Some existing investors – and importantly, new entrants – continue to offer lower-cost financing in exchange for federal and state tax credits and accelerated depreciation under pre-cash grant tax credit rules and familiar financing structures. Adding to this momentum, since May 2011, the Federal Energy Regulatory Commission (FERC) has taken significant steps aimed at developing a transmission grid infrastructure capable of supporting renewable project development in the United States. In May of this year, FERC approved another generous incentive package to encourage private investment in the Atlantic Wind Connection (AWC) project and accelerated review of the expansion of such incentives to spur new transmission projects. FERC followed up in July by approving comprehensive cost allocation regulations for new transmission projects.

Following similar renewable transmission incentive orders, on May 19, 2011, FERC granted important incentives to AWC – a $5 billion project – which if completed, will consist of a 250-mile offshore transmission grid capable of flowing up to 7000 megawatts of electricity along the Eastern seaboard, including offshore wind power. AWC is a joint venture among Google Inc., Good Energies, the Marubeni Corporation, and Trans-Elect Development Company, LLC to build an offshore “backbone” electric transmission system from Virginia to New York City. Smaller lines will connect the “backbone” to the onshore transmission grid and load in the states along its path.

FERC granted AWC a significant incentives package aimed at investors who might otherwise be deterred by the high risks associated with developing an innovative renewable transmission project. FERC approved a 250 base points adder to AWC’s return on equity (ROE) with a total overall ROE of 12.59%. AWC will also be able to include 100 percent of the costs associated with construction work in progress in its rate base. And add to that the approval of 100 percent of AWC’s prudently incurred costs should the project fail for any reason deemed outside of the sponsors’ control. These specific incentives are helpful because, under general ratemaking principles, costs are not included in rates unless demonstrated to be prudent, used and useful (meaning the asset actually is providing the contemplated service). FERC also authorized a hypothetical capital structure based on 60 percent equity and 40 percent debt – generous for an initial capitalization.

As a pre-construction package, these are critical incentives encouraging investment by limiting potential risk incurred by investors if the project fails. AWC must receive approval under the PJM Interconnection transmission planning process and be included in PJM’s regional transmission expansion plan before the incentives take effect.

On the same day FERC approved the AWC incentives package, FERC also issued a Notice of Inquiry (“NOI”) seeking stakeholder comments on further implementation of FERC’s transmission incentives, including for renewable transmission projects. The NOI comes roughly five years after FERC issued Order No. 679, implementing Section 219 of the Federal Power Act, with the goal of promoting investment in transmission projects, and the provision of reliable and lower cost power for consumers, by reforming certain long-held transmission development models.

Under Order Nos. 679 et al, FERC encourages and has granted transmission incentives if the transmission project can demonstrate that it either ensures reliability or otherwise reduces congestion and related costs. There is a rebuttable presumption that the project meets this reliability/congestion reduction test if the project is found acceptable as part of a regional planning or state siting process that evaluates projects for reliability and/or congestion reduction.

The project, moreover, must show a nexus between the package of incentives sought and the nature of the investment being made, including the scope, risk and challenges faced by the project. Importantly, FERC has in certain cases interpreted these conditions broadly.

FERC has allowed incentives to transmission projects that may not directly relieve congestion or meet a specific reliability need but, instead, provide the infrastructure to meet state renewable energy standards and to serve load growth reliably. Incentive packages, akin to AWC’s, include ROE adders, abandonment cost recovery, 100% CWIP, development and accelerated depreciation rate base recovery, and a hypothetical capital structure at the project’s inception.

Now, after five years of experience, FERC seeks stakeholder comments regarding the implementation of the next phase of transmission project incentives. FERC is gathering comments regarding its continued efforts to encourage transmission development, while balancing its open access, reliability, efficiency and equitable rate policies. FERC requested stakeholders to address:

• Incentives best suited to address transmission developers’ obstacles;
• Potential improvements to the cost estimate process;
• Nexus requirement track-record to date and suggestions for improvement;
• Additional incentives; and
• FERC’s considerations when an applicant cannot meet the rebuttable presumption that its project will either ensure reliability or reduce transmission congestion.

Parties have filed comments ranging from strong support for the incentive program (as implemented) to opposition. Some oppose transmission incentives for large-scale transmission projects in favor of incentives for small-scale localized distributed generation and micro-grid projects. Others suggested offering incentives tied to successful completion of project milestones.

Then, on July 21st, FERC continued the summer trend, when it unanimously adopted its final rule on Transmission Planning and Cost Allocation by Transmission Owning and Operating Public Utilities (“Order No. 1000”). Order No. 1000 follows a rulemaking that commenced in June 2010 and generally reforms transmission planning, cost allocation methods, and non-incumbent developer rules.

The rule requires each public utility transmission provider to participate in a regional transmission planning process that satisfies the requirements set out in FERC Order No. 890, including regional transmission planning. Each planning process at the local and regional level must consider transmission needs driven by federal or state statutes, regulations and policies, including renewable energy requirements. Moreover, each such transmission provider must coordinate with neighboring transmission-planning regions. Notably, each transmission provider must also participate in a regional transmission planning process that has a regional cost allocation method for new transmission facilities satisfying certain regional cost allocation principles. The rule also attempts to even the playing field between public utility incumbent and non-incumbent projects including the right of first refusal and right to construct and own facilities sponsored in a regional transmission planning process.

Renewable energy proponents continue to praise Order 1000 as an ambitious FERC action to encourage development of renewable energy projects. They are encouraged because Order 1000 will eliminate the first right of refusals and preferences over new transmission projects previously held by large, established incumbents with fossil fuel projects. Order 1000 also requires transmission planners to account for individual state renewable energy requirements (and other government policies aimed at encouraging renewable development) when considering new transmission projects. Renewable advocates also believe Order 1000 will benefit their projects by increasing access to information about the transmission planning and access process.

The order will go into effect October 11, 2011 and public utility transmission providers are required to make a compliance filing next year. The final rule does not specify a uniform approach for compliance leaving implementation details and impacts for the compliance filings.

The forecast: Headwinds, yes. But possibly stronger tailwinds, driven by ambitious regulatory policy and new market entrants going forward. Stay tuned for further developments…

About the Author

Gregory K. Lawrence is a partner in the Energy and Commodities group of the law firm Cadwalader, Wickersham & Taft LLP. Mr. Lawrence focuses his practice on regulatory proceedings, projects, negotiations, enforcement and agency litigation relating to the wholesale and retail electricity and natural gas industries. Mr. Lawrence would like to thank Ben Chesson, associate, with Cadwalader’s energy and commodities advisory group, for his contributions to this article.