Capitol Hill lawmakers, federal and state regulators and anumber of power industry representatives last week indicated thatthe results of the FERC staff inquiry into the pricing turmoil inthe Midwest power market were a vindication of their originalsuspicions. Staff proved once and for all, they said, thatelectricity restructuring was not the culprit behind the pricespike in late June, and it found nothing that smacked of marketmanipulation.

“…[W]hile there were allegations of market manipulation, the[FERC staff] team was unable to conclude that the regional pricingabnormalities were attributable in any measurable way tomisconduct, self-dealing or manipulation,” Chairman James Hoeckersaid last Thursday during an oversight hearing before the SenateEnergy and Natural Resources Committee, where the results of thelong-awaited staff team report were released. Although it found no”direct evidence” linking the price spike to market manipulation,staff noted that it did uncover some questionable practices.

It cited two specific practices – the use of swaps to circumventmaximum tariff rates and the use of brokers to create falseimpressions of the current price in the market – as especiallytroublesome. “Neither of the practices appears to be a direct causeof the price spike, but both diminish confidence that marketinstitutions are working in a fair and nondiscriminatory manner,and appear to be potentially questionable.”

Commissioner Jolynn Barry Butler of the Ohio Pubic UtilityCommission said its staff also was conducting a review of theMidwest price spike, but that the evidence so far didn’t point toany manipulation. “From our informal conversations to date, I doubtthat there will be a finding [by] the Ohio staff that inappropriateutility behavior occurred…” Although a number of large industrialcustomers had their service interrupted in late June, it appearsthat the utilities in Ohio followed their interruptible protocolsin their tariffs “to the letter,” she said.

The Electricity Consumers Resource Council (ELCON), whichrepresents large industrial power users, was “fairly comfortable”with staff’s finding that manipulation wasn’t a factor, said JohnHughes, director of technical affairs. He advised, however, hestill believes that some “subtle gaming” involving utilities’regulated and unregulated affiliates took place in June. “Whilethis…might have been legal, it might not have been really thetype of behavior that we’d expect in a real competitive market.”

The Edison Electric Institute (EEI), whose members are largeinvestor-owned utilities, was extremely pleased with staff’sconclusion “on that score,” said spokesman Jim Owen. “It reinforceswhat we had said all along, which was our members, the transmissionowners, were doing the very best to play by the rules and giveeveryone access to the system.”

In another significant finding, FERC staff concluded that the”particular combination of events” that led to the extreme natureof the power price spike in June were “quite unusual,” and were”not likely to recur.” Still, Hoecker told lawmakers, “neither thestaff team nor I underestimate the possibility that [some sort of]pricing abnormalities may occur in the future.”

Staff believes the operational problems that triggered the Juneprice spike – such as generation and transmission constraints -will continue to plague the power industry at least in the shortterm, which could allow other price abnormalities to occur, but itadded that the market conditions that aggravated this summer’spricing situation – ineffective short-term buying strategies andfailure to closely review creditworthiness of power marketers -already are being addressed by the power industry. “This suggeststhat market factors have already begun to act to reduce pricespikes, and can be predicted to do so in the future,” staff said.

Although the power market will continue to be volatile, thelessons learned by the market and its participants from the Juneprice spike will help to prevent future prices from reaching suchlofty levels, according to the staff report.. “[A]s buyers andsellers gain experience in the emerging…market, they will developways to better manage their exposure to the risk of future priceincreases.”

Hoecker told the Senate panel that he believes the unprecedentedprices were “at least exacerbated and perhaps caused by thecontinued balkanization of transmission planning and systemoperations.” To correct this, he said regulators need to stronglyencourage the formation of independent system operators (ISOs) andother regional transmission institutions. He asked lawmakers toclarify the Commission’s authority with respect to ISOs as part ofits legislation to restructure the retail power industry.

Sen. Dale Bumpers (D-AR) also voiced strong support for ISOs.”If we had had in place…a national system of independent systemoperators to deregulate the transmission lines in this country [inJune], a lot of this would have been avoided.”

