August 2004

Code Orange For Power Competition

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2005/01/08)
 

The signal from Washington is that at home and around the world the highwater mark for deregulation and competition has passed, and the question is how to fine-tune the role of the traditional regulated power companies and their relationship with “unregulated” affiliate cousins. Or is it?

Domestically, FERC conditionally approved the acquisition by Oklahoma Gas and Electric of a majority interest in a powerplant in its service territory previously owned by a bankrupt NRG affiliate, NRG McClain. Its earlier intransigence in doing so had been seen as an indication of its desire to prevent reabsorption of IPPs into the regulated utility ambit. The new verdict, permitting the acquisition based on the presence of “sufficient mitigation measures,” seems likely to a harbinger of change. The mitigation measures consist, as Chairman Wood emphasized, in reliance on the frequent advice of anti-trust agencies to rely on structural, rather than behavioral remedies to mitigate market power. He placed little weight on the potential for simply monitoring market power, although a beefed-up market monitor was one requirement of the ruling. By “structural,” though he seems to have meant infrastructure, not ownership patterns. This all might sound like good cracker barrel wisdom, until it is learned that the plaintiff, Intergen, was arguing that the “structural” remedy - a permanent transmission bridge between OG&E’s control area and Intergen’s generation facility - was not nearly enough to reverse larger market power concerns, because it served only to replace generation eliminated from the market - not to restore OG&E’s market concentration to pre-acquisition levels. Therefore, Intergen argued, the mitigation measures would effectively block their ability to be competitive, while enhancing regional utility market power.

Ironically, at about the time of the decision, one of the now more heeded antitrust agencies, the Federal Trade Commission, was weighing in with a dissonant view on a related issue; discrimination by utilities in favor of their own affiliates in competitive solicitations (a situation whose jurisdictional assumption by FERC Chairman Wood termed “awkward”.) Remarkably, the FTC perceived a very real possibility of affiliate abuse. It urged the FERC to return to its Order No. 2000 deregulation roots, by supporting independent evaluation of possible abuses by third parties. This approach, it suggested would make the review process more objective and “reduce” the risk of evasion of economically appropriate rate regulation through discrimination in purchases from affiliates or in cross-subsidizing of affiliates’ costs.

Probably, however, a whistle in the wind. As a practical matter, as FERC continues to levitate among potential screens for market-based rates; seek compromises on the application of its merger standards; and equivocate on issues of affiliate purchases from parents (all core facets of its overall deregulation scheme), there exists a real possibility that over time, market power control standards will be vitiated, the stated goal of competition will disappear like a Cheshire cat; the domestic profile of deregulation will continue to diminish as consolidation quickens.

As American faith in its deregulation/privatization wisdom seems to wane, so too does the vigor with which it is trumpeted as a panacea by the international financial institutions, which once exported it so vigorously. Such diminution in its former true belief is OK, indicated the World Bank’s recent research report , "Reforming Infrastructuring Regulation and Competition" in which Paul Jaskow and Michael Klein participated. “As with all economic elixirs, privatization [of critical infrastructure] has been oversimplified, oversold and ultimately disappointing. The Report, not surprisingly, highlighted the California experience: market liberalization under conditions of tight demand can lead to serious problems; unacceptable market clearing prices; and derailment of radical liberalization attempts. Interestingly, however, the World Bank report did note, as a key to effective deregulation, that making economic structural approaches - such as the degree of vertical and horizontal integration, and the clarification of market rules - most notably providing essential safeguards against market power - were essential first steps to a successful deregulation program. It suggested that “uncoordinated and  injudicious regulatory interventions in [a decentralized market] and an interconnected system can have perverse effects on interregional electricity trade.” It said nothing about regulatory ad hoc support for “mitigating” transmission bridges.

So what is Washington telling us? What is the future for the structure of the electric power industry structure, in this new age after the fall of the great liberalization of the grid? Perhaps an unsuspected answer comes from an unbidden Washington quarter, reflective of our times. The Department of Homeland Security has announced the proposed development of a National Electric Grid Monitoring System. “The purpose of ‘NEGMS’ is to aid the situational awareness of the state of the nation’s electrical grid and to share this information with the electricity sector.” A first tentative expression of the concern and the belief that in these perilous times power system oversight may ultimately be too sensitive to leave management entirely either in the hands of consolidating private utilities or the unrestricted operation of independent free trading markets. At least a code orange in the ISO control rooms, the world of OG&E bridges and, indeed, the World Banks’ Pacific Vision.

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.