Better Incentives for Efficient Transmission: The Potential Contribution of Price Cap Regulation

A low-cost method for increasing transmission capacity is to use grid-enhancing technologies (GETs). Setting transmission rates on the basis of cost may lead transmission providers to choose to install lines at greater cost than GETs. Price cap regulation (PCR) adjusts rates over time on the basis of inflation and expected (but not actual) cost reductions, thus giving the regulated firm an incentive to reduce costs, such as by adopting GETs. Allowed rates are likely to eventually diverge from costs enough to warrant regulatory recalibration, reducing the advantages of PCR. PCR is also not designed to incentivize quality, such as resilience. PCR can handle the multiplicity of rates over different nodes and times, but it will likely take more time for such rates to converge to efficient levels than it would take for regulators to adjust the rates accordingly. Because new transmission lines will likely be required, regulators will have to set an initial price for PCR, reintroducing rates based on cost. Nevertheless, regulators should consider PCR, given the importance of maximizing the efficiency of the transmission system and the use of GETs to achieve that efficiency.