Did Electricity Market Manipulation Cost New York Consumers $157 Million in the Summer of 2006?

The NYISO Capacity Market Price Cap
In papers filed in early 2007 with the Federal Energy Regulatory Commission (FERC), Con Edison asserted that manipulation of a wholesale electricity market cost New York consumers approximately $157 million in the summer of 2006. An association of large electricity users, Multiple Intervenors, also contends that economic withholding by electricity producers has driven up consumer prices by "tens if not hundreds of millions of dollars." The issue was flagged last summer in a Newsday article but at the time the total cost to consumers was not known.

These overcharges would have been possible because of the electric industry “restructuring” of wholesale electricity markets encouraged and facilitated by the New York Public Service Commission (NYPSC). To implement its 1997 “rate/restructuring” agreement with the NYPSC, Con Edison sold most of its power generating plants to three new owners, now KeySpan-Ravenswood, NRG and US Gen. As a result, Con Edison purchases electricity back from these new owners in wholesale markets to meet its customers' needs.

FERC-approved wholesale markets permit sellers of electricity to sell at “market based rates” that are not publicly filed in advance subject to FERC review before taking effect, in contrast to filed cost-based rates which prevailed prior to deregulatory initiatives of FERC. "Market-based rates," if they are actually set by a competitive market, may or may not be less than cost-based rates set under traditional regulation. "Market-based rates", however, have a serious shortcoming not present with cost-based rates - they are susceptible to market manipulation and strategic gaming. In this instance, Con Edison and others argue that certain wholesale "market-based rates" in the Summer of 2006 period were subject to manipulation and that this manipulation cost consumers $157 million. Con Edison passes such wholesale costs on to its retail customers through its monthly "Market Supply Charge."

The "New York Independent System Operator" (NYISO) is a private utility that operates the grid and wholesale electricity markets in New York. NYISO, with FERC approval, created an “installed capacity” (ICAP) auction market to collect payments from “load serving entities,” the largest of which in New York City is Con Edison. The "load serving entities" then pass along the costs of the capacity purchased in the ICAP market to their retail customers.

One of the intended functions of the ICAP market is to create regular payments to owners of existing power generation plants on the theory that this will incent them - or other electric companies - to build more power plants which would also qualify for ICAP payments. As the principal strategy for inducing private investment in new generation facilities, the ICAP mechanism was intended to replace the traditional resource planning processes once conducted by utilities and the state.

Although the NYISO capacity markets have transferred billions of dollars over the past decade to the owners of existing power plants, this has not significantly stimulated construction of new power plants in New York City to meet future needs. Instead, with shortages looming on the horizon, now power plants in the New York City area have been built by Con Edison, or under contract with Con Edison, or by the state-owned New York Power Authority (NYPA), which has built numerous peaker plants and a new 500 MW Poletti baseload plant.

The ICAP auction market pays all sellers the same price. It can make sense for ICAP sellers to withhold capacity (by offering a portion of it at the highest possible price) and thereby constrain supply so as to raise the price of all other segments of their output. The inflated price of the ICAP that is sold can far outweigh the loss from the portion withheld and, therefore, unsold. Mathematical game theory analysis, economics laboratory simulations, and experience demonstrate that this is a common flaw of the NYISO uniform clearing price auctions for energy, capacity, and ancillary services.

Due to the small number of wholesale electricity sellers in the New York City area and concerns about their having market power - the ability to drive prices up above competitive levels - a price cap for this ICAP market of $105/kW year applicable to the three largest owners of divested generation was established by the NYISO, and approved by FERC. With a tight supply situation, the ICAP price was uniformly at the $105 price cap level in auctions held prior to 2006.

Economic Withholding of Capacity in The Summer 2006 ICAP Market
When 1,000 MW of new capacity was added to the New York City area in 2006 (due to the two new 500 MW power plants, one built by NYPA and one by a company under contract with Con Edison) it was expected that the ICAP auction price would fall below the $105 price cap as this should when supply is increased in a competitive market. The Summer 2006 ICAP auction price, however, did not come down at all. Instead, capacity apparently was withheld by sellers, perhaps by demanding extremely high prices so that capacity was only available at the maximum price allowed by the price cap. Auction results indicated that approximately 800 MW of ICAP offered at the capped price of $105/kW year were not purchased. If the three major owners of divested power plants all had offered their capacity as price takers, as auction market theorists believe they should, then the May 2006 auction clearing price would have been much lower than $105/kW-year level.

