Enron's fall finds FERC toying with cost-based rates. But let's temper the nostalgia.
Enron may not be dead, but its death rattle is certainly being heard loud and clear on Wall Street, Capitol Hill, and in Houston and beyond. If Enron ever was king, will the new king be a scion that also is an aggressive advocate of deregulation? Or, will it be an aged consort, who yearns to return to the "just and reasonable" standard for rate regulation?1 The answer may be with the Federal Energy Regulatory Commission (FERC), which in two pre-Thanksgiving companion orders,2 indicated a strong preference for crowning the just and reasonable standard.
Before commenting on whether just and reasonable rates are an appropriate substitute for market-based rates for merchant plants, it should be noted that "Enron ... created an enormous legacy of good ideas that have enduring value." Those ideas included: "de-integration of power contracts," "minimization of transaction costs and frictions," "exploiting the optionality in networks," "rigorous risk assessment" and a "culture of urgency, innovation, and high expectations."3 On the other hand, even in these early days of Enron's Chapter 11 bankruptcy filing, it is clear that the unique business model of Enron-asset-light, trading operations that included numerous dissimilar commodities, lack of accounting transparency and conflicts of interest-were the Four Horsemen of the Apocalypse which brought its downfall.
Against this backdrop, plus California's energy woes, are FERC's Thanksgiving initiatives that retreat from market-based rates and substitute a "just and reasonable" standard appropriate? Although FERC is not alone in advocating a return to the past form of rate regulation,4 nostalgia should be tempered. When promulgating Order No. 888 five years ago,5 FERC made several observations:
- Inflation. In the late 1960s and throughout the 1970s, a number of significant events occurred in the electric industry. ... This was the beginning of periods of rapid inflation, higher nominal interest rates, and higher electricity rates.
- Overbuilding. During this same time frame, the construction of nuclear and other capital-intensive baseload facilities-actively encouraged by federal and some state governments-contributed to the continuing cost increases and uncertainties in the industry. ... However, due to conservation and economic downturns, the expected demand increases did not materialize. Load growth virtually disappeared in some areas, and many utilities unexpectedly found themselves with excess capacity. In addition, by the 1980s, the oil cartel collapsed, with a resulting glut of low-priced oil. At the same time, inflation substantially increased the costs of these large baseload-generating plants. Surging interest rates further increased the cost of the capital needed to finance and capitalize these projects and completion schedules were significantly extended by, in part, more stringent safety and environmental requirements.
- Rate Shock. As a result, expensive large baseload plants-for which there was little or no demand-came onto the market or were in the process of being constructed. Accordingly, between 1970 and 1985, average residential electricity prices more than tripled in nominal terms, and increased by 25 percent after adjusting for general inflation. Moreover, average electricity prices for industrial customers more than quadrupled in nominal terms over the same period and increased 86 percent after adjusting for inflation.
- Consumer Protests. Consumers responded to these "rate shocks" by exerting pressure on regulatory bodies to investigate the prudence of management decisions to build generating plants, especially when construction resulted in cost overruns, excess capacity, or both.
However, on Nov. 20, FERC issued 6 in which it acted on triennial market power updates for three generation companies and announced a new generation market power screen, , and a companion . The impending investigation is to determine whether existing "market-based rate tariffs ... of public utilities that sell electric energy and ancillary services at wholesale" and "all new market-based rate tariffs" are "just and reasonable." According to the commission, application of the just and reasonable standard "will protect customers from excessive rates." The commission's order also established a refund condition, which will have a chilling effect on the way Wall Street and others view the power marketing industry.
Without engaging in a Clintonesque argument about what is meant by "excessive," a return to a "just and reasonable" standard surely will insulate consumers from price swings, both high and low-but at a cost. The past has taught that just and reasonable rates are ineffective when supplies are short, a disincentive to investment, and an impediment that often prevents companies from being nimble enough to meet changing market conditions. In this regard, Alfred Kahn has concluded:
"Regulation, whether justified in terms of protecting consumers against monopoly or protecting competitors from what are perceived to be unfair handicaps, is itself a major obstacle to economic progress."7
There is no question that Enron's massive downfall and the energy woes of California warrant both governmental oversight and intervention to prevent abuses. But the objectives of regulation should be stable energy markets that promote efficiencies, abundant supplies, and innovations in service and products. Wholesale imposition of just and reasonable rates may not result in these benefits. As a consequence, the FERC should go slowly before deciding who wears the crown.
William A. Mogel is a partner in the law firm Squire, Sanders & Dempsey, in Washington, D.C. He is the editor-in-chief of the Energy Law Journal, and may be reached at firstname.lastname@example.org.
- Section 206 of the Federal Power Act, 16 U.S.C. _824e.
- , 97 FERC ¶61,219, and .
- Samuel Bodily and Robert Burner, Manager's Journal, (Nov. 19, 2001).
- See , p. 9 (Dec. 10, 01).
- 61 Fed. Reg. 21543-44 (footnotes omitted) (May 10, 1996).
- FERC subsequently announced that it would delay implementation of the new market power test until after a technical conference., p. 7 (Dec. 24, 2001).
- Alfred Kahn, Unleash the Broadband Economy, , p. A16 (Dec. 13, 2001).
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