V. Principles for Assessment of Economic Benefits of Transmission Lines
Benefits of a proposed transmission project can be evaluated by comparing estimates of total costs that would be incurred without the proposed project and total costs if the proposed project is built. Such comparisons include assumptions about the resource mix, which may differ in the scenarios with and without the proposed project.
In addition to base case (most likely) scenarios, the effects of possible variations in key factors of the analysis, e.g., load growth or fuel prices, also should be considered in assessing likely economic benefits of a proposed project. Identification and consideration of alternative cases or scenarios as a means of addressing uncertainty is addressed in Section V.B.4.
In economic evaluations of transmission projects, there are three general categories of costs and benefits: (1) the change in total production costs, or energy benefits, (2) changes in other quantifiable economic benefits and costs not included in production cost analyses, and (3) factors whose expected economic effects cannot be monetized. These three types of costs and benefits are addressed in Sections V.B, V.C, and V.D, respectively.
A. Benefit Perspectives
In evaluating a proposed transmission project, assessment of the distribution of potential benefits and costs among geographic areas and among various types of market participants is important. Because of the interconnected nature of the Western electricity system, the relevant geographic region affected by a transmission project may be much larger than the CAISO control area, particularly if the project is an inter-regional upgrade such as DPV2.
All four economic evaluations submitted in this proceeding determined energy benefits based upon production cost modeling of the entire WECC area. However, parties generally recommend that any Commission-approved methodology rely primarily upon the economic impacts on CAISO ratepayers-rather than WECC-wide economic impacts-in determining whether to grant a CPCN.
In its June 2004 report, the CAISO described the importance of the various perspectives as follows:
A critical policy question is which perspective should be used to evaluate projects. The answer depends on the viewpoint of the entity the network is operated to benefit. If the network is operated to maximize benefit to ratepayers who have paid for the network, then some may consider the appropriate test to be the ratepayer perspective. Others say this may be a short-term view, which does not match the long-term nature of the transmission investment. In the long run, it may be both the health of utility-owned generation and private supply which is needed to maximize benefits to ratepayers. Advocates of this view claim that the network is operated to benefit all California market participants (or for society in general) and, therefore, the CAISO participant or Western Electricity Coordinating Council "WECC" perspectives of benefits may be the relevant test.
If a benefit-cost ratio is greater than 1.0 for one perspective but less than 1.0 for another perspective, the transmission project may transfer benefits from one region or stakeholder group to another.
The CAISO describes that quantifiable benefits of proposed transmission expansions can be evaluated from various perspectives, and describes three particular perspectives: the WECC or Societal perspective, the CAISO Ratepayer perspective, and the CAISO Participant perspective. Benefit-cost ratios can be calculated for other perspectives as well, e.g., for other geographic regions such as the Southwest or the Northwest, or other groups of market participants such as non-utility generators or municipal utilities.
The WECC or Societal perspective takes into consideration all market participants in the WECC area. It identifies the net benefit to all consumers (or their load serving entities), producers, and transmission owners in the WECC region. The CAISO describes two versions of the Societal benefit-cost test. The basic Societal test includes all producer revenues, whereas what the CAISO calls the Modified Societal test includes only the portion of producer profits derived from competitive prices, and excludes additional producer net revenue obtained from uncompetitive market conditions, i.e., through the exercise of market power. The rationale for the Modified Societal test is that, if producers' market power profits are given the same importance as consumer benefits (as occurs in the CAISO's basic Societal test), transfers of market power-derived profits from producers to consumers as a result of a transmission upgrade would net to zero. The CAISO explains that, to the extent policymakers believe there is value in reducing producer monopoly profits, what it calls the Modified Societal test will be more appropriate than the basic Societal test as a measure of the value of a transmission upgrade.
The CAISO describes that the CAISO Ratepayer perspective focuses on the benefits that would accrue to all parties that are responsible for contributing to the transmission revenue requirement balancing account for the CAISO Participating Transmission Owners (PTOs) and who thus directly or indirectly fund the transmission project. In addition to CAISO consumers, utility-retained generation is included in the CAISO Ratepayer perspective because profits from this generation flow into the balancing account. Transmission owners (or holders of congestion revenue rights or firm transmission rights) in the CAISO-controlled grid are also included because their congestion revenues flow into the balancing account. The CAISO assumes that utility-retained generation does not exert market power, which may be a reasonable assumption. Because of this assumption, there is no need for a Modified CAISO Ratepayer test.
