How can transmission providers safely serve noncreditworthy customers?
In 2001, with California and Midwest energy markets in turmoil, the Federal Energy Regulatory Commission (FERC) warned that such market uncertainty had sounded a "wake-up call" for electricity transmission providers to assure customer creditworthiness to pay for services.1 While the natural gas pipeline industry has responded to increased credit risk with an industrywide initiative and numerous tariff filings that enhance credit security, most electric utilities have failed to heed FERC's warning by modifying their tariffs.
The precarious financial situation of some market participants has ceased to be headline news, but the potential for significant financial risk remains. Electric utilities owe it to their ratepayers and their stockholders to focus with care on their credit security issues. Plainly, how utilities address the issues of whether to do business with companies that do not meet creditworthiness standards, the amount and type of credit security to require, and how and when to suspend or terminate service to noncreditworthy customers can have significant financial consequences.
Inadequate Protection Against Today's Credit Risks
The credit security provisions of FERC's Open Access Transmission Tariff (OATT) reflect the period in which they were developed. In 1995 and 1996, most transmission customers were integrated public utilities, rural electric cooperatives, or municipalities that had substantial physical assets. The industry as a whole was financially stable. Consistent with that economic environment, the OATT contains only minimal credit security provisions. OATT Section 11, "Creditworthiness," authorizes transmission providers to require "reasonable credit review procedures," while under other OATT sections customers must pay deposits equal to the cost of up to one month of service in connection with requests for firm point-to-point transmission service and network integration transmission service (but not non-firm point-to-point transmission service).2 Transmission providers may apply to FERC for termination of service to customers that default on their payments.
The tariff provisions are entirely inadequate to deal with today's heightened volatility in the electric industry and the resulting financial instability of some market participants. The vague reference to reasonable credit review procedures provides no guidance as to the customers a transmission provider may refuse to do business with, leaving customers potentially vulnerable to discrimination and transmission providers vulnerable to charges (both founded and unfounded) that they may have acted unfairly. The one-month deposit requirement does not apply to non-firm service, and even with regard to firm transmission customers it is generally inadequate to protect a transmission provider against the risk of nonpayment. The provisions of the OATT for termination of service for default cannot be implemented in less than five months,3 leaving transmission providers exposed to the risk of at least four months of unrecoverable charges in the event of default. Additionally, except for such termination for default provisions, the OATT gives transmission providers no ability to protect themselves against customers that are creditworthy when they apply for service but then become financially unstable after transmission service commences.
Credit Security Activity by Interstate Gas Pipelines
In the natural gas industry, recent downgrades of shipper credit ratings to below investment-grade quality (e.g., Enron, Dynegy) caused serious concern to FERC-regulated pipelines that they might be left holding the risk-of-nonpayment bag since, like the electric industry, they lacked both adequate credit security and the ability to obtain adequate security quickly enough. Reiterating the "increased importance" of an open and objective creditworthiness evaluation process,4 several recent FERC orders5 have approved pipeline tariff changes, permitting service to noncreditworthy customers while protecting against the risk of nonpayment, that:6
- establish more stringent but explicit, plain and objective creditworthiness criteria;
- require additional credit security for customers that do not meet creditworthiness standards;
- require customers that fail to maintain creditworthiness during the term of service to meet the credit security standards applicable to noncreditworthy customers;
- permit temporary suspension of service on relatively short notice to customers that fail to maintain creditworthiness and do not comply with enhanced credit security requirements;
- require security equal to three months of service charges to protect against nonpayment during contract termination;
- require shippers subject to SEC reporting requirements to notify the pipeline when a material event or corporate change affecting their financial condition results in a report to the SEC; and
- allow optional negotiated agreements with defaulting shippers to terminate, liquidate, net, and set-off credit risk across all of the shipper's agreements and all of the pipeline's agreements and those of its affiliates. A customer does not pay for service that is not provided due to a suspension.7
FERC has rejected proposed tariff provisions that apply creditworthiness standards to agents that have been delegated the responsibility to make the customer's payments,8 and it has required pipelines that conclude a customer is not creditworthy to provide the bases for that conclusion in writing.9 FERC also has rejected pipeline proposals to:10
- require shippers that lose their creditworthy status to provide three months' security within 5-10 business days;
- deem shippers noncreditworthy due to the default or other loss of creditworthiness by affiliates;
- collect charges for service after suspension or termination of service;
- require shippers to confirm in writing that they are not aware of any change in business conditions that would cause a substantial deterioration in financial condition;
- deny shippers interest on pre-payments;
- require shippers to confirm they are not subject to the uncertainty of pending litigation or regulatory proceedings;
- require noncreditworthy shippers to post more than three months' collateral;
- use (except for small customers) a shipper's past payment history as the sole creditworthiness criterion; and
- allow the pipeline broad discretion to determine when shippers become noncreditworthy.
