As an initial matter, I would stress that any state savings clause related to electric reliability should assure that any state-directed action does not result in undue discrimination or other unnecessary impediments to competitive bulk power markets. I believe the above statutory language may be overly broad and could lead to problems for competitive wholesale power markets. For example, the language in subsection (b) "saves" even those State actions that impair competition in wholesale markets by discriminating in favor of certain transmission grid users or certain generating facilities located within a particular State.

The primary change in this version of the savings clause, in contrast to prior versions, is subsection (c), which provides that nothing in the reliability title preempts any authority of any State to take action to ensure the safety, adequacy, and reliability of electric service within that State, as long as such action is not inconsistent with any Organization Standards. First, it is not clear what "not inconsistent with" means. This could be interpreted to mean that the State can deviate from an Organization Standard as long as it does not choose a less stringent standard. Alternatively, the provision could be interpreted to mean that the state cannot deviate at all from an Organization Standard, and is free to regulate only in subject areas not covered by an Organization Standard. If given the former construction, the provision could lead to continued balkanization of the nationwide grid by up to 48 sets of rules of the road. Moreover, the provision does not explicitly provide that the State action cannot result in undue discrimination under the Federal Power Act. Therefore, I therefore recommend at a minimum that subsection (c) be modified as follows (changes indicated in bold):

(c) Nothing in this title shall be construed to preempt any authority of any State to take action to ensure the safety, adequacy, and reliability of electric service within that State, as long as such action is not inconsistent with any Organization Standard and is just, reasonable and not unduly discriminatory or preferential, and in the public interest.

[The bold language is verbatim the language contained in Section 201 (the reliability title) of H.R. 2944, governing the substantive standards the Commission_must use to approve an Organization Standard. It is contained in the title's amendment to FPA section 218(e)(3)(A).]

The new version of the savings clause also specifically gives the Commission authority to stay a State action pending the Commission's determination of whether the State action is inconsistent with any Organization Standard. I believe that the Commission can provide important "backstop" to ensure the reasonableness of "state actions," the lack of clarity of the provision may pose troublesome legal and administrative problems.

Question 2. In your April 27, 2000 testimony on pending electric industry restructuring bills, you called on Congress to enact a six-point program to allow the FERC to more effectively promote competition and to ensure a balanced approach to restructuring. In addition to reform of the Public Utility Holding Company Act and classification of Federal/State jurisdiction issues, you said that Congress should enact legislation to:

(1) place all electric transmission in the continental U.S. under the same rules for non-discriminatory open access and comparable service;

(2) reinforce the Commission's authority to foster regional transmission organizations;

(3) establish a system of mandatory reliability rules to protect the integrity of transmission service, relying on a self-regulating organization with appropriate Federal oversight of rule development and enforcement; and

(4) provide the Commission with appropriate authority to remedy market power. Could these six measures, if enacted alone as a package, achieve substantial competitive benefits for consumers and the economy even if the Congress were unable to legislate improvements in the retail power markets?

Answer. Yes. These measures would improve the reliability of the electrical grid and the reliability benefits would accrue to all customers, wholesale and retail, taking power from the interconnected grid. These measures would promote greater efficiency and competitiveness in wholesale power markets as well as in retail power markets in states that have adopted retail choice for consumers. In addition, even consumers in nonretail choice states would benefit. This is because most or all electric utilities buy power in the wholesale markets at times to meet the needs of their retail customers, and then pass the costs (or cost savings) associated with these purchases through to those customers. The savings these utilities realize from more efficient and competitive wholesale markets generally would be passed through to their retail customers, even if those customers do not have retail choice. Thus, di

rectly or indirectly, retail customers would benefit from the measures I recommend even if state law does not allow those customers to choose their electricity supplier. Question 3. You testified on April 27, 2000 that legislation is needed to place all transmission, even if it is publicly owned or cooperatively owned, under the same non-discriminatory open access standards. Would it be sufficient to give the Commission authority to require comparable transmission service by PMAS, munis and coops, but not to extend FPA section 205-206 authority over the transmission services of these entities, as provided for in the H.R. 2944? If not, why not?

Answer. I do not believe it would be sufficient to require comparable open access service by non-public utility entities (e.g., PMAs, municipal utilities, cooperative utilities TVA) but not to explicitly extend the substantive and procedural requirements of FPA sections 205 and 206 to these entities. Expanding the Commission's authority to require these entities to provide comparable open access transmission service would be an improvement over existing law, which only permits the Commission to order transmission services by these entities on a limited case-by-case basis. However, a provision that does not apply FPA sections 205 and 206 to these entities would not provide adequate mechanisms to ensure comparable rates and terms of service among transmission-owning utilities.

