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SCIENTECH IssueAlert, November 9, 2000
Outlook for Midwest ISO Brought into Question
By: Will McNamara, Director, Electric Industry Analysis
===============================================================

Standard & Poor's (S&P) revised the outlook to negative from stable on
the Midwest Independent Transmission System (Midwest ISO). S&P also confirmed
its triple 'B'-plus issues credit on the Midwest ISO, the non-profit 
independent
corporation that will manage the operations of a portion of the transmission
assets of utilities across a 12-state region.

ANALYSIS: This is the latest in a string of developments that has put into
question the future of the Midwest ISO, as the organization continues to
sort through the recent announcements of two key members that have decided
to depart. The Midwest ISO was organized to ensure that energy suppliers
are protected against price instability and discriminatory access to the
transmission grid, among other potential problems associated with grid
management.

For those unaware of the terminology, let me offer a brief explanation.
Under the Federal Energy Regulatory Commission (FERC's) Order 2000, utilities
that own, control or operate transmission assets were essentially mandated
to join a regional transmission organization (RTO), an umbrella term that
can include a not-for-profit ISO (independent system operator), for-profit
transmission company (transco) or a hybrid of both models.

Although roundly considered the favorite ISO model by FERC, the foundation
of the Midwest ISO began to shake a bit when two founding members announced
they were departing to join a competing RTO. Commonwealth Edison (ComEd)
announced just last week that it would be leaving the organization and
joining the rival Alliance RTO, a move it expects to complete by Dec. 15,
2001. ComEd's announcement followed a similar decision last September by
Illinois Power, also a founding member, to depart and join the Alliance
RTO. The Midwest ISO is a not-for-profit model, while the Alliance is a
transco model.

Although both utilities cited unique reasons for their departure, their
move to the Alliance RTO does support a clear preference for the transco
model of transmission management, over the ISO model. ComEd contends that
since the completion of its merger with PECO Energy*forming the new company
Exelon*it has a significant amount of transmission assets in the 
Pennsylvania-New
Jersey-Maryland (PJM) region, and the Alliance RTO offers a "better fit"
for the combined PECO / Unicom transmission assets. Specifically, ComEd
argued that the bulk of its customers and suppliers are in the eastern
half of the United States, where the Alliance RTO is more prominent. The
Midwest ISO, on the other hand, has established its presence to the north
and west of ComEd's service territory. From a legal standpoint, ComEd claims
that it can break its ties with the Midwest ISO because, under a charter
agreement, it is allowed to depart since its transmission facilities changed
ownership through the merger. Thinking it might be able to avoid litigation,
ComEd has promised to meet any financial obligations to the Midwest ISO
before it officially departs for the Alliance RTO.

Illinois Power, one of the original nine participants in the Midwest ISO
dating back to January 1998, was the first utility to make its exit from
the Midwest ISO. Illinois Power, like ComEd, claimed that its acquisition
by Dynegy constituted a change in ownership, freeing itself from the ISO
agreement, and that a move to the Alliance RTO would be more appropriate.


However, as I've inferred, I believe both utilities have made their attempted
moves because of a desire to operate under a for-profit transco model.
The impetus for both of their departures probably had less to do with their
respective mergers and more to do with the fact that previous talks to
form a transco, operating separately under the Midwest ISO, fizzled last
summer. Perhaps concluding that the ISO model would be restrictive, Illinois
Power has stated that its reasons for the change-in-heart came about because
of greater flexibility and cost savings that would be realized by being
a member of the Alliance RTO. These benefits would originate from the RTO's
experience in deregulated markets (many members of the Alliance RTO operate
in deregulated states as opposed to the members of the Midwest ISO). The
Alliance RTO also eliminates pancaked rates and provides price certainty
through its "postage stamp" rate for transactions providing power outside
of, or through, the Alliance and its "license plate" rate for all transactions
that deliver power within the Alliance.

Although ComEd and Illinois Power have announced their departures, it's
important to note that the Midwest ISO is not going to let them leave without
a fight. Realizing that losing the transmission assets of both utilities
severely diminishes the bulk of its organization, the Midwest ISO has 
submitted
a motion with FERC to block the utilities' exit. ComEd, for instance, 
contributes
about 26 percent of the load that was originally scheduled to flow through
the Midwest ISO. Thus, the Midwest ISO is arguing that creating a broad
RTO, based on widely dispersed transmission assets, is in the best interest
of all of its members. In addition, the Midwest ISO contends that allowing
utilities to easily switch from one RTO to another would compromise 
reliability
across interconnected transmission grids.

Ironically, the departure of ComEd and Illinois Power, along with the FERC
investigation of the case, comes at a time when the Midwest ISO appeared
to be growing. Just last month, Kansas City-based UtiliCorp and Fergus
Falls, Minn.-based Otter Tail Power Co. announced that they were joining
the Midwest ISO. The addition of UtiliCorp was a major coup for the Midwest
ISO, as the energy company owns about 6,200 miles of electric transmission
lines. Wisconsin Public Service Resources and American Transmission recently
joined as transmission-owning members and Calpine Corp. joined as a 
non-transmission
member. In addition, the Midwest ISO just announced that it is assuming
management responsibility for the operating functions of the Mid-American
Interconnected Network (MAIN), which provides electricity to about 19 million
people within key Midwest states overseen by the Midwest ISO. The partnership
of the two organizations should help to facilitate a smooth transition
for the Midwest ISO to become operational on its target date next December.

In any event, it is clear that the S&P downgrading of the Midwest ISO is
a direct reaction to the likely departure of ComEd and Illinois Power,
something that FERC may not be able to prevent. Specifically, S&P is 
acknowledging
that the departure of ComEd and Illinois Power will result in a "material
loss of some load subject to the Midwest ISO cost adder." What this means
is that the Midwest ISO's debt repayment obligations are based on a cost
adder that is applied to certain transmission loads. The cost adder is
capped at 15 cents/MWh during the transition period from the start of 
operations
(fourth quarter 2001) until the fourth-quarter of 2007. As noted, ComEd
contributes about 26 percent of the load that is scheduled to flow through
the Midwest ISO. If ComEd and Illinois Power actually do leave the Midwest
ISO, this could result in a higher cost adder being placed on remaining
members. While the Midwest ISO's costs are fully recoverable under its
tariff with remaining members, raising its cost adder could have a negative
impact on the low-cost economic incentives that the Midwest ISO has used
to attract new members.

Moreover, the future prospects for the Midwest ISO remain questionable.
If ComEd and Illinois Power are allowed to leave, it could spark a mass
exodus of other members, which obviously would shrink the organization
and cast in doubt its status among other RTOs. Moving forward during this
period of upheaval, the central challenge for the Midwest ISO is to identify
the benefits of joining its not-for-profit model when so many utilities
clearly prefer the for-profit transco model.

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Sincerely,

Will McNamara
Director, Electric Industry Analysis
wmcnamara@scientech.com
===============================================================
Feedback regarding SCIENTECH's IssueAlert should be sent to 
wmcnamara@scientech.com
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