Skip to main content
Article

Regional Transmission Organizations as Market Platforms III

Knowledge Problem

January 31, 2025

As a follow-on to my previous two posts on regional transmission organizations (RTOs) in electricity, I was heading in a direction that relies on you, dear reader, having a foundational understanding of the investor-owned utilities (IOUs) that are the transmission owners (TOs) in RTOs. Many of you do, but lots don’t, especially tech folks who are somewhat new to electricity and are wondering why the heck it takes so long to get stuff built and why this industry is so freakin’ complicated. So today I’m diverting slightly to offer some background on monopoly regulation and the really complicated incentives that TOs face in operational and investment decision-making over their monopoly infrastructure in a context intended to foster competition in wholesale power markets. I rely heavily on Ari Peskoe’s 2023 Energy Law Journal article “Replacing the Utility Transmission Syndicate’s Control” (published version) (SSRN preprint), and if you want to read more deeply on this topic and consider the evidence to support these analyses, Ari’s paper is great. At one level you can read this whole post as a teaser to go read his paper.

To summarize the RTO story I’m telling, thus far: grounded in historical power pool arrangements among vertically-integrated investor-owned utilities, RTOs have complicated stakeholder-based corporate governance that makes them struggle with economic dynamism and technological change. Let’s drill down more specifically into the perverse incentives facing the incumbent IOUs who were the founding partners of RTOs and remain the most powerful decision-makers in them, in their role as transmission owners (TOs) and investors. Part of the problem of transmission investment is a problem of perverse incentives facing TOs, due in large part to legacy monopoly regulation. As Peskoe summarizes his analysis:

I argue that RTO governance is now holding the industry back for the benefit of last century’s power players. The industry is in the early phase of a technological revolution, but the commercial interests and individual entities that held formal power and informal influence in regional decision-making processes are largely the same today as they were twenty-five years ago. As a result, regional rules tend to cater to incumbents’ interests, to the detriment of competition, consumers, and innovation. I explain why RTO governance stagnated, detail how the power industry changes its the rules, and outline a path for reform. Despite the drawbacks of RTOs, I contend that independent control over transmission operations and planning is indispensable for moving the industry forward.

Cost-of-Service Based Rate-of-Return Regulation of Government-Granted Monopoly

Many, but not all, of these perverse incentives arise from cost-of-service based monopoly regulation. Transmission investments by IOUs are subject to cost-of-service regulation, which allows utilities to recover their capital and operating costs while earning a regulated return on their investments. This regulatory model includes the rate base, which are the capital assets that determine the IOUs revenue requirement; the allowed return on equity (ROE), a regulated profit margin that utilities are permitted to earn on their investments, set by regulators to ensure a reasonable return for shareholders; and depreciation and operating costs, which IOUs are allowed to recover through the rates they charge. Some states use formula rates that adjust automatically based on cost inputs, while others operate under fixed rates that require periodic regulatory review and approval.

For interstate transmission projects, IOUs/TOs are regulated by the Federal Energy Regulatory Commission (FERC). Under FERC-approved rate structures, utilities receive a regulated rate of return on capital investments in transmission infrastructure. This creates perverse incentives for transmission owners to favor large capital-intensive projects that expand their rate base, even if lower-cost alternatives could achieve similar outcomes. It also encourages them to resist transmission investments that enhance competition, particularly those that would increase access to cheaper power sources or independent generators. Finally, it creates incentives to delay or obstruct projects that do not directly benefit their service territories, even if those projects provide regional benefits by reducing congestion or integrating renewables. Transmission owners within RTOs thus have strong incentives to prioritize projects that maximize their revenue while discouraging projects that would enable greater market competition or lower wholesale electricity prices. RTOs struggle to coordinate large-scale transmission projects across multiple regions because incumbents are incentivized to protect their own service territories rather than optimize the grid at a regional level.

Transmission Planning, Expansion, and Federal-State Jurisdiction

RTOs often entrench incumbent utilities’ control over transmission expansion, leading to inefficient outcomes, delays, and higher costs. RTOs oversee regional transmission planning, but their processes are often slow, bureaucratic, and susceptible to the influence of incumbent utilities. Because RTOs operate under a stakeholder governance model, transmission owners—who also hold voting power within RTO committees—have significant influence over which projects move forward and how they are designed. This influence allows transmission owners to steer investment toward projects that protect their market positions rather than projects that maximize regional system efficiency or benefit consumers/transmission ratepayers.

