Thursday, June 26, 2008

Supreme Court Leaves Fundamental Questions About FERC Market Rate Scheme Unanswered

Legality of FERC's Market-Based Rates Unresolved
Today's Supreme Court decision in Morgan Stanley Capital Group v. Public Util. Dist. No. 1 of Snohomish Co. left unanswered fundamental questions regarding FERC's scheme of unfiled and largely unregulated wholesale market rates for electricity. The Court said
We have not hitherto approved, and express no opinion today, on the lawfulness of the market-based-tariff system, which is not one of the issues before us. It suffices for the present cases to recognize that when a seller files a market-based tariff, purchasers no longer have the option of buying electricity at a rate set by tariff and contracts no longer need to be filed with FERC (and subjected to its investigatory power) before going into effect.
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We reiterate that we do not address the lawfulness of FERC’s market-based-rates scheme, which assuredly has its critics. But any needed revision in that scheme is properly addressed in a challenge to the scheme itself, not through a disfigurement of the venerable Mobile-Sierra doctrine. We hold only that FERC may abrogate a valid contract only if it harms the public interest.
The Supreme Court's allusion to issues regarding FERC's unfiled market rate regime may encourage others to challenge market rates.

In a recently concluded proceeding, FERC finally adopted official regulations to implement its market-based rate system, which had been constructed through a series of orders that never seriously grappled with the legal issues of market rates. See Market-Based Rates For Wholesale Sales Of Electric Energy, Capacity And Ancillary Services By Public Utilities, Order No. 697, 72 Fed. Reg. 39904 (2007). In that case, for the first time, FERC discussed -- in detail, in 100 paragraphs -- legal issues concerning its effort to jettison longstanding consumer protection provisions of the Federal Power Act. See "Nonregulated" Sellers of Electricity Become "Market-Regulated" Under New FERC Rule. A new judicial review proceeding brought by consumer groups to challenge the FERC market rate rules was recently filed in the D.C. Circuit Court of Appeals and another challenge is pending in the Ninth Circuit.

Contract Rates Presumed Reasonable
Very expensive long term wholesale electricity contracts were signed in an effort to avoid spiking prices and rampant market manipulation in the California and Western electricity spot markets. Later the municipal utility from Snohomish County asked FERC to modify the contracts and fix reasonable rates in an effort to protect their customers. FERC refused, citing the "Mobile - Sierra doctrine" which favors repose for contract rates. The Ninth Circuit reversed, saying that market rate contracts could be revised by FERC if the unfiled contract rates were unreasonable because markets were dysfunctional when the contracts were formed. Before FERC decided the issue on remand, the sellers - Morgan Stanley Capital Group and others - sought and obtained Supreme Court review of the legal standard used by the Ninth Circuit. At oral argument on February 19, 2008, members of the Court expressed deep skepticism, if not hostility, toward that rationale. The decision still requires FERC to review the rates, but under a different legal standard.

In its amicus brief, PULP urged the Court not to adopt the narrow standard of contract review contained in the "Mobile-Sierra doctrine" pointing out that in the Mobile and Sierra cases the sellers had filed their contracts publicly in advance, providing market transparency intended by Congress and an opportunity for intervention by interested parties and FERC before they took effect. It was only after compliance with the filing requirement that the contracts were given deference. Previously, there was no special standard of review if contracts were unfiled, and they could be revised even after they had been performed, if they had not been filed. See U.S. Supreme Court to Decide Electricity Market Rate Refund Case, and PULP Files Supreme Court Amicus Brief in Electricity Market Rate Case.

The Supreme Court, however, skirted the rate filing issue in this case, which had not been pressed by the buyers, and erected a new presumption that could make it more difficult to revise a contract rate on the ground that it is not just and reasonable. Now, FERC "must presume that the rate set out in a freely negotiated contract meets the "just and reasonable" requirement imposed by law" and this "presumption may be overcome only if . . . the contract seriously harms the public interest." The Supreme Court sent the case back to FERC to reconsider reasonableness of the disputed contract rates under the new standard. Although it is not altogether clear because the Court steered away from filing issues, sellers with market rate permission from FERC probably will invoke the presumption of reasonableness whether or not their contracts are publicly filed under Section 205 of the Federal Power Act .

