June 18, 1999
The United States Government appreciates the opportunity to provide comments on the draft report on electricity transmission by the Electric Utility Industry Council (EUIC) Joint Subcommittee on Basic Policy Directions and Electricity Charges, issued May 19, 1999. We commend the Joint Subcommittee for the open and transparent manner in which it has conducted its work on this important and complex issue.
The United States supports the Government of Japan's goal of reducing electricity prices, which are the highest of any OECD country, to internationally-comparable levels by the year 2001. The OECD also has made recommendations to the Japanese Government on the economic benefit Japan would derive from reducing high energy costs through deregulation. We note the Japanese Government has reiterated the importance of this objective in its June 11 economic revitalization package, which includes measures to lower the costs of Japan's high-cost infrastructure, including the energy sector.
However, the United States believes that the current draft recommendations of the EUIC with respect to electricity transmission fail to adequately address a number of issues critical to the creation of a competitive electricity market and the lowering of energy costs. Specifically, the draft recommendations would allow the existing utilities to retain an excessively high degree of autonomy and authority, and do not provide for the establishment of the clear, effective, and independent oversight needed to ensure that the transmission system is operated in a fair and open manner. This is of particular concern because the electricity sector continues to be among the sectors exempt from the Antimonopoly Law. In addition, details on key issues critical to the achievement of the Government of Japan's stated goals in this sector, such as how transmission tariffs are to be determined, remain vague or incomplete, making it difficult for new entrants to anticipate market risks and opportunities and to make rational business decisions.
Open, fair, and non-discriminatory access to transmission is critical to creating a competitive electricity market. The experience of countries that have moved successfully from monopoly to a competitive market in the electric utility sector demonstrates that appropriate procedures must be put in place to eliminate opportunities for anticompetitive use of market power either in generation or transmission by the existing utilities. Unbundling previously vertically integrated power utilities' operations into separate generation, transmission, and distribution operations is generally viewed as necessary to encourage competition and to achieve significant efficiency gains. Worldwide experience also shows that it is essential that appropriate incentives for pro-competitive behavior be developed and sufficient oversight by the government or an independent authority be established to ensure open and fair access to the transmission system. Finally, full transparency in operating rules and procedures by both the government and electricity suppliers and open access to information are crucial. These principles were included in the APEC Manual of Best Practice Principles for Independent Power Producers, endorsed by APEC Energy Ministers, including Japan's, in August 1997.
Japan stands at a critical juncture in its efforts to reform the energy sector. It should be able to benefit from the experiences and avoid the mistakes of other countries that are farther along in the deregulation process. The United States and Japan have discussed some of the key issues related to energy sector deregulation in the Energy Working Group under the Enhanced Initiative for Deregulation and Competition Policy, and we look forward to continuing these discussions in the coming year.
Below, the United States provides specific comments on the text of the draft EUIC proposals, and suggested revisions where applicable, in the interest of helping ensure that the manner in which the Government of Japan deregulates the electric utility sector leads to a more open and competitive market and a lowering of energy costs, benefitting the Japanese economy and increasing market access.
Part 1
Preface Basic Viewpoint. The United States Government agrees with the EUIC principles that transmission costs should be clearly specified and shared impartially between users. However, we urge the Japanese Government to take a more active role in ensuring these goals are achieved, assuring that transmission charges accurately reflect the costs of service and that revenues from transmission are not used to subsidize other services provided by the utilities. The U.S. Government believes that it will be extremely difficult to ensure that transmission costs are set impartially as long as the Japanese Government relies only on accounting separation of transmission from other services and allows the utilities to develop the accounting procedures that will be used. For these reasons, the United States Government believes that the EUIC should incorporate into its final report a recommendation that the Japanese Government require a clear separation of the utilities' business functions or, at a minimum, mandate the establishment of an independent, neutral organization to monitor wheeling rates and the manner in which they are developed.
The United States Government is concerned with the EUIC's draft recommendations' apparent preferential consideration of the interests of utilities throughout the draft report. With regard to the four basic viewpoints that will be followed in designing transmission rate policy, the draft report includes discussion of cost recovery, investment incentives, and assuring efficiency and technological innovation for the existing utilities. While the draft recognizes the need to share burdens among all market participants, it should be revised to expressly recognize the importance of profits, incentives, and other benefits of all parties, not just the existing utilities.
Issue 1: Basic Concepts for Assessing Transmission Costs. The draft report recommends use of a cost accumulation methodology to establish transmission charges, but fails to provide details on this methodology and how it is to be determined. The United States believes that it is critical that the methodology for determining costs be developed by the Government of Japan or an independent regulatory authority and not by the existing utilities. Allowing utilities to establish methodologies for developing transmission costs will create opportunities for them to unfairly manipulate the system to their competitive advantage and reduce transparency. In general, transmission charges should be based on the fully depreciated costs of those facilities identified as used in providing transmission services, including a fair return on investment. Rates should not be set to guarantee a profit and must be applied fairly to all transmission users.
