Out of the Loop: FERC Finds No Gaming, No Manipulation, and No Remedy in Lake Erie Loop Flow Case

FERC issued an order on July 16, 2009 denying any significant relief that would affect consumers in the Lake Erie "loop flow" case. Last year, emergency action was belatedly taken the NYISO board asking FERC to approve on an emergency basis a ban on certain circuitous transactions made by energy traders. As one consequence, these now-forbidden gambits raised NYISO costs that were passed on to wholesale buyers and eventually to utility customers.

Instead of booking straightforward transactions, energy traders apparently booked a series of transactions to take advantage of lax and varying market rules and pricing variations in neighboring electric system control and market areas. Due to grid conditions, it was difficult to schedule the transactions which may have contributed to higher congestion pricing charges payable by all buyers in a congested area, and to a physical reversal of normal flows of electricity around Lake Erie. When the transactions, apparently only for the purpose of exploiting pricing differences under divergent market rules of NYISO and neighboring RTOs, led to the assessment of large charges by NYISO to buyers in New York, some municipal utilities objected and eventually the practice was halted. About $96 million was estimated by NYISO to be the added costs due to the circuitous electricity scheduling transactions; other estimates were much higher.

FERC found that the sellers making the circuitous transactions did it openly and for the purpose of exploiting price variations due to rules of the RTOs, and that they had not violated any existing tariffs, which at the time did not prohibit the particular transactions, stating

the circuitous transactions, by capitalizing on those [pricing] incentives, simply exposed rather than created a market inefficiency. The fact that a market inefficiency exists is not, in itself, proof that market participants engaged in market manipulation.

FERC seems to have addressed the question why would anyone sell electricity in a circuitous way in a series of transactions difficult to effectuate when straighter contract paths were available and more harmonious with the way electricity actually flowed with the answer that if they could profit from it and it wasn't forbidden and did it openly, it is OK.

In response to intervenors' assertions of tariff violations or market manipulation by market participants in the placement of scheduling requests, we thus find that no further action (including the awarding of refunds, disgorgement of profits, civil penalties, mitigation measures, or other requested remedies) is warranted.

FERC said the convoluted transactions purporting to schedule transactions out of New York and its NYISO system into Ontario and across its IESO system and then into Michigan and through and out of the MISO system and then into the PJM system in Pennsylvania, when electricity flowed differently, the transactions increased economic congestion prices shifting major cost burdens to others, and when more straightforward contract paths directly from New York to Pennsylvania were available merely took advantage of existing price signals and differentials "rather than artificially affecting them."

Apparently FERC believes that an opportunity to make a profit due to market inefficiencies will justify an anomalous transaction even if it otherwise makes no economic sense from a societal point of view and risks physical disruption of the grid, as the NYISO had stated in its emergency petition.

The Watertown Daily Times reported on the reaction of municipal utilities:

Many people who were affected by the process are not happy with the ruling.

"I certainly respect FERC's decision, but the fact that the eight trade paths were shut down and the counterflow costs came back under control indicates that there was in fact manipulation," said Andrew J. McMahon, supervisor of the Massena Electric Department. "There's no parallel universe, but ... it probably cost us about $1 million."

Lori Shull, FERC: 'Loop Flow' Wasn't Used to Raise Rates The New York Post reported on the response of Senator Schumer, who had urged FERC to take strong action:

"It is disappointing that FERC's ruling confirmed the exploitation of this loophole by greedy energy traders but did not help New Yorkers who got taken advantage of," said Sen. Chuck Schumer (D-NY).

Bill Sanderson, Electric $Hocker, New York Post, July 17, 2009.

Also, the FERC analysis did not report the amount by which the circuitous transactions may have affected market prices in the various RTOs or unregulated energy trading markets by increasing the congestion charges. As reported by Platts Megawatt Daily

However, largely absent from the FERC staff investigation report was any discussion about the possibility that the market participants engaging in these transactions were possibly benefitting from the congestion through financial transactions such as financial transmission rights or financial transactions done on Intercontinental Exchange.

In this area, market participants expressed concern that the FERC investigation did not take a holistic approach in its probing regarding financial transactions, to examine whether the market participants did certain trades in one market to benefit in another, as what has been argued in the Energy Transfer Partners natural gas trading case.