When the results of the Summer 2006 auction became known, buyers such as Con Edison and NYPSC staff expressed concern to the NYISO that its May 2006 auction outcomes resulted from economic withholding by a pivotal supplier, indicating a problem with the capacity market design that needed to he addressed. The CEO of the NYISO, however, wrote a “Letter to FERC Staff addressing certain issues that have been raised regarding the Installed Capacity market in New York City” in June 2006, stating

neither the [NYISO] tariff nor the Commission's [FERC's]regulations have been violated. We must conclude that the bidding and auction results have been consistent with the market conditions contemplated by the NYPSC and the Commission, and with the price cap approved by the Commission.

This NYISO letter essentially concedes that sellers' withholding of capacity to drive prices up to the maximum price cap is perfectly legal and consistent with existing NYISO market rules, and it further concedes that NYISO has no effective way to prevent withholding of capacity to drive prices up in future ICAP auctions. Under FERC’s market rate system, which consumer advocates are challenging in other cases, there is no way for effective review and revision by FERC of “market based rates” and there is no way for consumers to recover overcharges from the 2006 auction.

In July 2006, the Chairman of the New York State Assembly Energy Committee, Assemblyman Paul Tonko, wrote to the NYPSC, the NYISO and FERC to investigate whether “Enron-like gaming in the New York electricity markets” is occurring.

NYISO's Response to Market Manipulation: Reduce the Price Cap
After vigorously contested internal proceedings, the NYISO decided in a split committee vote to limit the profitability of economic withholding by lowering the maximum price that can be set by the major owners of divested generation. NYISO then filed an application with FERC in December 2006 to approve a tariff change effectively reducing the ICAP market price cap from $105 kW year to $82 kW year. The NYISO’s market advisor submitted an affidavit supporting the price reduction, explaining how ICAP market manipulation can occur and stating

Given the current level of the ICAP requirement and the available supply in New York City, the owners of the generation divested by ConEd in 1998 ("Divested Generation Owners" or "DGOs") were all pivotal suppliers during at least a portion of the two most recent Capability Periods, and one or more of the DGOs was pivotal for all of those Capability Periods. This has been true notwithstanding the recent entry of approximately 1,000 MW of new generation into the Capacity market in New York City. That entry, while significant, was not large enough to render "all of the DGOs no longer pivotal.

I have performed an analysis of the largest DGO's incentives based on the Capacity that it owns, and have determined that it is rational for that DGO to withhold Capacity to raise the Capacity price up to its offer cap level. This is the case because the percentage increase in the market clearing price is larger than the percentage decrease in the quantity of Capacity it sells when it withholds, which results in a greater overall profit. New entry of generation in amounts that would be sufficient to render all of the DGOs no longer pivotal is highly unlikely to ever occur because such investment would not be economically rational. Therefore, one may conclude that the market power issues in the capacity market in New York City will exist for the foreseeable future.

Prior to 2006, nearly all of the ICAP in New York City was scheduled or sold in the NYISO Capacity markets. Beginning in January 2006, more than 1000 MW of new Capacity has been installed in NYC. Given that the marginal cost of selling Capacity is close to zero for most units, the amount of Capacity sold in New York City under the NYC Locality Demand Curve would have increased by this quantity if the market were performing competitively. However, the total ICAP sales actually fell slightly after approximately 500 MW of new capacity at Poletti became available in early 2006. This occurred because one incumbent supplier reduced its sales by approximately the same amount as the new capacity at Poletti. This supplier routinely offered the bulk of this unsold Capacity into the Energy market, which indicates that it could have been sold in the Capacity market with little additional cost. The unsold Capacity quantities increased in May 2006 when an additional 500 MW of Capacity from the SCS/Astoria Energy LLC facility came online. * * * *

I conclude that the ICAP Spot Market Auctions during the 2006 Summer Capability Period have been characterized by economic withholding of Capacity to exercise market power to the maximum extent allowed by the existing offer cap for the DGOs.

The largest DGO in the New York City area, KeySpan-Ravenswood, filed papers opposing the NYISO's proposed price cap reduction, asserting that the existing $105/ kW year DGO price cap is actually too low. In contrast, Con Edison supported reduction of the price ceiling, stating in its papers

the impact on New York State’s consumers of economic withholding during the 2006 Capability Year on was approximately $157 million, of which approximately $119 million impacted New York City consumers alone.