All transmission-owning utilities should be subject to the same substantive as well as procedural requirements and protections contained in FPA sections 205 and 206. Under sections 205 and 206 of the FPA, transmission rates, terms and conditions must be just, reasonable and not unduly discriminatory or preferential. In addition, sections 205 and 206 provide important procedural mechanisms for rates, terms and conditions to be kept open for public inspection, for utilities to be able to seek rate increases, for customers to be able to seek rate decreases if rates are unjustifiably high, for notice and opportunity for hearing for proposed rate changes, and for the Commission to suspend rate changes, if appropriate, for up to five months, subject to refund. A provision such as that in H.R. 2944 provides no such procedural protections and mechanisms with respect to rate changes.

Question 4. If the Commission were given FPA section 205-206 authority over the rates, terms and conditions of transmission service by municipal utilities and cooperatives, would the Commission be bound to apply the same ratemaking methodologies to these entities that it applies to traditional investor owned utilities, or would it have flexibility in setting rates under sections 205-206 to take into account the unique characteristics of munis and coops (e.g., the fact that they do not have equity holders, may have certain bond covenants, etc.)? Has the Commission ever set rates for these entities under FPA section 211, or in other contexts? If so, what ratemaking methodologies did it apply?

Do you think the Administration's bill appropriately addresses the concerns of municipal utilities and coops with respect to transmission regulation by the Commission?

Answer. No, the Commission would not be bound under the FPA to apply the same ratemaking methodologies to municipal and cooperative utilities that it applies to traditional investor-owned utilities. The FPA requires that rates be just, reasonable and not unduly discriminatory or preferential, but it does not dictate a particular ratemaking methodology. The Commission already has had experience in setting rates for transmission service by municipal utilities under section 211 of the FPA, and for electric power cooperatives who have paid off their Rural Utilities Service (RUS) financing and become subject to regulation by the Commission under sections 205 and 206 of the FPA, and the Commission has been sensitive to their special circumstances. In every instance, the Commission has adapted its rate-setting policies to address the fact that these are not investor-owned utilities. For example, the Commission has approved rates for jurisdictional cooperatives that include an equity allowance based on the interest coverage requirements of the cooperative's lenders and that accommodate the patronage capital practices that cooperatives use to obtain equity financing from their customers. Summarized below are a number of cases where the Commission has adopted the cost-of-service treatments proposed by municipals and cooperatives in setting rates for jurisdictional services.

With respect to municipal utilities, when the Commission evaluated proposed transmission rates for the Southern Minnesota Municipal Power Agency in the context of FPA sections 211 and 212 (section 212, like sections 205 and 206, requires rates to be just, reasonable and not unduly discriminatory or preferential), the Commission found Southern Minnesota Municipal's proposed rates cost-justified, and accepted them, based on Southern Minnesota Municipal's own cost-of-service studydespite objections from the customer that would be taking transmission service and paying the rates. Minnesota Municipal Power Agency v. Southern Minnesota Municipal Power Agency, 68 FERC J61,060 (1994). More recently, while conditionally ac

cepting the New York Independent System Operator's proposed transmission tariff, in response to concerns raised by the Long Island Power Authority that in joining the ISO it did not wish to relinquish its authority to set its own rates, the Commission explained that "we are committed to fostering regional transmission arrangements that will embrace public utility and nonpublic utility entities alike and would not lightly take actions that might deter entities like [the Long Island Power Authority] from participating." Central Hudson Gas & Electric Corporation, et al., 86 FERC J61,062 at p. 61,213 (1999). In addition, in a later order, in a similar vein, the Commission accepted revisions to the ISO's transmission tariff that provided that the Long Island Power Authority would "not be required to provide transmission service where the provision of such service would result in the loss of its tax-exempt status for its bonds." Central Hudson Gas & Electric Corporation, et al., 88 FERC J61,138 at p. 61,402-03 (1999).

With respect to cooperatives, when Deseret Generation & Transmission Cooperative paid off its RUS financing, the Commission accepted Deseret's pre-existing generation and transmission service agreements and rates-without changing Deseret's rates and despite objections from customers purchasing Deseret's power. The Commission found that the rates were cost-justified based on a cost-of-service analysis done by Deseret. Deseret Generation & Transmission Co-operative, 78 FERC J61,274 (1997). Another example is Wolverine Power Supply Cooperative, Inc. which also paid off its RUS financing. The Commission accepted Wolverine's proposed transmission rates without change. Wolverine justified these rates based on a cost-of-service study. Wolverine Power Supply Cooperative, Inc., 81 FERC J 61,369 (1997).