The CAISO Participant perspective includes CAISO ratepayers plus California merchant generators (independent power producers). No party evaluated DPV2 from this perspective.
The CAISO, SCE, PG&E, DRA, and TURN recommend primary reliance on the CAISO Ratepayer test because it focuses on whether a transmission project will yield benefits to those who pay the costs of the project and aligns closely with the group of customers whose retail rates are established by the Commission. These parties generally recommend that results from other perspectives be reviewed as well.
The CAISO evaluated DPV2 using four perspectives: the Societal test, the Modified Societal test, and two versions of the CAISO Ratepayer test. The CAISO's calculations for what it calls the CAISO Ratepayer (LMP Only) test were based on the assumption that a locational marginal price (LMP) market structure and physical flow-based scheduling would be applicable throughout the WECC. However, most of the WECC operates based on contract path (rather than physical-flow network model) scheduling. For the interfaces between the CAISO control area and external control areas, day-ahead scheduling is based on contract paths and interface scheduling limits, and actual conditions may result in congestion that must be mitigated in real time. The CAISO acknowledges that its LMP-based calculation overestimates the loss of congestion revenue due to DPV2 and underestimates California consumer benefits, compared to what may occur under the scheduling paradigms prevailing now and for the foreseeable future.
The CAISO undertook a second CAISO Ratepayer test for DPV2 to compensate for the inaccuracies of the WECC-wide LMP assumption. The CAISO's simulations for its CAISO Ratepayer (LMP + Contract Path) test utilize selected contractual paths between the CAISO and the Southwest. The CAISO believes that these results more closely reflect DPV2 benefits to CAISO ratepayers under current WECC scheduling rules. Recognizing some shortcomings to this adjustment as well, the CAISO believes that "the true answer lies somewhere between the CAISO benefits computed with and without this adjustment."
SCE reported results of its economic evaluation of DPV2 from three perspectives: CAISO Ratepayers, WECC-wide, and the impact to Arizona. DRA reported results of its economic analysis of DPV2 only from the CAISO Ratepayer perspective. Since SCE and DRA forecasted market prices based on marginal production costs and did not include any effects of strategic bidding, the adjustments that the CAISO made to its Societal perspective to obtain a Modified Societal perspective would not be applicable to the SCE and DRA analyses. Also, since SCE and DRA analyses were based on contract flows WECC-wide, the CAISO's variations to the CAISO Ratepayer perspective to compensate for inaccuracies in its LMP-based modeling likewise would not be applicable to their analyses.
In addition to the CAISO Ratepayer perspective, DRA proposes that inter-utility equity issues be considered. DRA states that it will be impossible to guarantee that ratepayers of all three major investor-owned utilities (IOUs) always benefit from a transmission project that provides CAISO-wide benefits. However, it recommends that the Commission verify that no IOU bears a disproportionate share of the project costs. To that end, DRA recommends that IOU-specific benefit-cost ratios be calculated and a project be approved only if no IOU-specific benefit-cost ratio falls below 0.75. SCE and the CAISO maintain that the Commission should license a transmission project if it benefits CAISO customers in aggregate, since its costs will be collected from all CAISO users. The CAISO maintains that, while each project may not benefit all users equally, over time the aggregate projects as a whole should benefit all CAISO customers.
DRA also proposes that the Commission only approve transmission projects that have an expected benefit-cost ratio of at least 1.25 and an undiscounted payback period of 15 years or less. In DRA's view, this requirement would provide some assurance that ratepayers will receive benefits. TURN states similarly that it would like to see a benefit-cost ratio of at least 1.2, but that transmission projects with benefit-cost ratios between 1.1 and 1.2 could be considered if there are significant non-quantifiable benefits. The CAISO asserts that the Commission should consider any transmission project with a benefit-cost ratio greater than 1.0, and should give weight to other factors such as risk reduction, environmental impacts, State policy considerations, local economic impacts, and deliverability of renewable resources. The CAISO opposes any criterion for an undiscounted payback period, arguing that benefits over the entire economic life of the project should be considered.
