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Panelists Question Whether FERC Screens Eliminate Market Power Possibility

January 31, 2005
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There's a chance that power companies could successfully pass interim generation market power tests adopted last year by federal energy regulators and yet still have the potential ability to wield market power, FERC staff and Commissioners were warned at an all-day technical conference last Thursday.

The overall message delivered by several utility industry representatives and other parties is that the two screens should be considered a work in progress and that FERC should take a good, hard look at revising the tests.

Panelists convened at FERC headquarters in Washington, DC, for the first of a two-day technical conference related to market-based rates (MBR) for public utilities [RM04-7]. The conference is examining issues associated with generation market power and affiliate abuse, two of the four prongs the Commission uses to determine market power for purposes of reviewing applications for MBR authorization by power companies.

The first day of the conference considered whether, and if so to what extent, the Commission should modify the interim generation market power screens [pivotal supplier and market share] adopted by FERC in 2004 and the appropriate mitigation for those found to have generation market power.

Both screens "provide very useful information to this Commission and we would urge you not to stray from these screens," said Denise Goulet, senior assistant consumer advocate for the Pennsylvania Office of the Consumer Advocate. "But we do believe that these screens alone do not tell the whole story." FERC should "undertake some additional revisions to these screens," Goulet said.

"We believe that an entity can pass both the interim screens and yet still possess the potential to exert market power," Goulet went on to say. "We believe that because that entity may very well be able to control a critical section of the supply curve in the market in which they find themselves. I guess you would put us in the category of those who think the screens can produce false positives as opposed to false negatives."

Goulet said her office believes that FERC "should modify the interim screens and require applicants for market-based rates to submit a supply curve analysis that will allow the Commission to discover where the applicant's units fall on the supply curve and also whether the applicant has the incentive to exert market power." In order to undertake such analysis, "we believe that you should require the applicants submit additional information reflecting the type of the units they own and the heat rates of those units."

Mark Hegedus, appearing on behalf of the American Public Power Association (APPA) and the Transmission Access Policy Study Group (TAPS), said that these groups "worry about cases where applicants pass the screens, but nonetheless have the ability and incentive to exercise market power and for this reason we support incorporating an analysis of supply curves into the MBR test."

He said that APPA and TAPS "strongly disagree with those who would ditch the market share screen or neutralize it by using what has been called contestable load or truncated market share analysis." He said that such analysis "ignores the competitive capability provided by the generation fleets of large sellers, especially ones that operate their own transmission control areas. These fleets make an enormous difference to those firms' ability to compete and influence price."

But Louis Jahn, director of wholesale market policy at Edison Electric Institute (EEI), said that EEI "believes that there is a need at this point to implement a market power screen that would provide the Commission with a more accurate determination of whether the applicant does or does not possess market power based upon an assessment of the actual state of competition in the marketplace."

From EEI's perspective, "that determination process should focus on an analysis of the relationship between contestable loads and competitive generation resources in the market. This is the conceptual premise, or the basis, for EEI's contestable load analysis."

For his part, James Bushnell, research director at the University of California Energy Institute, asserted that the interim screens "create unnecessary risks for both false positive and false negative indications of market power."

Bushnell said that "the spirit of the changes embodied in the development of the interim screens could be improved upon by embracing screens that are just more fundamentally based in economic oligopoly models." A screen based on an oligopoly model "could be implemented in a way that really would require no more computing power than the types of formulae we've been talking about."

Stephen Henderson, vice-president of Charles River Associates, appeared before the conference on behalf of Entergy Corp. Henderson said that while it's appropriate to use two indicative screens, he also believes that the screens in question "are flawed and need to be modified."

His overall message to the Commission? "To study wholesale electricity markets requires separating the wheat from the chaff -- in this case, separating the capacity and load that's in the wholesale market and subject to market price risk from the capacity and load that's not in that position."

The "chaff" that needs to be removed "is the capacity that's committed to native load and, if you're going to study non-peak periods, off-peak periods, it's the uneconomic capacity. If one's going to study uncommitted capacity, you necessarily must remove the committed capacity from the analysis and to do so requires an accounting of native load and such load does not pay market-based prices in the first place."

Also, in any examination of non-peak periods, "you necessarily must remove the economic capacity that's not in the market. It's just simply not possible to raise market prices by withholding generation that's not in the market in the first place," Henderson said.

Meanwhile, London Economics International LLC Managing Director Julia Frayer said that FERC needs to refine the market power tests using "best practices from energy sectors abroad and the experiences of other industries."

Among other things, Frayer said that the current market power tests do not differentiate between scarcity rents -- above marginal cost profits during period of tight supply-demand -- and market power, and indeed could misinterpret scarcity for market power. Scarcity rents are legitimate because they signal the need for new investment and demand response, she said.

Frayer floated the idea of recasting the pivotal supplier test as a residual demand analysis, based on the necessity of a supplier's capacity to serve load, relating its bidding decisions to market-clearing prices and considering competitors' positions.

"On market power testing, FERC needs to address some of the well-documented shortcomings of the current tests in light of scarcity and pricing behavior," Frayer noted in her summary remarks. "Even if the interim screens and methodologies for market power analysis are refined and then retained, I believe that FERC should allow applicants to present the results from simulation models and other market power diagnostic measures for review and validation as a supplement to the set of tests required by the Commission."

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