FERC Split Over Market Power Review Adequacy

Divisions emerged last Wednesday at the Federal Energy Regulatory Commission over whether tools used by the Commission in analyzing market power issues are antiquated and in need of an overhaul or are sufficient. Commissioner William Massey believes FERC should initiate a generic inquiry into improving those standards, while Chairman Curt Hebert and Commissioner Linda Breathitt see the regulatory agency's current approach as more than adequate to meet market power issues.

Last week's debate was sparked by two draft orders issued by FERC involving market-based rates. In the first order, FERC accepts for filing a market-based rate application filed by Sierra Southwest Services Inc. The second order denies a rehearing request filed by the Illinois Commerce Commission (ICC) of an order in which the Commission granted Exelon Generation Co. market-based rate authority. In its rehearing request, the ICC asked FERC to immediately rule that when Exelon performs its updated market power analysis in 2003, it will be required to use a delivered price test market power analysis, instead of a hub-and-spoke analysis. FERC said that it would be premature for it to commit at this point in time to the use of any particular market power analysis in 2003.

"These two cases both continue to rely on an outdated and unreliable analytic standard to assess market power and for that reason, I must dissent from these orders," said Massey at the Commission's biweekly meeting. In the Sierra Southwest order, Massey said FERC allows the cooperative's power marketing affiliate to charge market-based prices based on the results of the Commission's "standard, old-fashioned" hub-and-spoke analysis and a 20% market share threshold for concern. "Because this analytic method is so unreliable, the Commission, frankly, has no basis upon which to make a reasoned determination whether the marketer will be able to exercise market power here," Massey asserted.

Turning to the Exelon rehearing order, Massey noted that the ICC asked FERC to commit now to using the more sophisticated analytic method the Commission uses for merger cases when FERC re-evaluates Exelon's market-based pricing authority in 2003. "But today's order brushes aside the Illinois Commission's concern," Massey said. He noted that the ICC is concerned with the prices its retail customers will face in the future and that the state commission argues that the hub-and-spoke method "simply does not produce meaningful conclusions."

"In this case, we have the commission of a state that has committed to retail competition, asking this Commission for some assurance that we will ensure just and reasonable prices in wholesale markets," Massey said, noting that in his judgment, FERC has failed to do so. "If we continue to fail to assure our state colleagues about just and reasonable prices in wholesale markets that their retail customers will ultimately depend upon in a restructured world, I fear that the states will lose confidence in this Commission, and restructuring at the retail level will stop dead in its tracks," Massey stated.

Massey asserted that the Commission's 20% market share threshold is too simplistic. "Surely, our painful experience in the California market has demonstrated that suppliers can successfully exercise market power and drive up prices with market shares well less than 20%," the Commissioner said. "The Commission must move immediately to develop a more sophisticated approach to market analysis. The urgency of improving our standards is squarely before us now," he said. "We cannot delay."

Massey urged his fellow commissioners to support an immediate generic inquiry into improving FERC's analytic standards. "We need to consider a full range of factors that are relevant to evaluating market power." He detailed what he thinks such an inquiry should touch upon. "First, I would look at market concentration, but surely not using the old-fashioned hub-and-spoke method." He said that markets could be defined as FERC now defines them for mergers. "Second, in addition to concentration, it's also important to evaluate whether any market rules create perverse incentives or obstacles to market participants behaving in a competitive and efficient manner," he said. In addition, Massey argued that adequate demand responsiveness is important and said that FERC should look at past behavior in the market. He emphasized that these are only his initial thoughts on what he thinks the Commission should consider as elements of a market analysis and that he has not "carved them in stone."

In contrast, Hebert and Breathitt voiced their support for the Commission's current approach to market power analysis. "I support both of these orders," Breathitt said. "For now, the hub-and-spoke method of market power analysis and market-based rate cases is our method of analysis and in these cases, this method produced reasonable results."

For his part, Hebert pointed out the "limited" and "uncontroversial" circumstances surrounding the Exelon and Sierra Southwest cases. FERC's chairman noted that in the Sierra case, no party objected to the application for market-based rate authority and, in the Exelon case, Hebert highlighted the fact that the only party seeking rehearing, the ICC, does not ask FERC to deny Exelon market-based rate authority. Hebert addressed the Commission's decision in the Exelon case not to commit to the use of any particular market power analysis in 2003. "I think with the speed that this Commission is moving at, with the speed that deregulation and competition and restructuring in this industry are moving at, I don't think this Commission can guess where we will exactly be as to the analysis of market power two years out," the chairman said.

Hebert went on to highlight the number of tools at FERC's disposal to detect and, if necessary, to redress market power. While acknowledging that the market power analysis used by FERC in the Exelon and Sierra Southwest orders dates back to the early 1990s, Hebert also noted that the standards have been used in "many hundreds" of market-based rate cases. "It is important to make clear, however, that those analyses do not represent the full extent of the Commission's ability or commitment to analyze market power," Hebert said.

"The key point here is flexibility and discretion," FERC's chairman went on to say. "If actual circumstances suggest that market power may be exercised, the Commission stands ready and able to take appropriate action." He noted that in just the last month the Commission has issued a series of orders and data to "get to the bottom" of recent increases in the prices of electricity and natural gas out in the West. Hebert further pointed out that FERC has also convened technical conferences to allow market participants to explain the causes of market flaws and how to fix those identified market flaws. "And the Commission has upgraded its ability to monitor generator outages and to prevent the physical and economic withholding of capacity in the market," he added. "All of these actions, taken together, demonstrate that the Commission's ability to detect and remedy market power continues to evolve to reflect rapidly changing circumstances."

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