I believe the Administration's bill, which would bring the transmission facilities of municipal utilities and RUS-financed cooperatives within the Commission's authority under FPA sections 205 and 206, does adequately address the concerns of such entities. It specifically provides that in setting rates for these entities the Commission may take into account different structure and operating characteristics of transmitting utilities, assure to the extent practicable that RUS-financed utilities meet their loan obligations, and not jeopardize the tax exempt status of non-profit cooperatives under the Internal Revenue Code. These requirements are consistent with actions the Commission has already taken with respect to non-public utilities and I believe it is appropriate to include them in legislation.

Question 5. Does the Commission have authority under existing law to ease the regulatory and filing burdens on small municipal utilities and cooperatives if their transmission were to become subject to FPA sections 205-206? Does it have authority under existing law to waive open access requirements and burdens, or to exempt certain entities, where Justified? Is specific legislation needed in this regard?

Answer. The Commission does have authority to ease its regulatory requirements and filing burdens for small utilities. No additional legislation is necessary to accommodate small utilities. For example, the Commission can waive, and has waived, its accounting and reporting requirements for cooperatives that sell power at market-based rates, and that, because they have paid off their RUS financing, have become public utilities subject to Commission regulation. Edgar Electric Cooperative Association d/b/a EnerStar Power Corporation, 83 FERC J61,160 (1998). The Commission also has authority to waive, and has in fact waived, the requirements of its open access and OASIS rules-Order Nos. 888 and 889. When Wells Rural Electric Company, a RUS financed cooperative that serves approximately 5,300 customers in northeastern Nevada and Utah, filed stating that it anticipated it would be paying off its financing and so would become subject to regulation by the Commission, the Commission granted waiver of the requirements to file an open access transmission tariff under Order No. 888 and the requirements to adopt Standards of Conduct and develop an OASIS under Order No. 889. Wells Rural Electric Company, 90 FERC J61,013 (2000). To take another example, when United Power, Inc., a RUS financed cooperative that serves approximately 32,000 customers in Colorado, found itself in the same situation, the Commission granted waiver of the requirements to file an open access transmission tariff under Order No. 888 and the requirements to adopt Standards of Conduct and develop an OASIS under Order No. 889. United Power, Inc., 89 FERC J61,034 (1999). The Commission's waiver standards for small utilities or for utilities that own transmission that is not part of an integrated grid applies to cooperatives, municipal utilities and any other type of transmission-owning utility.

Hon. FRANK MURKOWSKI,

FEDERAL ENERGY REGULATORY COMMISSION,
Washington, DC, May 23, 2000.

Chairman, Committee on Energy and Natural Resources,
U.S. Senate Washington, DC.

DEAR MR. CHAIRMAN: Enclosed are my responses to questions for the record of your Committee's April 27, 2000 hearing on pending electric industry restructuring bills.

I hope that this information is helpful to you. If you have any additional questions, please do not hesitate to let me know.

Sincerely,

Enclosures.

CURT L. HÉBERT, Jr.,
Commissioner.

RESPONSE TO QUESTIONS FROM SENATOR CAMPBELLL

Question. Several of our witnesses have urged us to pass legislation that would put the FERC in charge of all transmission, including the transmission associated with a bundled retail sale, which, as I understand it, is now regulated by the States. Do you believe that there is a way of compromising this issue so that we meet the legitimate interests of the States while making all transmission subject to a single regulator and a single set of rules?

Answer. I think FERC has found a way to "compromise the issue." Order No. 2000 creates incentives for the establishment of stand-alone transmission businesses, including for-profit companies. These for-profit companies, transco's, would include within them facilities for efficiently running the transmission grid in the service of competition. Transactions would encompass wholesale power and those related to retail choice, namely unbundled transmission for retail. As FERC regulated utilities, these transco's would enable FERC to maintain its proper role in the competitive market. By the same token, bundled retail sales, the traditional utility business, would remain within the purview of the States, where these matters legitimately belong.

Question. Would a 3 or 5 year transition period be helpful in accomplishing this? What about ensuring transmission owners that, at a minimum, State allowed transmission rates would [be] provided during this transition period?

Answer. As I wrote in the preceding answer, stand-alone transco's under Order No. 2000 solve the matter. Under current regulation, these entities must begin operation on December 15, 2001.

Question. The Commission has taken the lead in trying to encourage the formation of Regional Transmission Organizations, or RTOS. I am concerned, however, that RTOs are only one element of a sound transmission policy. A more fundamental and important issue is whether we have the right regulatory incentives in place to encourage the siting and building of adequate transmission capacity. For example, one case, three years old now, is a fight over whether the utility will be entitled to earn a rate of return of 9% or 12%. How do we better ensure that adequate transmission is being sited and built?

