THE CALIFORNIA DEBATE OVER ELECTRIC RESTRUCTURING IS now nearly four years old. And though it is nearing its final stages (the opening is now set for March 31), some of the most important questions as to how this will work in practice are just emerging.
The original bargain had called for the state's three large investor-owned utilities to vest basic control of their transmission networks in the new independent system operator in exchange for maintaining combined ownership of generation and transmission assets (and for a good level of assured stranded cost recovery). That bargain didn't last, however, owing to concerns over market power.
With transmission access apparently resolved, one might have thought that most concerns over abuses of market power would dissipate. That assumption proved to be a dangerous illusion, however. Instead, there emerged a whole new set of regulatory concerns over "horizontal" market power. These concerns related to utility concentrations in generation, generation units strategically located to take advantage of or needed to relieve transmission constraints ("must-run" units in California's jargon). Concerns even arose that individual units could exercise market power in setting market clearing prices in auction markets by virtue of their typical placement on the supply curve. Similar concerns have been expressed in the ISO New England restructuring and surely will be raised in others.
Hence, even after agreement from the investor-owned utilities on the basics of vesting control of transmission in the ISO (effected through "transmission control agreements"), the California debate over IOU market power in generation continued unabated. The Federal Energy Regulatory Commission devoted a lengthy separate order to the issue in its late 1996 rulings on the basic concepts of the California restructuring proposal; and its only technical conference on the proposal (in January 1997) was devoted solely to these market power concerns. In its December 1996 order, with very little discussion, the Commission imposed a requirement that has enormous implications of how market power concerns will be addressed in restructuring situations. The ISO was ordered to file a "detailed monitoring plan," which includes how market power will be identified and mitigated and what information will be collected and submitted to the FERC.
Since then, regulators have imposed similar requirements on the three "tight" Northeast power pools (New England, New York and the Pennsylvania-New Jersey-Maryland Interconnection) in setting up restructuring proposals driven in large part by FERC's regulatory requirements under Order 888. At press time, the New England pool had made considerable progress in developing a market monitoring program analogous to California's. PJM was in the early stages of developing its proposed program under a tight FERC deadline. The New York pool had submitted a revised proposal to federal regulators.
How well will these programs work? The early evolution of the market surveillance programs in California and the northeastern pools, and perhaps in other jurisdictions such as Alberta, should tell us a great deal. Regulators clearly hope that these monitoring programs, through daily, detailed monitoring of transactions, will give them the ability to protect competitiveness and efficiency of markets never yet experienced or regulated.
At the same time, however, these programs may create a new model for integrating traditional, state-imposed utility regulation with the principles of federal antitrust law. They necessitate a clear definition of relationships and procedures for interaction between these programs and federal and state regulators and antitrust enforcement agencies. They may even encourage federal and state agencies to re-examine their own respective roles and relationships in restructured electric markets (see sidebar, "Otter Tail's Odyssey").
One thing is already clear: These programs will have to be highly creative in developing the substance of their monitoring efforts, and regulators will have to be flexible in their responses. The debate in California over IOU market power in generation is still in flux.
The New Oversight:
Reasons and Realities
Two realities compelled the FERC to impose these self-monitoring functions. First, the FERC realized how little experience there was in operating the new auction markets, especially as envisioned in California. Second, FERC was concerned with the limited capability of the traditional regulatory agencies, and antitrust enforcement agencies, to monitor effectively market power abuses in these emerging auction markets.
Considering these realities, it's clear why the FERC issued its ground-breaking decision to entrust one the most sensitive regulatory issues to "frontline" self-regulation by entirely new industry institutions. The types of abuse that might concern regulators and market participants, and their relationship to market power, are undefined and may only emerge once these markets start operating. Many issues unfamiliar to electricity regulators will emerge. Traditional tools regulators have used to detect market power abuses, such as comparing prices with costs, may not be available. Regulators will turn to monitoring programs to develop the necessary analytical tools, data requirements and criteria for corrective action.
