Investing in the North American Electricity System

To watch video of this event, follow the links at the top of the screen.

The Canada Institute of the Woodrow Wilson International Center for Scholars and the Canadian Centre for Energy Information co-hosted the fifth Cross-Border Forum on Energy Issues in conjunction with the Canadian Embassy in Washington, D.C on March 2, 2006. The program, "Investing in the North American Electricity System," considered policy, regulatory, and technical challenges for expanding electricity generation, transmission, and distribution in North America. The forum was organized in partnership with the Canadian Electricity Association and Global Public Affairs, and benefited from the support of Powerex Corp., KeySpan Energy, and Hydro-Québec.

WELCOME & OPENING REMARKS (webcast begins)
David Biette, Director, Canada Institute, Woodrow Wilson International Center for Scholars
Colleen Killingsworth, President, Canadian Centre for Energy Information

OVERVIEW OF THE CROSS-BORDER ELECTRICITY MARKET
Hans Konow, President and CEO, Canadian Electricity Association

PANEL REMARKS

U.S. Electricity Policy since the Energy Policy Act of 2005
Kevin Kolevar, Director, Office of Electricity Delivery and Energy Reliability, U.S. Department of Energy

Challenges and Opportunities in Ontario's Electricity Sector
Rick Jennings, Assistant Deputy Minister, Energy Supply and Conservation, Ontario Energy

The Real Reasons behind Transmission Underinvestment
Joseph Welch, President and CEO, International Transmission Company

Investing in the Cross-Border Electricity Market: A Canadian Industry Perspective
Linda Chambers, Executive Vice President, Generation Technology & Supply Chain Management, TransAlta

Investing in the North American Electricity System: Investors' Perspective
John Thorndike, Vice Chairman, Investment Banking, Merrill Lynch

Electric Reliability Standards—Raising the Bar
Richard Sergel, President and CEO, North American Electric Reliability Council

CLOSED DOOR DISCUSSION
Barbara Kates-Garnick, Vice President, Corporate Affairs, KeySpan Energy (Moderator)

LUNCHEON PROGRAM
Jon Allen, Chargé d'affaires, Embassy of Canada
Tom Parkinson, President and CEO, Hydro One

KEYNOTE ADDRESS
The Hon. Samuel W. Bodman, U.S. Secretary of Energy

The forum provided an opportunity for more than 50 high-level Canadian and U.S. government officials, industry representatives, and energy experts to continue an ongoing dialogue on cross-border energy cooperation. The half-day event started out at the Wilson Center with a panel of presentations followed by a closed-door roundtable discussion. Representatives of government, industry, business, and investment banking discussed policy issues, reliability standards, investment trends, and challenges associated with building new generation and transmission capacity in the electricity sector. The forum continued with a luncheon program at the Canadian Embassy, where U.S. Secretary of Energy Samuel Bodman delivered the keynote address..

The Canadian and U.S. electric systems are integrated into a single, cross-border market, which remains one of the most reliable in the world. Secretary Bodman emphasized the importance of jointly managing our common electricity grid: "our shared electric system must be planned, built and managed as if our border did not exist." Yet as current and projected demand for electricity continues to grow, the expansion of the North American electricity system is stifled by bottlenecks of all sorts. The 2003 blackout, as Joe Welch pointed out, underscored both the degree of cross-border interdependence and the "fragility" of the electric grid. The greatest fear among players in the electricity market, according to Linda Chambers, is another event such as the 2003 blackout, which could prompt a "legislative overreaction."

Having suffered from chronic underinvestment, North America's electricity is now at a crossroads: on the one hand, existing generation and transmission infrastructure requires significant maintenance and refurbishing; on the other hand, new capacity must be brought online before demand outstrips existing supply. As Hans Konow put it succinctly, "investment is necessary across the full spectrum."

Bringing new sources of electricity online requires significant, long-term capital investment. Risks and uncertainty in the regulatory environment, the political sphere, and the market structure undermine such long-term, costly commitments. Moreover, consumer expectations are such that new sources of electricity supply must be reliable, affordable, and environmentally sustainable. The gap between consumer expectations and industry constraints suggests challenges of its own, of which policymakers, business leaders, and the public at large must be cognizant for investment in new and existing capacity to produce tangible improvements. "Education is key," asserted Konow, as is the role of regulatory and government authorities, who have the power to shape the playing field. Linda Chambers concurred, noting that "the public needs to understand the realities of the electricity market, including its cost structure"; otherwise "it is difficult to raise [electricity's] profile and push policy forward."

