits) and lower risks. From
an entrant’s perspective, an attractive risk-reducing contract is one in which the supplier
is better able than the customer to control or sustain the risk. In such a situation, the
supply contract allows the entrant to pay an amount that is less than the value to the
entrant of the reduced risk.
21 Lack of long-term FTRs also may affect the demand for long-term supply
arrangements. Wholesale customers may be more likely to rely on short-term supply
arrangements, rather than demand long-term supply arrangement, because they also
cannot hedge long-term transmission risk.
.

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transmission risk. In the generation sector, long-term supply contracts are well-
established means of reducing major sources of risk (e.g., fuel prices). Long-term FTRs
may reduce long-term transmission risk if the complexities and potential problems
identified by FERC can be dealt with successfully.
III. 	Reducing Long-Term Transmission Risk Outside of RTOs May Be Even
More Important for Efficient Entry Than Doing So Inside RTOs
A. 	Overview
The FTC recommends that FERC develop policies that would allow potential
generation entrants and their customers to reduce long-term transmission risk in non-
RTO areas (not merely in areas with an RTO). Long-term transmission risk is likely
even greater for potential generation entrants (and existing independent generators) in
areas of the nation without a functioning RTO. Incumbent or potential independent
generators outside of RTOs face the risk of transmission price volatility and reliability
problems stemming from both transmission discrimination and transmission congestion.
22 More effective competition from a new entrant may prompt more severe transmission
discrimination targeted at the entrant.23
22 Transmission price volatility is likely to be greater outside of RTOs because
uncertainty about transmission discrimination is added to uncertainty about transmission
congestion. Thus, if the same level of transmission congestion risk exists in otherwise
equivalent RTO and non-RTO settings, the transmission price volatility in the non-RTO
area would be greater because transmission charges during congestion periods may have
an additional component due to transmission discrimination in the non-RTO area.
23 FERC has described in detail how transmission discrimination disrupts the operation of
wholesale electricity markets. See Regional Transmission Organizations, Order No.
2000 (Dec. 20, 1999), available at http://www.ferc.gov/industries/electric/indus-
act/rto/iss-2000/2000.pdf.

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B. 	Potential Generation Entrants Considering Locating Outside of RTOs
Face an Additional Source of Transmission Risk
The previous section of this comment described the transmission congestion price
risks faced by potential entrants supplying customers in areas with a fully operational
RTO. Potential generation entrants in areas outside of a fully operational RTO face an
additional source of transmission risk: transmission discrimination. Because the rates
they can charge are regulated, a transmission-owning generator with market power at the
transmission level is likely to have the incentive to exercise that market power by
discriminating against rival generators. Indeed, FERC has concluded that, even when
vertically integrated utilities have functionally unbundled their generation assets from
their transmission assets, they have continued to engage in undue discrimination in
access to their transmission facilities and thus to impede competitive markets.24 In
addition to discrimination against competitors seeking access to their transmission
facilities, vertically integrated firms may exercise their market power through cross-
subsidization in favor of their unregulated affiliates. Both forms of behavior likely will
reduce the degree of competition facing the integrated firm's generation assets, even
though continued regulation of the firm's transmission assets may well prevent the full
exercise of transmission market power.25 As a result, the generators owned by the
transmission owner/operator will obtain higher prices (and profits) and wholesale
customers will face higher prices.
24 See supra note 23 at 2.
25 Letter from the FTC to Thomas E. Bliley, Chairman, Committee on Commerce, U.S.
House of Representatives (Jan 14, 2000), available at
http://www.ftc.gov/be/v000002.htm.