In developing its required "plan" for market monitoring, the California ISO had no direct precedent to follow. But one significant analogy did exist for the type of self-monitoring or market surveillance envisioned in the FERC order. %n1%n The Canadian province of Alberta had developed a similar surveillance program about a year earlier. %n2%n This system may have influenced the FERC's thinking in requiring monitoring in California and the northeastern pools. Certainly, the FERC's decision builds upon the concept of "frontline" regulation, which has been more broadly encouraged by the FERC for regional transmission groups and ISOs, but with one additional feature of great significance: These monitoring programs could also become, potentially, the frontline for antitrust enforcement.
Shaping the Details:
Bids, Prices and Data Collection
California and New England have now begun to shape the details of effective monitoring programs. Regulators are determining what data to gather, developing indicators to detect problems and to trigger further analysis and defining criteria to determine if a violation has occurred. In California's plan, the FERC wants more detailed standards for corrective action than the general "criteria" filed in the original plan: (1) practices indicating market power adversely affecting market operations; (2) gaming; and (3) "behavior that more generally undermines the efficiency, workability and reliability¼ of the markets."
The ISO and PX argued that these criteria are best refined while the new markets are in operation; the FERC apparently accepted this "bottoms up" approach of developing only data requirements and monitoring indices at first. In their informational filings with FERC last fall, the ISO and power exchange submitted tentative but detailed lists of the types of data and indices that might prove critical. A sampling of these requirements shows how much this monitoring function will diverge from traditional regulatory or antitrust analysis of market power:
DATA REQUIREMENTS. Includes information on market clearing prices, supply bids, withdrawals and redeclarations during bidding cycles, transmission constraints, market shares of players under different conditions, historical unit costs and availability, and "vulnerable periods" (e.g., congestion; seasonal variations in outputs, imports and demand and facility outages).
MONITORING INDICES. Indicators include market clearing prices (the frequency with which specific players in different markets have set market prices); bidding strategies of participants (i.e., their correlation with setting market clearing price and strategies under different market conditions); market concentrations based on actual, real-time data for each condition (e.g., peak- and off-peak, congestion); unit outages; and unexpected congestion.
These data and indices might yield instances of what the economic experts testifying at the FERC's January 1997 Technical Conference described as "anomalous market behavior." This term includes, they elaborated, the withholding of generation capacity normally offered in a competitive market, unexplained redeclarations of generator availability or pricing and bidding patterns out of sync with prevailing market conditions.
What About Bilateral Markets?
One of the most difficult policy issues California will have to deal with is how far to monitor for market power and other abuses in the large, complex bilateral markets and other voluntary exchanges that may emerge. These markets will compete with the ISO and PX administered markets. The preservation of "existing contract rights" (em an article of faith for many stakeholders (em is almost absolute and, for those who choose not to play in the new auction markets, theoretically perpetual. FERC has rejected even minor derogations from these rights to simplify the functioning of the auction markets.
But how can the California ISO and PX ensure a fair and efficient market without monitoring the bilateral markets and other competing exchanges? It is not clear whether the PX and ISO even possess the mechanisms and legal authority to monitor such a market. The FERC doesn't appear deterred, however, since it has required the ISO and PX to file proposals on how they will monitor bilateral markets. Because IOUs are required to market all their power through the PX energy market and the ISO-administered ancillary markets for the first four years, apparently, the FERC does not believe this matter is urgent. That may change as large-scale IOU divestitures of generation capacity occur.
Any effort to monitor bilateral markets and other exchanges will surely prove controversial. Some players will likely resist even the collection of basic market data, the starting point of analysis.
This issue will likely factor in most other U.S. jurisdictions where it is unlikely that mandatory trading pools (such as those in England & Wales and other jurisdictions abroad) will be imposed to the exclusion of bilateral trading arrangements, especially given FERC's apparent predilection to protect the sanctity of the latter. The three northeastern pools, which have for decades had more inclusive and centralized trading arrangements than other regions, should provide the first test.
The other major monitoring issue in California has been whether monitoring should be limited to conduct specific to auction markets or whether it should look also at broader issues that have dominated most recent antitrust debates in this industry, such as market structure.