Hoecker formed the staff team in July to investigate thecircumstances that led to the unprecedented power prices amidindustry cries that utilities had manipulated the prices during theJune 25-26 period. On those days, staff reported electric pricesrose from a $25 per MWh range to as much as $2,600 per MWh, with atleast one hourly price reaching $7,500 per MWh on June 25.

In its report, staff chalked up the exorbitant, yet”short-lived” power price increases to planned and unplannedgenerating outages, prolonged and unseasonably hot temperatures,transmission constraints, a lack of “clear, current and reliable”short-term price signals, defaults on power sales contracts, andthe “simple inexperience” of some market participants in dealingwith these circumstances. Despite the high prices, staff notedsystem reliability was maintained throughout the Midwest. “Noblackouts occurred.” And except for a “smaller flare-up in July,”power prices in the Midwest have since returned to normal.

Another key reason for the price spike was the fact thatconstruction of new generation capacity in the Midwest has failedto keep pace with the “substantial growth” in peak electricitydemand in the region, Hoecker noted. “These factors have causedMidwest utilities to depend more and more over time on purchases ofpower from other regions to meet peak demand.” Part of the problem,Bumpers noted, is that utilities and independent power producersare “essentially frozen” from adding new generation capacityuntil they know “what the rules of the road will be” with respectto electricity restructuring.

ELCON’s Hughes blamed the Midwest generators themselves,specifically their failure to operate capacity when it was neededthe most. “They’re not very good at generation. They’re just lousymanagers,” he said of the Midwest utilities. “That’s what theproblem was. If those generators had been running when they shouldhave been, there would have been no need for this investigation orthis report.”

No Direct Intervention

Contrary to the pleas of some industry sectors, staff said itsconclusions did not justify FERC taking the extreme step ofimposing price caps on sellers of electricity with market-basedrates, nor did they necessitate the Commission getting involved inthe setting of standards for creditworthiness for power marketersor require it to take other direct action that might “control orstifle the operation of the market.”

Sen. Richard Durbin of Illinois took issue with staff’s findingon creditworthiness. “…I don’t think it is unreasonable to have athreshold requirement before anyone is licensed to be a powermarketer in the United States,” he said, adding that he wasn’tadvocating re-regulation of the industry, but rather simply “basicstandards” for power traders. FERC “exercises almost no oversightto ensure that power marketers are financially responsible…” IfCongress wants the Commission to do creditworthiness tests,countered Bumpers, “we ought to give them authority or direction todo that.”

Like FERC, EEI’s Owen believes assessing the creditworthiness ofpower marketers should be left up to industry. “Individual tradersand players in the market really need to take it upon their ownpart to do the very best they can to make sure their partners arecreditworthy.”

In a “white paper” also issued last week, the Electric PowerSupply Association (ESPA) agreed with the FERC staff that the pricevolatility in the Midwest market did not warrant “drasticmeasures,” such as a mandated cap on the price for power. “Pricecaps and other forms of intervention would only serve to weakenthis rapidly developing market,” said ESPA Executive Director LynneH. Church. “What lawmakers and regulators – both federal and state- need to do is bolster this market by allowing full competition toflourish.”

Still, staff believes there are actions the Commission could andshould take. It recommended that FERC re-examine its monitoringactivity to assess whether new competitive markets are functioningproperly. “Improved monitoring methods would permit the Commissionto better detect whether any manipulation of wholesale markets orunduly discriminatory transmission practices are occurring,” itsaid. Toward this aim, staff suggested that FERC “formalize itsworking relationships and data-sharing arrangements with [the NorthAmerican Electric Reliability Council] and the network ofcontrol-area operators and security coordinators.”

Additionally, the report called for staff to review how to”maximize compliance” with the requirements and policies of Orders888 and 889, including standards of conduct, and prevent anyattempts to manipulate the market or circumvent the Commission’srules governing the interstate electric industry. Staff also thinksFERC and industry should consider developing real-time reporting ofthe prices for and availability of wholesale power and interstatetransmission, and take further steps to create regional independentsystem operators. Lastly, staff recommended that FERC, stateregulators, NERC and other entities “maintain open communication onways to use their respective authorities or organizations to helpensure that power markets function efficiently.”

Susan Parker

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