Dr. FERC: Band-Aid/CAT Scan/Cure
by Roger Feldman -- Bingham, Dana L.L.P.
FERC is posing as a stern but kindly doctor for the troubled state of deregulation. “We’ve got to address this surgically,” announced the Chairman. Far more is involved than the headlines declaring “Big Power Firms Face Price Curbs” (although that is true enough). Market-based rates have been granted since deregulation to both old and new facilities – EWGs, generation acquired as a result of divestiture and power marketers. That’s why there’s new deregulation gold in the old power system hills. The golden spikes of California were market-based rates.
Now that the California experience is receiving recognition to a certain extent as one where market power permitted gouging occurred (sorry about that, Gov. Davis), and the effort to restructure access-neutral RTOs is running into the reality of the continued might and breadth of the remaining regulated utilities and their holding companies, FERC now has sucked it up and announced that it is serious about being an aggressive policeman of the grid. The investigative and other measures recently taken are, in the Surgeon General’s words, “a stop gap Band-Aid to address market power. . .”
But these are Band-Aids that will pass the ouch test when tugged:
• The investigation, in principle at least, extends to all market-based tariffs that will continue to be tagged with a FERC triennial right of review so that the rates remain just and reasonable.
• A new generic rulemaking is to be launched, the upshot of which will be a replacement for the “hub and spoke” 20% control of installed and uncommitted generation market test that, arguably, may have fit the old vertically-integrated power markets but does not fit them now.
• Potential refunds of prior rate “overcharges” will be the principal penalty for anti-competitive behavior or exercise of market power. Indicia of such behavior have a definite California sour tang to them: physical withholding, economic withholding (offering output to the market at a price that is above both its full incremental costs and the market price), barriers to entry (including denial of natural gas service).
The poster children, to whose knees these Band-Aids are first forcibly being applied, were announced by FERC in a parallel order with respect to the triennial market power updates submitted by AEP/CSW, Entergy and Southern Company Energy Marketing (now Mirant). At this proceeding, the Commission announced its preferred market power screen to be used in preference to hub and spoke – to be applied at least until the culmination of the proposed Market- Based Rates Rulemaking. No Band-Aid, but rather a CAT Scan, this Supply Margin Assessment (“SMA”) screen is. While the formal legal tests remain the same, up until now the presence of an approved open access tariff was deemed a sufficient mitigant of market power (along with representations and public policing). This no longer will be the case.
The new metric, the SMA screen, has two key new features. It defines a market in terms of whether transmission will allow supply to reach buyers (taking into account the total (transmission) transfer capacity – “TTC” – into the market). This metric measures the significance of the level of applicant’s market presence in terms of whether its capacity must be used to meet the market’s peak demand. “An applicant (for market-based rates) will be pivotal in the markets if its capacity exceeds the market’s surplus of capacity above peak demand – that is, the market’s supply margin. The SMA test therefore is sensitive to the potential for an applicant to successfully withhold supplies in the market in order to raise prices. By implication, the SMA labels as “pivotal” all generators in severely capacity-inadequate markets.
Dr. FERC will withhold its MBR stinging Band-Aid cure if the patients go directly to his designated waiting room. If all their sales, including bilateral sales, are made to an ISO or RTO with Commission- approved market monitoring and mitigation, they will be exempt from the SMA and be subject instead to the thresholds and mitigation provisions of the Commission-approved market governance body. In other words, if a power marketer wants to pass the SMA in three control areas, it will be able to do so once RTOs have taken charge of those control areas. (In forensic medical circles, this type of arrangement is called a “forcing function.”)
Applying its newly-minted SMA tests of market dominance to the cases at hand, FERC arrived at the remarkable conclusion that each of the applicants had the generation needed to meet market peak demand in its control area (i.e., did not pass the SMA screen test); and since none of them were yet RTO denizens, they are to be subject to “mitigation” – the plaster on the sticky side of the Band-Aid. That mitigant is the subjection of the hourly excess capacity for spot market sales in the relevant market to split the savings cost-based rates. The traditional reasoning behind this mitigant is two-fold:
• By eliminating an applicant’s ability to negotiate trade benefits, the seller applicant’s market power in the spot market will be checked.
• Abuses in the longer-term (forward) markets will be prevented by customers shrewdly uniting to purchase in the red time market. (Consequently, no longer-term, cost-based rate controls will be applied.)
Seller applicants must provide the 24-hour incremental costs for energy offered for spot market sales in the company’s control area. Independent third parties will be required to operate and administer the OASIS sites of the applicant utilities – none of which is a member of up-and-running or soon-to-be-running RTOs.
Basically, the doctor is really a social engineer. It will only apply the CAT Scan and apply the Band-Aids In the absence of RTO governance. It will apply no long-term price caps, because it will require intense monitoring of California. And, by way of learning from its California HMO colleagues, “if in the future a legitimate concern is raised that indicates an exercise of market power in the longer term products offered by the applicants, further mitigation may be necessary.” The Chairman has publicly sighed, and said he wishes to see no more Californias in his operating room ever again (and that he wants California market mitigation in place by the time of renewal of the current artificial price limitation measures).
The doctor may not have considered the uncertainties as to rates (and the ramifications of this fact for financing based on forward price curves) pending the full ingestion of his RTO cure. FERC also is reposing a great deal of faith in a cure that itself is now being challenged by angry patients – like the industrial customers throughout the West and the beleaguered citizens of the Peoples Republic of California. More broadly, its cure’s effectiveness is de-pendent on the mitigants installed by the still nascent-RTOs (taking into account the ultimate results of FERC’s approach to interconnection and related policies). It is a cure, in short, that wouldn’t get past the FDA at this time. So, while (anachronistically) we tip our “cap” to FERC’s efforts, we can only hope that the patient will survive its clever operating procedure.
ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years. In particular, he has analyzed and executed a wide variety and substantial value of project financings. He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration. He is a graduate of Brown University, Yale Law School and Harvard Business School.