Agreeing with a number of parties, including industrial gas users, that it could be valuable to develop a generic creditworthiness standard, FERC also encouraged the wholesale gas quadrant (pipelines and their customers) of the North American Energy Standards Board (NAESB) to attempt to develop consensus creditworthiness standards.11 Beginning in late 2002, NAESB's wholesale gas quadrant met repeatedly to develop some two dozen proposed creditworthiness standards for pipeline customers and to consider them for adoption. Those NAESB-proposed standards largely reflected the less contentious principles that FERC has already established in individual pipeline dockets. FERC has indicated it will take time to consider NAESB's work before considering how to proceed with any unresolved creditworthiness issues. In the second half of 2003, it will be interesting to see to what extent, if at all, any NAESB standards differ from recently declared policy in the individual pipeline cases.
Credit Security Provisions of OATTs
While the natural gas industry has been taking steps to enhance credit security, the electric industry has, for the most part, not filed revisions to its tariffs.12 Most transmission providers, including some regional transmission organizations (RTOs), have adopted the OATT provisions without change. Indeed, some transmission providers that have modified the OATT's credit and security provisions actually have weakened their protection against credit risk by waiving the deposit requirements entirely for customers with good payment histories. That step, which was taken to avoid having to pay the above-market interest rates on deposits that are required by the OATTs and by 18 C.F.R. § 35.19a(a)(2)(iii), was reasonable when electric market participants were financially strong, but it unnecessarily increases credit risk in a period of financial uncertainty.
Some RTOs have taken steps to upgrade the credit security provisions of their tariffs. However, probably with disregard for FERC's concern that credit provisions should be presented plainly, at least two RTO tariffs, one effective for the New England Power Pool (NEPOOL)13 and one proposed for the New York ISO Inc.,14 contain elaborate creditworthiness requirements. The very extensive NEPOOL provisions for alternative forms of acceptable security to protect against nonpayment and for termination of defaulting parties are set forth as follows: a financial assurance policy for NEPOOL members, with attachments (about 96 tariff pages); a financial assurance policy for NEPOOL nonparticipant transmission customers, with attachments (about 65 tariff pages); and a financial assurance policy for nonparticipant financial transmission rights customers and nonparticipant demand response providers, with attachments (about 32 tariff pages), for a total of nearly 200 pages of details on credit security. The New York ISO OATT provides for transmission customer operating requirements that must be met or exceeded by customer unsecured credit or additional security or collateral in an Attachment W, "Creditworthiness Requirements for Transmission Customers," which is 20 pages long.
The Duquesne Light Order: Limitations on Electric Utility Credit Provisions
On May 23, 2003, FERC rejected Duquesne Light Co.'s proposed credit security amendments to its OATT.15 Duquesne had proposed complex credit security provisions modeled on those that the PJM Interconnection RTO had adopted in its transmission tariff. FERC held that Duquesne's proposal might be acceptable for an RTO, which is independent of the market participants that are its transmission customers. However, the commission concluded that such provisions are not acceptable for an integrated electric utility whose merchant function competes for both transmission capacity and power sales against other potential transmission customers and power sellers. FERC also noted that PJM was susceptible to greater amounts of credit risk than a traditional public utility since it operates a fully integrated electricity market. Finally, FERC stated that credit security provisions for RTOs benefit the customers, while credit security provisions for gas pipelines and electric utilities are designed to protect the pipeline or utility. FERC cited with approval the CP&L/FPC creditworthiness provisions, which it characterized as "more like standards seen in the gas industry."16
FERC established four guidelines in the Duquesne order for transmission providers seeking to modify the credit provisions of the tariff.17 First, the transmission provider must show a direct correlation between a risk of default and the level of security required. Second, it must also be able to show that its provisions will be applied in a nondiscriminatory manner. Therefore, creditworthiness criteria must specifically identify and quantify how particular criteria will be weighed and scored. Third, the creditworthiness provisions must balance the risks of default against the amount of security that must be posted so that the amount of security does not stifle competition. Finally, the criteria must apply only to transmission service, and not to any retail access program.
