UNITED STATES OF AMERICA BEFORE THE FEDERAL ENERGY REGULATORY COMMISSION

Investigation of Terms and Conditions Docket No. EL01-118-000 of Public Utility Market Based Rate Authorizations

Pursuant to the Commission’s Notice dated November 30, 2001 in the above-captioned docket, the National Association of State Utility Consumer Advocates ("NASUCA") hereby submits reply comments in the above-captioned docket. On November 20, 2001, the Commission had issued an Order Establishing Refund Effective Date and Proposing to Revise Market-Based Rate Tariffs and Authorizations (hereinafter "November 20 Order"). In that Order, the Commission requested public comment on its proposal to amend all orders issued for jurisdictional entities granting market based rate authority to set a refund effective date and to condition continued authorization of market based rates on prohibitions against the seller engaging in anti-competitive behavior or the exercise of market power; a requirement to make refunds; and on other remedies found to be just and reasonable such as termination of, or restrictions on, the seller’s market based rate authority. The Commission received over 100 comments on this proposal, many of them protesting the Commission’s decision to affirmatively address market power issues on grounds that the Commission lacks authority to undertake such action or on grounds that any possible remedy is too uncertain and would have adverse impacts on the development of competitive markets. Based on its recent experience, NASUCA shares the Commission’s concerns and encourages the Commission to continue along the track described in the November 20 Order. Thus, NASUCA disagrees with such comments for the reasons discussed below.

It is tempting to look at the existing wholesale electricity markets as established institutions because of the extensive activity they have supported. Nonetheless, they have been in existence for only a few years. Experience continues to accumulate, rules continue to evolve and products and services proliferate. In this unsettled and evolving context, the potential for the exercise of market power to exist is very real, as experience has shown, most prominently, in California. Even within the PJM Interconnection, LLC (PJM), which is recognized as one of the most liquid and competitive markets in the world, the PJM Market Monitor detected the extensive exercise of market power in PJM’s capacity markets within the past year. The cost to PJM markets approached $12 million with unknown additional costs in bilateral markets. The Commission can not turn a blind eye to the fact that rational, profit-maximizing concerns will do whatever they can to take advantage of markets flaws to their benefits. The Commission’s proposals in this docket are consistent with protecting consumers against market manipulation in these developing competitive markets.

I. Authority to Require Refunds

EEI, EPSA and others challenge the Commission’s authority to establish a refund effective date in this proceeding as a violation of the requirements in Section 206 of the FPA limiting the circumstances under which a refund effective date may be established. Additionally, these parties challenge the Commission’s authority to otherwise order refunds as a violation of the filed rate doctrine and the rule against retroactive ratemaking. Their arguments lack substance.

First, the arguments related to the limitations on the establishment of a refund effective date in Section 206 of the FPA are without merit. The Commission has evidence that market power has been exercised in both California and PJM markets and that conditions exist making it possible for market power to be exercised in these and other markets in the future. The fact that Section 206 limits the effective refund period to a fifteen-month time frame is not a reason to reject the use of this tool to remedy potential abuses. It is entirely possible that fifteen months will be sufficient time for current markets to transition to more competitive conditions. If not, the Commission always has the option at the end of this period to open a new Section 206 investigation and establish another effective refund period in order to ensure that consumers remain fully protected from market power abuses until workably competitive markets are in place.

