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<title>January 2002: Dr. FERC: Band-Aid/CAT Scan/Cure</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>
January 2002</u><br>
</b></p>
<p><font size="6">Dr. FERC: Band-Aid/CAT Scan/Cure</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:
2002</em>/03/09)<br>
</font><span style="font-size: 10.0pt; font-family: Palatino; color: black">
</span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">FERC is posing as a stern but kindly doctor
for the troubled state of deregulation. “We’ve got to address this
surgically,” announced the Chairman. Far more is involved than the headlines
declaring “Big Power Firms Face Price Curbs” (although that is true enough).
Market-based rates have been granted since deregulation to both old and new
facilities – EWGs, generation acquired as a result of divestiture and power
marketers. That’s why there’s new deregulation gold in the old power system
hills. The golden spikes of California were market-based rates.</span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Now that the California experience is
receiving recognition to a certain extent as one where market power
permitted gouging occurred (sorry about that, Gov. Davis), and the effort to
restructure access-neutral RTOs is running into the reality of the continued
might and breadth of the remaining regulated utilities and their holding
companies, FERC now has sucked it up and announced that it is serious about
being an aggressive policeman of the grid. The investigative and other
measures recently taken are, in the Surgeon General’s words, “a stop gap
Band-Aid to address market power. . .” </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">But these are Band-Aids that will pass the
ouch test when tugged: </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">• The investigation, in principle at least,
extends to all market-based tariffs that will continue to be tagged with a
FERC triennial right of review so that the rates remain just and reasonable.
</span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">• A new generic rulemaking is to be
launched, the upshot of which will be a replacement for the “hub and
spoke” 20% control of installed and uncommitted generation market test that,
arguably, may have fit the old vertically-integrated power markets but does
not fit them now. </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">• Potential refunds of prior rate
“overcharges” will be the principal penalty for anti-competitive
behavior or exercise of market power. Indicia of such behavior have a
definite California sour tang to them: physical withholding, economic
withholding (offering output to the market at a price that is above both its
full incremental costs and the market price), barriers to entry (including
denial of natural gas service).</span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">The poster children, to whose knees these
Band-Aids are first forcibly being applied, were announced by FERC in a
parallel order with respect to the triennial market power updates submitted
by AEP/CSW, Entergy and Southern Company Energy Marketing (now Mirant).
At this proceeding, the Commission announced its preferred market power
screen to be used in preference to hub and spoke – to be applied at least
until the culmination of the proposed Market- Based Rates Rulemaking. No
Band-Aid, but rather a CAT Scan, this Supply Margin Assessment (“SMA”)
screen is. While the formal legal tests remain the same, up until now the
presence of an approved open access tariff was deemed a sufficient mitigant
of market power (along with representations and public policing). This no
longer will be the case.</span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">The new metric, the SMA screen, has two key
new features. It defines a market in terms of whether transmission will
allow supply to reach buyers (taking into account the total (transmission)
transfer capacity – “TTC” – into the market). This metric measures the
significance of the level of applicant’s market presence in terms of whether
its capacity must be used to meet the market’s peak demand. “An applicant
(for market-based rates) will be pivotal in the markets if its capacity
exceeds the market’s surplus of capacity above peak demand – that is, the
market’s supply margin. The SMA test therefore is sensitive to the potential
for an applicant to successfully withhold supplies in the market in order to
raise prices. By implication, the SMA labels as “pivotal” all generators in
severely capacity-inadequate markets. </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Dr. FERC will withhold its MBR stinging
Band-Aid cure if the patients go directly to his designated waiting room. If
all their sales, including bilateral sales, are made to an ISO or RTO with
Commission- approved market monitoring and mitigation, they will be exempt
from the SMA and be subject instead to the thresholds and mitigation
provisions of the Commission-approved market governance body. In other
words, if a power marketer wants to pass the SMA in three control areas, it
will be able to do so once RTOs have taken charge of those control areas.
(In forensic medical circles, this type of arrangement is called a “forcing
function.”) </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Applying its newly-minted SMA tests of
market dominance to the cases at hand, FERC arrived at the remarkable
conclusion that each of the applicants had the generation needed to meet
market peak demand in its control area (i.e., did not pass the SMA screen
test); and since none of them were yet RTO denizens, they are to be subject
to “mitigation” – the plaster on the sticky side of the Band-Aid. That
mitigant is the subjection of the hourly excess capacity for spot market
sales in the relevant market to split the savings cost-based rates. The
traditional reasoning behind this mitigant is two-fold: </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">• By eliminating an applicant’s ability to
negotiate trade benefits, the seller applicant’s market power in the spot
market will be checked. </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">• Abuses in the longer-term (forward)
markets will be prevented by customers shrewdly uniting to purchase in the
red time market. (Consequently, no longer-term, cost-based rate controls
will be applied.) </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Seller applicants must provide the 24-hour
incremental costs for energy offered for spot market sales in the company’s
control area. Independent third parties will be required to operate and
administer the OASIS sites of the applicant utilities – none of which is a
member of up-and-running or soon-to-be-running RTOs. </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Basically, the doctor is really a
social engineer. It will only apply the CAT Scan and apply the Band-Aids In
the absence of RTO governance. It will apply no long-term price caps,
because it will require intense monitoring of California. And, by way of
learning from its California HMO colleagues, “if in the future a legitimate
concern is raised that indicates an exercise of market power in the longer
term products offered by the applicants, further mitigation may be
necessary.” The Chairman has publicly sighed, and said he wishes to see no
more Californias in his operating room ever again (and that he wants
California market mitigation in place by the time of renewal of the current
artificial price limitation measures). </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">The doctor may not have considered the
uncertainties as to rates (and the ramifications of this fact for financing
based on forward price curves) pending the full ingestion of his RTO cure.
FERC also is reposing a great deal of faith in a cure that itself is now
being challenged by angry patients – like the industrial customers
throughout the West and the beleaguered citizens of the Peoples Republic of
California. More broadly, its cure’s effectiveness is de-pendent on the
mitigants installed by the still nascent-RTOs (taking into account the
ultimate results of FERC’s approach to interconnection and related
policies). It is a cure, in short, that wouldn’t get past the FDA at
this time. So, while (anachronistically) we tip our “cap” to FERC’s efforts,
we can only hope that the patient will survive its clever operating
procedure. </span></p>
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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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