FERC has recognized that enhanced credit security provisions decrease the risk to creditworthy customers associated with providing service to noncreditworthy customers.18 This is because transmission providers are less likely to incur unrecoverable costs that they will attempt to recover from their other customers. FERC also has acknowledged that credit security reform protects customers from unduly burdensome creditworthiness standards.19 That certainly is true if the revised standards result in noncreditworthy customers being able to obtain transmission service that they would have been denied under the OATT provisions. Improved credit security provisions protect utilities and their ratepayers against the risk that the utilities will be unable to recover payments for the services they provide. Consequently, modification of credit security provisions to protect against the risk of nonpayment, while ensuring that customers can receive service, is consistent with prudent utility management. That process should begin on an industrywide basis as soon as possible.
- California Independent System Operator Corp., 94 FERC 61,132, 61,505 & 61,510 & nn.13-16.
- Order No. 888, OATT, Sections 7.3, 11, 17.3 and 29.2, FERC Stat. & Regs. 31,036, 31,935-37, 31,944 & 31,952 (1996).
- Section 7.1 of the OATT provides that a customer must pay a bill not more than 20 days after it is received, which means that the transmission provider typically has provided nearly two months of service before the customer is obligated to pay its bill. Section 7.3 requires the transmission provider to give notice of nonpayment and wait another 30 days (for a total of 3 months after service commenced) before making a filing with FERC for termination of service for default. Under 18 C.F.R. § 35.15, a notice of termination of service must be filed at least 60 days in advance of the termination. While the regulations provide for terminations on less than 60 days' notice for good cause, FERC is unlikely to act on a notice of termination in significantly less than that period of time. Consequently, five to six months elapse between the commencement of service to a customer and the date on which service can be terminated for nonpayment.
- Gulf South Pipeline Co., LP, 103 FERC 61,129, P. 24 (2003).
- Tennessee Gas Pipeline Co., 102 FERC 61,075, order on reh'g, 103 FERC 61,275 (2003); Northern Natural Gas Co., 102 FERC 61,076, order on reh'g, 103 FERC 61,276 (2003); accord North Baja Pipeline, LLC, 102 FERC 61,239, P. 5 (2003).
- Tennessee, supra, 102 FERC 61,075, PP. 10, 16-19, 21-23, 39-46; 103 FERC 61,275, P. 53; Northern Natural, supra, 102 FERC 61,076, PP. 2-3, 36-37, 39, 49, 68; 103 FERC 61,276, PP. 33-37; North Baja, supra, 102 FERC 61,239, PP. 13-26; Trailblazer Pipeline Co., 103 FERC 61,225, PP. 17-21, 58 (2003).
- Gulf South, supra, 103 FERC 61,129, P. 56.
- Id. at P. 11.
- PG&E Gas Transmission Northwest Corp., 103 FERC 61,137, P. 71 (2003).
- Tennessee, supra, 102 FERC 61,075, PP. 17, 29, 32, 34-35, 38; Northern Natural, supra, 102 FERC 61,076, PP. 31-37, 39, 48, 68; 103 FERC 61,276, PP. 29-32; Natural Gas Pipeline Co. of America, 102 FERC 61,355, PP. 29-30, 51-52, 69, 72 (2003); Trailblazer, supra, 103 FERC 61,225, PP. 17-19, 21, 41, 49, 59, 64.
- PG&E, supra, 103 FERC 61,137, PP. 4, 17-22; Tennessee, supra, 103 FERC 61,275, PP. 12-13.
- Some transmission providers have adopted more stringent business practices without including them in their OATTs. While this may be adequate as a short-term response, it is unlikely that FERC would look favorably on an attempt to suspend service pursuant to business practices that are not included in an OATT, and the denial of service pursuant to unfiled business practices is not likely to fare much better.
- NEPOOL, 1st Rev Sheet No. 59; Attachment L, 3rd Rev Sheet No. 333, et seq.; Attachment M, 1st Rev Sheet No. 382, et seq.; Attachment O, 2nd Rev Sheet No. 457, et seq.; FERC Dkt. No. ER03-590 letter order accepting NEPOOL 94th agreement on financial assurance policies. NEPOOL, 103 FERC 61,120 (May 2, 2003).
- New York ISO, First Revised Sheet No. 91, Mar. 6, 2003, Docket No. ER03-552 corrected filing of Substitute Original Sheet Nos. 717-36.
- Duquesne Light Co., 103 FERC 61,227, P. 16 (2003).
- Id. at P. 17 & n.6.
- Id. at P. 18.
- CP&L, supra, 103 FERC 61,159, P. 1; Tennessee, supra, 103 FERC 61,275, P. 1.