No party disputes that the CAISO's standardized benefit-cost methodology is a reasonable approach to measure the economic benefits of proposed transmission projects, and we adopt it to the extent described in this order. We agree that the perspective of CAISO ratepayers is of primary importance in the Commission's evaluation of a proposed transmission project, since it reflects the effects on customers of the utilities within our jurisdiction. While CAISO ratepayers include some non-jurisdictional entities,5 consideration of all CAISO ratepayers is an analytical convenience with minor effects on the analysis. We agree with TURN that there is value in reviewing the cost-benefit results from other perspectives as well.
In a restructured energy market that is not fully competitive, producers and traders may garner monopoly rents through the exercise of market power. When the market price is above costs of the least efficient generator whose output is needed to meet market demand, as occurs in a market that is not fully competitive, efficiency is reduced and consumers are harmed. A transmission expansion may improve the import capability over a transmission path and allow access to additional sources of power, thus reducing producers' ability to exercise market power and lowering production costs. Because consumer benefits arise due to this reduction in monopoly power, we view this as an important benefit of a transmission project. If a party models strategic bidding behavior in its economic analysis, the party should reflect the transmission project's effect in reducing producers' monopoly profits as a benefit of the project. For evaluations that include estimates of the effects of strategic bidding, the Modified Societal perspective, rather than the basic Societal perspective, is the appropriate perspective to use in evaluating the societal benefits of the proposed project.
In CPCN proceedings for transmission projects proposed wholly or partly on the basis of expected economic benefits, the applicant and any other party presenting economic evaluations should analyze benefits from, at a minimum, the CAISO Ratepayer perspective and the Societal perspective. If a party attributes benefits to the proposed project due to mitigation of market power, it should report benefit-cost results using both the Societal and the Modified Societal perspectives. Parties may choose to report benefit-cost results using other perspectives as well.
Consistent with the flexibility we have provided, the Assigned Commissioner or assigned ALJ may require that parties in a transmission CPCN proceeding report benefit-cost results from additional perspectives as appropriate. As an example, the CAISO Participant perspective could provide useful insight regarding the impact of a transmission project on merchant generators within the CAISO area as we consider the need for additional generation near California load centers.
We find the CAISO's development of CAISO Ratepayer (LMP) and CAISO Ratepayer (LMP + Contract) perspectives for DPV2, as explained above, to be very helpful in understanding the intricacies of modeling inter-regional power flows under anticipated market conditions. Any party submitting economic evaluations in transmission CPCN proceedings should explain how it models power flows throughout the WECC region, to the extent applicable.
We decline to adopt DRA's inter-utility equity proposal, or a pre-specified benefit-cost threshold or payback period that a transmission project must achieve in order to be granted a CPCN. We expect that transmission projects that individually provide benefits to CAISO ratepayers as a whole will, in the aggregate, benefit customers of each IOU. Additionally, transmission projects may have other benefits and costs in addition to those that can be quantified in a benefit-cost ratio. The Commission will continue to consider and weigh all relevant factors in reaching a decision on a CPCN request.
Parties took differing positions on the discount rate that should be used in calculating benefit-cost ratios. Consistent with our determination in D.05-04-051, the applicant's weighted cost of capital, as adopted most recently by the Commission, should be used as the discount rate in evaluating the benefits of a transmission project. Consistent use of the utilities' weighted cost of capital as a discount rate will facilitate our comparison of proposed transmission projects and alternative investments.
B. Quantification of Energy Benefits
The CAISO, SCE, and DRA all used the CAISO's energy benefits framework to report the change in production costs and thus the potential energy benefits of the studied transmission projects. At the most basic level, energy benefits are the difference between the production costs to serve load in a region without the proposed transmission project and the lower production costs with the upgrade in service. Of course, while transmission upgrades are generally viewed as providing positive energy benefits, this may not be true for all projects or from all perspectives.