Answer. I cannot speak to pending cases. Overall, I do agree that we need to create an incentive rate structure for stand-alone regional transmission organizations sufficiently to expand the grid, when necessary. At the least, RTOs need to have the wherewithal to take advantage of new technology that increases the efficiency of the current system, or try new business plans that compensate customers for changing their consumption. The incentives we outlined in Order No. 2000 and our willingness to consider others will ensure adequate capacity to meet demand.

Question. Today, transmission costs constitute only about 6% of an average consumer bill, yet transmission owners tell me that the transmission assets represent about 90% of their problems. It is difficult or impossible to site new transmission lines and transmission owners not yet in approved RTOs do not know who will regulate their transmission assets, what the rate of return will be or whether they will be allowed to operate these assets. In addition, although transmission constitutes only about 6% of a customer's bill, no one, it seems, is willing to pay the cost of transmission upgrades or expansion. What is the FERC doing to address these problems? What should Congress do to address them?

Answer. As the FERC has yet to approve an RTO, we have not addressed the issue of rate of return for these organizations. RTOs will be FERC-regulated as utilities transmitting electricity in interstate commerce. In the context of a for-profit transco, the transmission owners will operate their assets, as is the case in busi

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ness. Efficiency-and just as important-accountability requires the combination of ownership and operation. In the not-for-profit independent system operator arena, in which integrated utilities continue to own both generation and transmission, someone else operates the system. This creates bureaucracy and inefficiency, as we have seen in California and New England.

On the issue of paying for expansion, Order No. 2000 allows regional transmission organizations to adopt incremental pricing for new transmission. Under this model, the customer that wants the line pays for it and the attendant facilities, just as in unregulated industries, the customer-and no one else—pays for the equipment it purchases. Therefore, Congress need not do anything.

Question. S. 2098 does not provide the Commission with any additional authority to address "market power" concerns. Do you believe that you need additional authority?

Answer. No. The questions below on "Market Power" mention that the antitrust laws apply to the electric industry. The Justice Department and Federal Trade Commission enforce those laws. These agencies also review mergers in the electric industry, making FERC review superfluous. Beyond that, as the second question below on market power indicates, the Federal Power Act prohibits undue discrimination. These laws cover the gamut of market power problems. States can deal with market power problems at the retail level.

QUESTIONS REGARDING RELIABILITY

Question. The power grids of the eastern U.S. and the western U.S. are basically separate. How should electricity reliability be addressed?

Answer. I see reliability as part of efficiency. Customers want electricity at low rates, but they want the electricity to flow. I would make reliability part of performance-based rates. I do not want to have FERC or NERC decide standards that would fail to take local conditions into account, or, conversely, fail to achieve the goal of allowing transactions to occur efficiently. I prefer that the RTO, especially a for-profit, stand-alone transco, establish standards, by contract, or otherwise. Since a transco exists to advance commerce, it will know best. We did not legislate national standards in other businesses, such as the electric appliance industry, though reliability matters. Companies that earn more for greater reliability and suffer losses for less reliable service will know how to address legitimate differences between the eastern and western power grids.

Question. Commercial practices or commerce is the important subtext of reliability. What would recognizing the differences between the eastern and western grids mean?

Answer. In an environment in which a transco with performance-based rates operates, commercial practices and commerce-in a word, efficiency-will dictate what differences the industry should recognize between the eastern and western grids. Moreover, unlike a command and control approach, proper incentives can lead to mean to bridge these differences, if they stand in the way of a well-functioning market. We can incent invention, not order it. Companies will not commit the resources necessary for technological progress, unless they see the possibility of improving shareholder earnings as a result.

QUESTIONS REGARDING MARKET POWER

Question. The Chairman's bill does not give FERC additional authority to deal with market power accusations. Some people think that FERC needs that authority. But, doesn't the FTC and DOJ, along with state agencies, already have the power to address concerns about market power?

Answer. I agree that existing enforcement agencies can deal with problems of exercise of market power.

Question. Is there anything in the Federal Power Act that would prevent a state from dealing with market power allegations concerning the state's utilities?

Answer. States regulate retail sales. The states, therefore, have the authority, if their Legislatures have enacted the proper laws, to deal with market power allegations on the state level, where, in fact, the complaints about market power originate.

QUESTIONS REGARDING STATE'S RIGHTS

Question. Does FERC support the provision in the Chairman's bill which would defer to states that have already adopted plans for retail competition for electricity? Answer. FERC has not taken an official position. I think Congress should defer to the states on retail choice.

Question. We all know that each state will probably have variations of plans for competition that will work best for their respective situations. Would FERC support