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In non-RTO areas, potential generation entrants as well as established
independent generators may face non-price forms of transmission risk. In particular,
transmission congestion difficulties outside of RTO areas are more likely to be addressed
through curtailments of transmission service (in the form of transmission line loading
relief orders) than through transmission pricing effects. The transmission operators
outside of RTOs may have incentives and the ability to target the timing and location of
curtailments toward independent suppliers. Similarly, transmission operators outside of
RTOs may purposefully understate actual availability.26 Under this form of transmission
risk, available transmission access could be denied entirely to the entrant or the
independent generator.
C. 	Potential Generation Entrants Considering Locating Inside RTOs
Also Face Transmission Risk in Supplying Customers Outside of
RTOs
To the extent that new generators are more efficient than existing generators
because they utilize new technology, entrants can be expected to seek wholesale
customers across broad geographic areas, especially absent transmission congestion and
discrimination. Therefore, just because a generator is located within an RTO does not
mean that the generator is immune to the risk of transmission discrimination and
transmission congestion in non-RTO areas. Because wholesale transactions should – and
26 FERC Docket No. RM05-17-000 is an initiative regarding this concern. Because
reported congestion outside of RTOs may be influenced by available transfer capability
(ATC) postings of transmission operators with incentives to understate ATC (in order to
protect their generation assets from competition), FERC policies that encourage accurate
ATC postings may also have a salutary effect on reported transmission congestion in
these areas. 	National Electrical Reliability Council, Long-Term AFC/ATC Task Force
Final Report (revised Apr. 14, 2005), available at
ftp://www.nerc.com/pub/sys/all_updl/mc/ltatf/LTATF_Final_Report_Revised.pdf.

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to some extent already do – span RTO and non-RTO areas, the transmission
discrimination problems in non-RTO areas likely affect interstate supply from generators
in non-RTO areas to wholesale customers in RTO areas as well as interstate supply from
generators in RTO areas to customers in non-RTO areas. In recognition of the
interaction between transmission risks in different areas, FERC may wish to address
long-term transmission access rights in non-RTO areas as well.
IV. 	Policies to Reduce Long-Term Transmission Risk Should be Coordinated
with Policies to Promote Efficient Transmission Investment
A. 	Overview
FERC may wish to coordinate its policies to reduce transmission risk with its
policies to promote efficient transmission investment projects, including those whose
primary benefits are in the form of enhanced reliability of the transmission system.27
These two policy areas are closely related because transmission investment is often at
least a partial substitute for long-term transmission rights from a transmission customer’s
perspective. A lack of efficient transmission investment can result in high, inefficient
levels of transmission congestion that give rise to high levels of long-term transmission
risk. If FERC considers the potential interaction between these two related policies, it
may be able to enhance the competitiveness of wholesale electricity markets and increase
both policies’ likelihood of success.
B. 	Increased Transmission Investment Reduces Demand for FTRs
27 Comment of the Federal Trade Commission, United States Department of Energy
Matter of Designation of National Interest Electric Transmission Bottlenecks (Sept. 20,
2004), available at http://www.ftc.gov/os/2004/09/040924nietbcomment.pdf.

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Because uncertainties about transmission congestion (and transmission
discrimination in non-RTO areas) are the motivation for generators and other
transmission customers to acquire FTRs or other instruments to reduce transmission risk,
FERC policies that directly influence transmission congestion have a direct bearing on
FERC’s decisions about FTRs and other methods to secure long-term transmission
access. FERC policies that facilitate efficient transmission investment are likely to lead
to lower transmission congestion levels and lower demand for long-term FTRs or other
techniques to reduce transmission risk. Policies that promote efficient transmission
investment will create more efficient signals for generation entry as well.
If efficient transmission investment policies are coupled with long-term FTRs or
with similar instruments to reduce long-term transmission risk, potential generation
entrants will face lower levels of transmission risk and will be able to reduce the
remaining risk by contract. Absent these complementary policies, potential generation
entrants face inflated transmission pricing risks that they are unlikely to be able to
address.
In the event long-term FTRs or other forms of long-term transmission rights were
available in non-RTO areas and the transmission operator chose not to invest in grid
improvements, the generation competitors of the grid operator would not be protected
from transmission congestion costs. The transmission operator could increase wholesale
prices in the areas where it controls transmission and capture the benefits in the
electricity sales of its generation affiliates in the area. It could do so because the bids of
its generation rivals would include higher transmission congestion charges (created by
the lack of transmission investment) that the transmission operator does not face.

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V. 	Conclusion
The FTC encourages FERC to promote instruments that reduce long-term
transmission risk in all areas of the nation in order to promote competitive wholesale
electricity markets. FERC could make efficient generation entry more probable by
coupling long-term FTRs (or a similar risk-reducing instrument) with policies to promote
efficient transmission investment. Absent long-term FTRs (or similar means to reduce
transmission risk) and efficient transmission investment, efficient potential generation
entrants are likely to face high transmission pricing risk (relative to returns) that will be
difficult to manage. Electricity customers may face higher prices if FERC does not
promote efficient generation entry by pursuing a coordinated policy of reducing
transmission risk and facilitating efficient transmission investment.
Respectfully Submitted,
Donald Clark
Secretary