by Roger Feldman -- Bingham, Dana and Gould, P.C.
Stock props of the deregulation consultants patter to private generators are phrases like: unbundle and recombine your services, be attentive to customer requirements, be nimble, etc. The unstated question looming in the background has been: "How feasible is that scenario if deregulation principally involves the transfer of selected packages of assets from the original hometown Goliath to out-of-town Goliaths?" The first hint, perhaps, is the "surprisingly significant order" FERC issued recently to Houston Lighting and Power in connection with its acquisition of several of Southern Californias generating facilities.
The facilities acquired (some of which were must run and some of which were not) were granted market based rates treatment because of a finding that (with certain minor correc-tive steps) because they met the requirement that the seller and its affiliates did not have, or had adequately mitigated market power in generation and transmission. HL&P market power was found not to be enjoyed with respect to generation either in the pertinent geographic area or in the line of business.
For these findings, there is FERCs well developed (if perhaps somewhat mechanically applied) "affiliate abuse" standards. HL&P will engage in no self dealings and will upgrade its "code of conduct" to include simultaneous sharing of all (Commission emphasis) market information between itself and its power marketing entity with non-affiliates. Why then is there any issue regarding the ancillary services which HL&P wishes to also be able to provide at market based rates (e.g., reactive power; voltage control; spinning, nonspinning and replacement reserves; blackstart services)? The reason is that while the capability to provide the services necessarily came with the generation, the services are "transmission re-lated products" for which the Commission was unwilling to provide market rate authority without market power analyses. Emphasizing that HL&P might be uniquely positioned to supply at least some of the services (e.g. reactive supply, voltage control), the Commission emphasized HL&Ps need to conduct case-by-case analyses.
HL&P did not meet this test. It referenced its share of the total generation nameplate capacity in the California-Nevada market, and a SoCal Edison study from which it inferred it did not have market power in reserve services. (Unfortunately for HL&P, this was the exact same study on the basis of which in 1997 FERC had declined to extend market based services to PG&E in 1997.) It provided no analysis at all with respect to blackstart services. HL&P did not "conduct . . . an in-depth analysis of spinning, nonspinning and replacement reserve ancillary services or the characteristics of plants which are conducted to the grid."
The Order then lays out the approach for requests to offer an ancillary service at market-based rates (which in most particulars could be derived from a textbook; viz. definition of relevant product market (including substitutes comparable in price, quality and availability); description of the relevant geographic market in which the ancillary service is sold (e.g. potential suppliers, quality of facility, cost of service, prices of potential suppliers); supplier market shares (as a basis for calculating market concentration); ease of market entry which could obviate the potential exercise of market power. Each ancillary service is deemed to be a separate product.
Several possible reactions are possible to this Order. First, it is merely a transitional document: a methodology and formulation for dealing with the issues will follow. Certainly, it is analytically consistent with prior commission analysis. Second, it may be a small gift to the economic consulting and appraisal industries: every asset sale will have to be accompa-nied by either a seller's or buyer's separate evaluation of asset value in terms of the ancillary services prices which they can command.
A final reaction (for which admittedly technical corrobora-tion is required) is that this is a fine example of FERC fine-tuning of its conceptualizations. While the fundamental viabil-ity of its deregulatory architecture remains in some question: whether this assertion is true turns on several issues.
- Has Order No. 888 functionalization led to major modifi-cations of market power by the major wholesale utilities?
- Has ISO governance been so well established that the impact of Order No. 888 on market power can be assured in the future?
- How significant to market power exercise are ancillary services? Even if judged important, is it the type of activity best overseen by command and control or complainant exception than by elaborate (and certainly suitable) review of market power constructs?
- If FERC analysis is conducted in this way, will it, in fact, be conducive to the nimble and frequent competitive offering of ancillary services which it set out to render feasible?
In short, is FERC approaching market power issues of tactical significance like ancillary services or of strategic sig-nificance, like industry profile, that - over a five year time horizon - those who would be nimble will continue to have a meaningful place alongside those who are large and will be larger.
Perhaps this is the "surprisingly significant" question.
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.