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<title>August 2003: Wooden Wall</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 2003</u></b></p>
<p align="center"><font size="6">Wooden Wall</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: 2</em>003/09/26)<br>
</font><span style="font-size: 10.0pt; font-family: Palatino; color: black">
</span></p>
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<span style="font-family: Arial">The Maginot Line, built in the 1930s, was
to be France’s fortress defense line against any subsequent invasion by
barbarians from the East. Its reflected “lessons learned” from World War I
that defense, not offense, was key to survival. There were two catches
regarding the efficacy of that wall: part of the fortress line was left
unbuilt because it was thought unnecessary, since the terrain was
impassible; another part was unbuilt because it abutted a neutral nation
whose neutrality would naturellement never be compromised by invaders. The
terrain wasn’t impassable, the neutral nation was compromisable, and the
Third Republic was overrun.</span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Chairman Wood’s version of the Maginot Line
(the “Wooden Wall”) (EL01-118-000), “Order Seeking Comments on Proposed
Revisions to Market-Based Tariffs and Rates,” has its roots in the Great
California Market War, which occurred at a time when FERC’s promulgation of
rules allowing wholesale market-based rates under virtually all
circumstances proved no match for the “Fat Boy” bombs that Enron and its
gothic trading hordes unleashed on California’s ill-constructed deregulation
market design. </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">After belatedly and laboriously uncovering
the skullduggery involved in the California Market War and issuing a series
of orders, FERC now is tendering new higher standards and requirements for
generator entitlement to receive market-based rates. Availability of
market-based rates is a keystone to the operations of the deregulated
market. Consequently, FERC has stressed in the Order its need to balance
three valid and necessary objectives: remedies for anti-competitive
behavior, clear rules of the road, and limitation of regulatory uncertainty.
Build it right, says the FERC, and “an environment that will attract much
needed capital will come – while the barbarians will be kept from the gates
of the self-regulating Republic of Electric Deregulation. The new rules
would apply, whether the market was governed by an ISO or an RTO, i.e., with
or without full implementation of Standard Market Design.</span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">The FERC Order reflects the new-found
understanding that it is not a sufficient defense against anti-competitive
behavior to prohibit it generically in an Order and to provide for rights of
affected parties to obtain refunds or other remedies. Some precision is
required. Without explicating its very significant details, the proposed new
Market Behavior Rules (MBRs) are essentially as follows:</span></p>
<ol>
<li>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Operate and schedule all generation in
compliance with the applicable power market rules (thereby affording FERC
direct remedial authority in that regard).<br>
</span></li>
<li>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">No “market manipulation,” defined in
terms of a non-exclusive list of non-permissible activities, including the
abuses established to have occurred in California. (This MBR is subject,
however, to what could become known as the “Maginot Caveat”: “…we will
appropriately balance our need to remedy anti-competitive behavior with
the legitimate needs of market participants for clear rules.”)<br>
</span></li>
<li>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Accurate and factual communications to
all regulators.<br>
</span></li>
<li>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Factual information to publishers of
indices.<br>
</span></li>
<li>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Detailed record retention for five (5)
years.<br>
</span></li>
<li>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">No collusion to violate the Seller’s Code
of Conduct or the Order No. 889 standards of conduct.<br>
</span></li>
<li>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Profits unjustly obtained by violations
are subject to disgorgement, if sought in a timely manner. </span></li>
</ol>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">As fully fleshed out, these are not
insignificant requirements and, properly enforced, should repel classic
Enron invaders along the Wooden Wall. </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">But alas, The Wall Street Journal reports
that the “rare star” of the electricity industry, the Southern Company, has
cleverly found a “sweet spot” even larger than the Panzer commandos found in
and around the Maginot Line in 1940. As the Journal puts it, “The Atlanta
Titan Capitalizes on a Regulatory Quirk, Ties Between Its Units.”
Gotterdammerung, y’all. </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Basically, Southern’s wholesale affiliate,
Southern Power, has been supplying 80% of its new power supplies (at, you
guessed it, “market-based rates”) to the Southern Company’s regulated,
monopoly retail utilities (which are allowed by state legislators and their
regulators to pass through the costs). Southern Power can earn much higher
wholesale profit margins than its retail corporate siblings. Shifting assets
(such as real estate) at bargain prices to an unregulated affiliate thus may
shift higher profit potential as well. Up to now, Southern and Entergy have
defended the secrecy of information on their wholesale price power contracts
as “trade secrets.” (FERC has now begun to reject that particular argument.)
</span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Put generically, the gap in one party’s
defensive line has become the sweet spot favored by the other’s offense.
Holy Sarbanes-Oxley Wood man, what is to be done? It all comes down to
whether the spirit of deregulation will be preserved by strengthening and
clarifying the “market-based rates” rules or, whether absent complete
national, wholesale/retail structural deregulation, the existing distinction
between regulated and unregulated affiliates is one that will be exploited
to produce competitively distorted results. </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">The treatment of market-based rates is
important, because FERC has withdrawn from its forward SMD position. The
Market Behavior Regulation (“MBR”) line, therefore, is critical to the
preservation of the objectives of deregulation. As the FTC has stated
recently: </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">“When regulatory costs disproportionately
disadvantage more efficient firms, higher-cost firms continue to serve the
market, and customers are likely to face higher prices than would otherwise
prevail.”</span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Like the Maginot Line before it, the MBR
line has been designed in a way that leaves room for its excursion. Whether
FERC can plug the gap tenaciously with individual proceedings when there
remain structure flaws, as it has begun to do, remains to be seen. </span></p>
<p class="MsoNormal" style="text-autospace: none">
<span style="font-family: Arial">Gen. Maginot, meet Colonel Wood.</span></p>
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<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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