The CP&L/Florida Power Order
FERC has signaled its willingness to allow individual transmission providers to adopt enhanced credit security provisions in their OATTs. On May 9, 2003, FERC approved new OATT credit security provisions for the two operating utilities of Progress Energy, Carolina Power & Light Co. (CP&L) and Florida Power Corp. (FPC).1 FERC stated that those OATT revisions would allow the companies to reduce the financial risk to themselves and to creditworthy customers and protect customers against unduly burdensome creditworthiness standards. CP&L and FPC made several modifications to their proposed creditworthiness provisions as they negotiated with their customers in an attempt to address all of their concerns. The companies ultimately agreed, in an answer to customers' protests, to make further modifications to their creditworthiness provisions in a compliance filing. FERC's order approved the companies' proposals, subject to their making the promised compliance filing. FERC discussed and approved the companies' specific creditworthiness criteria for transmission customers; requirements that customers who do not meet the creditworthiness standards must either provide 90 days of credit security or prepay for service; and requirements for customers that lose their creditworthy status to meet the enhanced credit security requirements within specified time frames. FERC also acknowledged the need for credit security for non-firm transmission service and rejected contentions that transmission providers needed only 60 days of protection against the risk of non-payment.2
FERC described but did not criticize CP&L's and FPC's proposals to suspend service on 30 days' notice to noncreditworthy customers that are in default, to suspend service immediately to noncreditworthy customers that fail to comply with their commitment to prepay for service, and to suspend service on 30 days' notice to customers that lose their creditworthy status and do not meet the enhanced credit security provisions for noncreditworthy customers.3 Those provisions would provide substantially greater flexibility to transmission providers than do the OATT provisions, which make it virtually impossible to terminate service in less than five months after service commences. However, FERC rejected the suspension provisions without prejudice to refiling, stating that the companies had proposed extensive changes, and that the parties to the proceeding had not had an opportunity to review or comment on them. FERC stated that a resubmitted suspension of service provision should be "clear, accurate and consistent with the billing dispute terms" of the OATT.4
It is important to note that several of FERC's gas pipeline decisions approve suspension provisions that are similar to the provisions that the commission rejected without prejudice to refiling in the CP&L order.5 FERC approved a requirement that when a shipper loses its creditworthiness status, it must within five business days pay for one month of service in advance to continue service; and then within 30 days must provide the next three months' security for service. Significantly, if the shipper fails to provide the required security within those time periods, the pipeline may suspend service immediately. The pipeline also may provide simultaneous written notice that it will terminate service in 30 days if the shipper fails to provide security. Such notice must be given to FERC, as well as to the shipper. -J.M.M. & T.L.B.
- Carolina Power & Light Co. and Florida Power Corp., 103 FERC 61,159, PP. 32, 36, reh'g request filed, June 9, 2003.
- Id. at PP. 33-34.
- Id. at PP. 29-31, 36.
- Id. at P. 36. CP&L and FPC resubmitted such suspension provisions on June 17, 2003.
- Tennessee Gas Pipeline Co., LP, 102 FERC 61,075, PP. 18-19; Northern Natural Gas Co., 102 FERC 61,076, PP. 49-50; North Baja Pipeline, LLC, 102 FERC 61,239, P. 19; Gulf South Pipeline Co., LP 103 FERC 61,129, PP. 50-52; PG&E Gas Transmission Northwest Corp., 103 FERC 61,137, PP. 49-51; Trailblazer Pipeline Co., 103 FERC 61,225, PP. 42-43.
Guidelines for Credit Security Provisions
The CP&L/FPC order and the Duquesne order, in conjunction with FERC's gas pipeline orders, provide a substantial amount of guidance to electric utilities that are seeking to revise the credit provisions of their tariffs. Utilities should bear in mind the following principles:
- Achieve consistency with the OATT. FERC will evaluate whether the proposal is consistent with or superior to the tariff provisions.1 Creditworthiness standards that are more explicit than the provisions are likely to meet this requirement, provided that they also are objective and are not so stringent as to stifle competition.
- Be understandable. The credit security provisions should be reasonably easy to comprehend and administer.2 Such provisions have the most value when they provide sufficient detail to allow customers and tariff administrators alike to understand the rules and comply with them. Certainly, there should not be so much complexity that the utility customer does not bother to understand the utility's creditworthiness standards in the first place and the administrator has difficulty administering its own tariff provisions. Arguably, some of the existing RTO credit security provisions would not meet this criterion.