Even if it is rational to presume that parties to a wholesale electricity contract have negotiated prices that are reasonable for them in light of their interests, the prices may not be reasonable from the perspective of the consumers to whom the cost will be passed. This is because there is not always an identity of interest between the purchasing utilities and the consumers.

Retail utilities may have little or no incentive to challenge unreasonable or manipulated wholesale rates they pay for the energy they resell to their customers. The buyer in the Supreme Court case was a feisty small publicly owned municipal utility whose management ultimately was accountable to local voters. In contrast, we do not see the likes of Consolidated Edison fighting hard to correct abuses and reduce rates in the wholesale markets to benefit consumers, because they have been allowed by the New York PSC simply to pass through to customers the wholesale prices they pay with no consequence to the utility. See Con Edison Electricity Rates for Energy Spike 21% in June. Also, Con Edison, like many other utilities, has holding company affiliates that may benefit from high wholesale prices and weak standards of FERC rate review.

Ways to Rebut the Presumption: Rate Impact or Market Manipulation by the Seller
The Court stated that on remand FERC could look at whether the contracts, during their lifetime, increased rates to consumers only
If [consumers paid more under the long term contracts than they otherwise would have paid] and if that increase is so great that, even taking into account the desirability of fostering market-established long-term contracts, the rates impose an excessive burden on consumers or otherwise seriously harm the public interest, the rates must be disallowed.
The Court also indicated that
if it is clear that one party to a contract engaged in such extensive unlawful market manipulation as to alter the playing field for contract negotiations, the Commission should not presume that the contract is just and reasonable.
So, now it appears that a contract rate with a seller who has market rates will be deemed reasonable unless it creates an "excessive burden on consumers" or "serious harm" to the public interest, or if a seller's unlawful market manipulation was "extensive" enough to be successful and change the market. This raises many more questions for future litigation, for example:
  • What is an "excessive" burden on consumers?
  • Is the consumer burden "excessive" if it harms only the poor, but has little impact for comfortable judges and regulators who can absorb price increases due to unreasonable rates?
  • If contracts of sellers with "market-based rates" are unfiled and secret, as FERC allows, and if the terms, quantity and price are not known, how could the public know whether the contract will impose an "excessive burden" on consumers over time?
  • Is a little market manipulation by sellers to raise price O.K. so long as it is not "extensive"?
  • What if multiple market participants each manipulate a little in similar ways so that the combined effect of their contract rate demands is enough to raise prices?
  • How could anyone know when rates are manipulated if the contracts are secret and not publicly filed with FERC?
  • When does harm to the public interest reach a level to become "serious"?
In a footnote attempting to rebut the dissenting opinion of Justices Stevens and Souter who protested that the new standard could limit FERC's ability to fix unreasonable contract rates, the Court said
the circumstances identified in Sierra as implicating the public interest refer to something more than a small dent in the consumer's pocket, which is why our subsequent cases have described the standard as a high one.
Actually, the Sierra case involved an attempt of a utility to raise rates previously set in a filed contract, which the Court disallowed, thus protecting customers, saying that even if a particular contract was unprofitable, it could not be revised upward to relieve the utility of its bargain unless the public interest would be harmed:
In such circumstances the sole concern of the Commission would seem to be whether the rate is so low as to adversely affect the public interest - as where it might impair the financial ability of the public utility to continue its service, cast upon other consumers an excessive burden, or be unduly discriminatory.
Thus, Sierra actually stopped the utility and the Commission from making even a "small dent in the consumer's pocket." The Court's revisionist approach to what is reasonable under the Federal Power Act, and new dismissiveness of a "dent" in the consumer's pocket, seems at odds with the Court's previous concern for consumer interests in Texaco v. FPC
Even if the effect of increased . . . prices would make a small dent in the consumer's pocket, when compared with the rates charged by [others], the Act makes unlawful all rates which are not just and reasonable, and does not say a little unlawfulness is permitted. (emphasis added).
What will FERC Do on Remand?
It is doubtful that FERC will interpret the decision and its rubbery standards for review of contract rates in favor of consumers. The agency currently is populated by zealous marketizers, uninterested in probing market flaws or fixing unreasonable rates, who urge consumers to respond in the marketplace to unreasonable rates by using less -- not an option for consumers on fixed incomes who are already minimizing their usage.

