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Supreme Court Remands Western Crisis Contracts to FERC

While upholding the use of the Mobile-Sierra doctrine of contract sanctity, the Supreme Court last Thursday said the Federal Energy Regulatory Commission did not do an adequate job of evaluating harm to consumers, nor in reviewing the possible role of alleged unlawful market manipulation, in its decision to uphold long-term contracts signed by utilities with power suppliers in the midst of the implosion of the California power market in 2000 and 2001. While discarding major premises advanced by the Ninth Circuit Court of Appeals, which had rejected FERC's decision, the high court described its own reasons for remanding the case to the Commission and the Ninth Circuit for further review.

The 5-2 decision, with Judge Antonin Scalia writing the majority opinion, involved contracts signed by the Snohomish County Public Utility District (PUD) in Washington state and by Las Vegas, NV-based Nevada Power Co., which is owned by Sierra Pacific Resources, with marketers, the Morgan Stanley Capital Group (06-1457) and American Electric Power Service Corp. (06-1462). The utilities said the long-term contracts they signed with power suppliers during a period of market dysfunction locked them into high prices, substantially above market prices they could have obtained after the market stabilized.

The cases before the high court put a spotlight on the Mobile-Sierra public interest standard that the Federal Energy Regulatory Commission used in June 2003 to uphold the sanctity of long-term power contracts. That standard, established by the Supreme Court in historical cases, states that to meet the public interest standard, the challenger must prove it would impair the financial ability of a public utility to continue service, cast upon other customers an excessive burden, or be unduly discriminatory.

The high court rejected arguments aimed directly at application of the Mobile-Sierra doctrine, which were advanced by the Ninth Circuit in overturning FERC's decision. The Ninth Circuit had said the doctrine should not apply to contracts entered into under market-based tariffs because the Commission had not reviewed the initial contract and that FERC must evaluate whether the contract was signed during a time of market disruption.

"Markets are not perfect, and one of the reasons that parties enter into wholesale power contracts is precisely to hedge against the volatility that market imperfections produce...It would be a perverse rule that rendered contracts less likely to be enforced when there is volatility in the market," the Supreme Court said.

The court also rejected the lower court's proposition that contracts must be within a "zone of reasonableness" based on marginal costs. Calculating marginal costs of market-based contracts would place an impossible burden on regulators and inject uncertainties regarding rate stability and contract sanctity into the market.

But, in questioning FERC's conclusion that the impact of the contracts did not reach the level required for abrogation under the public interest standard, the Supreme Court said the Commission looked at the rates under the contract compared to then-current rates to determine whether the consumer burden was excessive, but it did not look at how the rates would compare against market rates several years into the contract. If there is a significant disparity between the contract rates and market rates that consumers would have paid in later years after the market stabilized, "that disparity, past a certain point, could amount to an 'excessive burden,'" the opinion stated. Here FERC's analysis "was flawed -- or at least incomplete."

The nine-year contract signed by Snohomish with Morgan Stanley called for a rate of $105/MWh compared to historical averages in the Pacific Northwest of $24/MWh. At the time the contracts were signed power prices in the area peaked at $3,300/MWh.

Since it had determined that the contracts could not be challenged under the public interest standard, FERC then said it did not need to consider charges by the utilities that their contracts were influenced by market manipulation. The Supreme Court, however, said a contract could not be considered valid if it is not the product of fair, arms-length negotiation. "Like fraud and duress, unlawful market activity that directly affect contract negotiations eliminates the premise on with the Mobile-Sierra presumption rests..."

Other cases involving contracts signed during the western power crisis are still in litigation and could be affected by the high court's decision.

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