December 1999

Steaming: The Merchant Power Legislative Situation

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2000/01)

What can one say about the energy deregulation bill that couldn’t; a bill that Congressman Ed Markey at one point summarized as one for which all stakeholders representing competition have serious problems and which all monopolies support; one that has set many Congressmen to wondering whether any bill at all is necessary?

The answer: private power must rethink and repackage what is being sold; critique opposition on objective standards; and redefine the supporting coalition. Obviously easier to say than implement, but necessary to avoid protracted gridlock. Here’s a roadmap.

First, restate the analytical premises of deregulation legislation in a more concrete and coalition-broadening manner. The litmus test for effective Federal legislation should be whether it facilitates the emergence of competitive new merchant plants. That is because the measure of competitiveness of these plants will in significant measure be all - in per unit price for the fungible electric commodity and collective flexibility in providing different classes of energy customers with different demand profiles with more cost effective service than before. Unleashed marketing innovation, using new technologies, and engineering and transmission improvements will all find their expression if these two metrics are being met. In short, if Federal legislation achieves these goals, deregulation would be good for consumers and would be laudable. Otherwise it would be an exercise in theoretical economics and system building in which some players got bigger and rich; others were stripped of their assets; and many ultimately unproductive transactions took place.

Second, identify what problems Federal legislation must deal with if it is to be of value to merchant plant development. Such plants face uncertainty and volatility because of their dependence on competitive markets, often on a real time basis, that sets them apart from the PURPA IPPs. They face a level of regulatory uncertainty not faced by the traditional utilities, because they must operate in a setting of on-going transition from regulation to competition. The playing field with the traditional players has not been leveled. Where existing traditional players retain significant market share or customer access, their competitiveness is more problematic.

Consequently, developers of merchant plants must evaluate the impact of legislation on four key criteria: (a) risk sharing, (b) market structure, (c) project economics and (d) transaction structure. Corresponding criteria for deregulation legislative evaluation are appropriate and should be established.

Third, translate these criteria into the topic titles used in Federal legislation. It is apparent that the questions that drive the future of merchant plants can roughly be categorized as follows:

(a) How large and uniform in characteristics is the market for plants, retail access and interstate retail wheeling.

(b) How accessible is that market to new players, free of barriers to unfair competitive practices and policed effectively? Regulation of mergers and corporate structure; regulation of former PURPA beneficiaries and Federal power systems.

(c) How much residual uncertainty is left as to how individual State or regional markets may be governed? Electric reliability and transmission governance.

Fourth, without self-flagellation, analyze the specifics of how the Administration’s pro-competition proposals got thoroughly mangled in the House. Here’s the breakdown:

(a) Market Size

The Administration proposed one market, indivisible, with FERC liberty and justice for all. Sounds attractive for merchant plants seeking to firm up their competitive potential. Something happened in the House... No hard landing date for retail competition; FERC jurisdiction over public power rates cut back to a "comparability requirement; no FERC jurisdiction over bundled sales; bright distinction between the use of the interested transmission grid between "bundled" retail sale of energy and the "unbundled" sale of the interstate transmission component of electric energy, which threatens truly comparable terms for all users of the grid.

(b) Market Access and Unfair Competition

As a means of protecting players from competitive abuses, the Administration would have somewhat Federalized the policing of the national marketplace, notably by providing FERC with enlarged oversight over mergers, particularly with respect to retail competition and enlarged powers to take remedial measures. Indeed, in areas of market power oversight, FERC would have been vested with the power to override the states. Anti-trust and FERC coverage would have been extended as well to the Federal power systems. In effect, the Administration proposed that to assure liberal open markets conducive to merchant power, more centralized Federal power better capable of dealing with the perceived ever present possibility of market stifling.

States rights concerns (notably advocated by utilities poised to defend their potentially invaded service territories) led the House bill to endorse reduced FERC approval rights over mergers; limited FERC’s authority to react to allegations of market abuse; and shifted consumer protection from the FERC to the States.

(c) Reliability and the Structure of Governance

The Administration’s proposals for the creation of a National Electric Reliability Organization which delegated responsibility to regional organizations sought to provide for rationalization of regional system control areas through requiring mandatory utility participation in ISOs, in a manner which facilitated dealing with key issues such as congestion management, which affect the siting and the success of merchant plants.

While not precluding the development these concepts, the House bill would eliminate mandatory RTO participation requirements and increase the ownership rights of existing transmission owners in RTOs, without affecting their deemed ability to meet independence requirements for the organization.

In sum, congress has left merchant plant developers with major residual issues as to market size, fairness and certainty of operation. Clearly Congressional inaction is not stanching localized merchant plant development, which is relying on state deregulation and specific regional cooperation initiatives. As long as growth, replacement or substitute power needs are present, whenever a market emerges in this ad hoc fashion, enterprise will follow. Coupled with State deregulation progress, that may be largely why Congressional intensity on the issue is not what it once was.

At the same time, given the optimum requirements for use of merchant plants as articulated in the above criteria, it is clear that Federal gridlock over a protracted time will at the least impede the extent of merchant plant growth, and thus, silently subject consumers to a higher cost and more erratic power system, even as deregulation proceeds. In addition, combinations and arrangements may be permitted to occur that make sense for individual firms, but may actually obstruct the productive development and use of merchant plants. They are challenging enough to develop that they only take root in fertile soil, let alone in circumstances where transmission grid management and market receptiveness are in flux.

Therefore, a new plan is necessary informed by the above analysis, focused on strengthening the intellectual base and broadened coalition of support for deregulation legislation. To succeed private power must make the case Federal deregulation legislation is based on what merchant plant development can do for consumers, rather than the theoretical benefits of competitive markets. The public has seen competition result in consumer unfriendly situations as consolidation occurs, and as retail advertising has been confusing. It must focus on the merits of broad market creation in a stable environment as the key to obtaining those benefits and emphasize how merchant plants can flourish in this environment, even while their sponsors are willing and able to accept the uncertainties which resulting competition can produce. It must actively publicize activities of incumbents which have an anti-competitive effect to the public and to regulators; how that affects the merchant plant services beneficial to the public; and how legislative change may be necessary to address the problems presented.

In short, solutions become more palatable when it is clear what problems they are solving. Private power must meet the opposition head on. Be prepared to rebut criticism of "re-regulation" and convince consumer advocates to embrace their course.

Today’s merchant power fleets are (or are perceived by the public to be) like mid-nineteenth century ships that have both sails and steam power. They are haltingly becoming steamer lines, but will have a great deal of difficulty in achieving that status unless Congress chooses to treat them that way. It is quite clear that - after this Congress - private power clearly needs to pick up steam to achieve that result.

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.