Cost-efficient electric transmission planning, development and operations are vital for grid reliability and economic development. Investor-owned utilities (IOUs) have access to ample capital and spend about $20-25 billion per year on transmission in the United States. However, billions of dollars are misallocated annually, which erodes net benefits to consumers and suppresses the development of cleaner and lower-cost energy generation. The problem rests squarely on a regulatory system that is outdated and structurally flawed.

Investor-owned transmission utilities operate under cost-of-service regulation. Doing so provides IOUs assurances of investment cost recovery and above-market equity returns paid for by captive customers under rules established by the Federal Energy Regulatory Commission (FERC). This regulatory model creates a financial incentive to increase capital expenditures excessively, which places the interests of utilities at odds with the goal of serving their captive customers in the most cost-effective and reliable manner. The bias in favor of inflated capital investment has long been known as the “Averch-Johnson effect.”

Regulatory mechanisms achieve economic discipline either by facilitating robust competition or through strict cost-of-service oversight. FERC transmission regulation hardly does either, instead layering an incomplete competitive framework over an incomplete cost-of-service structure. This lets incumbent utilities control planning terms and avoid competitive solicitation requirements by exploiting exemptions. FERC grants utilities a presumption of prudence in order to make the agency’s case load more manageable, and cost recovery is rarely denied on prudence grounds.

The flawed regulatory structure results in a severe lack of economic discipline, evidenced by incumbent utilities overspending on less efficient transmission projects while underinvesting in newer, more efficient technologies. For example, utilities flock to local reliability upgrades that they can unilaterally implement with little regulatory oversight. This often comes at the expense of transmission projects that could bring lower-cost resources from outside a utility’s footprint or that improve the efficiency of the existing system at a fraction of the cost of traditional projects.

The incentive problem is particularly acute with utilities that own both generation and transmission because they can advantage their own power plants and raise power prices by underbuilding transmission that would enable competing generators to reach their consumers. Beyond costs, this bias toward building local power plants over upgrading or building new transmission can have disastrous reliability consequences, as illustrated recently by Hurricane Ida. Entergy New Orleans obstructed transmission that could import more power from other utilities and instead only offered its regulators a power plant to ensure reliability in its footprint. During Hurricane Ida, all of New Orleans’ neglected transmission lines failed and the power plant took days to come back online.

Fixing regulatory defects is technically complex, time-consuming and fraught with the risk of rare but cascading outages that could be career-ending for public officials and reliability entities. There will always be information asymmetry in favor of utilities, and thus most regulators and stakeholders are ill-equipped to hold them accountable. Opposing the utilities can be resource intensive and, in the extreme, can cost decision makers political reappointments.

Nevertheless, a rare opportunity to remedy regulatory flaws has emerged. After years of experience and building records on the shortcomings of its transmission policies, FERC recently opened multiple transmission reform proceedings. If done well, reforms could yield tens to hundreds of billions in customer savings and avoid billions of metric tons of emissions.

Press Release: A new agenda for FERC: outlining priorities for electric transmission reform

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