- Adopt objective standards. Creditworthiness criteria should be objective, without interfering with the transmission provider's right to exercise business judgment in evaluating creditworthiness.3 CP&L/FPC successfully based their creditworthiness standards on ratings from commercial rating agencies such as Standard & Poor's or Moody's, evaluation of financial statements under the standards of the credit rating agencies, other objective indicia of financial strength (such as a minimum x Interest Earned Ratio and Debt Service Coverage Ratio for rural electric cooperatives) and guarantees by parent companies that meet the creditworthiness criteria.4
- Relate general security requirements to default risk. Credit security requirements must be based on the risk of default.5 Utilities should bear in mind that it may be more difficult to justify multiple levels of creditworthiness and corresponding levels of security than to justify the more simple creditworthy/noncreditworthy dichotomy that CP&L/FPC adopted.
- Review creditworthiness periodically. The transmission provider should conduct periodic reviews of customer creditworthiness, including review at the request of a customer.6
- Notify customers of adverse creditworthiness decisions. The transmission provider should inform the customer in writing of the reasons why the customer is noncreditworthy and provide the customer an opportunity to challenge the decision.7
- Relate noncreditworthy security provisions to default risk. The enhanced credit security provisions for customers that do not meet the creditworthiness standards must relate to the risk posed to the transmission provider in the event of default.8 CP&L/FPC met this requirement by demonstrating that they were at risk for at least 80 days of unpaid bills, and that therefore 90 days of security was necessary.9 Transmission providers may be able to demonstrate the need for more security based on different facts.
- Pay interest. Transmission providers either must pay interest on prepayments, or must allow the customer to place prepayments in an escrow account to which the transmission provider has access.10
- Set deadlines to provide security. Transmission providers can require customers that lose their creditworthy status to provide short-term credit security (prepayment or security against nonpayment for one month of service) within 5 days of notice by the transmission provider, and to meet all of the enhanced credit security provisions within 30 days of notice.11 The transmission provider is not required to provide service to noncreditworthy customers that cannot provide reasonable collateral.
- Provide for service suspension after notice. Transmission providers can temporarily suspend service, with notice to the customers and FERC, to customers that lose their creditworthiness status and that do not meet the enhanced credit security requirements.12
- Treat billing disputes separately. A customer that does not pay a bill because of a billing dispute cannot be subject to loss of creditworthiness, suspension of service, or service agreement termination.13
- Resume service after compliance. The transmission provider must resume service to the customer when it complies with the credit security provisions.14
- Don't charge when service is suspended. Customers are not required to pay for service during a period of suspension.15 Note that this does not provide complete protection to the transmission provider, since it may well forgo revenues that it could obtain by reselling the transmission capacity of the suspended customer. However, the transmission provider can recoup at least a portion of its expected revenues by reselling the service on a non-firm basis, subject to interruption when the suspended customer complies with the tariff requirements. Also, the transmission provider may bring suit in an appropriate forum for damages related to the customer's contractual breach. -J.M.M. & T.L.B.
- Duquesne Light Co., 103 FERC 61, 227, P. 16.
- Carolina Power & Light Co. and Florida Power Corp.,103 FERC 61,159, P. 36, reh'g request filed, Jun. 9, 2003.
- Tennessee Gas Pipeline Co., LP, 103 FERC 61,275, PP. 40-41; but see Duquesne supra, 103 FERC 61,227, P. 19.
- CP&L, supra, 103 FERC 61,159, P. 9; Tennessee, supra, 103 FERC 61,275, P. 68.
- Duquesne, supra, 103 FERC 61,227, P. 18.
- CP&L, supra, 103 FERC 61,159, P. 13.
- Tennessee, supra, 103 FERC 61,275, P. 45; Northern Natural Gas Co., 103 FERC 61,276, P. 43.
- Duquesne, supra, 103 FERC 61,227, PP. 18-19.
- CP&L, supra, 103 FERC 61,159, P. 34; see Tennessee, supra, 103 FERC 61,275, P. 35.
- CP&L, supra, 103 FERC 61,159, P. 22; Tennessee, supra, 103 FERC 61,275, P. 21.
- CP&L, supra, 103 FERC 61,159, P. 15; Northern, supra, 103 FERC 61,276, P. 54.
- Trailblazer Pipeline Co., 103 FERC 61,225, PP. 42-43; see CP&L, supra, 103 FERC 61,159, PP. 31, 36.
- Natural Gas Pipeline Co. of America, 102 FERC 61,355, P. 40; see CP&L, supra, 103 FERC 61,159, P. 36.
- Northern, supra, 103 FERC 61,276, PP. 52, 55; Natural, supra, 102 FERC 61,355, P. 69; see CP&L, supra, 103 FERC 61,159, PP. 30-31, 36.
- Tennessee, supra, 102 FERC 61,075, P. 32; 103 FERC 61,275, PP. 17, 84-87; Northern, supra, 103 FERC 61,276, P. 49.
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