FERC Plan to Curb CA Prices Comes Under Attack

FERC "took a large step" forward last Wednesday by approving the much-anticipated market monitoring and mitigation plan for the out-of-control California energy market, but it didn't go far enough, according to officials with Williams Companies, the New York Public Service Commission and Dynegy Corp. California lawmakers, however, were far more blunt in their assessments.

Gov. Gray Davis, who has been a sharp critic of FERC's handling of the California power crisis, called the Commission monitoring/mitigation plan a "shell game," and said the federal regulators "blew it" in their latest order (See related story). "FERC had a chance to bring meaningful relief to California's outrageous wholesale prices and they blew it," Davis said in a prepared statement. "It makes no sense whatsoever to condition the twelve months of [price mitigation] relief...to California's willingness to join a regional [transmission] organization that under the best of circumstances cannot be functional for another eighteen months.

"Last summer, the federal government found that wholesale prices were unjust and unreasonable. They have yet to enforce their finding."

Sen. Dianne Feinstein (D-CA), who is pushing price-cap legislation in Congress, also held out little hope that the Commission's price-mitigation plan would offer much relief to her home state. "The good news about the FERC decision is that it finally recognizes the problem of unjust and unreasonable rates facing the West. The bad news is that the FERC order doesn't solve the problem."

Rep. Bob Filner (D-CA), who has also been hypercritical of FERC's actions in California, also was rough on the Commission. FERC's latest mitigation effort "is a joke, but I'm not laughing and neither are the millions of Californians who will continue to suffer..."

FERC's plan will mitigate real-time prices for "relatively few days of the year," but "we are paying illegal prices 24 hours a day, seven days a week," Filner noted. Moreover, he questioned how effective the mitigation would be since generators would be paid prices based on the plants that are the costliest to operate. "This action ensures that everyone gets paid the most expensive price while maintaining an incentive to run dirty, inefficient generation."

By its latest action, the Commission "wanted to appear as though it is doing something --- hoping that the appearance of action would appease us. Well, I have news for Chairman [Curt] Hebert, I'm not going to stop...until we get real relief from these criminal prices" for electricity in California, Filner said.

Dynegy Senior Vice President Ken Randolf wasn't as blatantly critical of the Commission's monitoring/mitigation plan, but he still found problems with it. FERC's market mitigation provisions will do very little to solve the state's power crisis without significant progress in demand-side management and conservation efforts by the state, he said last Thursday at a National Energy Summit on Energy Policy at Oklahoma State University.

"Essentially what those provisions do is for a one-year emergency period they put cost-based rates in, not on a unit by unit basis, but based on the highest marginal unit, and it reflects full gas costs, emissions costs and some rate of return. Hopefully what that demonstrates is that FERC has all the ability it needs to address any kind of price mitigation on an interim basis and that Congress doesn't need to do anything further," said Randolph.

"The problem with price caps in general is that they do nothing to increase supply or to decrease demand, so even with this latest FERC action there still will have to be demand reduction and conservation in California," he added. "The sooner we get to addressing that, the more likely it will be that we can avoid implementing a curtailment plan or administrating where the blackouts are going to occur."

Responding to analysts' questions during a financial earnings conference call, Williams Chairman Keith Bailey said FERC's order "has positive attributes" in that it rewards efficient generators, but it fails to address credit risk. Defending his support for a short-term western region price cap on power, Bailey said that as long as a risk premium, based on the possibility of non-payment, has to be written into prices, "it drives us further away from a solution. We have got to get by the logjam of the credit risk existing in California."

Lawrence Malone, general counsel for the New York Public Service Commission (PSC), was critical of the Commission's decision to limit price mitigation to only real-time deals that are transacted when reserves are down to 7% or below (Stage I, II and III emergencies) in California. "...[M]arket power can be exercised at other times [other than emergencies), and there's a need to monitor when that occurs," he told attorneys and industry executives during the Energy Bar Association (EBA) annual meeting in Washington D.C. last Thursday.