The NYPSC in its comments also agreed that the ICAP market had been manipulated by withholding to make capacity scarce and raise prices:

NYC is a large load pocket that requires about 9,300 MW of local ICAP, while about 5,900 of capacity in NYC is owned by three large DGOs (i.e., KeySpan, USPower Gen, and NRG). Each of these suppliers is pivotal is the sense that supply from each is needed in order to avoid a capacity deficiency. As such, each supplier has the ability to exert market power and to set market prices.

In 2006, approximately 1000 MW of new capacity entered service and was offered into the NYC ICAP market, leading to a reasonable expectation that capacity prices would decline, both in NYC and in the statewide market. However, the NYC ICAP spot market continued to clear at the highest of the DGOs' bid/price caps, despite this recent addition of capacity. The explanation for this result is that there has been a significant increase in economic withholding in the NYC market, impacting both the NYC and statewide capacity markets.

In another proceeding pending at the NYPSC, the City of New York made the following comments regarding price manipulation in New York City electricity markets:

One factor currently impeding the operation of a merchant market in Zone J is the market power of the three major in-City generators. Market power allows those generators to maintain market prices above competitive levels and discourages them from adding capacity that might dilute their market power* * * * [A]ny one of them can set the price above the level that would be the market-clearing price if all capacity were to be bid in at prices intended to clear in a market not subject to distortion. They have every financial incentive to do so * * * *

In the case of KeySpan, its status as a pivotal capacity bidder has also been exacerbated by the company’s use of a contractual arrangement [with Morgan Stanley] to financially purchase 1,800 MW of capacity in the New York City market for a period of three years at a fixed price of $7.57 per kW-month. When coupled with its ownership of the largest in-City generation facility, this gives KeySpan a direct or indirect stake in some 4250 MW of capacity, and a significant interest in higher capacity prices.

FERC Rejects the Price Cap Reduction
On March 6, 2007, FERC issued an order rejecting the NYISO request to reduce its ICAP market price cap, finding that the NYISO had failed to submit "cost support" and "economic justification" for the revised price cap. FERC did not directly mention the apparent withholding and market manipulation. After rejecting the price reduction, FERC stated "[n]evertheless, upon consideration of the pleadings filed in this case and the problems they identify with the current in-city ICAP market rules" it would commence a new case to examine NYISO market rules. FERC also directed commencement of confidential settlement proceedings in the new case, with a refund effective date 60 days hence.

Thus, instead of investigating withholding or on its own motion taking action to correct and refund overcharges due to market manipulation, FERC is examining whether to change the market rules prospectively. This is consistent with FERC's effort to rely on markets without examination of the rates they produce. Indeed, even in cases of egregious manipulation, FERC has opposed subsequent correction of market rates that were set as a result of market power exercise in dysfunctional or non competitive markets it had approved. Recent court decisions, however, have rejected FERC's approach, which is to treat unfiled market rates as if they had been previously filed and approved. These court decisions hold that unreasonable market rates which were not set in a competitive market and which were not subject to review by the public and FERC before they took effect are illegal and correctible. The Court of Appeals for the Ninth Circuit in a December 2006 decision dealing with unreasonable contract rates of sellers with "market-based rates" summarizes FERC's failure to protect customers, which is the primary purpose of the Federal Power Act:

Ultimately, the fatal flaw in FERC’s approach to “oversight” is that it precludes timely consideration of sudden market changes and offers no protection to purchasers victimized by the abuses of sellers or dysfunctional market conditions that FERC itself only notices in hindsight.

As a result,

• FERC has allowed the current NYISO tariff and DGO price cap to remain in effect
• FERC commenced no proceeding to investigate withholding, market manipulation, or to require refunds of unreasonable ICAP market rates charged in the Summer of 2006
• FERC began a new proceeding only to consider tinkering with NYISO market rules that would be prospective in nature.
  
• FERC and the NYISO have no effective curbs on economic withholding by pivotal sellers to drive prices up in future NYISO ICAP auction markets.

Depending on the date the NYISO holds the next ICAP auction, and the results of the new FERC proceeding, it is possible that the ICAP auction market manipulation and overcharges could recur.

A Role for State Action
It its 1996 "vision order" charting the course for its experiment with restructuring, the NYPSC expressed a prescient concern that things might not go as hoped, stating:

In order to ensure that electricity customers are not subject to the abuses of dominant market power, we reserve our authority to protect consumers if a supplier obtains dominant market power.

