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Did FERC's market power ruling go too far?
Fortnightly Magazine - August 2004

ability to rebut the results of the market screen.

But the head of the largest utility association was not amused. Thomas Kuhn, president of the Edison Electric Institute (EEI), in one of the most scathing and strongly worded press statements I've come across in a long time, said, "We are deeply troubled by FERC's decision to reject out of hand our request to fix major defects in the Commission's proposal for assessing market power.

"This FERC order will exclude an entire category of suppliers from actively competing in wholesale markets, based on a deeply flawed market power analysis. It forces traditional utilities into a Hobson's Choice of accepting the certainty of traditional, cost-based rates versus accepting unknown mitigation measures that the commission may impose for wholesale transactions.

"Moreover, such mitigation measures likely will increase tensions between FERC and state regulators."

And Wall Street Isn't Happy

If you were a client of investment bank Lehman Brothers on May 28, you would know already that Wall Street is not thrilled with FERC's recent regulatory machinations, mainly because of the uncertainty it is creating in valuing utility earnings.

In fact, equity research analyst Daniel Ford warned his clients about large-cap utilities such as AEP, Entergy, and Southern Co.-the original targets of the market-screen ruling. As the Fortnightly went to press, those companies were submitting their revised generation market-power analyses, as ordered by FERC.

"We believe Entergy (ETR), American Electric Power (AEP), and Southern Co (SO) will likely be the most affected by structural shifts in the market-power screens. It would appear that the largest companies will be highly discouraged from expanding state-regulated generation and competitive profit centers concurrently. We highly doubt asset disposition will be required, but we see generation growth opportunities for larger-cap companies being reduced," wrote Ford.

Furthermore, Lehman Brothers fears that FERC's screen could interfere with state regulation. It could affect earnings per share for utilities seeking to expand rate base. It could influence the fate of multiple merchant power companies sustaining themselves on the life-support of low-interest rates.

As for merchants, Ford says, "The FERC process will have a material impact on the merchant power companies, but the direction and magnitude remains quite unclear. While the evolving FERC regulations appear intent on sustaining a competitive model, many states (especially the Southeast and Western regions) appear willing to sacrifice competition for higher reliability and avoiding repeated mistakes in the past.

"We believe the current direction of regulation will likely have a shrinking roll for the competitive merchant power company with only select geographic opportunities."

Enter the Reluctant Monopolists

Meanwhile, there's no standing pat by the large vertically integrated utilities that have yet to join RTOs, and that face the most serious problems from the new FERC screen. Instead, they appear hard at work to carve out a new model that might work in areas where RTO formation has been stymied, such as in the Southeast and South Central states.

With so many megawatts of merchant generation having been sited in those regions, regulated utilities there face a public relations and legal nightmare.