Transmission planning and investment are highly contentious issues, made even more challenging by the division of authority between state public utility commissions (PUCs) and the Federal Energy Regulatory Commission (FERC). PUCs regulate retail electricity service and local transmission and distribution within state boundaries, overseeing distribution system rates, approving in-state transmission projects, managing cost recovery for state-mandated infrastructure, and directing integrated resource planning for vertically integrated utilities. Their jurisdiction is limited to in-state projects, complicating regional and interregional transmission expansion. In contrast, FERC has exclusive jurisdiction over interstate transmission and wholesale electricity markets, regulating high-voltage transmission that crosses state lines, overseeing RTOs and ISOs, approving transmission tariffs and cost allocation for multi-state projects, setting ROE for transmission-owning utilities, and enforcing open-access transmission rules under Orders 888, 889, and 1000. These split responsibilities create regulatory fragmentation, as states retain authority over transmission siting while FERC regulates pricing and market access, leading to inefficiencies, cost allocation disputes, and delays in expanding transmission infrastructure to support regional energy needs.

The division of regulatory authority between state commissions and FERC creates significant challenges for transmission expansion and investment, leading to inefficiencies and delays in modernizing the grid. Because investor-owned utilities (IOUs) earn profits based on capital investment, they have strong incentives to favor expensive new transmission projects over lower-cost alternatives such as efficiency upgrades or advanced grid technologies. At the same time, states frequently oppose large-scale regional transmission projects that do not directly benefit their ratepayers, often blocking infrastructure that primarily serves out-of-state customers, which in turn slows renewable energy deployment. FERC’s limited authority over transmission siting further exacerbates these challenges; unlike natural gas pipelines, where FERC has clear siting authority, transmission siting remains under state control, making it difficult to develop long-distance lines even when they provide regional benefits. 

Cost allocation also remains a major point of contention, as utilities in different states often disagree over who should bear the costs of new transmission infrastructure, resulting in prolonged legal and regulatory disputes. Overlapping federal-state jurisdictional barriers ultimately delay necessary transmission expansion, increase costs, and hinder efforts to integrate renewable energy resources efficiently. Transmission costs are allocated through RTO rules that often favor incumbent utilities, reinforcing their market dominance and discouraging competition. Many cost allocation methods also tie benefits strictly to a utility’s service area rather than considering broader regional efficiencies, which discourages investment in large-scale, long-distance transmission projects that could enhance grid reliability and integrate renewable energy more effectively. These structural biases in cost allocation perpetuate the status quo, limiting competition and slowing grid modernization efforts.

For example, transmission owners may prefer to upgrade existing assets rather than approve new transmission lines that could lower congestion costs or improve market access for independent generators. Incumbents often favor incremental upgrades to existing assets rather than approving large-scale new transmission projects, as upgrades expand their rate base while still foreclosing substantial competition for vertically-integrated (in SPP and MISO, where RTO members are monopoly utilities) or affiliate generation (“functionally unbundled” but still owned by the same company, in restructured states). By prioritizing lower-cost, incremental upgrades over large-scale new transmission projects, incumbent utilities can limit competition while maintaining control over infrastructure investment decisions.

Why Independent Transmission Is Hard to Build

Independent transmission developers face significant barriers when attempting to build projects outside incumbent utility control, largely due to regulatory, financial, and procedural hurdles that favor existing transmission owners. The complex permitting and regulatory approval process spans multiple state and federal jurisdictions, creating bureaucratic delays that incumbent utilities can more easily navigate due to their established relationships with regulators. Utilities frequently advocate for cost-recovery mechanisms that allow them to recoup investments through regulated transmission charges, even when more cost-effective alternatives exist. Independent developers, by contrast, face significant financial hurdles since they must negotiate voluntary payment agreements rather than relying on guaranteed cost recovery, making their projects riskier and less likely to be pursued. 

A related perverse incentive arises from the fact that many states maintain Right of First Refusal (ROFR) laws, which grant incumbent transmission owners the first opportunity to develop new transmission projects within their service territories before competitive developers are allowed to bid. Despite FERC’s Order 1000 (2011) attempting to introduce competitive bidding into regional transmission planning, many states have enacted state-level ROFR laws to shield incumbents from competition. While proponents argue that ROFR laws provide continuity and reliability in grid planning, critics contend that they create artificial barriers to entry by preventing independent developers from competing to build transmission projects at lower costs. A ROFR essentially requires a market entrant to get the incumbent’s permission before entering; who would expect them to say yes? 

This fragmented system enables incumbent transmission owners, protected by ROFR laws, to block independent developers from building cost-effective projects, effectively undermining FERC’s attempts to introduce competition in transmission through Order 1000. 

Institutions and Governance, Again

The governance structures of RTOs and the regulatory framework surrounding transmission investment create substantial barriers to transmission competition and efficient grid expansion. Incumbent transmission owners have strong financial incentives to maintain control over transmission infrastructure, prioritize projects that benefit their business models, and limit access to independent developers. As a result, necessary transmission expansion, particularly for integrating renewable energy and reducing congestion costs, remains slow and inefficient. Addressing these barriers will require policy and regulatory reforms that promote competition in transmission development, streamline permitting and cost allocation, and reduce the undue influence of incumbent utilities over regional planning processes.

This article was originally published on Lynne’s Substack, Knowledge Problem. If you enjoyed this piece, please consider subscribing here.

About the Author

Lynne Kiesling