The second argument raised by EEI, EPSA and others relating to the filed rate doctrine and retroactive ratemaking is likewise without merit. These parties argue that since the Commission can’t rely on Section 206 of the FPA to remedy past instances of market power abuse, any refund remedy would violate the filed rate doctrine and the rule against retroactive ratemaking. However, the course of action proposed by the Commission in the November 20 Order would constitute neither a violation of the filed rate doctrine nor retroactive ratemaking. The Commission’s discussion of these issues in its July 25, 2001 "Order Establishing Evidentiary Hearing Procedures, Granting Rehearing in Part, and Denying Rehearing in Part" in San Diego Gas & Electric Co. v. Sellers of Energy and Ancillary Services into Markets Operated by the California Independent System Operator and the California Power Exchange, et al., Docket No. EL00-95-004 et al., 96 FERC ¶ 61,120 (2001), offers illumination on this issue. In that order, the Commission addressed arguments raised by the parties as to whether the Commission had the authority to consider ordering refunds for a period prior to the refund effective date for prices charged in the California markets in 2000 and 2001 that exceeded a competitive market price. That discussion in essence established the basis for the Commission’s action in the November 20 Order in this docket.

In San Diego, the Commission determined that it could not reach back prior to the refund effective date to remedy market power abuse incidents occurring prior to that date in that proceeding. Several parties in that proceeding had argued that the Commission could reach back into periods prior to the establishment of the refund effective date on the theory that market based rate orders contained implicit conditions as follows:

1. market based rates are only just and reasonable if the market is sufficiently efficient and free from the ability of market participants to exercise market power;
   
2. there was an implied condition in the market based rate authorizations that the exercise of market power would be a violation of the market rate tariffs and subject the seller to retroactive refund liability; and
   
3. the Commission may order refunds where the rate charged violates the tariff by exceeding a market based rate because such proceedings are similar to disgorgement proceedings in which the Commission requires disgorgement of profits gained by violation of tariff provisions.

San Diego, supra at 61,507. The Commission rejected these arguments in San Diego on the basis that no such implicit conditions existed in the market based rate orders in that proceeding.

However, the Commission recognized in that order that it can remedy circumstances where a seller did not charge the filed rate or violated statutory or regulatory requirements or rules in applicable rate tariffs. Where a jurisdictional entity violates a tariff, or charges a rate other than that on file with the Commission, action to remedy such wrongful behavior is not retroactive ratemaking since the action does not change the rate or tariff on file, but rather obtains compliance with that rate or tariff and consequently prevents the utility from being unjustly enrich by the wrongful behavior. cf: Niagara Mohawk Power Corp. v. FPC, 379 F. 2^nd 153, 158 & n. 18 (D.C. Cir. 1967).

The parties in San Diego attempted to argue that market based rate orders implicitly contained the concept that anti-competitive market behavior would be a violation of the market based rate order since those orders presumed that competitive market conditions would exist and that the entity would behave in a competitive manner. The Commission found, however, that no such implicit condition existed in those orders. Thus, the Commission determined that no orders or conditions had been violated. The Commission stated:

the conditions hypothesized by the parties are not evident from the market-based rate schedules or our orders. Thus there is no basis for finding that the sellers acted inconsistently with Commission-filed tariffs or with specific requirements in their filed rate authorizations. Id. at 61,507-08.

In the present docket, the Commission seeks to explicitly impose in all jurisdictional sellers’ market based rate orders the conditions that it found missing in San Diego. The Commission here explicitly provides notice of the conditions with which sellers will have to comply, i.e. agreements not to engage in anti-competitive behavior or in physical or economic withholding of capacity, as well as agreements to comply with refunds requirements if market power abuses are detected, or to termination of, or limitations, on market based rate authority. Consequently, the Commission proposes here an appropriate remedy for market power abuses in the future.

An essential goal of the FPA is to protect consumers against the exercise of market power in the payment of unjust and unreasonable rates. 16 U.S.C. Sections 824(d) and 824(e) Within this context, the Commission has the authority to grant market-based rate authority where it finds that market based rates will accomplish the purposes of the Federal Power Act in ensuring that consumers pay only just and reasonable rates. Louisville Gas & Electric Company, 62 FERC ¶ 61,016 (1993). In so doing, the Commission has the authority under Section 206 and Section 309 of the FPA to reopen market based rate authorization orders to condition the grant of such authority upon the proviso that certain requirements are satisfied.