As the dissent points out, the new presumption may limit FERC's powers in the future. If FERC were reconstituted in the next administration, with Commissioners less influenced by Enronian ideology and possessing a genuine desire to effectuate the Federal Power Act's primary goal of protecting consumers, they may not be able to revise unreasonable contracts.

Myths Perpetuated
The "Drought"
The Supreme Court perpetuated a myth propounded by Enron and other market defenders as an explanation for the unreasonable market rates that spawned the case. Denying or minimizing the role of manipulation, sellers had claimed the California spot market prices were high because supply was short due to low hydropower resources, which in turn were due to drought. FERC includes the drought excuse as part of a list of causes other than manipulation, which it lists as the last of several causes, ranked lower than the weather. Witnesses for sellers accused of manipulation who testified at FERC joined in an amicus brief pushing the drought theory as an explanation for the high prices.

In its decision, the Supreme Court quoted the FERC litany of causes for the extraordinary prices that put market manipulation at the end of it.
In the summer of 2000, the price of electricity in the CalPX's spot market jumped dramatically—more than fifteen fold. See ibid. The increase was the result of a combination of natural, economic, and regulatory factors: "flawed market rules; inadequate addition of generating facilities in the preceding years; a drop in available hydropower due to drought conditions; a rupture of a major pipeline supplying natural gas into California; strong growth in the economy and in electricity demand; unusually high temperatures; an increase in unplanned outages of extremely old generating facilities; and market manipulation." Californians for Renewable Energy, Inc. v. Sellers of Energy and Ancillary Servs., 119 FERC ¶61,058, pp. 61,243, 61,246 (2007).
The fact is that there was no drought, hydro power was ample, and demand was actually lower at the times of the blackouts and price spikes. The wild market price excursions only ended when it briefly appeared there would be meaningful congressional oversight and when FERC imposed a price cap.

There was no need to cite a FERC opinion from another case restating the FERC litany of excuses for unreasonable rates that minimized the role of manipulation. Sellers have settled claims of manipulation in California for billions.

FERC's Watchful Eye
The Court showed poor scholarship when it repeated a blatant factual error describing how FERC substitutes its market power assessment for the utility's statutory duty to publicly file rates in advance, eliminating any opportunity for FERC to review rates for reasonableness before they take effect. The linchpin of FERC's argument for letting utilities charge what they want is the notion that a market where individual sellers are believed to lack market power will yield a just and reasonable rate (which the Court sarcastically described as somewhat "metaphysical").

There is now a pro forma FERC requirement for sellers seeking market rate permission to file an affidavit claiming they lack the power - individually - to drive prices up. Citing a mistaken Ninth Circuit opinion California ex rel. Lockyer v. FERC, 383 F. 3d 1006, 1013 (CA9 2004), the Supreme Court said that a seller with market rates "must also demonstrate every four months that it still lacks or has adequately mitigated market power."

In fact, under the actual FERC orders and rules, sellers are required to file an updated market power analysis every three years. FERC relaxed that general requirement for power generators and sellers, eliminating the triennial review completely for many, and easing rules for scrutiny of sales between utility affiliates when one of them has retail customers, in Market-Based Rates For Wholesale Sales Of Electric Energy, Capacity And Ancillary Services By Public Utilities, Order No. 697, 72 Fed. Reg. 39904 (2007), of which the Court was surely aware, because it cited Order 697 for other propositions in its decision.

The Supreme Court's reliance on a secondary source -- the description of a four-month market power review contained in the Lockyer case -- and failure to notice FERC's actual orders and rules, was a mistake no new associate in a decent law firm would make.

As a result, the Court repeated a confusion between the meaning of triennial and triannual that could have cost a prospective law student the points needed to gain admittance to a decent law school.

Worse, due to this obvious mistake, the Court perpetuated the myth that FERC is alert to market power issues.

Nothing could be farther from the truth. The FERC market power tests are easily passed. FERC has found it unduly burdensome to investigate whether its markets are gamed. FERC's revocations of market rate permission have been rare, mainly coming after public scandal and bankruptcy of the sellers, such as Enron and Ameranth, when no meaningful refund relief is available to consumers.

The glaring error thus may perpetuate a mistaken notion -- which placates those who would conflate competitive rates with reasonable rates -- that FERC is actually looking out for market abuse, protecting consumers, requiring refund of overcharges, and ensuring reasonable rates, when assuredly it is not.

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