Malone echoed the sentiments of FERC Commissioner William Massey, who partially dissented from the order because of the Commission majority's decision to restrict price mitigation to emergency-only situations. Massey had argued that the majority's action was so watered down that it would have little impact on California's power prices.

"I believe that FERC needs to support an active, comprehensive market monitoring [program], with suitable circuit-breakers or other market mitigation kicking in promptly when there is evidence of market-power abuse or irrational functioning of the market," Malone said.

He especially believes that the Commission must more actively monitor companies --- merchant generators, utilities and power marketers --- that have authority to charge market-based rates for electricity. "An agency decision that a market is sufficiently competitive to authorize market-based rates does not mean that the market [has been] deregulated. FERC has an ongoing obligation to ensure that the terms and conditions under which market-based pricing is implemented are being followed, and that the competitiveness of the market is sufficiently monitored," Malone noted.

"...All stakeholders, particularly generators, should recognize that a decision to establish market-based rates does not end regulation. On the contrary, regulators must be vigilant and diligent in monitoring competitive markets," he told the EBA gathering. Where "the market doesn't work as premised because of market-power abuse or market design flaws, regulators must step in and devise suitable remedies to ensure that rates are 'just and reasonable.'"

The Commission made a move in this direction last week when, as part of the monitoring/mitigation plan, it placed conditions on suppliers' authority to sell at market-based rates. Price bids with certain unexplained characteristics will become subject to FERC scrutiny, and if unjustified will be subject to refund.

Douglas W. Smith, former general counsel at FERC, thinks FERC may need to go even further and re-consider its market-based rate policies, given the likelihood of congressional oversight, legislative action and judicial review of them. Some key issues to be examined are whether: 1) applications for market-based rates should be analyzed in the context of the Appendix A analysis used for mergers; 2) the initial market-based rate analysis should focus more heavily on the competitiveness of the market as a whole, rather than on the market share of a particular applicant; 3) triennial reviews should be a forum for serious re-consideration of market-based rate authorizations; and 5) market-based rates should carry conditions that would better enable FERC to take remedial action in the event the rates are found not to be just and reasonable.

With respect to the New York wholesale market, Malone noted there are "troubling similarities" to the problems facing California. "Because of sustained economic growth, peak-demand growth has recently outstripped supply additions...While reserve margins are adequate, they are shrinking, and we have already reached demand levels on a normalized basis in 2000, which were forecasted for 2003," he said.

The state as a whole, and New York City and Long Island in particular, needs new capacity now, Malone noted. While "there is no shortage of suppliers attempting to enter the market," he said the timeline for approving new power generation plants isn't what it should be.

In New York, FERC has established "some important fixes" to ensure competition in the bulk power market. "But I think must more needs to be done," he said, especially in the area of ensuring "just and reasonable" rates.

In New York and elsewhere in the nation, the Commission "should be receptive to needed market fixes during this embryonic period, without adopting a cookie-cutter approach for all regions."

Dynegy's Randolph also noted that the proposed 45% retail rate increase in California, which was designed to reflect the high cost of natural gas for generation in the state, also will have very little impact on the market there this summer. It should have been done six months ago, he noted. "In February, Gov. Davis was quoted as saying 'If I had wanted to increase retail rates, I could have solved this problem in 20 minutes.' Well that may or may not have been true when he said it, but certainly if it was true, the time has passed and it's really too late for even that 45% increase to solve the problem."

The retail rate hike still has not been implemented. Regulators currently are attempting to allocate the increase among the various customer classes. "Who knows what the demand side reaction in California is going to be to the rate increase," said Randolph. "We don't know and we won't know until we get into the summer."

"What they need to look at possibly are some Kaiser Aluminum situations," he added. Kaiser Aluminum shut down its plants in the Pacific Northwest earlier this year and sold its power supply for a profit. "Companies could consider using less power, shutting down their business for a day, a week or a month in order to release that power for sale back into the market. Apparently, that is a provision that has been included in the latest version of Congressmen Joe Barton's (R-TX) emergency bill."

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