A Vision for Transmission: COMPETITION

1. A Vision for Transmission: COMPETITION Massachusetts Restructuring Roundtable Boston, MA November 16, 2001 José A. Rotger Manager, Regulatory Strategy

2. Is Transmission a Competitive Business? • Historically, not treated as a business at all • Generation and transmission planned together • New transmission driven by generation plans • Inter-area links for reliability ONLY, not economic efficiency & trade – “must maintain self-sufficiency” • But, industry restructuring has changed role for transmission => economic trade • New transmission competes against new generation, demand-side measures, distributed generation, etc.

3. Problems with Conventional Wisdom • Undermined by new technology • More modular, less “lumpy” => changes economics • Far less environmental/community impact => affects siting • Undermined by new regulatory structure • Allows incentives inherent in restructured electricity markets to be applied to transmission investment • Recognize that transmission competes with other solutions (G, DG, DSM) to meet customer needs • Owners bear risks, rewards of investments => No stranded cost risk

4. Framework for Market-Based Transmission • Bid-based markets • Security-Constrained Economic Dispatch • Locational Wholesale Prices • Preferably nodal • Tradeable Financial Transmission Rights • Supporters of transmission expansions receive FTRs • Term of FTRs should be as long as possible • PJM, NYISO have this framework in place • ISO-NE, Ontario IMO to follow

5. Benefits of Market-Based Transmission • Benefits to the environment • More transmission => more markets for cleaner energy • Deployment of advanced technologies with much lower impacts • Benefits to the community • More underground transmission (faster permitting) • Eminent domain not needed by market providers • Benefits to consumers • The right investments in the right place at the right time • Protection from stranded costs • Efficient competition among all sources of delivered energy will lower costs to consumers

6. Current Issues in Transmission • Does a monopoly transco serve the best interests of consumers? • Transco will be a market participant because it will affect market outcomes • How will merchant transmission fit in? • How will the RTO conduct transmission planning? • Will the transmission planning & expansion process focus on reliability or economic needs? • Will the incumbents control the process? • Do we need a regional/national approach to siting?

7. RTOs & Market-Based Transmission –What is needed? • Defined & marketable property rights • Supporters of transmission expansions receive Financial Transmission Rights (FTRs) that can then be monetized via RTO • Free entry by entrepreneurial transmission companies • No de jure or de facto monopoly over new transmission • Level competition between new entrants & incumbents • Equal opportunity for new entrants to compete for new transmission investments – regulated or market-driven • RTO planning function: Maintain reliability • Planning serves as “backstop” for market failure, not preempt it • Threat of “socialized” investments undermines market alternatives • Allow greatest competition among all alternatives

8. The Alternatives • Status quo: Gridlock in grid investment • Endless debate about “net benefits” of project & who will pay • No mechanism to address links between markets • Monopoly transmission company (ITC) • One transmission company: • Operates under incentive rates • Responsible for all congestion, losses, & reliability • Makes unilateral investment & operating decisions to maximize profit • But, regulator must guess at correct incentive rates • Why not let market set marginal transmission rates? • Strong central planning by RTO • Requires crystal ball, and consumers bear risk of imperfect planning foresight

9. So, how do we get there? • Don’t fall prey to commonly held myths regarding transmission expansion: “Our Top 10 myths”

10. Top 10 Myths About Grid Expansion No. 10 Transmission is and will remain a natural monopoly • Fact: • True for grid operation, but NOT for additions and expansions • With LMP and tradeable property rights, G, T, DSM, etc. all compete to meet new energy needs • Free rider problems, economies of scale arguments are being resolved by technology

11. Top 10 Myths About Grid Expansion No. 9 Free riders restrict market-based transmission investment • Fact: • New controllable technologies address free riders – only users pay (HVDC, FACTS) • FTRs discourage free riders and provide vehicle for investment recovery – only users pay • The combination of risk aversion (bankruptcy) and well-designed energy markets (with volatility) prevents or eliminates free riders (woe to the unhedged)

12. Top 10 Myths About Grid Expansion No. 8 Economies of scale (“lumpiness”) restrict market-based transmission investment • Fact: • New controllable technologies are smaller and more modular (HVDC, FACTS) • Modularity preserves options • Grid capacity can match market demand • Generation has residual economies of scale (even with GTs), but few worries of market failures

13. Top 10 Myths About Grid Expansion No. 7 Need eminent domain and other state police powers to site transmission • Fact: • New cables are smaller and easier to place underground (HVDC Light) in existing ROWs (railroads, highways, pipelines, etc., just like fiber optic cables) • New point source and converter devices allow capacity to be increased in existing substations • Siting regulations/statutes changed to reflect merchant generation – why not transmission?

