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<title>August 2002: "Doggone"</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>
August 2002</u><br>
</b></p>
<p><font size="6">"Doggone"</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>/11/27)<br>
</font><span style="font-size: 10.0pt; font-family: Palatino; color: black">
</span></p>
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<p ALIGN="JUSTIFY">The dog days of summer have arrived. At the flicks, it’s
Scooby Doo. In the serious tabs, it’s the cry for market "watchdogs."
Canine-mania seems to extend to the quality of politicians’ performances
regarding restoration of faith in markets’ operations and accounting
numbers. </p>
<font FACE="Palatino" SIZE="1">
<p ALIGN="JUSTIFY"></p>
</font>
<p ALIGN="JUSTIFY">Everyone says they want a watchdog now for some facet of
the economy’s operation. Recent events have led commentators (and,
evidently, the investing public) to the radical conclusion first articulated
by Adam Smith and resurrected last by the New Deal: markets need oversight,
if they are to maintain the credibility needed to be effective capital
allocators. A subset of this principle in the deregulated energy industry
is: market participants need the specificity of a detailed oversight
approach, if those markets are to perform in the public as well as the
private interest. But energy companies already have a watchdog – the
regulators put in place to watch the regulated industries. Right? Maybe,
wrong.</p>
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</font>
<p ALIGN="JUSTIFY">At the core of the promise of electricity deregulation
was the role of trading markets, making possible far greater movement of
power than had been the case when wholesale utilities periodically
accommodated their respective needs through inter-regional wholesale trades.
Improved reliability, price reduction, and smoothing of rates were all
results to be anticipated. The confluence of electronic trading capability
with deregulation was further touted as enhancing their trends, as well as
making possible new wealth creation through financial products trading. One
of the ongoing rhetorical cornerstones of deregulation proponents –
post-Enron – has been that market liquidity gaps were quickly closed after
the demise of the largest player.</p>
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</font>
<p ALIGN="JUSTIFY">Now, however, the vision of electrons being virtually
moved in time and in response to true market needs has begun to fade.
"Energy Woes Drain Online Power Trading" announces the Wall Street Journal,
citing the demise of additional major trading players like Dynegy, and the
sharp pull-back of many of the market leaders. The resulting switch back to
older trading outlets – and lower tech trading modes – in turn promises to
bring a new level of unpredictability of energy prices, as a diminishing
number of trading outlets scramble for business.</p>
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<p ALIGN="JUSTIFY">In addition, the possibility of significant takeovers
within the industry has been raised, as many of the familiar leading players
in trading face deep market discounts and the prospect of a wave of
takeovers is presented. Balance sheet pressures and executions of asset
sales programs seem likely to create additional uncertainties.</p>
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</font>
<p ALIGN="JUSTIFY">In short, absent restoration of market operations,
deregulation faces less liquidity, potential greater possibilities for
control of markets by a few parties, and more volatile prices.</p>
<font FACE="Palatino" SIZE="1">
<p ALIGN="JUSTIFY"></p>
</font>
<p ALIGN="JUSTIFY">With these present and looming threats in mind, we turn
with anticipation and concern to the response of the mother of deregulation
– the Federal Energy Regulatory Commission. Its capabilities were most
recently assessed in a GAO study entitled "Concerted Actions Needed by FERC
to Confront Challenges that Impede Effective Oversight" (the "Study").</p>
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<p ALIGN="JUSTIFY">What we learn from the Study might, without exaggeration,
be summarized as follows: FERC </p>
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</font>
<dir>
<li>
<p ALIGN="JUSTIFY">has not yet developed a detailed oversight approach for
competitive markets;<br>
</li>
<font FACE="Palatino" SIZE="1"></font>
<li>
<p ALIGN="JUSTIFY">does not have outcome measures for its goals and
objectives, so that its progress can be assessed; and<br>