Issue 2: Assuring Efficiency and Technological Innovation Incentives for Electric Companies. The draft report would guarantee a "fair profit rate" for utilities. The United States believes that all participants, not just utilities, should be guaranteed an "opportunity" to earn a fair profit. However, guaranteeing profits to the utilities is at odds with the competitive market that Japan is seeking to establish.
Moreover, the draft report's recommendation that the handling of excess profits be determined by the utilities gives them too much discretion and provides them with incentives to over-charge for transmission services. Merely requiring electric companies to explain to the public how they plan to allocate and utilize excess profits and verifying earnings and expenses through accounting audits are insufficient to ensure consistent, fair, and equal treatment of new market entrants.
The United States believes that the Government of Japan or an independent regulator -- with input from transmission users -- should establish transparent procedures for reviewing utilities' plans for allocating costs, including profits, before transmission rates are established, in order to ensure a fair balance of interests between utilities and users. Unless such a system is established, development of an open and competitive generation market will be unnecessarily delayed. The United States urges the EUIC to incorporate this recommendation into its final report.
The United States disagrees with the draft report's recommendations that transmission rates should provide incentives for utilities to increase the efficiency of the transmission network, that these rates should be fixed for a length of time to be determined by the utilities, and that the yardstick method used to promote competition among Japanese utilities should be sufficient to keep rates low. While wheeling rates can be used to support necessary strengthening of the transmission network, these investment decisions should be subject to review by the Japanese Government or an independent regulatory agency. Moreover, the Government of Japan should address the issue of additions to transmission capacity directly and separately from the need to develop efficient pricing and open access to transmission facilities. We also believe that competition under yardstick method is insufficient to ensure that utilities are operating in good faith to promote open and fair access to transmission facilities.
Issue 3: Calculation of Standards for Identification of Transmission Costs. As stated above, the United States believes that relying on accounting separation alone to ensure fair and open access to transmission is insufficient. However, even if accounting separation is to be used to ensure competition, additional information is needed to evaluate the draft report's recommendations on establishing transmission costs. It is unclear from the report how costs would be allocated under the ABC accounting system. In order to ensure transparency and non-discrimination in the establishment of transmission costs, the Government of Japan should establish regulations that set out explicitly how transmission costs are to be calculated and should not leave decisions regarding this important issue to the discretion of the utilities. The approach used by the U.S. Federal Energy Regulatory Commission (FERC) in its Rulemaking on open access could serve as a useful point of reference in this regard.
We welcome the draft report's recommendations on the need for neutrality in developing the related ministerial ordinances concerning transmission. The United States strongly urges the Japanese Government to solicit input on these ordinances from all interested parties, including transmission system users, as well as academic and other experts, to seriously consider any public comments it receives, and to modify its final regulations to address concerns identified through the public comment process.
Further information also is needed to assess the draft report's recommendations for securing additional impartiality through inspections by certified public accountants or other neutral third parties. The recommendations should include details on when or with what frequency such audits would occur, what actions the auditors would be authorized to take should they uncover problems, and how disagreements between the auditors and the utilities would be reconciled.
Issues 4 and 5: Assuring Impartiality Among Users in Sharing Burdens. With regard to the EUIC's recommendation that a "postage stamp" method be adopted, the United States acknowledges there can be advantages to initially using such a system to help develop a competitive electricity market. Although the postage stamp method does not reflect the variation of costs over long distances or assess congestion fees, these rates are easy to develop, comprehensible, and stable. Another benefit of the postage stamp rate structure is that it eliminates "rate pancaking" or charging separate and additive transmission charges for each network over which a transmission transaction travels. In doing so, this system promotes trade in electricity over a wide area, thereby contributing to effective competition in generation markets (although if the area is too large and does not recognize the differences in costs in serving customers in different parts of the rate area, it may unduly discourage efficient transactions).
However, the potential benefits of the postage stamp method would be undermined by the draft report's recommendation that transmission service extending over several zones should be adjusted to take into account grid structure, operation and electric current conditions, usage rate and system management costs. The report provides no details about how and on what basis these adjustments are to be made and what type of monitoring mechanism will be established to ensure that adjustments are fairly implemented. In using zonal pricing, it is important to design zones correctly and to allocate costs correctly among zones. If zones are incorrectly drawn, efficient transactions will be discouraged.
The draft report also fails to address the issue of whether all users will be charged the same transmission rates. Currently, the transmission charge among utilities and the rate charged to the utilities' large-scale industrial users is much lower than that charged new market entrants. To promote competitive generation markets and open access to transmission facilities, the final EUIC report should mandate that transmission and ancillary services be available to all transmission users at tariffs that reflect costs (and non-cost factors) and are set in a non-discriminatory manner, and should indicate how this objective will be achieved.