14. Top 10 Myths About Grid Expansion No. 6 Transmission takes too long to build – need to “pre-approve” projects • Fact: • New transmission technologies can approximate project schedule for generation (e.g. 2-3 years) • If RTO-sponsored transmission is pre-approved, generators will locate at sending end of planned upgrades (and what is the future of distributed generation?)

15. Top 10 Myths About Grid Expansion No. 5 Transmission is only 5-6% of total cost – why bother? • Fact: • Marginal cost of transmission much higher than average cost (10x? 20x?) • Congestion charges visible under LMP/FTR frameworks – N.E. Mass & Boston congestion costs 5/99-7/00 = $80+ million • To achieve efficiency, get prices right at the margin • or generators in remote locations will push RTO to expand grid

16. Top 10 Myths About Grid Expansion No. 4 Why not over-build transmission – the benefits outweigh any efficiency losses • Fact: • “Must build to eliminate congestion” (at any cost) – why bother with LMPs and FTRs? Let this market structure work! • Why saddle captive customers with uneconomic transmission investments? (think nuclear) • “Must build to mitigate market power” – there are cheaper and better ways (behavioral solutions) • “Must build to improve liquidity” – at what price?

17. Top 10 Myths About Grid Expansion No. 3 Only a central planning process can efficiently reduce congestion • Fact: • Backstop role for reliability-driven upgrades, but NOT for economic upgrades • Why forfeit the competition benefits of new entrants? • Central planners are destined to be wrong – and the burden is on captive customers, NOT shareholders • Central planners may be biased and may NOT be sufficiently independent • Any residual central planning requires complete independence and a competitive solicitation process

18. Top 10 Myths About Grid Expansion No. 2 We need incentive rates (PBR) to build new transmission • Fact: • Why not rely on market-based CMS -- LMPs and FTRs? Let this market structure work! • Why do we need incentive rates for the existing wires in order to build new ones? • Price caps (RPI – X): With LMPs & FTRs in place, why pre-determine and lock in productivity improvements (X)? Why not let the market set X?

19. and the Number One Myth about Grid Expansion is…

20. Top 10 Myths About Grid Expansion No. 1 Market-based transmission cannot be financed or built on basis of market rights • Fact: • The US (and other nations) have implemented the market structure (LBMPs & FTRs) necessary for market-based transmission investments • Let the markets work! • TEUS is actively building transmission in USA and Australia on a fully market basis – over 1,200 MW of in service and proposed projects (& more to come)

21. Our Solution • Over $500 million in market-driven projects • Australia • Directlink 180 MW, 65 km u/g DC Operation • Murraylink 220 MW, 180 km u/g DC Construction • Southernlink 150 MW existing lines upgrade Permitting • United States • Cross Sound 330 MW, 40 km subsea DC Permitting • Final permit may be issued by December => operational by summer 2002 • Lake Erie Link 325-975 MW, 120 km DC Permitting • Harbor Cable 330-990 MW u/g & subsea Development • Other competitors: NU (CLIC), Neptune, GenPower

22. Final Thoughts • Market-based solutions are a reality • Technology is changing the industry • Trust, but verify • Markets can and do work! • But, ensure that the right structures are in place to allow full and fair competition

23. For more information • Our web sites: • US www.transenergieus.com • CSC www.crosssoundcable.com • Australia www.transenergie.com.au • Contact information: • Jeff Donahue (508) 870-9900 x105 jeff.donahue@transenergieus.com • Ray Coxe (508) 870-9900 x106 ray.coxe@transenergieus.com • José Rotger (508) 870-9900 x108 jose.rotger@transenergieus.com