In this regard, the Energy Policy Act of 2005 (EPACT) represents a new milestone and reference point. According to Kevin Kolevar, EPACT would help spur investment in a number of ways. There are incentives for new transmission. The law also repeals the Public Utility Holding Company Act (PUHCA), which will allow for more mergers & acquisitions and economies of scale. Kolevar argued that the congressional debate alone fostered investment in the electricity sector as the industry anticipated a clear set of rules of the roads.

The law also requires the U.S. Department of Energy (DOE) to undertake a "congestion study" of the electricity grid by August 2006, whereupon DOE will designate special "electricity corridors." Secretary Bodman noted that this study will draw on the extensive body of existing cross-border studies. A comment period, which ended on March 6, 2006, afforded companies and individuals an opportunity to provide feedback and make a case for "expedited corridor designation." New projects proposed within these corridors can be approved by way of an expedited process, with the Federal Energy Regulatory Commission (FERC) empowered to grant eminent domain if state authorities with jurisdiction over the proposed project routes fail to complete the review process within a given timeframe. DOE officials expect that few cases will require the FERC to consider granting eminent domain—the existence of the eminent domain rule alone should spur states to act on transmission project.

The EPACT also directs the FERC to name an Electric Reliability Organization (ERO) to establish and enforce mandatory electric reliability standards. On February 2, the FERC issued a final rule directing potential applicants to file within sixty days. Richard Sergel discussed the North American Electric Reliability Council's plans to apply to be the ERO (with simultaneous applications to the relevant authorities in Canada). He stressed the need to vigorously enforce compliance in order to maximize the effectiveness of the present system, while providing strong incentives for investment to improve the reliability of the electric grid.

Rick Jennings highlighted the current challenges and opportunities facing Ontario's electricity sector. As the province faces an electricity supply gap in the near future, developing new sources of supply (including controversial plans for a new plant in downtown Toronto), refurbishing existing generation capacity (including Ontario's nuclear plants), and implementing energy conservation procurement are taking on renewed importance. Other challenges include moving away from coal-fired generation by embracing renewable energy as source of electricity production, including hydropower and wind power. As other states and provinces, Ontario must grapple with coordination among and between various regulatory bodies and with opposition from environmental and local interests (i.e., the NIMBY ["Not-In-My-Backyard"] syndrome).

Joe Welch discussed the difficulties of building new transmission capacity. He highlighted a number of critical challenges, including the widespread use of the controversial "Location Marginal Pricing" mechanism, hidden constraints of financial transmission rights, frozen rates for end-users, overlapping and conflicting regulatory jurisdictions, and a host of disincentives to regional-based planning, coordination, and implementation of transmission projects. John Thorndike highlighted similar investment hurdles such as the "free rider" and "contingency" disincentives: investors are reluctant to expand transmission or build spare capacity when there is disproportionately little or no cost-sharing, even though the benefits are widespread. Welch also spoke at length of price distortions resulting form the existing market structure, which deter investment in transmission because "the money goes to generation." He was skeptical that EPACT alone will be sufficient to address many of the underlying causes of underinvestment.

Linda Chambers detailed the prospects for investment in new generation capacity. The EPACT's repeal of the PUHCA is "a good start" as it will encourage investment in what is a long-cycle, capital-intensive business, which relies on capital markets for financing. Yet hurdles remain, including permitting and siting restrictions as well as obstacles to expanding the transmission grid. Moreover, technological breakthroughs are no panacea either, as most generation companies do not have the scale or research and development budgets required to bring technological innovations to market.

As a result, volatility and political risk remain, dampening the appetite for investment. Accordingly, to reduce such volatility, electricity generation companies tend to spread risks across markets, fuel types, and partners. Financial institutions have also been active participants in the international commodities market, some, such as Merrill Lynch, offering "one-stop shopping" for financing large-scale, capital intensive energy projects. By putting together financing proposals that cover the typical lifespan of a project, investors can sufficiently reduce the commodity risk with multi-year, fixed-price contracts, thus yielding attractive rates of return.

The forum continued with a 90-minute closed-door discussion of the issues mentioned above. The conversation revealed a sense of "cautious optimism" about the prospects for progress in modernizing and expanding the electric grid, a point Tom Parkinson emphasized in his overview of the forum discussion at the luncheon program. Referring to the hurricanes and political uncertainty around the world, Secretary Bodman remarked that in times of stress and hardship "it is comforting to know that Canada and the United States can work together to ensure energy security."

David N. Biette
Director, Canada Institute

Drafted by Christophe Leroy