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Power Measurements

Failing the Market-Power Test:
Fortnightly Magazine - October 2004

of 136 IOUs passed the test. In the second, 3 additional IOUs passed the test. That left 64 companies to either complete the optional delivered price test or proceed directly to mitigation in an effort to rebut FERC's presumption of market power. Of the companies that passed the test, 51 are in an ISO and 21 are not. Most of these 21 companies fall into one of three categories: They don't own any capacity of their own, they are a small company in a bigger company's control area, or their control area includes more than one significant player.

The Power of the ISO

None of the companies that belong to an ISO failed; additionally, all of the non-ISO companies that passed belong to a control area that diminishes their market position (such as Michigan Electric Coordinated System). While it's likely that some of the high passing ratios in the ISOs were caused by requirements that utilities sell their capacity before joining the ISO (as happened in California, Texas, and New England), ISOs are also one of the few places where a large amount of capacity can be absorbed in an effort to pass a 20-percent market-share test.

It's no secret that FERC wants all U.S. utilities to join an ISO or RTO, and this ruling may well encourage many IOUs to do just that. In fact, as soon as FERC ruled on the new market-based rates tests, American Electric Power (AEP), one of the named utilities in that ruling, moved aggressively toward membership in the PJM RTO. We examined what PJM will look like with the addition of AEP and determined that AEP would pass the market-share test if it joins PJM. In fact, when combined with PJM, AEP nearly passes the test without including any interconnected capacity because of the quantity of capacity installed in the PJM RTO. If AEP does join PJM, the PJM RTO will be large enough to absorb any other market participant without concern for market-share issues. This will provide a market that can offer safe harbor even to very large players like Southern and Entergy without challenging FERC's definition of market power. Now that Com Ed has joined PJM, there aren't even geographic boundaries that would keep participants from joining PJM. FERC appears to be using the carrot and the stick approach to encourage companies to join an RTO.

Power Market Impact

What will this ruling do to utility earnings? Some have referred to this ruling as a "death sentence" for the utility industry, and our analysis does indeed show that there's much at risk. We analyzed FERC's Electric Quarterly Report data for the first two quarters of 2004 and evaluated the possible impact on these transactions of enforcing a cost-plus-10-percent requirement for power transactions within the applicants' control area. The total dollars transacted in the first half of 2004 by power marketing organizations affiliated with companies that failed the market share test was more than $1.92 billion. Again, this number represents only market-based rate activity inside of a company's own control area.

FERC stated that