While states should be given plenty of leeway in deciding whether they need additional power supplies, FERC is legally bound under the Federal Power Act (FPA) to step in and review the possible competitive impacts of a vertically-integrated utility’s decision to purchase generation assets, FERC Commissioner Joseph Kelliher told a gathering of investment professionals last Thursday.

Kelliher’s remarks before a UBS natural gas and electric utilities conference in New York City came as the Commission’s review of such transactions is being questioned by certain electric utilities.

For example, Allen Franklin, CEO of Southern Co., last month said that the Commission’s recent response to applications involving utilities wanting to buy generation assets in their regions is “not good policy,” and if it stands, the acquisition of such assets “is going to be more difficult.”

Franklin cited FERC’s recent response to an application filed by Oklahoma Gas & Electric (OG&E) to purchase a majority stake in a power plant from an affiliate of NRG Energy. The Commission in December set for hearing the issue of the proper mitigation as a result of an increase in OG&E’s horizontal and vertical market power stemming from the company’s plans to purchase the stake in the McClain plant.

“In my view, I think the states should be given deference when they make a decision that there’s a need for increased electricity supply by a state-regulated utility,” Kelliher said at the UBS conference.

But he also noted that there are three different ways in which states could satisfy this need. “One is the regulated utility could build generation. Second, the utility could purchase power under contract from an affiliate or non-affiliate or third, the utility could acquire generation from a generating facility from an affiliate or a non-affiliate,” Kelliher said.

“In the first case, I don’t see that the Commission has an interest at stake. If the utility is building generation that typically is purely a state matter up to the state regulators,” the Commissioner noted. “In the second case, the Commission has a legal duty to review the contract. Under current law, the Commission has to assure that rates are just and reasonable under that transaction.”

The third option — the acquisition of generation assets by a utility — falls under a different category of FERC law and is “considered a quote, disposition under Section 203 of the Federal Power Act.” Kelliher noted that under Section 203 of the FPA, FERC “has a legal duty in that kind of case to review the impact of the acquisition on rates, regulation and competition.”

Meanwhile, Kelliher told the UBS conference that FERC is “exploring options” with respect to grid reliability. “The last three major regional blackouts in this country — July ’96, August ’96 and August 2003 — were all caused in part by violations of voluntary reliability standards,” he noted.

“Enforcement of reliability standards is absolutely essential,” Kelliher underscored. “I don’t know how many times we have to learn the same lesson before we have to make compliance mandatory.”

While he expressed optimism that energy legislation pending on Capitol Hill will be enacted, “it is possible the Senate will fail to invoke cloture and end the filibuster. That raises the question of whether the Commission can take any steps to encourage or require compliance with reliability standards.” FERC is currently reviewing its legal authority “to determine just what options are available to us.”

Kelliher noted that passage of comprehensive energy legislation is “very important” to FERC. “Perhaps the best example of why legislation is needed, in my view, is in the area of market manipulation,” he said, noting that the Commission only has the tools that Congress chooses to give the federal agency.

“In my view, the Commission lacks the necessary tools to prevent market manipulation. A comparison of the Federal Power Act with other federal economic regulatory laws makes that plain. Securities and commodities law include express prohibitions of market manipulation and tough civil and criminal penalties for violations.”

By contrast, Kelliher said that “there is no express prohibition of market manipulation in the Federal Power Act and the Commission can only levy civil penalties for violations of electricity provisions added by the Energy Policy Act of 1992 — principally, the wheeling provisions.” The Commissioner also noted that criminal penalties are capped at $500 a day, “the sum that was set in 1935 and, I’m not sure, but it may be less than the registration fee at this conference.”

Under current law, when market manipulation constitutes a tariff violation, FERC “can impose a stiff penalty — disgorgement of profits. However, even that penalty is inadequate in two scenarios: when market manipulation is designed to lower prices, not raise them, and when attempted market manipulation is unsuccessful. In the first case, a party that engaged in market manipulation that successfully lowered prices may not realize a profit, but instead may forego a loss. There still is an economic gain, but not one that the Commission can sanction. While the effects of this form of market manipulation are certainly less dramatic than market manipulation that is intended to raise prices, it’s no less serious.”

As for the second case, Kelliher believes that “unsuccessful attempts at market manipulation must be subject to some kind of sanction, as they are in commodities and securities law.”

With respect to the pending energy legislation, the Commissioner thinks the measure “takes a big step in the right direction by prohibiting certain market manipulation practices and strengthening the Commission’s civil and criminal penalty authority. Because I believe the bill would improve the ability of the Commission to discharge its duties, I urge the Senate to pass the comprehensive energy legislation.”

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