RE: Draft - Questions to Ashley Brown Paul Great help. Thanks.  Let's see how Ashley Brown reacts to those questions (we made some minor changes based on your comments)  We will get back to you. Regards LM  -----Original Message----- From: 	Dawson, Paul   Sent:	Wednesday, November 21, 2001 5:15 AM To:	Dawson, Paul; Maurer, Luiz; Steffes, James D.; Nicolay, Christi L.; Stroup, Kerry Subject:	RE: Draft - Questions to Ashley Brown Sorry this was sent before I'd finished.  I was about to add that the list of questions looks good and I'd be happy to discuss further if required! Cheers Paul  -----Original Message----- From: 	Dawson, Paul   Sent:	21 November 2001 11:13 To:	Maurer, Luiz; Steffes, James D.; Nicolay, Christi L.; Stroup, Kerry Subject:	RE: Draft - Questions to Ashley Brown The state of transmission/transportation regulation here is continually evolving and a full treatment would qualify for an economics doctorate.  You should also be aware that not everything out of Ofgem (the UK regulator) makes sense.   Hence, while I've provided some answers to your specific questions below, I would see these only as broad guides to the issues you are facing in the US and would retain a healthy degree of scepticism about the lessons to be drawn from UK schemes.  In particular, I would caution against relying solely on the NGC incentives document, since this is only a small part of a much large jigsaw of price controls etc. 1) Do you think that the UK  for-profit Transco model has been working satisfactorily? We know it is still early for you to make a final judgement, but have the incentives and penalties shaped the way NG behaves (in terms of costs and elimination of T contraints)?  The for-profit model has worked reasonably well so far.  Both RPI-X regulation and NGC/Transco's incentive schemes have driven out many operating costs.  However, the link into ensuring long-term investment is not clear.  RPI-X in it's purest form has poor investment incentives.  Ofgem are seeking to remedy this by introducing longer-term contracts for transmission capacity, together with upside rates of return if the companies improve on some key output measures (they are leading the way on this in gas).  Nevertheless, I think they're still some way short of solving the problem. In my view, this is because the problem borders on the insoluble.  Ofgem are obsessed with introducing "market based" signals for new investment.  I'm deeply sceptical about this - while you can auction fixed amounts of capacity and thereby get a "market price", the capacity made available at one location depends on the amount made available at all other locations.  In short, there are major network externalities which are the source of the natural monopoly in transmission.  As a result, the regulator and/or the Transco will always need to define how much capacity should be built and made available at particular locations.  In turn, this means that while contracts can play some role, we can't leave regulation behind in ensuring that sufficient network capacity is made availalble. As far as the for-profit and non-profit debate goes, I'm an agnostic.  The former can undoubtedly focus the mind (NGC have virtually removed voltage constraint from the system, due to installation of reactive compensation equipment), but serious doubts still remain about the ability of the UK system to implement major new investment.  On the flip side, I would be concerned about how to ensure appropriate performance incentives for non-proift transmission organisation. 2) We took a good look a the NGC system operator price control and incentive schemes under NETA - Final Proposal - Dated December 2000 (attached) . Which of the alternative proposals on page 21 has been adopted? The final proposals are here. http://www.ofgas.gov.uk/docs2001/ngcmod_22march.pdf  These might be useful if you're having trouble sleeping, but I suspect that the finer details of NGC's scheme are too case-specific to be of any use elsewhere.  The key element, I think, is the fact that Ofgem gave NGC a choice from several different incentive schemes.  This mirrors some economic theory developed by Laffont and Tirole on the design of optimal incentive sctructures.  The idea is to overcome the information assymmetry between the regulator and company, because the company "reveals" the optimal structure in choosing between the alternatives.   3) Have the incentives/penalties system been working or have them been subject to reviews in terms of targes, upsides, collars, and other parameters due to external factors beyond Transco control? The incentive schemes are subject to regular review, but for the reasons above, I'm not sure you can draw any lessons beyond the general lesson that incentive schemes can be useful ways of making efficiency gains.  I'm not aware of any scheme being reopened because of external factors. 4) Could you send us (or help us find) the "official"  Transmission Licence Agreement, where all incentives and penalties are clearly spelled out? As above - but again, how relevant are these specifics for your purposes? 5) Question related to NETA rules:  As I understood, there is not a central pool, and market participants (generators and suppliers) have to submit a balanced schedule in the forward market. NG is responsible for [small] imbalances or residual purchasing. If that is true, how can NG be made accountable for energy deviations in the real time that it has no control whatsoever? (It seems that the incentive mechamism takes this metrics into account) NGC accepts offers (for more generation or less demand) and bids (for less generation and more demand) which it calls off to balance the system in real time.  