New York state needs to take action to protect its electricity customers from manipulated prices in NYISO auction markets. In a recent decision, New York’s highest court stated that the NYPSC

maintains ‘light regulation’ over [electric companies that sell only at wholesale] covering ‘matters such as enforcement, investigation, safety, reliability and system improvement. This light regulation also gives the PSC authority to limit . . . power in the market . . . and any actions in contravention of the public interest.’

The NYPSC can and should exercise more fully its powers to correct exercise of market power by sellers in the NYISO markets and to assure that the NYISO and other electric companies act in the public interest in the future. See NYISO Costs Skyrocket, Benefits Questioned.

Connecticut General Assembly Holds Forum on Electricity Restructuring Problems

Like New York, Connecticut also "restructured" its electricity industry by allowing utilities to sell off their power plants and form holding company structures. This meant that power must be acquired for consumers in wholesale markets ostensibly overseen by the Federal Energy Regulatory Commission (FERC), which has adopted a system of wholesale electricity market rates tantamount to deregulation. Connecticut revised its statutes, in contrast to New York, where the New York Public Service Commission (NYPSC) effectuated restructuring through voluntary "rate/restructuring" agreements with the state's utilities and "light regulation" orders.

With most small customers still dependent on the distribution utilities for energy supply, with Connecticut electricity prices rising, the Connecticut General Assembly held an Energy & Technology Committee Informational Forum on Electric Retail Competition on March 6 and 8, 2007 to consider its options and legislative proposals to address the situation.

In one proposed bill, the failure of retail competition to attract significant numbers of small customers would be addressed by adopting a "retail choice referral program" similar to the "ESCO Referral Program" adopted by the NYPSC in 2006. PULP's Executive Director, Gerald Norlander, was invited to present testimony regarding the New York "ESCO Referral Program," in which he recommended that it not be implemented in other states.

A video webcast of the forum is at CT-N. Slides and summaries of the forum testimony are available at PULP's website.

N.Y. Court of Appeals Revives Suit to Recover Excessive Charges for Inmate Telephone Calls

Litigation has been pending for years in state and federal courts challenging excessive rates and charges for collect calls made by state prison inmates to relatives and friends, who often are so poor they experience financial hardship or simply cannot accept the calls. The main cause of the expense is a high "commission" on each call paid to the state; in New York, the commission is established under a contract between the New York State Department of Corrections (DOCS) and the telephone company contractor. In soliciting bids for telephone companies to provide secure calling services, a major factor in selection of the winning bid is the amount of the commission the company will remit to the state.

Currently, the commission paid by Verizon Business Services to the state is 57.5%, amounting to approximately $20 million per year collected from some of the poorest people in the state. The high commissions make it unaffordable for many New Yorkers living in poverty to accept calls. In 2003, according to a DOCS newsletter:

Approximately 500,000 inmate calls are now completed each month, totaling roughly 9.5 million minutes. Attempted calls that are not completed add in excess of 2 million phone uses per month.

All contracts and rates for telephone service in New York state must be approved by the Public Service Commission (PSC). When the PSC approved a contract between DOCS and MCI (now Verizon Business Services, after a merger) in 1998, it approved the entire rate -- including the commission -- in an order that was quietly issued without any SAPA notice and which waived the general statutory requirement for publication of notice in newspapers. The order in Case 98-C-1765 was not posted on the PSC website, and was not published by LEXIS until PULP brought it to the attention of LEXIS after it was referred to in a court decision in a case begun in 2000, Bullard v. DOCS. That case was dismissed by the state court of claims on May 1, 2002 (ironically, "Law Day") because the plaintiffs had failed to exhausted administrative remedies at the PSC in what amounted to a secret order in a secret proceeding. The Appellate Division affirmed, stating, in its decision on July 3, 2003:

since the alleged injury asserted by claimants arose directly from their payment of the filed rate approved by the PSC,'[t]he filed rate doctrine bars [judicial proceedings] against regulated utilities grounded on the allegation that the rates charged by the utility are unreasonable.'

Meanwhile, the DOCS contract was revised in 2001 and again in 2003. When the PSC considered the revision of the contract in 2003, public notice was given. In light of the 2002 court of claims decision faulting plaintiffs for not objecting about the rate at the PSC, many parties, including relatives of inmates, community, legal, and religious organizations intervened and filed comments protesting the commissions. Even though the PSC had approved the entire rate in 1998 (when no one had intervened in the case), this time, the PSC decided it had no jurisdiction over the commission portion of the rate on October 30, 2003.