A transmission upgrade will lower production costs if it increases market access to economic supply. However, there will be a redistribution of benefits among consumers, producers, and transmission owners. In particular, a transmission project that increases access to economic power will reduce costs to consumers, thus increasing the consumer surplus. At the same time, the project may reduce income for those generators not accessed by the transmission upgrade, reducing the producer surplus. It may also reduce transmission owners' congestion revenues and thus the transmission surplus. Thus, the energy benefits due to a transmission project consist of the net changes in consumer costs (consumer surplus), producer net income (producer surplus), and congestion revenues flowing to transmission owners or holders of transmission rights (transmission surplus). The sum of the changes in consumer surplus, producer surplus, and transmission surplus equals the change in energy production costs.
The composition of the three components of the energy benefit calculation depends on the geographic area and the market participants' perspective being examined. For example, a WECC Societal benefit calculation would include the effects on all consumers, generators, and transmission owners in the WECC region.
The CAISO Ratepayer perspective considers only changes in consumer procurement costs and generator and transmission profits that affect rates in the CAISO area. From this perspective, the change in consumer surplus is limited to the change in energy procurement costs for consumers in the CAISO area. The change in producer surplus is calculated only for those generation assets owned or controlled by CAISO-area utilities, which may earn less income due to the additional competition from power accessed by the new transmission project. Parties refer to this component of the CAISO Ratepayer benefits calculation as the change in the utility-retained generation producer surplus. Similarly, PTO-owned transmission assets may earn lower congestion revenues because of the increased flow of power over key transmission interfaces. In summary, energy benefits from the CAISO Ratepayer perspective are the net result of the increase in consumer surplus and changes in the utility-retained generation producer surplus and PTO congestion revenues in the CAISO area.
All parties appear to support the CAISO's conceptual framework as an appropriate representation of the energy benefits of proposed transmission projects. As TURN notes, this framework represents a significant advance in the economic evaluation of transmission lines, since it incorporates changes in congestion revenues, a factor not included in prior analyses. Because it provides a more complete representation of the energy benefits due to a transmission upgrade, we adopt the CAISO's energy benefits framework as reasonable to the extent described in this order.
Parties presenting economic evaluations should report separately the three components of their energy benefit calculations, that is, the changes in consumer surplus, producer surplus, and transmission surplus (congestion revenues), to aid our understanding of their results.
In the following subsections, we address several areas of concern regarding how energy benefit calculations should be performed.
Parties disagree about the type of production cost computer model that should be used to simulate network operation and forecast energy benefits of proposed transmission projects. There are two basic types of production cost models: network models and transportation models (also called transshipment models).
A network model provides a detailed depiction of the transmission network and forecasts physical flows and nodal prices on the network. Network models can have differing capabilities. An AC-OPF network model is the most complex and most accurate type of production cost model currently available. AC-OPF models typically are used to simulate short periods of time for reliability analyses. Parties agree that it would be expensive and very time-consuming to perform an economic analysis using an AC-OPF model, because of the numerous simulations needed to analyze multiple scenarios and the lengthy time periods to be simulated.
In a DC-OPF network model, simplifying assumptions are made. In particular, a DC-OPF analysis does not model reactive power or variations in voltage magnitudes and phase angles. These simplifications allow a DC-OPF analysis to be less time-consuming than use of an AC-OPF model, but there are tradeoffs in the accuracy of its calculations.
In a transportation model, groups of nodes are aggregated into areas or zones, and power is simulated to flow along simplified contract paths between the zones. The transportation model constrains power flows on paths using specified line limits and multi-line constraints to approximate real-world network constraints. A transportation model calculates zonal prices, whereas a network model calculates nodal LMP prices. To make their simulations manageable, network models typically contain a somewhat simplified treatment of generators and their operating constraints, compared to the more detailed treatment of generators contained in transportation models.
The CAISO states that TEAM requires use of a network model, in order to capture the physical constraints of the transmission grid and impacts of a proposed transmission project on locational marginal prices. The CAISO maintains that the production cost simulations must, at a minimum, use a network model derived from a WECC power flow case and perform a DC-OPF analysis that models the physical power flows on transmission facilities for each hourly load and generation pattern. The CAISO states that it is acceptable for a DC-OPF model to compute Power Transmission Distribution Factors (also called shift factors) for every hour of the simulation (variable shift factors), or just for the initial hour (fixed shift factors). Use of an AC-OPF analysis would be optional. The CAISO states that transportation models may be sufficient for many types of resource studies, but maintains that approach is insufficient when analyzing a transmission project that will affect regional transmission flows and locational prices.
