A two-part tariff for financing transmission expansion

•We model a transmission addition in an RTO market.•We demonstrate a two-part tariff for allocating the new line's cost.•The fixed part of the tariff is a standard usage fee.•The variable part is based on the project's reduction in congestion cost.

Cost allocation for transmission expansion is a thorny problem, especially when a new line crosses state boundaries. Sometimes there are misalignments between costs and benefits associated with investments in transmission, because payments for transmission investment and its use are made at the state level, but the economic impacts from these investments extend beyond state boundaries. Thus, transmission expansions that maximize social welfare may not produce Pareto superior outcomes, resulting in justifiable local opposition from such projects. This paper's basic theme is that in absence of widespread penetration of merchant transmission in the United States, funding for transmission lines connecting interconnecting control areas should incorporate market-based principles to the maximum extent, while leaving no group worse off than before the expansion (with the exception of generators displaced by the line). The latter qualification is necessary to reduce opposition to a line seen as harmful to key interest groups. The paper advances a two-part approach to financing transmission expansion consisting of a variable component, which provides essentially the same remuneration as an FTR, adjusted for lumpiness of transmission. The second is a fixed component, as necessary, to compensate generation-pocket consumers, who would otherwise be left worse off by the imposition of the new line.