Some in California's governance structures advocated not dealing with market power abuses at all but only with other forms of manipulation distinctive to these markets. %n3%n FERC's late 1997 orders, however, made clear that it expects the monitoring units to detect market power abuses in the auction markets and that it welcomes their input on broader issues of market structure. However, FERC recognizes that the resolution of these issues more likely would occur in other contexts such as FERC or antitrust agency proceedings.
Fines, Penalties and Corrective Action
One reason that the FERC prefers broad-scope surveillance in California stems from a recognition that simply setting up programs to monitor market power does not presuppose that the programs will be equipped to deal with abuses once they are identified.
In proposing their monitoring "plans" to FERC, both the ISO and PX contemplated (and FERC accepted) a menu of options for enforcement or corrective action in descending order of probable use. At the top of the list is prospective modification of the detailed rules of new markets to eliminate design flaws that permit market power abuse or other forms of manipulation (using ADR where appropriate to broker compromises between conflicting stakeholder views). Notably, the proposed New England monitoring plan adopts a similar approach, preferring deterrence rather than punishment for exercises of market power, seeking explanations from market players for apparently problematic conduct before acting and allowing them to institute ADR reviews of ISO mitigation actions.
For clear offenses of existing rules, the California ISO and PX will develop a menu of fines and other sanctions. The Commission, sensitive to its own prerogatives and limitations in this area, already has signaled that it will scrutinize carefully these assertions of enforcement authority, especially where they involve limiting the rights of market players to compete.
Where serious violations of FERC's regulatory policies or those of the antitrust agencies are perceived, direct referrals to these agencies probably will be used. The monitoring programs may provide information, and perhaps their views, to the pertinent agency but leave the discretion to take corrective action in its hands.
In situations such as California's, where the ISO and PX both have stakeholder-dominated governing boards, special attention has been given to the "independence" of the monitoring programs (em by ensuring them a direct avenue to the regulators and antitrust enforcement agencies where a potential exists for stakeholder interests in the governance structure to block effective action.
In northeastern pools, where each system has now proposed governing boards of external experts, unaffiliated with any stakeholders, the concern over the "independence" of the monitoring function has not been such a major issue. F
Reinier Lock is a founding partner of the law firm of Cameron McKenna, LLP, resident in the firm's office in Washington, D.C. He developed the plans and protocols for the market monitoring programs for the California ISO and the PX and advised plans for ISO New England and PJM. He was the legal advisor to former commissioner Charles Stalon at the Federal Energy Regulatory Commission, and deputy assistant general counsel for regulatory interventions at the U.S. Department of Energy.
Otter Tail's Odyssey
Seeking a Balance With Antitrust
After a quarter century, regulators are still unsure how to coexist.
WELL before competition began in the electricity industry, the
courts questioned (em without really answering (em how antitrust enforcement and traditional regulation should coexist and interact in the oversight of the electric utility industry.
SHATTERED ILLUSIONS. In its renowned Otter Tail decision in 1973, the Supreme Court shattered any illusions that public utility regulation at the federal level (under the Federal Power Act) might provide any sort of immunity from antitrust laws. In that case, a utility's efforts to use its monopoly power to prevent wholesale customers from obtaining power elsewhere were found to violate the Sherman Act; and the district court ordered wheeling to correct the abuse.
The expectation of immunity at the federal level had been based in part on an analogy to the previously recognized "state action" doctrine, which provides a level of immunity from antitrust liability for utility activities regulated by state commissions. However, that doctrine is based upon principles of federalism that hold at bay the federal antitrust laws when states have authority to regulate a field of activity. It is not based upon any systematic effort to define the relationship between antitrust law and public utility regulation.
The Otter Tail decisions, then, also dispelled any hope of finding some clear dichotomy between the scope of these bodies of law. Instead, a hazy line has grown up between them. This ambiguous boundary creates an uncertainty that is compounded by the curious disjuncture between the effect of state and federal regulation on antitrust law, the former conferring some level of antitrust immunity, the latter not.
Moreover, court decisions after Otter Tail made clear that even the state action doctrine does not confer blanket immunity in state-regulated areas of activity. Its application has fallen subject to increasingly rigorous tests: the courts now require that the state's intent to displace competition with regulation is "clearly articulated and affirmatively expressed" and that the regulator concerned "actively supervises" the conduct in question.