Part 2
Issue 1: Concluding and Ending Contracts. The draft report states that electric companies made clear that they would "in principle" accept transmission requests. However, the report provides no details on under what circumstances it would be acceptable for electric companies to deny transmission requests and what criteria would be used to make such a decision. The United States urges the Government of Japan to adopt a requirement that new market entrants be guaranteed access to the transmission network on a non-discriminatory basis, except for exceptional reasons clearly defined by the utilities and subject to the approval of the Government of Japan. As in the United States and other countries that are restructuring their electricity sectors, in Japan the burden of proof for denying a request for transmission service should be on the transmission-owning utility, and should be limited to conditions such as congestion or other technical problems that the Government of Japan or an independent third party can verify. These conditions are necessary to ensure that the utilities do not unfairly block new entrants' access to transmission.
While contractual issues generally must be worked out between the utilities and new entrants, the Japanese Government should limit the discretion of utilities with regard to concluding and terminating contracts. The Japanese Government must impose the obligation on utilities to provide open, fair, and non-discriminatory service at rates that reflect the cost of service. In addition, the Government of Japan should establish an independent mechanism to adjudicate disputes between utilities and new entrants over issues related to access to distribution.
Issue 2: Simultaneous Balance of Power, and Supply Order. The draft report would provide the utilities the responsibility for managing the transmission system to achieve various public interest goals. These goals include maintaining system stabilization, energy security, and environmental objectives, and the obligation of third-party users to obey the instructions of the utilities in order to ensure maintenance of system reliability. Although the draft EUIC report provides that utilities should be instructed to achieve these public interest goals in a non-discriminatory manner, incentives and opportunities exist for them to manage and operate the transmission system for the benefit of their own generation facilities. For instance, purportedly to help ensure system reliability, new generators are required to provide detailed information on their business plans and transmission needs to the same utilities that may be their competitors. Utilities are not required to provide any such detailed information to other transmission users. To address these conflicts of interest in the U.S. market, FERC has strongly encouraged the formation of Independent System Operators (ISO), and is considering additional policies that would mandate the establishment of ISOs. The United States urges Japan to put in place similar policies and mechanisms that would ensure that these conflicts of interest are adequately and fairly addressed.
Issue 3: Assuring Neutrality. The draft report notes that it is critical for the design of just and fair transmission rules that information obtained by the utilities not be inappropriately shared internally, but the United States believes that the measures included in the draft report are insufficient to ensure achievement of this key objective. The limited measures included in the draft report to assure that information is not shared internally are too general, and no mechanisms for monitoring the utilities or enforcing these measures are included. Moreover, the recommendations regarding contract dispute settlements are too vague and provide the utilities with too much authority for fairness to be ensured. While interested parties should, to the extent possible, settle their own disputes, the Japanese Government should establish a system to ensure that new entrants have adequate mechanisms of recourse, including the right to appeal to the government or an impartial third party.
The EUIC report remarks that U.S. Orders 888 and 889 do not mandate separation of organization of U.S. electric companies, but simply call for a separation of function. However, the United States Government notes that these regulations require U.S. utilities to undertake a much clearer separation of generation, transmission, and distribution functions than the limited accounting separation envisioned in the draft EUIC report. Utilities in the United States are required to provide these services as though they were provided by separate entities and are strongly encouraged to divest their generating facilities. While the federal regulator does not presently have the authority to mandate divestiture, many states have required the utilities to do so. The United States Government believes that Japan should, at a minimum, require functional separation (or corporate unbundling) of the generation, transmission, and distribution functions of the utilities through a process that establishes independently operated and managed units (or "profit centers") within the utility.
Part 3
Issue 1: Final Security Contract System; and Issue 2: Definition of Location of Power Demand. The draft report recommends that the agreement on final prices, terms, and conditions for service be negotiated between the parties. It is essential that this negotiation be conducted on the basis of mutual interest, and be subject to transparent procedures and oversight by the Government of Japan or an independent regulatory authority. The utilities must not be allowed to unreasonably restrict trade through the unfair exercise of market power or other practices. As noted above, ensuring this outcome will require: active monitoring of utility practices and procedures; effective unbundling of utility generation, transmission, and distribution functions; and transmission charges based on costs of service and fairly applied to all market participants.
Conclusion
A fundamental premise of the use of public comment procedures is that governments, even when they have the assistance of advisory councils and other experts, do not necessarily have all, or the best, answers. Under public comment procedures, governments have an obligation to modify draft regulations to address in an effective manner the comments provided by interested parties. From its long use of public comment procedures, the United States has learned the importance and the value of responding in a positive manner to public comments.
The United States recognizes and appreciates the extensive work that has been undertaken to develop this draft report. However, if the Public Comment Procedure, which was recently adopted by the Japanese Government, is to be effective, it is essential that the Joint Subcommittee of the EUIC and MITI demonstrate a serious consideration of the comments received, and modify the final report, as well as any regulations or procedures that are subsequently adopted, to address deficiencies identified by the comments. In conclusion, the United States strongly urges Japan to consider the issues we have raised, and to make the changes we have recommended, before the draft report is finalized.