PULP promptly petitioned for rehearing on November 26, 2003, pointing out the plenary power of the PSC over all contracts for telephone service under section 92 of the Public Service Law and precedent of PSC modification of rates set in a contract between the state police and a telephone company. Although N.Y. Public Service Law § 22 specifies that "the decision of the commission granting or refusing the application for a rehearing shall be made within thirty days," the PSC denied that petition more than a year later, on January 12, 2005.

Meanwhile, following the PSC's refusal to review the DOCS commissions, plaintiffs represented by the Center for Constitutional Rights commenced a new action against DOCS in 2004, Walton v. DOCS, challenging the 2001 DOCS contract as modified and approved by the PSC in November 2003. The plaintiffs asserted numerous causes of action, including violations of equal protection, freedom of association, unconstitutional taxation, and due process. Judge Ceresia dismissed the action at the trial level in a decision finding six of the seven causes of action to be untimely because plaintiffs had sued too late to challenge the underlying 2001 contract within four months of its approval, and rejecting one cause of action based on the November 2003 PSC decision. The Appellate Division affirmed in a January 19, 2006 decision.

The state's highest court, the Court of Appeals, granted a motion for leave to appeal in Walton v. DOCS. On the brink of oral argument held January 9, 2007, New York Governor Spitzer announced that the practice of collecting commissions on inmate calls would cease as of April 1, 2007. See Governor Spitzer Promises Reform of Prison Inmate Telephone Charges. With the need for a prospective injunction mooted, the issue of damages claims remained. In a decision issued February 20, 2007, the Court of Appeals effectively reversed the decisions of the lower courts insofar as they held that the constitutional claims were untimely, and remanded the matter to the trial court for consideration of four claims and damages flowing from any constitutional violations. In a concurring opinion, Judge Smith indicated his belief that some of the constitutional claims are "quite substantial" and joined with three other judges in finding that the case had been timely commenced.

Plaintiffs and petitioners in Walton v. DOCS are represented in their herculean effort to reform the prison inmate telephone commission system by Rachel Meeropol of the Center for Constitutional Rights. For more information on inmate telephone issues in New York and other states, see PULP's web pages and archive web page on the topic.

City Bar Committee Issues Report on Electricity Regulation in New York

The Energy Committee of the Association of the Bar for the City of New York (ABCNY) issued a report on Electric Regulation in the State of New York on February 8, 2006. The report attempts to take stock of the electricity restructuring experiment of the New York Public Service Commission (PSC). This was accomplished by "rate/restructuring" agreements with most of the major investor owned utilities, who agreed to sell their power plants in exchange for being allowed to form new holding companies. The ABCNY Energy Committee previously issued a report on electricity restructuring in 1998. Their 1998 Committee report mainly catalogs what the PSC and utilities agreed to do in their "rate/restructuring" plans.

Until now, the ABCNY Energy Committee made no report assessing the electric industry restructuring, even though serious flaws were obvious years ago. See, e.g., Disconnected Policymakers (Electricity Journal 2001) ;Deregulation of Electricity Isn't Working out as Hoped (Buffalo News 2001); Power Politics: A Failed Energy Plan Catches Up to New York (N.Y. Times 2001); The Perfect Storm (NY Assembly 2002); and other articles and reports at PULP's archive web site, and at PULP's current web page on New York Utility Energy Issues.

Notably, the ABCNY Energy Committee watched without comment as the PSC attempted to eliminate the consumer protections of the Home Energy Fair Practices Act ("HEFPA") with repect to energy purchased from "ESCOs". After flagrant consumer abuse occurred, that deregulation effort eventually was rebuffed by the state legislature with the enactment of the Energy Consumer Protection Act of 2002. Non-residential customers of ESCOs, however, do not have the protection of HEFPA or the PSC rules for dispute resolution and protection, and many small businesses have been victimized by ESCOs promising better rates than the traditional utility only to find they are locked into more expensive boilerplate contracts for long durations with high early termination fees.

