Frontlines
February 15, 2003
Break Out the Big Stick
By Richard Stavros
Carrots haven't worked. FERC needs to get tough on backing its SMD vision.
The time for diplomacy is over. It is more than clear that if the Federal Energy Regulatory Commission (FERC) ever hopes to see its vision realized of a standardized market design, the agency will have to take a more aggressive stance with those who disagree. In particular, FERC should tackle head-on the utilities that want to protect their regulated home turf while playing in others utilities' competitive backyards, and the state regulators that do their political bidding.
It's time for FERC to come out swinging, especially because FERC Chairman Pat Wood's gentlemanly, collaborative approach, while it should be commended, hasn't attracted as much support from state PUCs as the market advocates had hoped for. In fact, the hardball politics that is being played by some state PUCs and congressional constituents can only explain, some say, the commission's recent backtrack on the SMD timeline.
Some observers feel that the announcement of an issuance of a "white paper" on SMD before moving forward on the plan is analogous to raising a white flag (see "FERC's Market Design: The End of a Noble Dream," p. 22). That would be disastrous, given the financial problems many utilities have been experiencing. Merrill Lynch's Steve Fleishman estimates that during 2002 the top 20 utilities had negative cash flow of almost $10 billion after paying dividends. Not to mention that some of that dividend money had to be financed externally at higher rates.
The Wall Street financial analysts, investment bankers and credit ratings agency reps that testified at FERC's January technical conference on capital adequacy all agreed that the industry needs regulatory certainty in wholesale markets to restore investor confidence. "Policy-makers must fix the legal and regulatory uncertainty. Each investment relies on a consistent regulatory framework. The industry needs standard rules for its markets," cried one investment banker. Merrill's Fleishman added that FERC and states must come together.
But it has been long known that coming together on the issue of standard markets would always be a tough battle between states and the federal government, and between the states themselves. It's common knowledge that a map of regulated and deregulated states would perfectly overlay a map of high-cost and low-cost states. If FERC is to get what it and other states want-a union on SMD-it will have to play hardball too. Ironically, the way that FERC might realize its vision is to give its opponents exactly what they want.
Repeal of Market-Based Rates: A Sword of Damocles
It's almost a given that following Order Nos. 888 and 889, FERC liberally gave market-based rate authority to almost anyone who applied for it. And why not? In theory, everybody had access to each other's markets. But very real market power issues have forced » our industry move toward functional unbundling for true competition to flourish. At the FERC conference, companies like Calpine reported that in states that are regulated, utilities there still make it difficult for Calpine to site plants and, on many occasions, have dispatched less efficient plants before its own gas-fired turbines.
Meanwhile, some vertically integrated utilities like Avista, Idaho Power, Duke Power, and FPL have remained untouched in their states by the restructuring movement. Yet, all four companies have wholesale energy divisions and merchant operations, which operate in many unregulated wholesale markets throughout the country.
The issue of reciprocity has been discussed time after time with no real results. Also, reciprocity as some may remember was introduced in one of the many proposed national energy bills to eliminate the patchwork quilt of regulated and unregulated states, but it never gained any ground in Congress.
Most say it is patently unfair and uncompetitive for some utilities to be able to compete and take market share from other utilities in competitive states while their vertically integrated utility is being protected at home from competition by their state PUC. In fact, even in Europe, the European Union recently began proceedings against protectionist laws in Spain and Italy that were designed primarily to keep France's EDF from acquiring assets in those countries. Italy and Spain had reasoned that since France hadn't reciprocated by allowing acquisition of French assets, EDF shouldn't be allowed to buy Italian and Spanish assets, according to Fortnightly's Feb. 1 issue.
Naturally, everyone thought the standard market design would solve the reciprocity issue in the U.S. But with pushback from some state PUCs and those states' representatives in Congress on SMD, FERC must play a stronger hand.
Some say FERC should just repeal market-based rate authority for those companies who operate in regulated states. That would be consistent with state PUC arguments against SMD. After all, such companies do pose a market power problem under the new market power screen. If regulated utilities and their state PUCs are so enthusiastic about the virtues of cost-based rates, shouldn't FERC accommodate these views by providing a more consistent rate-of-return framework across all market segments?
It's hardly surprising that state regulators in the South have chosen to oppose SMD, while accepting the idea of market-based rates at the wholesale level. That way, they get to have their cake and eat it too. Regional players are shielded from imports, but remain free to export power and reap the benefits of an opened wholesale market.
FERC should demand reciprocity, not hypocrisy.
FERC's Market Screen: The Industry's Great Equalizer?
FERC last year quietly adopted its Supply Margin Assessment (SMA) or market power screen, which exempts those joining ISOs or RTOs, but puts other power suppliers under a microscope.
"To prevent economic withholding, we will require that an applicant who fails the SMA screen offer uncommitted capacity for spot sales in the relevant market. The uncommitted capacity will be priced under a form of cost-based rates," according to FERC.
Bill Hieronymus, on behalf of Exelon last year, said that, "SMA's test … will result in denial of market rate authority in the failed market without further inquiry, and the SMA would deny market rate authority to nearly all IOUs in their home territories [vertically integrated utilities]." That's quite a big stick. But consumer advocates say the stick should be even bigger. The Pennsylvania Office of Consumer Advocate, the Maryland Office of People's Counsel and the DC Office of People's Counsel, in filings under the Joint Consumer Advocates (Docket No. PL02-8-000) say the SMA should be applied to regions [or utilities] governed by RTOs despite the existence of market power mitigation remedies within such RTOs, as market power has been evidenced in some RTO and ISO markets such as PJM.
Repeal of market-based rate authority is politically feasible. The Federal Power Act mandates that FERC must ensure "just and reasonable" prices. FERC worries that Congress will take away its SMD plan. So FERC should just drop the other shoe and let Congress and state PUCs focus on the alternative-a return to cost-based rates-a "death penalty," according to some utility CEOs.
And given the current president's record in Texas on executions, regulated utilities may find that their political maneuvering in Washington against SMD will land them in the chair.
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