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<title>October 2001: Wagon Train</title>
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<p align="left"><font face="Arial"><strong><small>About The Author:<br>
<br>
</small></strong><span lang="X-NONE" style="color: black"><font size="2">
ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon
Markets Group has practiced law related to the finance of environmental and
energy projects and companies for 40 years. In particular, he has analyzed
and executed a wide variety and substantial value of project financings. He
chairs the American Bar Association’s Committee on Carbon Trading and
Finance, serves on the Board of the American Council for Renewable Energy,
and has been a senior official in the Federal Energy Administration. He is
a graduate of Brown University, Yale Law School and Harvard Business School.</font></span></font></p>
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<img src="../images/feldman.gif" alt="Washington Viewpoint by Roger Feldman" border="0" width="375" height="75"><p><b><u><br>
October 2001</u><br>
</b></p>
<p><font size="6">Wagon Train</font></p>
<p><strong>by Roger Feldman -- Bingham, Dana L.L.P.<br>
</strong><font face="Arial" size="2">(<em>originally published by PMA OnLine Magazine:
200</em>1/01/19)<br>
</font></p>
<p class="MsoNormal"><span style="font-family: Palatino">As the power
buckboard rides faster and faster into the new frontier of deregulation, the
local marshals are taking a worried look at whether the wheels of the wagon
are sound.</span></p>
<p class="MsoNormal"><span style="font-family: Palatino">It looks like the
buggy may get jacked up for repair soon. It’s no less important a matter
than getting deregulation fixed so that there is no rationale for return to
re-regulation further down the trail.</span></p>
<p class="MsoNormal"><span style="font-family: Palatino">At the core of
electric industry restructuring is the availability of market-based rates (MBR)
for new power generation. What PURPA did for IPPs, MBR does in significant
measure for merchant generation in growth markets.</span></p>
<p class="MsoNormal"><span style="font-family: Palatino">While MBR is not
granted without FERC review, the standards have proved to be readily met.
Briefly, these include either no ownership of transmission, or no
anti-competitive control over transmission, with control most notably
mitigated through open access transmission tariffs; showing of no affiliate
abuse or reciprocal dealing with parent entities; and the absence or
mitigation of market power in generation.</span></p>
<p class="MsoNormal"><span style="font-family: Palatino">Essentially the
same rules apply with respect to the rates for acquired divested utility
generation: MBR authorization is usually sought by asset buyers, and is
often granted on the same terms as MBR authority for new generation, with
particular attention to market power issues. </span></p>
<p class="MsoNormal"><span style="font-family: Palatino">This last issue has
in the past been resolved by the commission through the folksy application
of “hub-andspoke” analysis, i.e. measurement of relevant market shares in
both installed capacity and uncommitted capacity, relative to particular
point-to-point service. This is approximately the test for separate wagon
service on a series of separate roads, each considered independently of all
the other adjacent roads and wagon traffic that a late 19th century bronco
trust buster might apply. Not surprisingly, there have been fewer than 10
MBR rejections out of over 800 MBR applications. FERC tacitly acknowledges
that in its regulations the hub-and-spoke test is so likely to be satisfied
that, since 1996, most new generators have been almost automatically
entitled to MBR treatment and need not even show the marshal how their
hub-and-spoke road will carry wagons.</span></p>
<p class="MsoNormal"><span style="font-family: Palatino">This was, of
course, the idea: the MBR hub-andspoke test was supposed to be a step toward
competitive “deregulation.” It was supposed to both promote the blooming of
a thousand private power-pumping flowers and lever open the integrated
generation-transmission systems of vertical utilities. The approach
certainly has begun to work – with just one drawback wildly demonstrated in
California. It is possible to have ferocious consumer-painful price swings
in an economically competitive market (at least from a hub and- spoke MBR
standpoint) due to the way that market is regulatorily structured, since
market power can be exercised by some players at least at some times with
respect to their plants. It’s hard to ignore the evidence of the California
experience. It’s also hard to structure a better MBR mousetrap for
anti-competitiveness. But that’s going to happen soon, as current thinking
about market structure and about appropriate competitive screens to
determine market competitiveness rise higher and higher in the FERC’s
consciousness.</span></p>
<p class="MsoNormal"><span style="font-family: Palatino">The last trail
