The background of the KeySpan antitrust case is discussed here and here. Basically, KeySpan withheld capacity from the NYISO market, by offering to sell it at the maximum allowable price per Megawatt, as a strategy to drive up the price paid to all suppliers under the NYISO auction rules. KeySpan "insured" itself against sales lost due to the high price per Megawatt by entering into a financial derivative contract with Morgan Stanley which paid off handsomely for KeySpan when the price per Megawatt exceeded a threshold level. KeySpan's share of profits was only part of the higher prices paid by consumers, because all capacity providers received the same inflated price. In 2006 alone, the amount of price inflation was estimated to be $157 million, and KeySpan's share of profits due to inflated prices was variously estimated to be from $44 million to $68 million. DOJ in its response to public objections said that it estimated KeySpan's gain from the swap strategy was $49 million. In addition to these gains from the derivative contract, the price of all the capacity sold by Keyspan was inflated.
The Justice Department tentatively agreed with KeySpan to settle the case with no admission of wrongdoing by KeySpan and payment by KeySpan of $12 million to the United States Treasury. After receiving critical comments, DOJ stated:
the United States remains of the view that the proposed Final Judgment provides an effective and appropriate remedy for the antitrust violation alleged in the Complaint and that its entry would therefore be in the public interest. Plaintiff's chosen remedy in this case deprives KeySpan of ill-gotten gains, effectively deters the harmful behavior, and establishes the United States's willingness to seek disgorgement in appropriate cases.DOJ indicated it will now ask federal judge Hon. William H. Pauley III for an order approving the proposed settlement.
The public comments question the claim of the government that the proposed settlement would actually deprive KeySpan of enough of its "ill-gotten gains" or that it would deter future harmful behavior or provide an equitable remedy.
AARP
AARP led the consumer opposition in its comments opposing the proposed settlement. As summarized by DOJ in its Response:
AARP asserted that the settlement is not in the public interest because of the “lack of any monetary remedy or other discernible benefit for injured consumers, and the absence of a credible deterrent.” It claimed that there is an inadequate factual foundation to determine the appropriateness of the amount of the remedy and its deterrent effect. It further noted that the decree contains no admission of guilt by KeySpan and no “public shaming.” AARP requested that the proposed Final Judgment be amended to require an acknowledgment of wrongdoing, identification of total “inflated prices” for capacity, identification of the derivative contracts at issue, and disgorgement of all profits. In the alternative, AARP argued that the record should be augmented to show the total profit “achieved by all sellers in the NYISO capacity market,” an estimate of the “total damage and economic harm” to consumers in the entire state of New York, the revenues KeySpan received under the Swap, and the rationale for accepting less than full disgorgement and for not providing any remedy to benefit injured customers.Con Edison
Con Edison in its comments did not question adequacy of the amount of the proposed partial disgorgement, but urged that the $12 million be distributed equitably for the benefit of consumers. Con Edison argued that the settlement should provide relief to the customers who were overcharged due to the KeySpan gambit that successfully raised NYISO prices.
The settlement is not in the public interest because it does not provide relief to the individuals that have been harmed by KeySpan's actions under the KeySpan Swap Agreement. . . . While the DOJ commendably condemned KeySpan's anticompetitive actions, which artificially raised New York City capacity prices, and sought an equitable remedy disgorging profits, its proposed remedy is inadequate in that it provides for KeySpan to pay the $12 million to the U.S. Treasury rather than to the individuals who ultimately were harmed.Con Edison asked the court to "find that the proposed consent judgment is not in the public interest until and unless any monetary payments disgorged by KeySpan are used to provide relief to New York City's electricity consumers."
Unless these funds are paid to the consumers who were injured, the effects of the violation stated in the CIS are not cured and the proposed consent judgment is inadequate. Without providing relief to these parties, the settlement fails to satisfy the public interest standard. . . . Finally, it is not a bar to providing relief to consumers that the precise amount of harm to them has not been calculated. KeySpan's conduct may have caused much greater injury than the $12 million it has agreed to disgorge. Equity does not allow a party to take advantage of imprecision that a wrongdoer is responsible for creating.
Under Con Edison's retail rate tariffs, the cost of wholesale electric capacity purchased in NYISO markets is normally flowed through to retail customers, and Con Edison makes monthly rate adjustments to reflect changing wholesale costs. A refund could easily be flowed through to benefit customers with credits in the same manner as the overcharges were flowed through. Or it could be administered through the NYISO.
