With Joe Hack, RMI Transmission Fellow
June 2025
Studies suggest that well-planned, efficiently built transmission connecting balancing authorities is generally net beneficial in terms of cost savings, reliability and other public benefits. However, existing models for planning and financing new transmission in the US, whether through regulated cost recovery processes or merchant models, can pose barriers to these projects.
A hybrid merchant-regulated financing model known as cap and floor can derisk interconnector projects while incentivizing efficient asset use. Implemented in 2014 between Great Britain and its neighbors, cap and floor has since produced several operational interconnectors between European countries.
Cap and floor financing could mitigate problems associated with cost allocation and information asymmetry in the US by aligning risks and rewards to incentivize efficient infrastructure build and operation.
Transmission projects crossing jurisdictional boundaries face challenges with planning and rate-regulated processes where more than one planning authority is involved. These authorities may not agree on how to share costs that are borne by their electricity customers. Further, many lines are not fully utilized because transmission is planned to meet peak demand and build in redundancy in case an element of the grid fails.
Merchant project developers have incentives to optimize asset use to maximize revenues. However, these merchant models face financing challenges because some benefits of interregional transmission accrue to the public more generally and are hard for developers to monetize. The risks of the projects are borne by developers and/or their private sector sponsors unless public funding is involved.
Cap and floor is a hybrid financing mechanism that combines aspects of merchant and regulated cost recovery to help interregional projects achieve bankability while incentivizing transmission owners/operators to efficiently use their assets. This mechanism for transmission interconnectors between Great Britain (GB) and its neighbors has been in place since 2014. Under cap and floor, regulators grant developers the right to build an interregional line with a guaranteed minimum revenue (floor). This floor is underwritten by consumers through their regulated electricity rates and is not paid unless certain conditions are met.
The transmission owner/operators are expected to earn revenues, e.g., by selling line capacity for energy trading and by participating in capacity and ancillary services markets. In GB, they can also earn constraint payments (compensation for curtailing output) and insurance receipts.
If the transmission is well planned and managed, a cap and floor project could potentially earn more through market revenues than a similarly situated regulated asset. This profit opportunity incentivizes its owner/operators to efficiently use the line. To balance the downside risk to consumers for underwriting the floor, consumers are entitled to revenues that exceed a cap. If the cap is high enough such that the project sees an effective return that is higher than alternative investments, then these projects may be able to draw in capital that would have gone elsewhere.
Determinations of project need and agreements on how potential floor and cap payments are shared between jurisdictions are still required. But because only the amount up to the floor for certain projects could be recoverable through consumer rates, this lower stake could mitigate cost allocation disputes. Cap and floor can work between countries, states or regions as long as they agree to share risks, even if they have different regulatory structures.
Under the existing cap and floor regime in Europe, regulators determine the project needs case and approve projects. OfGEM (Office of Gas and Electricity Markets), the GB energy regulator, considers the proposed projects’ benefits to GB consumers and other stakeholders. The regulator on the other side of the interconnector would have a similar determination.
OfGEM accepts project applications during windows and considers interactions between projects. Regulators assess the efficiency of the developers’ capital costs and decide whether a project qualifies for cap and floor treatment and their preliminary cap and floor levels. A post construction review considers the efficiency of operations and maintenance costs, examines the final capital costs and finalizes cap and floor levels.
Initially, OfGEM evaluated projects on congestion relief and electricity cost savings and has since widened its criteria to include grid flexibility and energy security. OfGEM performs assessments of system impacts (including those difficult to monetize), project location and technical design, and market modeling.
Under the GB regime, the floor is set to guarantee that the project owner can cover its annual operating expenditure and service its debt. The cap is set to ensure that equity investors receive sufficient but not excessive returns. There is some symmetry between the cap and floor levels to ensure that the risks and rewards to consumers are fair, and the gap between the cap and floor determines the merchant exposure.
The cap and floor may be adjusted to incentivize performance, as measured by availability under the GB scheme. Availability is expressed as a percentage of the maximum possible availability of the interconnector in GWh over a year. To qualify for consumer underwriting, interconnectors must achieve a minimum of 80% availability. If this performance requirement is not met, the floor payment is set to zero. If interconnectors underperform or exceed assigned availability targets, their caps can be adjusted by up to 2%. Thus, a line with a higher than target availability could keep more revenues under a higher cap.
A cap and floor pilot, Nemo Link, was approved by OfGEM and Belgian regulators in 2014 and commenced operations in 2019. This 1 GW cable was developed by National Grid Nemo Link Ltd (a subsidiary of National Grid PLC, the GB transmission system operator) and Elia Transmission Belgium NV/SA, the Belgian transmission system operator. Each owns 50% of the shares in Nemo Link.
Nemo Link’s estimated project cost was £1.238 billion and was granted a floor of £50.4 million and a cap of £80 million per year. Contract durations are 25 years, and interconnector revenues are assessed against their cap and floor over five-year periods. Nemo Link completed its first 5-year assessment in 2023. It surpassed its assigned availability target of 97.05%, and its cumulative 5-year revenues exceeded its cap by over £185 million. Much of this was due to price differentials between the EU and GB.
Above-cap revenues were split 50/50 between GB and Belgian consumers. In addition to this consumer payment, Nemo Link predominantly imported electricity to GB, which exerted downward pressure on the region’s wholesale electricity prices.
As of July 2024, OfGEM has approved eight projects, and four are operational. A third cap and floor solicitation in November 2024 selected another three out of seven projects to move forward.
Project impacts on regulated utility consumers underwriting the floor depend on where interconnector revenues fall in relation to the cap and floor and the line’s availability.
If revenues fall below the floor, transmission owners could recover up to their floor through customer rates, as long as the project met minimum availability.
If revenues exceed the floor, customers do not pay for the project.
If revenues exceed the cap, transmission owners return revenues above the cap to customers.
Aside from these potential customer impacts, cap and floor projects could also produce overall electricity cost savings, improved reliability, and cost-effective achievement of policy targets. Because of the merchant exposure, cap and floor project developers have an incentive to efficiently build and use their assets to produce monetizable benefits. This efficiency could reduce production costs and help avoid unnecessary generation and transmission build. Importantly, projects with higher returns due to efficient utilization could potentially attract capital from less efficient projects at lower ROEs normally placed in customer’s regulated rates.
Cap and floor could be another option for financing regional and interregional transmission in the US. This mechanism could incentivize efficient build and operations while reducing the risks customers bear compared to traditionally rate-based assets. Regulatory processes to determine the need for projects, verify costs and revenues, and negotiate how risk/rewards are shared would have to be established, but there is a possibility that existing processes in the U.S. could be adapted.