It doesn't need "control" because people are free to price these offers and bids as they see fit.  NGC can also enter balancing services contracts for particular ancillary services (reserve, reactive support etc).  NGC is subject to a balancing services incentive scheme which ensures that they balance the system economically. 6) Do you think the profit-RTO as proposed by NETA could live with a completely different congestion management system, such as central dispatch/LMP/financial rights (as current in used in the PJM pools in the US)?We have the impression that NG advocates a profit RTO and a self-dispatch, physical rights congestion system. We have been advocating the former. I'm yet to be convinced that there are huge differences between physical/financial transmission schemes - despite noodling on the problem continuously for the last 7 years (it all started in CA in 1994 . . . . ).  At the end of the day, someone (the system operator) must decide what is required where to keep the system stable, ie, to make "spot" decisions on transmission availability.  If the capacity is fungible, you would also expect a secondary market to emerge in physical rights.  It would, however, be practically quite difficult to introduce an LMP scheme under NETA.  This is why we're moving down the entry-exit physical capacity route. 7) We prepared a list of questions to be sent to NG. Could you please take a look. Do they make sense? Are they based on correct assumptions regarding the UK system? Any other aspects to be investigated? Question 3 is the main problem to resolve both within an RTO's region and between RTO's.  You might want to expand this further to include efficient investment, maintenance and operation in the light of the comments above about the deficiencies of the UK system. LM -----------------------------QUESTIONS TO ASHLEY BROWN - ALLIANCE/NG  RTO PROPOSAL ---------------------------- 1) Profit-RTO - Where does your proposed organization fit  in the attached graph in terms of end state ? Stage III? Stage IV?  << OLE Object: Microsoft PowerPoint Slide >>  2) Regarding document "Response of National Grid USA to questions posed by the Commission": Does it imply that core, for profit functions should not be subject to a stakeholder process? Wasn't the NETA design subject to an extensive  consultation, even for profit, NG core functions? 3) If each Transco manages it own OASIS, how can we avoid fragmentation (balkanization), pancaking and many other negative aspects and seams that the RTO process is trying to eliminate? How can you achieve one-stop shopping? By outsourcing those functions to one singole  third party? 4) What kind of PBR mechanism are you envisioning for the Transco-RTO? Are you thinking about including "external" measures such as cost to provide ancillary services, congestion costs or costs incurred in energy balancing? 5) Are you envisioning an RTO-Transco model which will assume that all transmission assets in the region will be divested? Or can the model live with a "light" RTO where part of the assets are divested but others are not (and sign an operating agreement with the RTO. Would your proposed Matrix of RTO Functions (page 9) still be robust under this scenario? 6) Can your proposed RTO model dovetail with an LMP/Congestion Management system based on financial rights? [Our understanding is that NETA completely reorganized the UK pool. The UK system now looks like a "self-dispatch", physical rights model]  7) As a follow up of the previous question: Assuming Alliance adopts a self-dispatch, physical rights approach similar to the one NG operates in the UK today. Don't you think that this will create significant barriers/seams with other neighboring RTOs, considering that there seems to be a general trend towards security constrained dispatch, LMP and financial rights for most RTOs in the US? 8) If your proposed system can be dovetailed to a central dispatch, LMP/financial rights, shouldn't some functions in your "Martix of RTO Functions" be collapsed? For example: management of congestion prices, calculation of congestion, operations of energy markets and generation redispatch? 9) Procurement and deployment of ancillary services is listed as non-core. However, in the UK system, this represents a significant role of the Transco, with incentives and penalties attached to its achievement. Is there a different vision or do you assume that those functions will end up being developed by the RTO and consequently will be part of the PBR formula? 10) Generation interconnection. Obviously, your proposal did not go that far. Conceptually, do you favor a system whereby T fixed costs are recovered via a postage stamp rate across an entire region or do you favor the UK model whereby fixed costs (use of the system) are calculated based on incremental cost and have a strong locational component (and connection costs are treates separately, according to a shallow method? 11) Establishment of transmission rates. How to reconcile the fact that those should be regulated and you propose that the Transco itself will establish its T rates? Are you thinking about some possible non-regulated activities? 12) You stated that separation and control of T assets persists, to a large extent, in the Collaborative Model proposed as part of the Southeast Mediation. Do you think that the Independent System Administration model is superior in this regard? What are the key important differences in your view in the conceptual design of those models