Even though competitive circumstances at one point in time may justify the grant of market based rate authority, recent events in California, and even in PJM’s capacity markets, demonstrate that those circumstances can change rapidly, thus allowing sellers the opportunity to exercise market power. Even though the Commission may act swiftly once a complaint of market power abuse is brought to its attention, significant damage to consumers and to competition in general can occur while the abuse is on going. The course of action the Commission proposes to follow in this docket of placing explicit conditions on market based rate authorizations will enable the Commission to ensure that rates for consumers remain just and reasonable by enabling the Commission to remedy any abuses found to have occurred. Section 206(a) requires that the Commission take corrective action when it finds that "any rate … rule or practice" is unjust or unreasonable. Here, the Commission has determined that is unjust and unreasonable to allow sellers to charge market-based rates without the condition that there will be refunds if the seller exercises market power. Therefore, Section 206(a) not only authorizes the Commission to take the action proposed in this docket but requires it.

The Commission proposal to condition market based rate authorizations on agreement to the provisos listed in the November 20 Order in this docket will aid in promoting consumer confidence in the development of competitive wholesale energy markets. These markets are in their early stages. The Commission is currently investigating in Docket No. RM01-12-000 the prospect of standardizing energy market design in an effort to establish a market structure that would lessen the need for mitigation of market power. However, no one has yet developed a market design that is foolproof, as the events in PJM’s capacity market in the first quarter of 2001 demonstrate. Regulators, industry participants and consumers are learning much as these markets develop. However, consumers should not bear the high price of market power abuses during this transition period. The course the Commission proposes here comports with legal requirements for allowing remedies for violations of tariff conditions and the Commission should continue along this path.

II. Investment Concerns

Many commenters argue that the present course of action, if pursued, will result in uncertainty by investors and consequently lead to a reduction in investment, and thus competition, in wholesale markets (see e.g. the Edison Electric Institute ("EEI") at pages 7, 11 and 30 of its comments, and the Electric Power Supply Association ("EPSA") at page 2 of its comments).

First, the Commission must recognize that the opposite is true as well: an erosion in consumer and regulator confidence in the competitiveness of wholesale markets will also lead to a reduction in competition at both the retail and wholesale levels. The lack of confidence in the ability of industry to buy energy at reasonable rates in this country can lead to difficulty in gaining access to the capital markets for a large variety of businesses. Even though PJM is noted as the most liquid energy market, the sustained exercise of market power in PJM’s capacity markets in the first quarter of 2001 clearly aggravated the downturn in retail competition during that period in Pennsylvania’s retail choice program. Thus the Commission must walk the narrow line between investor concerns on the one hand and consumer confidence on the other in pursuing a course of action in this proceeding. Second, the Commission must recognize that the apocalyptic vision of investment fleeing the generation industry is speculative at best. Third, some comments imply that the financial risk is unlimited. Certainly, no basis for this is presented. In this context, examining the Commission’s recent actions related to market abuse and exercise of market power, it is clear that the Commission’s approach has been conservative. It is difficult to see that the magnitude of financial risk is significantly greater under the Commission’s proposed course of action.

To sum up, we submit that there will be only a limited impact on investor confidence resulting from the Commission’s approach. Balancing the need for consumer confidence to make markets function against the need for investor confidence to support construction, we submit that the Commission’s approach is balanced.

III. Incremental Costs

FirstEnergy recommended in its comments that the Commission clarify the definition of anti-competitive behavior, clarify certain terms in the November 20 Order, e.g. incremental costs, and limit the category of actions that might be considered evidence of physical or economic withholding. NASUCA agrees that these issues must be addressed, but not at this time. FirstEnergy seeks clarification of the guidelines the Commission intends to use in reviewing potential market power abuse cases pursued under the terms set forth in this docket. NASUCA agrees that the Commission should provide such clarification but submits that these are exactly the types of issues that should be pursued through a fast track NOPR process.