marker, before this new policy perspective is enacted, may be Huntington
Beach Development LLC (FERC Docket No. ER01-2390-000), involving the MBR
application to FERC of facilities restored by AES to provide additional
capacity to power starving Southern California. Seeking cost-based rates as
the only measure for what is “just and reasonable” under Federal law
(“re-regulation” in today’s jargon), the California Commission sought to
resist, alleging that applicable affected markets had not been demonstrated
to be “workably competitive” nor AES to have shown that it lacked market
power, in light of its ownership of multiple facilities in the region.</span></p>
<p class="MsoNormal"><span style="font-family: Palatino">To which the
Commission (then in transition to its current make-up), coyly and
cryptically allowed that – in its florid mating ritual with California
market realities – it was “not prepared to abandon the hub-and-spoke
analysis in favor of another market analysis framework.” The rationale: the
temporary market mitigation measures ultimately established by FERC in
response to the California crisis (caps to you and me) would put the
Huntington facility’s rates within the newly-sanctioned “zone of
reasonableness.” The probable pragmatic rationale: we need more generation
in California and won’t get it if only cost-of-service rates are made
available. Of course, the FERC market mitigation measures will expire in
2002, leaving both regulatory “reasonableness” and appropriate MBRs for
services after that expiring rate limbo.</span></p>
<p class="MsoNormal"><span style="font-family: Palatino">But while
Huntington served as a stopgap answer to a then pending problem, the
concurring opinions in the case point the direction to where the
Commission’s focus probably will be heading. Commissioner Massey, in
dissent, derided the hub-and-spoke standard as “anachronistic and
unreliable,” and mocked the Commission’s suggestion that the new quarterly
filing requirements provided (or even were intended by FERC to provide)
satisfactory monitoring capability. Then newlyappointed Commissioner
Brownell, in her concurrence, articulated what is likely to be the
Commission’s new focus: “Experience indicates that a methodology that not
only looks at individual market shares, but also examines the market itself,
would be a far superior method.” What the new methodology or methodologies
adopted by FERC may be currently is problematic. The Commission is still
reviewing staff reports on the issue at press time. But as Commissioner
Brownell emphasized, it will likely tie into assessment of the larger
overall market characteristics, including attention to enhanced regulatory
market monitoring and enforcement policies. “The market” may come to be the
proposed new RTO regions. In short, in the near term, given regulatory
uncertainties, it could be tougher to get MBRs. In the long term, in legal
principle, existing MBRs could be subject to new challenge, up to and
including the cancellation by FERC of MBRs and the imposition of cost-based
rates.</span></p>
<p class="MsoNormal"><span style="font-family: Palatino">Which creates the
following paradox: the current system really doesn’t address de facto market
power.</span></p>
<p class="MsoNormal"><span style="font-family: Palatino">If care is not
taken, however, the new standard could be tied to the possibly utopian
market regulatory models the Commission is now engrafting onto its RTO
policy. Those may take a while to actually implement. Even then, if care is
not taken, policies could be instituted which do not serve to address the
root of much de facto market power – insufficient transmission
infrastructure and inadequate attention to congestion pricing issues. In
effect, if care is not taken, the effort to better open markets to
competition could create barriers to the very development it sought to
encourage.</span></p>
<p class="MsoNormal"><span style="font-family: Palatino">So, we should all
watch carefully this wagon train meander on as its wheels turn, trusting
neither to its antique hubs and spokes nor yet to the vagaries of promised
virtual and perpetual motion arising from new complex market tests.</span></p>
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<p class="MsoBodyText" align="left" style="margin-bottom:0in;margin-bottom:.0001pt;
text-align:left"><font face="Arial" size="2">
<span lang="X-NONE" style="color: black">ROGER FELDMAN, Co-Chair of Andrews
Kurth LLP Climate Change and Carbon Markets Group has practiced law related
to the finance of environmental and energy projects and companies for 40
years. In particular, he has analyzed and executed a wide variety and
substantial value of project financings. He chairs the American Bar
Association’s Committee on Carbon Trading and Finance, serves on the Board
of the American Council for Renewable Energy, and has been a senior official
in the Federal Energy Administration. He is a graduate of Brown University,
Yale Law School and Harvard Business School.</span></font></p>
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