The CAISO describes that PLEXOS, the DC-OPF network model it used to analyze DPV2 and Path 26, employs a linearized DC-OPF solution and fixed shift factors, and that transmission constraints are enforced explicitly on high-voltage transmission paths. The CAISO stresses that the requirement to utilize a DC-OPF or AC-OPF production cost model does not constitute an endorsement of any particular vendor or software product, and that many vendors offer an acceptable production cost tool.
The CAISO maintains that use of a transportation model is not acceptable because it computes contract transmission flows instead of physical flows and provides zonal rather than nodal price estimates. The CAISO explains that transportation models cannot model the consequences of loop flow limitations accurately, and that with transportation models interfaces need to be derated artificially to account for loop flow impacts.
The CAISO states that the execution times required for network models limit the number of simulations that feasibly can be performed at this time, although this limitation may be eased in the future. Because of this limitation, the CAISO recommends that the effects of uncertainty be evaluated using a network model to perform as many discrete sensitivity simulations as possible. The CAISO asserts that the larger number of sensitivity cases that can be examined using a transportation model will not enhance the quality of a study because the underlying physical transmission system is not modeled accurately.
SCE, PG&E, SDG&E, DRA, TURN, and Global Energy unite in recommending that the Commission not require use of a network model for the analysis of energy benefits. SCE and DRA used the Global Energy transportation model in evaluating the economic benefits of DPV2.
SCE submits that the utility's choice as to which computer model to use in a particular certificate proceeding may be influenced by a variety of factors, including price, staff availability, regulatory familiarity, and adaptability to a particular project. SCE agrees with the CAISO that it is important to verify that simulated power flows are, but maintains this can be done with transport modeling, using power flow models and nomograms such as the Southern California Import Transmission (SCIT) nomograms.6 SCE describes that the network representation in its economic analysis of DPV2 incorporated SCIT limits to reflect operational constraints and ensure that flow is physically feasible. SCE also performed power flow analyses to demonstrate the physical feasibility of the DPV2 project. SCE concludes that its simulations using a transportation model produce reasonable forecasts of market prices and DPV2 economic benefits.
PG&E's position is that use of transportation models should be allowed, since selected power flow studies and known operational limits can be used to validate the results obtained using a transportation model.
SDG&E asserts that transportation models have certain advantages over network models. It would like to maintain the flexibility to use transportation models. SDG&E reiterates its overall position, however, that the Commission should grant deference to the CAISO's need determinations regardless of the particular model that is employed in obtaining the CAISO's approval for a project.
TURN would prefer to see both network and transportation models employed in certificate proceedings to the extent that time and resources permit, since both types of models have strengths and weaknesses. TURN submits that decision makers can act with greater confidence when both approaches produce the same end result. TURN comments that, if parties' showings using the different types of models produce markedly different results, that would be cause to delve more deeply and seek to determine why that is the case.
Global Energy does not consider the PLEXOS model, as used by the CAISO, to be a "true" DC-OPF model. It asserts that a network model that uses fixed shift factors is less accurate than a properly designed transportation model. In Global Energy's view, the Commission should require that a network model, at a minimum, use variable shift factors and that it model non-linear elements of the grid, namely, DC lines and phase-shifting transformers. Global Energy also submits that it is not clear that the CAISO's model reasonably reflects generation unit commitment and dispatch.
5 CAISO ratepayers include some non-Commission jurisdictional customers, including several municipal utilities and public power agencies such as the State Water Project that have joined the CAISO as PTOs. Entities who wheel energy through the CAISO control area and entities with Existing Transmission Contracts whose rates are tied to the PTO transmission revenue requirement also pay Transmission Access Charges and, thus, will also contribute to recovery of the costs of new CAISO transmission projects.
6 A nomogram is a chart showing the operational limits for simultaneous use of a set of particular transmission lines.