</li>
<font FACE="Palatino" SIZE="1"></font>
<li>
<p ALIGN="JUSTIFY">lacks a clear, articulated vision of how the agency
will monitor these markets.</li>
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<dir>
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<p ALIGN="JUSTIFY">Incidentally, the Study insightfully confides, some of
its difficulties also reside in the absence of suitable legislation for
carrying out these missions. The Study makes a few important constructive
observations, which it reiterates several times in different forms (either
its authors are paid by the word or were mesmerized by a college rhetoric
teacher regarding the power of repetition):</p>
<font FACE="Palatino" SIZE="1">
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</font>
<dir>
<li>
<p ALIGN="JUSTIFY">It is very difficult for an agency to enforce rules, if
it cannot levy civil penalties.<br>
</li>
<font FACE="Palatino" SIZE="1"></font>
<li>
<p ALIGN="JUSTIFY">It is difficult for an agency to oversee an activity
like trading, if its employees must still use its internal informational
resources to learn the basics of the business.<br>
</li>
<font FACE="Palatino" SIZE="1"></font>
<li>
<p ALIGN="JUSTIFY">It is hard for any organization to come up to speed
when it has recurring chief executive turnover, and over one-quarter of
its employees are slated to decamp in the next few years.</li>
<dir>
<dir>
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<p ALIGN="JUSTIFY"></p>
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<p ALIGN="JUSTIFY">Finally, at the heart of the Study’s matter, are its
"Recommendations for Executive Action." The suggestions are, as they relate
to the trading function, at once so fundamental and yet so seemingly out of
reach of the agency as to raise a real sense of what Winston Churchill
referred to as his "black dog" (i.e., depression). Picture the state of the
securities world, if a GAO report or the SEC felt compelled to recommend
measures such as these, which it commends to the FERC:</p>
<font FACE="Palatino" SIZE="1">
<p ALIGN="JUSTIFY"></p>
</font>
<ul>
<li>
<p ALIGN="JUSTIFY">"Update the agency’s strategic plan to include outcome
measures that can be used to assess how well FERC is doing in achieving
its strategic goals and objectives for overseeing competitive energy
markets."<br>
</li>
<font FACE="Palatino" SIZE="1"></font>
<li>
<p ALIGN="JUSTIFY">"Develop an action plan for overseeing energy markets,
in particular for electricity, until the transmission organizations’
market monitoring units become fully operational and FERC can implement a
comprehensive oversight approach for these markets."</li>
</ul>
<dir>
<font FACE="Palatino" SIZE="1">
<p ALIGN="JUSTIFY"></p>
</dir>
</font>
<p ALIGN="JUSTIFY">It should not be surprising that, in light of the Study’s
findings, Congressional reconsideration of the Feinstein derivatives trading
regulation bill re-introducing the CFTC to the energy trading picture is
receiving attention. Nor that the Congressional effort to cause FASB-reform
of "market to market" accounting procedures is not focused on that agency,
whose regulated commodity is the one whose trades are the ones to be marked
to market. What would one expect relative to an agency unable and unwilling
to monitor swaps and eliciting the comment from the Study that, unless it
opts to do so and compares simultaneous behaviors of participants in other
markets, it would be difficult to identify instances of market manipulation.</p>
<font FACE="Palatino" SIZE="1">
<p ALIGN="JUSTIFY"></p>
</font>
<p>Meanwhile, the screens blink off across the energy trading map and
liquidity of available power returns as an issue, particularly as the heat
of the summer dog days beats down, rekindling memories of summer shortages
past. The realization dawns that, while there may be times to teach an old
watchdog new tricks, there also are times to consider whether trading is a
dogfight to which the current watchdog is well suited at all. Unfortunately
for the unregulated trading power industry, the latter conclusion offers no
friendly hydrant to stop at. The industry must offer up oversight
alternatives that are credible. And in this political season where watchdogs
are in and lapdogs are out, if such suitable action is not taken, industry
trade proponents may find themselves between a Rottweiler and a closed
kennel place. A possibility that seems to be closing in.</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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