Setting up a possible showdown with states over how and when electric utilities should join regional transmission organizations (RTOs), FERC late Tuesday said that American Electric Power Co. (AEP) must “expeditiously fulfill” prior voluntary commitments and hand over control of its transmission facilities to PJM Interconnection. Significantly, the Commission also said that after considering various alternatives, AEP’s full integration into PJM is the best solution among the options before the federal agency.

AEP has alleged that it can’t fully join PJM because of the Virginia Legislature’s prohibition on any incumbent utility joining an RTO until July 1, 2004, as well as similar state actions, such as a Kentucky Public Service Commission’s (KPSC) order rejecting AEP’s bid to transfer control of its transmission facilities in that state to PJM.

“This is a highly political issue — certain to incite vociferous responses from Southeastern states beyond Virginia and Kentucky — however, we believe that over the long term this will be positive for AEP,” wrote Charles Schwab analyst Christine Tezak. “We expect participation in PJM to eventually provide greater opportunities for the firm’s surplus generation and relieve concerns regarding its market power position and possible vulnerability of its market-based rate authority.”

The case before FERC stretches all the way back to 1998, when AEP and Central and South West Corp. (CSW) filed a merger application at the Commission. FERC in March 2000 conditioned approval of the deal upon the adoption of certain mitigation measures. FERC accepted the utilities’ proposal to join an Commission-approved RTO and required that the transfer of operational control of their transmission facilities to such an RTO be completed by Dec. 15, 2001.

Under FERC Order 2000, issued in December 1999, FERC said that it expected utilities to voluntarily agree to form RTOs. All public utilities were required to file, by Oct. 15, 2000, either a proposal to participate in an RTO or an alternative filing detailing efforts and plans to participate in an RTO.

In order to “maximize reliability and connectivity throughout the Midwest and Mid-Atlantic regions, AEP must expeditiously fulfill its voluntary merger commitment and voluntary Order 2000 RTO commitment by fully integrating AEP into PJM,” FERC said in its order. “Due to AEP’s sizeable service territory and strategic location between current PJM, Midwest ISO and ComEd [Commonwealth Edison], AEP’s integration into PJM would allow the benefits of enhanced reliability that arise through RTO membership to extend seamlessly across the Midwest and Mid-Atlantic regions.”

FERC said that it has sought to bring about certainty in RTO formation through a voluntary approach, “but, since that approach has failed, must now consider more decisive actions, so as to enable the broad spectrum of parties in the region who seek certainty through AEP’s fulfillment of its merger commitment by entering PJM, to proceed with their own RTO formation. Absent such decisive action on the part of the Commission, the benefits of RTOs will flow to customers in a delayed and highly truncated fashion.”

In trying to break the logjam over AEP’s participation in PJM, FERC considered a wide range of solutions. AEP, for example, recently suggested having its entire transmission system placed under PJM’s control, while the utility’s generation remained outside of PJM’s markets. Another alternative called for AEP to initially join Midwest ISO and later migrate to PJM.

But the Commission decided that the best path to follow is for AEP to fully integrate into PJM. “First, under this solution, AEP will fulfill the voluntary commitment it made to alleviate concerns regarding the market power of the merged entity at the time that AEP and CSW merged,” FERC said.

“Second, if AEP joins PJM, the benefits of RTO membership will begin to flow to AEP’s customers and those in the entire region, including the benefits of PJM’s fully-functioning, robust markets.” Third, FERC said that requiring AEP to fulfill its merger commitment will provide certainty to all parties and to the marketplace in these regions.

“Not other proposed solution provides all of these benefits, or provides them to as great an extent. For this reason, and because the other proposed solutions all contain more serious flaws, the Commission will take steps to require the full integration of AEP into PJM.”

FERC preliminarily determined that the actions of Virginia and Kentucky, if allowed to stand unchallenged, would have the effect of: (i) preventing AEP from complying with its merger commitment to join an RTO in order to mitigate market power concerns associated with the merger; and (ii) blocking AEP companies — both in Virginia and Kentucky and in other states whose state commissions want the AEP companies to enter an RTO — from joining RTOs in the foreseeable future.

FERC set for hearing the question of whether AEP’s voluntary commitment to join PJM is designed to obtain economical utilization of facilities and resources in the Midwest and MidAtlantic regions, as set forth in a section of the Public Utility Regulatory Policies Act (PURPA). PURPA allows FERC to exempt utilities from state requirements “in cases where voluntary coordination between utilities is designed to obtain economical utilization of facilities and resources,” notes Tezak.

FERC also set for hearing whether the laws, rules or regulations of Virginia and Kentucky are blocking AEP from fulfilling both its voluntary commitment in 1999, as part of merger proceedings, to join an RTO, and its application to join an RTO pursuant to Order 2000. The Commission will also examine whether provisions of Kentucky and Virginia laws, rules or regulations are required by any authority of federal law or are designed to “protect public health, safety or welfare or the environment or conserve energy or are designed to conserve energy or are designed to mitigate the effects of emergencies resulting from fuel shortages.”

The Commission therefore returned the proceeding to FERC Administrative Law Judge William Cowan to conduct a hearing on these questions. Cowan was directed to issue an initial decision in the proceeding by March 15, 2004.

Cowan on Wednesday said that a prehearing conference will be held in the proceeding on Dec. 2 for the purpose of developing a hearing schedule. The ALJ offered a proposed procedural schedule, for discussion purposes only, that calls for hearings to start on Jan. 13, post-hearing initial briefs due by Feb. 6 and post-hearing reply briefs due by Feb. 13.

“Whether an energy bill eventually emerged from Congress or not, we believed that the Aug. 14 blackout would make it impossible for FERC to permit the painfully slow and seemingly endless debate over the RTO plans of Midwest utilities to continue,” wrote Tezak in a Nov. 26 “Electricity Bulletin.” Congressional leaders recently shelved a wide-ranging energy bill until next year over unresolved regional and partisan disagreements.

Tezak believes that it will “take some time” for FERC to execute this process to override the wishes of Kentucky and Virginia, “perhaps as early as 2Q04.” The decision could be litigated for a multi-year period thereafter, she said. “Since Congress appears unable to provide meaningful clarity to the industry on these issues through legislation, the courts appear to be the only recourse now. The electricity title in the pending energy bill has been criticized by some market participants for still leaving many issues open to interpretation and litigation.”

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