Despite the well recognized dysfunction of the wholesale and retail energy markets in the aftermath of the PSC/utility restructuring, the ABCNY Energy Committee cites a 2006 New York PSC Staff report which claims the agency's restructuring to have been a success. An academic review of that unsigned report has found it to be unconvincing and its methodology flawed. See APPA Study Debunks NY PSC Report on Electric Restructuring. Rates in the areas that most completely adopted the PSC model increased and became more volatile. Rates of New York utilities that -- contrary to the recommendations of the PSC Staff -- retained their power plants, or sold them more slowly and entered into long term energy buyback contracts when they sold their plants, remained stable and predictable, while rates of those utilities who relied more heavily on NYISO wholesale spot market purchases increased and became unpredictable. The PSC Staff report left out data on major rate increases in 2005 for the utilities with more volatile rates, and appears to have left out data on LIPA increases affecting most of Long Island, which rose due to rising prices for energy purchased from divested generating plants at FERC market rates. By leaving off major increases in 2005 (the data was available when the PSC issued its report in 2006) and by averaging typical bills of the higher priced utilities (i.e. Con Edison) with the bills of upstate utilities such as RG&E and NYSEG, whose lower, stable rates (maintained despite opposition from the PSC and PSC Staff) the real effects of what occurs when the PSC Staff model is implemented are masked. The Staff report also is based on just two snapshots for typical bills in each year. Although most utilities have stable rates, the rates of Con Edison and other utilities that have most fully followed the PSC preferences have become volatile from month to month, with major price spikes occurring in months other than January and July data used in the PSC staff repport. The ABCNY Energy Committee report fails to go beneath the surface and uncritically accepts the unjustified conclusion of the PSC Staff report.

The Committee Report does little more than address two issues: the failure of the PSC's deregulatory approach to result in the construction of new power plants sufficient to meet growing demand, and the absence of meaningful public energy planning and implementation process. Currently, the energy planning function has been abdicated by the state to utilities and the NYISO, a private utility which has no real power to implement a plan, and which is not directly accountable to New Yorkers.

The report acknowledges, belatedly, the failure of a largely deregulated merchant power generation sector to bring adequate supplies of power, when new power plants are generally considered to be necessary for reliability and reasonable prices, particularly in downstate areas:

the only truly merchant plant built in New York City since 1999 has been KeySpan-Ravenswood’s 250 megawatt (“MW”) project. Orion Power also invested approximately $25 million in restarting a retired unit at the Astoria Generating Station. Otherwise, all major new plants have been either built by the New York Power Authority (“NYPA”) or under long-term contract to the Consolidated Edison Company of New York, Inc. (“Con Edison”) or the Long Island Power Authority. Outside New York City, however, plants have been constructed on a merchant basis.

To that, one might add, the owner of the largest merchant power plant constructed outside of New York City went bankrupt, and other merchant power plants have been shut down by owners who deny having any obligation to serve. The Power Authority of the State of New York has become the de facto builder of last resort due to the failed reliance on markets and the private sector to increase supply needed for reliability.

It is often assumed that price relief will flow from construction of new plants (or from conservation or demand response measures), but if the merchant power sector maintains its ability to withhold power from the market, by physically shutting down, mothballing plants, or by bidding strategies, price relief may be illusory even if new plants are built.

The courses of action proposed by the Committee are narrow, and continue the main elements of the PSC deregulation agenda. To achieve more power plant construction, a new NYISO capacity market is proposed, for long term capacity. (As Robert Kuttner has observed in Everything for Sale, the Virtues and Limits of Markets, the deregulators' solution to market failures is always the same -- a new market). A long term capacity market would involve making large payments to owners of existing power plants in the hope that this largess will attract new companies (and the investment banking industry) to invest and build new plants, but with no requirement that anyone actually build any plant. Billions have been paid to power plant owners through past and current NYISO capacity markets with no discernible effect. A similar capacity market plan of the New England ISO ("NEISO") drew major resistance in New England.
The cost of the proposed long term capacity payments is paid, ultimately, by consumers. The capacity market proposal, if adopted, could raise New York's high electricity rates further, without assuring that future power needs will be met, resulting in opposition as it did in New England. Maine is considering leaving the New England ISO and joining a Canada grid group due to high capacity payments that will add $335 million to Maine customer bills in the next five years, and attorneys general of Massachusetts and Connecticut are opposing New England ISO capacity markets in litigation. Also, attorneys general of Connecticut and Rhode Island have joined in challenges to FERC's market rate regime in a pending FERC rule making proceeding on market rates.