GROWING AMBIGUITY. Today, the relevance of the state action doctrine is waning as state regulation retreats from its traditional comprehensive coverage of utility activities to accommodate both broader federal assertions of regulatory authority over a disaggregating industry and increasing competition at the wholesale and retail levels.
At the same time, however, antitrust principles are gaining in importance, as the electric industry creates new, markets and institutions (e.g., competitive power pools and independent system operators) about which regulators have little experience.
In fact, the growing ambiguity as to how far public utility regulation will afford antitrust immunity is compounded further by the shifting line between federal and state regulation. The "bright line" that the courts had sought to find in the Federal Power Act between the two (em never crystal clear (em is now blurrier than ever, as the FERC asserts new authority over utility activities now "unbundled" and removed from the scope of traditionally broad state rate regulation.
Who, for instance, will regulate to ensure "reliability" (em a mantra within the industry, and an article of faith with Congress and regulators (em is currently up in the air, as the FERC asserts jurisdiction over ISOs, and the Department of Energy re-examines the industry's self-regulatory role, carried out through the North American Electric Reliability Council and the regional reliability councils.
THE NEW MATRIX. In the wake of the Otter Tail decision, the FERC turned its attention to the principal antitrust concern in that case: how to control the inherent market power or natural monopoly characteristics of utility-owned electric transmission and system control, still largely integrated and generally viewed as an "essential facility." Here, for a quarter century, lay the primary policy battleground.
That all changed in 1992 with passage of the Energy Policy Act, which gave authority to the FERC to order nondiscriminatory transmission service. Within a few years, FERC had ensured open access through Orders 888, 888-A and 889. Much remains to be done, however, to develop transmission pricing principles and to ensure that these new systems, such as California's, provide equitable and efficient access, pricing and transmission planning regimes. Yet the fundamental debates over access that dominated the 1980s are over.
The FERC has encouraged industry players to deal with these inter-utility and interstate issues through regional transmission groups and independent system operators. Such institutions, FERC signaled, could create a self-regulatory role for the industry. The industry responded positively with a raft of RTG and ISO proposals.
Nevertheless, in the wake of the 1992 Act, skeptics questioned whether the FERC could succeed with its policy of heavy regulation of transmission to permit competition in generation. They wondered whether structural separation of the generation and transmission functions, as occurred in England & Wales and other international restructurings, would prove necessary. In fact, the FERC's implementation of the 1992 Act, without direct legal authority to order divestitures but requiring "functional unbundling," may have gone a long way to release the genie from the bottle. "Voluntary" divestitures (usually under regulatory pressure) by integrated utilities of generation assets have already occurred in California and New England; others may follow. (Ironically, the most active restructuring phenomenon this decade had been horizontal mergers of vertically integrated utilities, probably best explained as utilities positioning themselves to compete more effectively, or to divest more profitably, in ever-expanding regional bulk power markets.)
The FERC's functional unbundling policy has encouraged the formation of competitive pools for wholesale bidding and ISOs to manage transmission. These new institutions promise competitive, real-time or short-term auctions or spot markets, both for energy or other electricity services. They create a new matrix, combining antitrust principles with traditional state and federal utility regulation. Defining the exact role and modus operandi for these new "frontline" institutions will only compound the complexity of electric restructuring. California, the site of the most advanced U.S. restructuring effort to date, offers a striking case in point.
1 The terms "monitoring" and "surveillance" are used to describe essentially similar functions and are used interchangeably herein.
2 Fortuitously, Mark Rossi of BDR Inc of Fairfax, Va., who serves as chairman of the Alberta Pool's external Market Surveillance Committee and consultant to the Trustee of California ISO and PX, also played a major and insightful role in developing the basic precepts of the California monitoring programs.
3 However, it is not easy to see how the monitoring units readily could distinguish, at least at first sight, between exercises of market power and other forms of manipulation. Moreover, as former FERC Commissioner Charles Stalon has put it so well, "it is¼ not simple to distinguish between dynamic rivalry of firms¼ and the pursuit and capture of monopoly power."
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