Frontlines
Did FERC's market power ruling go too far?
Will utility executives and proponents of electric competition mark July 8, 2004, as a dark day? That was the day the Federal Energy Regulatory Commission (FERC) said it would make no changes to the extremely contentious "interim" screen-the one it adopted back in April to measure market power in electric generation.
I say "dark" because the market-based sales now put at risk are the financial lifeblood of some utilities, especially those of the multi-billion-dollar, vertically integrated variety. Those that fail FERC's market-power test will be forced to sell their excess generation at cost-based rates-a "death penalty," according to some utility CEOs.
And to make matters worse, some advocating open markets still question whether the new test will improve competition in wholesale power transactions.
FERC's new market-power test, the critics say, offers no real incentive for utilities to join a regional transmission organization (RTO). That's because RTO membership no longer provides a safe harbor-an exemption from having to pass the market-power screen.
But FERC has said that even if utilities fail the new screens they can point to membership in an RTO (or ISO) as evidence that their market power has been mitigated. And Jon Ecker, president of Energy Velocity, agrees at least in principle when he says, "The protections provided in structured markets such as RTOs generally result in markets where prices are transparent and attempts to exercise market power are mitigated."
Yet many proponents of free trade had long called for FERC to limit its use of the "death penalty" in a way that would persuade utilities to join regional energy markets and thus fall in line with the commission's own lobbying efforts on behalf of RTOs.
So as things now stand, there is considerable disagreement over whether FERC has done itself any good-or, for that matter, whether it has made anyone happy. The critics say that FERC's ruling failed to heed any of the suggestions by any of the major factions: the utilities, public power, the merchant generators, or even the state public utility commissions.
FERC Chairman Pat Wood III, in a press statement, asserted, "Market-based rate authority is not a right. … Today's order balances the competing views of a broad spectrum of commenters."
But many commenters disagree. They cite several key faults in FERC's final market-power screen, all involving the native-load obligation owed by vertically integrated utilities. They say FERC's screen:
1) Deducts too little in general for native load, and thus overstates uncommitted capacity available for market;
2) Wrongly relies on an average of native load in the "pivotal supplier analysis," which again tends to understate such obligations;
3) Offers a false hope for utilities that fail the screen, since virtually all traditional utilities with native load are doomed to fail the Delivered Price Test, which FERC has set up as a secondary safe harbor. A cursory read of the final order shows how these arguments are but a few of many that FERC rejected. Some utility executives say FERC did give utilities the greatest concession of all-the 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. How do they avoid allegations of favoritism as they go about their duties as control area operators in making dispatch decisions both for local merchant plants and their own proprietary generation, where there is no independent grid coordinator?
In our "Commission Watch" section on p. 26, Larry Eisenstat, the outside counsel for Duke Energy and partner with law firm Dickstein Shapiro, and his colleagues outline a plan for vertically integrated utilities that face this problem:
"We propose a market-access plan that does not advocate sweeping changes; it instead builds on existing frameworks with structural improvements that are technically feasible, cost-effective, and politically practical. The result assimilates the best of the [vertically integrated] and merchant models; benefits the industry investment climate," writes Eisenstat.
Furthermore, former FERC Chairman Curt Hébert Jr., in his first public appearance since stepping down as head of the commission, gives his analysis and proposes ideas on participant funding for transmission expansion projects-especially the upgrades required to accommodate new merchant plants that seek to interconnect with the grid (see p. 40).
Certainly, while these plans will be debated by the industry, the fact that regulated utilities are dialoguing and making an effort to improve on the current structure is a positive step in the right direction. Let's hope they get a fair hearing.
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1) Deducts too little in general for native load, and thus overstates uncommitted capacity available for market;
2) Wrongly relies on an average of native load in the "pivotal supplier analysis," which again tends to understate such obligations;
3) Offers a false hope for utilities that fail the screen, since virtually all traditional utilities with native load are doomed to fail the Delivered Price Test, which FERC has set up as a secondary safe harbor. A cursory read of the final order shows how these arguments are but a few of many that FERC rejected. Some utility executives say FERC did give utilities the greatest concession of all-the ability to rebut the results of the market screen.