New York City Economic Development Corporation (NYCEDC)
NYCEDC in its comments pointed out the disparity between the amount of the proposed disgorgement and estimates of what KeySpan gained in its gambit:
More than ten years ago, when the New York State energy markets were deregulated by the NYSPSC, the City power plants were divested in an effort to reduce the potential for market power abuse. However, as the Complaint herein describes, the in-City capacity market is an oligopoly, with three dominant generation suppliers known as the divested generation owners ("DGOs"). This was true during the operative period of the illegal conduct alleged by the Department of Justice ("DOJ") Antitrust Division here, and it remains true today. KeySpan was a pivotal bidder, i.e., at least a portion of its capacity was needed to permit the market to clear. Moreover, it was the largest generation supplier in the City, with some 2400 megawatts of capacity. . . .
The City and NYCEDC are in accord with the view expressed by NYSPSC that the proposed $12 million disgorgement is inadequate given the scale of the unjust enrichment to KeySpan here. We also believe that a credit for the disgorgement amount could readily be provided to the victims of the conduct here through credits provided through the NYISO wholesale market.
NYCEDC pointed out the anomaly of KeySpan giving up only $12 million of at least $44.3 million in profits from the challenged derivative agreement and questioned the deterrence effect:
Regarding the gain attributable to the conduct challenged here by DOJ as violative of the Sherman Act, at least a portion of the benefits were disclosed by the company itself: KeySpan stated its gain attributable to the Morgan Stanley agreement was $44.3 million in the period from May through September of 2006. . . . Given the workings of the market clearing process, the overall adverse impact on City energy consumers flowing from the practices described in the Complaint was of course far larger. . . . the City energy and capacity markets remain highly concentrated and bear the classic indicia of an oligopoly market: few significant suppliers, high barriers to entry, and accompanying high prices. Conduct similar to that outlined in the Complaint here may well occur in the future as it has in the recent past.New York Public Service Commission (NYPSC)
The NYPSC filed comments questioning both adequacy of the amount of the proposed disgorgement and the failure to provide any remedy for the consumers who ultimately paid for the overcharges. The NYPSC estimated KeySpan's share of excessive market rates due to the withholding/derivative strategy to be $68 million, being the difference between a competitive price and the inflated price achieved. Thus, ceding just a $12 million portion of the total profits to the government would not be a deterrent at all, and rather, could be seen as just another "cost of doing business." And, it could be added, that slight "cost of doing business" would only be incurred if a price inflation strategy was detected and pursued.
New York Consumer Protection Board
The CPB filed brief comments supporting the position of the NYPSC.
Pennsylvania Public Utilities Commission (PaPUC)
The PaPUC lobbed in a softball comment, praising DOJ for acting after the Federal Energy Regulatory Commission utterly failed to address or correct the NYISO market abuse. PaPUC's comment highlights the national importance of the case, because even though the particular rules have changed in the NYISO capacity market, analogous opportunities for price inflation may abound in other auction markets for electric energy, capacity, or other services characterized by similar oligopolistic pricing opportunities and behavior:
Moreover, it is not clear that the facts in this case are limited in time and place; while the tariff rules in question in this case apply to a specific geographic location and time period, the general method employed by the defendant to avoid competition (i.e., the purchase of a financial interest in the operations of a competitor through a third party) is not so limited.PaPUC acknowledges that "we cannot state whether the equitable and financial penalties in the [proposed] Final Judgment result in the full remedy of injury to the public from execution of the scheme."
DOJ's Response
Despite the broad consumer, utility, and regulator opposition to the proposed deal to close the case, the DOJ Antitrust Division adhered to its position in its Response to the public comments:
Had the case proceeded to trial, the United States would have sought disgorgement of the approximately $49 million in net revenues that KeySpan received under the Swap... contending that these net revenues reflected the value that KeySpan received from trading the uncertainty of competing for the certainty of the [economic withholding] strategy. . . . The $12 million disgorgement amount is the product of settlement and accounts for litigation risk and costs. . . . The United States contends that the Swap removed any incentive for KeySpan to bid competitively, locking it into bidding its cap instead of evaluating competitive choices, each of which could have resulted in different market clearing prices for capacity. . . . While we cannot quantify with certainty KeySpan’s bid levels or the outcome of the market clearing price that would have resulted but for the Swap, depriving KeySpan of $12 million in Swap revenues would have reduced the value to KeySpan of engaging in the anticompetitive Swap strategy, thereby shifting the results of KeySpan’s cost benefit analysis toward competitive strategies rather than entering into the Swap. . . .DOJ's argument lacks force.
