Need for Better Value Creation in MISO South        

A recent paper by the National Bureau of Economic Research (NBER) examined the benefits of transmission expansion in the Southwest Power Pool (SPP) and Midcontinent Independent System Operator (MISO) markets. The study found transmission constraint costs rising from $300-$400 million per year over 2016-2020 to over $2 billion in 2022. Existing transmission owners in those regions, especially in MISO South, have an economic incentive to create constraints that result in significant profits for the utility.  

Efforts of MISO to do transmission expansion across the MISO South region have had little effect on  better integrating MISO South with the rest of MISO and have effectively insulated utility-owned power plants from competition from projects located outside of MISO South. In other words, the lack of regional transmission in MISO or the SPP means that other generation resources, especially renewables imports, cannot compete against local generation inside MISO South—even if those resources cost less than resources inside MISO South. This is the political economy of protectionism, where the local utility prefers barriers to trade to increase its profits. According to the paper, this lack of transmission in MISO South resulted in one utility earning $930 million more in profit than if the region was better integrated with the rest of MISO.

Utilities limit opportunities to lower costs

The flip side of the utility earning excess profit is that its customers overpay for electricity—that is, access to lower-cost electricity would lower overall prices in that region. For example, lower-cost wind power from MISO Central and MISO North delivered to MISO South would reduce prices in the MISO South region. Remember that MISO, like the ancient region Gaul, is split in three parts. More competition in MISO South would mean greater value and benefits, and more opportunities for customers, even if the utility saw less profit.  

However, as the paper notes, “the fact that the two generating firms standing to lose the most from grid integration in 2022 are in MISO South is not surprising.” Furthermore, it shows that the transmission planning process, including at regional transmission organizations, favors utility incumbents. As R Street has previously noted, cost-of-service utilities profit by overcapitalizing self-built generation and transmission, which is antithetical to economical transmission development. In other words, the utility has the ability and incentive to erect barriers to entry for new regional transmission to their own benefit.

This is the opposite of what regional markets are supposed to accomplish. As the paper’s author notes, market integration “implies that those low-cost renewables can be exported to other regions, which can both displace fossil generation and also lower market prices for the remaining fossil generation.” This means that lower-cost resources from one part of MISO would have better access to other parts of MISO, thereby creating a more optimized system and lower costs. Instead, by maintaining transmission constraints to MISO South, those lower-cost resources are no longer competitive compared to resources located inside MISO South. The author also noted that “[g]eneration firms operating in southern MISO have no incentive to develop new transmission lines that better integrate their power plants” with MISO; instead, they “have strong incentives to block new lines—an incentive that has grown as wind has entered SPP and the rest of MISO.” Here, the utility is playing a game with its customers where heads, the utility wins; tails, the customer loses.

Utilities should not hide behind regulatory models

In response to this paper, the utility defends its practices by relying upon the regulatory model under which it operates. The retail model in MISO South is cost-of-service regulation, where utilities provide an estimate of costs to operate their utility and provide electricity to customers, plus a return on equity (ROE) for capital projects (i.e., profit). Under this structure, the regulator determines whether the costs and ROE are reasonable and then allows those authorized costs to be recovered through rates. The model creates a perverse incentive for utilities to overbuild local transmission and generation, which are often more costly than regional transmission investments that enable cheaper power imports. The trick is that state regulators only approve local transmission and generation, not regional transmission, and thus struggle to account for regional alternatives that may render utility proposals imprudent.  

Such a circumstance happened several years ago in Texas, where MISO identified a transmission need to connect parts of Texas and Louisiana. A third party won the bid to build the transmission line, but the utility decided to build a power plant at that location—obviating the need for the transmission line. (The utility also supported the passage of a right of first refusal (ROFR) law in Texas, which meant only the utility could then build the transmission line. That law was subsequently found unconstitutional by the Fifth Circuit Court of Appeals—a decision upheld by the U.S. Supreme Court.) In this instance, the competitive transmission project was to cost $115 million; however, with the passage of the Texas ROFR law, the utility instead built a new power plant that cost nearly $1 billion.  

This is not how it is supposed to work. The purpose of cost-of-service regulation is to determine how a firm would have acted if it was subject to competition. If MISO South was subject to more competition, the NBER paper shows that customers in that region would have been much better off—to the tune of $930 million in savings for utility customers in Arkansas and Louisiana. MISO itself would have a more optimized system with electricity flowing to areas in need, rather than curtailing excess generation due to high costs to transmit electricity stemming from congestion between regions. Instead, the utility hides behind the regulatory framework in place and claims its profits are all copacetic because it is regulated.  

Regulators must take action

Regulators should take a more active role in reviewing utility plans before MISO and before their state commissions. Integrated resource plans and long-term transmission planning are key initiatives that lay out utility investments and system needs over a certain period of time. Unfortunately, utilities have been playing state commissions off of MISO. For example, MISO proposed changes to its resource adequacy rules last year. Those changes were opposed by MISO South regulators and utilities, with two utilities saying they “are properly planning and procuring resources to meet their capacity needs with their retail regulators” and should be able to opt out of the MISO planning process. This is the problem identified in the NBER paper; rather than seeking better integration with the rest of MISO, MISO South utilities and regulators seek to minimize opportunities for lower-cost resources from the rest of MISO. Leaving the planning entirely to state commissions means the regulator only reviews intrastate plans, ignoring lower-cost interstate opportunities via the MISO system.  

MISO South is at a tipping point. With some of the least reliable electricity in the United States, the region is increasingly subject to power quality swings that can harm customer electronics and cause fires. As the rest of MISO continues to invest in generation and transmission resources, MISO South languishes under a framework that supports rent-seeking behavior that harms customers while benefiting the utility. Additionally, the region is unable to leverage a wider pool of resources that can increase reliability, resilience, and power quality to support or absorb such risks. The NBER report should be a wake-up call for regulators across MISO, but especially in MISO South. The regulator must ensure that its utilities act in a manner that promotes the public interest and benefits customers. Overpaying for electricity, overbuilding inefficient infrastructure, underbuilding efficient infrastructure, erecting barriers to entry, and limiting access to new markets is not how a firm subject to competition would act. It is, however, how a monopoly would act. Regulators must step up to call out this monopolistic behavior and insist that such actions are not in the public interest—and that MISO South should be better integrated with the rest of MISO to open new opportunities and lower costs for customers.