It “sounds like the FERC is going easy on traders and is not looking at the combination of activities to see the full extent of”the practices being investigated, said one trader.

Eric Weiser, FERC Says No Manipulation in Loop Flow Case, Megawatt Daily, July 17, 2009. In an intriguing footnote, the FERC decision states:

In its written referral [of the loop flow anomalies], the [NYISO Market Monitoring and Performance Department] also separately raised allegations of possible "wash" transactions into and out of New York. These allegations are distinct from its allegations involving circuitous schedules, and [FERC Office of Enforcement] staff is investigating them separately.

If the past is any guide, FERC's continuing nonpublic investigation of the alleged "wash" sales will be buried, or there will be a cryptic announcement of a wrist slap penalty due to "rogue traders" with no admission of wrongdoing, closure of the case, and sealing of the records.

It is anticipated that parties who sought a more consumer oriented approach will move for rehearing of the order.

The case also illustrates chronic problems in the design of the privatized rate-setting function in the wholesale markets operated by RTOS. The lack of any general tariff rule prohibiting anomalous transactions, coupled with FERC's approach, leaves New Yorkers without any refund remedy for overcharges flowing from the effects of gaming or anomalous transactions. Indeed, the FERC decision gives the green light to traders to engage in new circuitous transactions, and to exploit other market rules, as circuitous or other anomalous transactions are not prohibited; a few of the Lake Erie paths are banned as a result of the case.

In contrast, courts held refunds were possible when Enron and others manipulated markets in 2000 - 2001 in California, because the California ISO had a tariff rule prohibiting transactions that lacked a sound economic basis and simply gamed market rules to drive prices up. The NYISO needs to adopt such a rule to deter the inevitable future gaming invited by the FERC decision.

The primary purpose of the Federal Power Act, which FERC is charged to implement, is protection of the nation's electricity consumers. The law requires all rates to be reasonable, but FERC's approach seems to be to counteract unreasonable spot market prices not by regulating them, but by encouraging buyers to avoid them by "demand response" (not using electricity, which can mean shutting down factories when spot market prices go up), or by purchasing electricity elsewhere. See

• FERC's Advice: Avoid Our Deregulated ISO/RTO Spot Markets;
• See No Evil: FERC Refuses to Examine Gaming of RTO/ISO Electricity Spot Markets.

The failure of FERC to do more is an embarrassment and abdication of its duty. It signals the need for more state oversight of the NYISO. See NYISO Needs State Visitation.

It also signals the need for the New York PSC to reconsider its policies that encourage retail utilities to buy more energy at spot market rates and just flow unreasonable spot market prices through to consumers, instead of acquiring electricity through long term contracts or traditional utility generation.

The PSC rationale for flowing through spiking and possibly manipulated prices was its effort to create competition: customers could seek relief from new retail electric companies, "ESCOs," and they would provide a market solution to the PSC-created problem of higher, spiking and unpredictable rates with alternative (often even higher) prices that provide the customer relief from the flowed-through spot market prices.

ESCOs, however, may just be reselling electricity at spot market prices, and offering a slight savings through tax subsidies, rather than providing a better value on the price of electricity. See ESCO Tax Subsidies: A Hidden $128 Million Cost of the New York PSC's "Retail Access" Scheme.

Update
In an editorial, the Syracuse Post Standard said:

Last year, FERC closed the loopholes that allowed the trades to occur in the first place. But what's to prevent other traders from finding similar gaps to exploit? Are customers at risk of being overcharged again? Is the electricity grid at risk of being overwhelmed once again by traders taking advantage of flaws in the regulatory system?

The state of the wholesale electricity market seems eerily similar to the financial market before the meltdown on Wall Street. Most of what the big investment banks did before the system imploded was legal, too, but it caused a catastrophe just the same. Only after everything came crashing down did government move to impose more controls.

That must not be the fate of the electricity market. FERC and Congress need to review the law and the rules implementing it, identify potential weaknesses and exact tighter regulation with ratepayers in mind. Electric bills are too high as it is.

Shocking Outcome, Syracuse.com, July 28, 2009