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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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How Energy Bids Should Be Done

Industry Bidding

Wine critics ply their wares at blind tasting events. No more watching the glass poured from the bottle with the famous label, which they associate with a high price and a trip to the south of France to visit the chateau. As a result, the critic sometimes discovers the wine they like is not from the big name bottle but from a more obscure label. This sort of discovery makes for a sobering experience. In the electric business the competition-minded federal authorities want regional transmission organizations to award transmission construction contracts by a competitive process. Hopefully a lot of entities submit bids and the RTO picks the best one.

But what is a “best bid"? In most situations, the best bid is the lowest price for specified services rendered. But from looking at the SPP transmission organization’s criteria, the lowest price is only one factor they consider. The SPP bidding process takes into account engineering plans, project construction plans, operating plans and analysis of rates and financial considerations. SPP appears to set contract terms so that the local utility wins the contract for the transmission line in question--i.e., must have business experience in Kansas. The financial criteria probably favor existing utilities as opposed to competitors with a different financial profile. Although the submissions did not have the names of the competitors, would it have been difficult for a local expert to take an educated guess? Related: Can EVs Save Electric Utilities?

If some large outside firm desirous of doing business in Kansas made the equivalent of a low bid and guaranteed to provide the service at the low price, would it be turned down for lack of local experience (didn’t know about the lesser prairie chickens roosting in the vicinity)? The world is awash with cash and many financial institutions are eager to invest for predictable and safe return. Is SPP, by setting engineering-oriented and institutionally parochial terms, keeping out transmission-providers who might offer the same service for less? Local utilities might do better by pairing up with one of those investors and managing the project for them. Consumers might come out ahead.

Utilities use a similar process to make judgments about investments. Should this process make a lot of difference? Maybe it keeps the local utilities on their toes since they no longer can get this business without competing for it. Certainly it will screen out less credible bidders that haven’t thought through the project and those whose numbers are out of line. The SPP document showed a number of bids that were close, but one or two bids were 50-100 percent over the winner in terms of overall cost (as measured by net present value.)

The SPP transmission bidding process is competitive only in the sense that several firms bid to offer essentially the same service. SPP doesn't look for better ways to solve the problem. This is a variant of the usual engineering problem: having decided what to do, find someone to do it. A different solution, no matter how feasible, won’t fulfill the specific terms of the contract-bidding process. Related: The Biggest Winner Of The Oil Bust: Interview With Aeromexico

This process of separating out each aspect of the electrical grid system into biddable parts could lead to other outcomes presaged by developments in the UK. For instance, the UK has divided ownership of railways between the track owner and the train companies which bid to service routes. Every so often the government rebids and awards the routes to the highest bidder. The government also rebids the television channels every so many years. The effort to provide high quality service, woo the public and make consumers happy, that effort loses all value at the end of the contract term unless your firm again wins the bid. Could a pro-markets policy maker (the FERC?) require this treatment for electric franchises or transmission assets?

Then again, there might be another competitive solution: sell infrastructure assets to a fund who will accept a low return (and they will). Then let the infrastructure investor receive bids for management and operations every few years. The investor has every incentive to find competent and low cost service providers. This is not to suggest that such a procedure would produce better results for consumers than either the blind bidding or the traditional utility planning structure. But it is a logical destination on the path that policy makers have the industry on.

By Leonard Hyman and Bill Tilles for Oilprice.com

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