How is bad conduct deterred if, by DOJ's own calculation, KeySpan reaped $49 million from its gambit and after being caught, admits no wrongdoing and keeps $37 million of it? How does that calculation encourage one to bid competitively and forego the temptation to earn possibly $49 million and at worst $37 million if caught?
DOJ also questioned the NYPSC estimate that KeySpan earned $68 million due to the strategy. In an interesting analysis that should trouble anyone relying on NYISO market prices, DOJ rejected the higher number on the theory that the measure of price inflation was not the difference between the high inflated price achieved by KeySpan and a competitive price, but the difference between the inflated price and the NYISO market price that would have been set but for the KeySpan gambit. That price, DOJ recognized, is not competitive:
The United States believes that, absent the KeySpan Swap, KeySpan and the other pivotal suppliers would have engaged in tiered bidding upon the entry of new generation capacity in 2006. . . . In other words, in the but-for world, tiered bidding strategies at prices lower than the cap would have been compelling for KeySpan and the other pivotal suppliers because they offered significant upside, and these suppliers would have been able to structure their tiered bids to limit their downside risk relative to bidding their caps. As a result, market prices likely would have cleared at a level below the cap but above competitive levels.Stripped of the jargon, the players in the oligopolistic NYISO electricity markets may elevate prices through autonomous tiered ("hockey-stick") bids that do not require conspiracy or agreements to raise prices that would violate antitrust laws. Thus, DOJ's measure of the amount KeySpan reaped through its illicit agreement is the difference between the price obtained and the "normal" but still uncompetitive price that would have otherwise prevailed in the flawed NYISO marketplace. See Study Finds High Profits for New York's Electric Power Generators, PULP Network, June 08, 2009.
DOJ argues in support of the partial disgorgement that it is based on the government's assessment of the risk of litigation, i.e., KeySpan could win the case if it went to trial. The issue presented, whether an electricity market player violates antitrust law by withholding supply to raise prices coupled with a derivative contract that pays off when the price is elevated, needs to be decided.
If KeySpan's gambit was unlawful, all of its ill-gotten gains should be disgorged for the benefit of the consumers who were injured. DOJ argued that refunds for the benefit of consumers might run afoul of the "filed rate doctrine." However, neither the swap contract between Keyspan and Morgan Stanley nor the rates demanded by Keyspan in the private NYISO capacity auction were publicly filed with FERC in advance as required by Section 205 of the Federal Power Act, and so the "filed rate doctrine" does not apply at all. Unfiled contracts can be revised even after they have been performed. See Joshua Z. Rokach, FERC’s Jurisdiction Under Section 205 of the Federal Power Act, 15 ENERGY L. J. 83, 89 (1994).
If KeySpan's gambit was lawful, it should not have to pay a penny to the government. In that event, FERC would need to reconsider its laissez faire approach to market-based rates and scrutinize rates and contracts to ensure they are just and reasonable in order to protect consumers, which is the primary purpose of the Federal Power Act.
Under the proposed settlement, nothing is decided and market players are given the green light to engage in analogous schemes involving anomalous bidding in electricity markets coupled with financial derivative contracts that pay off when the market price is successfully skewed.
Updates
Mason, Monts III, and Edwards-Ford, Certain financial hedge arrangements can violate Sherman Act, International Law Office, July 15, 2010.
Matthew L. Wald, Critics Assail U.S. Plan to Settle With KeySpan, N.Y. Times, July 21, 2010.
The New York PSC's motion to file an amicus brief in response to the DOJ reply to public comments was granted in August, 2010. The court scheduled a conference of the parties to be held in October. PSC correspondence indicates DOJ opposes its presence in the case as either a party or amicus. The Court issued an order October 4, 2010 indicating its questions at the October 12 conference would include these topics: (1) The factual basis for the Government's calculation of Keyspan's earnings under the swap agreement; (2) The use of disgorgement as a remedy in an antitrust action; and(3) The Government's consideration of alternatives to the proposed final judgment.
Memorandum and Order, Feb. 2, 2011. U.S. District Court Judge William H. Pauley III, approved the settlement on the terms agreed to by the Government, rejecting the arguments of objectors.
Matthew L. Wald, KeySpan Price-Fixing Penalty Approved - Some Call It Low, N.Y. Times Feb. 2, 2011. "Although price-fixing by an electricity company may have cost New York customers nearly $300 million, the federal government can close the books on the case by collecting a penalty of just $12 million, a judge ruled on Wednesday."
Michael Giberson, United States v. KeySpan Corporation antitrust Case Settles for Paltry $12 Million, Knowledge Problem, Feb. 2, 2011. "$12 million seems like a too-modest remedy."
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