For example, FirstEnergy recommends that the Commission define incremental cost as follows:

1. the highest cost of fuel in the generator’s inventory at the time of generation;
   
2. the highest estimated emission costs the generator might otherwise incur during the year;
   
3. an Operations and Maintenance cost adder based on a 17 year average of actual, non-fuel operations and maintenance expenses for oil and gas fired steam plants;
   
4. the actual applicable heat rate for the incremental output that was not provided by the generator; and
   
5. expected start-up costs of the unit spread over the anticipated amount of energy that would be needed from the unit under must-run conditions.

Each of these proposals raises technical and policy issues that should not be adopted without full review and comment by affected parties. That is not possible at this stage of the proceeding

D. Precise Prescriptions

EEI and Alliance argue that the Commission should only control markets through proscribing specific behaviors and that the general prohibitions proposed by the Commission will sow confusion. (EEI and Alliance, 8-10) This ignores the reality of the competitive markets which the Commission seeks to foster. The creativity of market participants is the strength of the market as new products and services are constantly brought to the market. The power of creative markets cannot be predicted. The creativity of truly competitive markets translates into efficiency, i.e., more value is created at a given cost. Unfortunately, creativity is also seen in the exercise of market power. Just as it is impossible to predict the multiplicity of responses that a market will generate, it is impossible to know all the ways in which market flaws will be exploited. Thus, for EEI to argue against the proposed standard as too broad, flies in the face of the reality that FERC can never surely predict all approaches to market abuse and the exercise of market power.

E. Bidding Behavior

EEI and Alliance argue that the Commission will create such a degree of uncertainty regarding what constitutes market abuse that generators will be forced into a de facto regime of price regulation characterized by bids at short run marginal cost. It is a rhetorical exercise to suggest that the only "safe" bid is short run marginal cost. By suggesting that the Commission could view any competitive bid as reflecting market power, the vision is conjured up of a moribund electricity market. This overlooks the fact that the notion of market power has to do with the ability to control the market, not just with bidding at any price. PJM provides an excellent example, with the Market Monitoring Unit identifying the exercise of market power in only one of two prolonged periods when ICAP prices were at the bid cap. Indeed, as EEI observes, there are many components in the decisions to run a plant and how to price its output. These components are routinely examined by existing market monitoring programs whose operation was approved by the Commission.

F. Conclusion and Recommendation

NASUCA disagrees with certain commenters that the Commission lacks authority to pursue remedies in this docket or that the subject matter is too vague to be amenable to a behavioral remedy. We do acknowledge, however, that sufficient controversy exists to require additional input from stakeholders on these issues. NASUCA recommends that the Commission continue to pursue appropriate remedies to market power by initiating a Notice of Proposed Rulemaking ("NOPR") based on the course of action outlined in the November 20 Order to flesh out concrete terms and methodologies that will be implemented.

This NOPR should be placed on a fast track schedule of six months from start to finish. Most parties have been thinking about these issues for some time now and should be able to submit comments on a relatively short time frame. The NOPR approach has the advantage of curing the defects alleged by EEI, EPSA, and other to exist with the current Order, e.g. developing a methodology to calculate incremental costs or to better define economic and physical withholding. Such a fast track NOPR process will ensure that all parties are able to comment on all issues while providing the Commission the input it needs to fashion a rule that appropriately balances investor and consumer concerns as required by the Federal Power Act, 16 U.S.C. § 824 et seq. ("FPA").

In conclusion, it is important that the Commission continue to focus on the interests of consumers who ultimately pay the cost of market power. This cost may come in the form of increased prices or lost competitive alternatives.

NASUCA commends FERC for taking these steps to eliminate market abuse in the wholesale market and urges the Commission to continue these efforts in the manner set forth above.

Respectfully submitted,

Stephen G. Ward

Stephen Ward, President
National Association of State Utility Consumer Advocates
Public Advocate, State of Maine