The need to build more transmission is critical to modernizing the electricity grid. California’s grid operator, CAISO, estimates that the state will need an additional $45.8 billion to $63.2 billion of transmission investment to achieve its goals of a carbon-free grid by 2045. This naturally begs the question, who is paying for this? And secondly, who is profiting from this?
SPOILER ALERT: We (the ratepayers) pay, and utilities and their investors profit. The good news is that there are solutions to save us money: public financing for transmission is already working in several other states and may be coming to California soon via bills SB 330, AB 825, and SB 254. Okay, now still read the rest of my blog for a much deeper dive.
Who pays for new transmission?
To answer the ‘who pays’ question, I’m going to get into the weeds of some technical state agency processes, so bear with me. At a very high level, transmission infrastructure is financed in two ways—through investor-owned utilities (IOUs) and private developers. To understand the whole story though, let’s take a step back.
During its annual planning process, CAISO determines what new transmission infrastructure will be needed to support grid reliability, electricity affordability, and the state’s clean energy goals. This is a comprehensive process that includes additional planning inputs from the California Public Utilities Commission (CPUC) and the California Energy Commission (CEC). The development rights of most of these planned projects will default to the IOU that controls the service area. For larger projects or those that cross multiple service areas, CAISO will open a process for competitive solicitation that allows private developers to bid for these projects.
Whether it’s through an IOU or a private developer, these projects need a large amount of upfront money. Private investors provide the capital needed to move the projects forward. To give you a sense of who investors are, PG&E’s largest investors include the investment management firms Vanguard Group, BlackRock, and State Street Corporation.
Now that the money is there, I’m going to mostly skip over the next steps of project development, but they include processes such as siting, permitting, material procurement, and construction. Eventually, we have a new transmission line that can bring electricity from generation sources (like a solar or wind farm) to demand centers (like a city or server farm).
The transmission owner (IOU or private developer) can cede operational control of their lines to CAISO, which also operates the grid and makes sure electricity is delivered to customers. CAISO calculates a per-kWh fee for using the transmission system based on the revenue needed by these transmission owners to recoup the costs of building and maintaining the infrastructure. This fee becomes part of the electricity rates paid by customers.
So, to summarize:
- CAISO determines which new transmission projects are needed during its annual planning process.
- Depending on the size of the project, the utility is the developer or the project is open to competitive solicitation.
- The owner (either the IOU or private developer) uses capital for these projects provided by private investors.
- Transmission projects are built.
- IOUs and developers can cede operational control of their transmission facilities to CAISO.
- CAISO calculates a per-kWh fee for using the transmission system that allows transmission owners to recover their costs.
- These fees are incorporated into electricity customers’ utility bills.
Therefore, IOUs and private developers finance these transmission projects, but ultimately ratepayers in California like me (and probably you!) pay for these transmission projects.
To be clear: I don’t mean to suggest customers shouldn’t have to pay for grid upgrades. The grid is a truly amazing piece of infrastructure that facilitates an extremely important part of modern society—electricity! I am personally willing to pay, as a ratepayer or taxpayer, for infrastructure that provides clean and reliable power.
The *livelier* part of the debate is the next question.
Who profits from ratepayers paying for new transmission?
To answer this question, we’re going to have to get a bit into the technical realm of finance. Again, please bear with me.
Financing occurs through two methods: debt financing and equity financing.
- Debt financing is when the utility sells debt instruments (e.g. bonds, bills). In more common speak, a utility borrows a large sum of money from a lender and pays back the money over a long period of time with additional interest.
- Equity financing is when the utility raises money by selling a share of the company. The notable difference in equity financing is the money does not need to be repaid. The lender has instead received a share of the company, earning a return on their investment when the utility earns money and having a portion of control in decision-making.
You’ll notice that both financing sources have profit built into them. Debt financing includes interest paid over time, and equity financing includes a share of the overall profits made by the company.
As I’ve mentioned, it’s ultimately ratepayers that are paying for transmission. This includes paying back investors for loaning the money along with any interest or any shares of future earnings, as well as other expenses such as operations, maintenance, and taxes. Transmission owners determine the total revenue they need to collect from electricity customers to cover these costs. Since transmission is considered an interstate asset, this ultimately needs to be approved by the Federal Energy Regulatory Commission (FERC). Most of these expenses are straightforward to calculate – capital costs, operations, maintenance expenses, and taxes.
But now we get to the tricky part: How much profit should investors make?
Interest from debt financing is also mostly straightforward. Historical data can be used to benchmark how much interest lenders should be receiving for providing upfront money.
Returns from equity financing is much less straightforward. As described by the CPUC, the authorized return on equity is “a level that is adequate to enable the utility to attract investors to finance the replacement and expansion of its facilities so it can fulfill its public utility service obligation.” Essentially, regulatory agencies are trying to determine how much profit will attract investors to invest in utilities instead of something else.
In the current context of very high utility bills in California, how much profit utilities are authorized to collect from ratepayers is a concerning issue. This blog post is focused on transmission, but transmission costs are just one part of what utilities can collect from customers. A similar process for determining cost recovery and profit also exists for the utility’s other expenses, such as distribution infrastructure, although these need to be approved by the CPUC rather than FERC.
I won’t get into a full discussion on utilities’ rates of return, but I’ll drop in one academic paper, which uses various statistical methods (which I definitely won’t get into) to show that utilities are receiving much higher rates of return than various benchmarks and historical data suggests they should. And remember, these profits are paid for by customers.
So, to summarize:
- Private investors invest in utilities through either debt or equity financing, providing utilities with upfront capital.
- Utilities determine the total revenue they need to collect from customers to cover costs, including expenses related to investor profits.
- Utilities request to recover these costs and additional profit through electricity customer rates, which need approval by a regulatory agency.
- If accepted, the utilities pass along these rate increases to customers in their utility bills.
- Utility investors profit.
So, turns out I could have cut this 1500-word blog post into six: Electricity customers pay and investors profit.
With electricity rates skyrocketing in California, where does that leave us? Is there a way for California ratepayers to not pay exorbitant electricity bills and for our transmission lines to get built to facilitate a clean and modernized grid?
I’ve been told by my Communications team that I don’t have another 1500 words to get into all the potential solutions, but I’ll leave you with one.
A recent report estimates that public-private financing could save California’s ratepayers up to $3 billion per year. This is basically due to the fact that public debt is cheaper than private debt. Luckily, there are three bills (SB 330, AB 825, and SB 254) currently under consideration in California that would use public funds to finance new transmission, saving billions along the way.
This is a low-hanging piece of the solution to high electricity bills burdening Californians, and particularly low-income Californians. In a tumultuous landscape of climate-fueled extreme weather events, utility-caused wildfires, rising electricity demand, extreme wealth inequality, and a federal administration hostile to clean energy, it is critical that California’s legislature builds more pathways to accelerate an equitable clean energy transition.