Analysts: Tighter Affiliate Rules Will Lead to 'Cleaner' Market

The Federal Energy Regulatory Commission is expected to "explicitly clarify" its standards to regulate the flow of non-public information between regulated natural gas and power companies and their non-regulated affiliates at its scheduled meeting this week.

Specifically, the Commission is likely to take its current standards, which prohibit regulated pipelines and transmission owners from favoring their marketing affiliates, one step further by applying the restrictions to all corporate affiliates. FERC's existing Order 497 restricts the dealings between gas pipelines and their gas affiliates, while Order 889 limits the conduct between transmission owners and their electric affiliates. But both orders were fashioned prior to the surge in convergence mergers between gas and electric companies. As a result, there is nothing in the Commission's rules to prevent gas pipelines from showing preference to an electric affiliate, or to bar a transmission owner from passing on information to a gas affiliate to give it a competitive edge. FERC is expected to close this loophole this Wednesday.

"If what was good enough for gas-gas is good enough for electric-electric, there is no logical reason to assume that the FERC would let such a loophole in gas-electric or electric-gas conduct exist for long, particularly if it was found to be very lucrative," said analysts Christine Uspenski and Debra G. Coy of Schwab Capital Markets LP in a "bulletin" last Monday.

"While some may bemoan the loss of a perceived advantage, we argue that a 'cleaner' market, in which marketers are not viewed as fleecing their customers by trading on information entrusted to them, is of greater benefit in the long run to all participants, including the trading firms themselves," the analysts noted.

"We believe that the long-term potential of energy trading operations is not submarined by such a regulatory move," they said. As to the near-term impact on energy companies, this will depend on the degree to which "trading profits have been padded by some 'wink, wink, nudge, nudge' behavior between gas and electric affiliates," the analysts wrote.

"..[C]leaning up and clarifying the applicability of these standards would be completely consistent with what we see as [Chairman] Pat Wood's approach toward regulation in competitive markets: make it clear what the rules are -- and what behavior is out of bounds -- and ensure a level playing field for all participants."

The analysts believe that FERC's action to tighten the affiliate rules will be modeled after steps the agency took in a 1999 order approving the merger of Dominion Resources and Consolidated Natural Gas. In that order, FERC explicitly barred regulated pipeline and transmission affiliates of the merged company from sharing non-public information with any unregulated corporate affiliate, be it gas or electric.

"The antitrust experts we consulted on this matter believe it could be expected, and probably would be relatively easy, for the FERC to extend the Dominion-CNG standard to all companies," said Uspenski and Coy. The analysts believe the Commission has several options before it: 1) issue a policy statement simply stating that affiliate standards of conduct already established for gas-gas and electric-electric apply to "convergence" companies; 2) make a regulatory determination through a case currently before the Commission; or 3) initiate a full rulemaking process with a proposal, comment period and final order.

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