Perhaps in recognition that yet another capacity market approach will not work, the ABCNY Energy Committee Report proposes that new generation be attracted by having utilities who sold their power plants, or a public authority such as the New York Power Authority, enter into long term agreements to purchase power and capacity from a new power plant, or otherwise to guarantee a stream of payments to enable a merchant power plant developer to attract investment capital. For an interesting discussion of long term financing contracts, see the recent comments of New York City in a PSC proceeding that is considering energy purchasing practices.

The stream of long term contract payments needed to assure financing of the new plants would be collected, ultimately, from consumers. The ABCNY proposal represents a major departure from the Enron model adopted in 1996 by the PSC, in which the assumption of risk by the merchant power sector was touted as a consumer advantage, because consumers would no longer be saddled by capital cost overruns of large central station power plants built by the old utilities. The Committee proposal puts risk back on consumers, who will be required to pay for the output of the plant at rates high enough to rapidly recover the capital cost, but with no assurance that the customers will receive long term benefits. Essentially the utility consumer will provide the security demanded by lenders, and the consumer will pay for the power supply contract via the distribution utility.

When plants were built by the old utilities, the cost was amortized over the lifetime of the plant, and as the plant depreciated, the cost of energy could go down, because customers would pay cost based rates set by the state PSC. When plants are built by the merchant sector with utility or public power guaranteed contracts, the capital cost of the plant may be rapidly amortized long before the lifetime of the plant expires, but once the contract obligation needed to obtain financing expires, the merchant power plant owner may sell the output at the market price set in wholesale spot markets by the most expensive plants, so the producer rather than the consumer will receive the value of low production costs.

There is nothing inherently wrong with long term contracts. New York once had a law (it expired along with the Article X siting law) which required utilities to attempt to purchase power rather than build new power plants if that was the least cost solution. Long term contracts could be a good idea, but only if they ultimately benefit the consumers who essentially would assume the risk of stranded costs (i.e., that during the term of the contract, less expensive energy could become available through new transmission lines or less costly new plants). What is missing in the ABCNY Committee Report is any benchmark test -- that a long term power supply agreement used to induce construction of a merchant plant must be more cost effective in the long run, over the life of the plant, than if the plant were built by a state regulated utility or by the Power Authority.

Other states that restructured also lost control over the cost of power, once state regulated, because when it is unbundled from a vertically integrated state regulated utility it must be purchased at wholesale rates, under a FERC system of market rates that is not based on the actual cost of production. Other states (Connecticut, Virginia, and others) are now moving to allow distribution utilities to build power plants again, whose rates would again be under state jurisdiction and control. New York utilities still have that option, because the state legislature never changed the laws to prevent distribution utilities from building power plants. Also, public power entities such as NYPA and LIPA have been quite proactive in recent years to address the failure of the deregulated markets to deliver power needed to maintain reliability. The ABCNY report does not consider the obvious option of plants built by state regulated utilities or public power entities, and instead perpetuates deregulation dogma with talk of new capacity markets and transfer of investment risk to ratepayers or the general public without assurance of benefits.

Competition is a means to an end, not an end in itself. That end is defined by New York, in its public service law, as safe and adequate service to consumers upon demand at reasonable rates.The continued adherence to marketizer solutions in the absence of evidence they work anywhere - for the benefit of consumers - reflects the ABCNY Energy Committee "agenda". The Committee agenda promotes a deregulation - competition model and focuses mainly on shareholder concerns, as follows:

Agenda includes increasing the competition in the energy marketplace, utility shareholder equity and environmental issues. The Committee also deals with nuclear power issues and international energy projects.

An examination of the roster of the ABCNY Energy Committee (at the end of the Committee report) shows that the Committee is predominantly comprised of attorneys who represent the very utilities and merchant power entities who supported and continue to support the PSC restructuring experiment, with some environmentalists, but no attorneys from consumer groups.

The ABCNY Committee Report says it is occasioned by "[t]he election of a new Governor, following a twelve-year administration by a Governor who supported the Commission's restructuring initiative * * * [presenting] an appropriate opportunity to examine the regulation of New York's electric utility industry."

The Committee held its tongue and did not issue reports when failure of the deregulation approach was obvious for years. The Committee did not signal the now apparent supply crisis, and did not previously publish a report describing corrective measures. Instead, the Committee remained silent until the election of a new Governor who has already indicated openness to long term contract solutions such as those described in the ABCNY report. In describing its long term contracting solutions the Committee has done little to identify fully the complex scope of the public interests that would need to be addressed through those contracts. The report excellently represents the corporate and self interests of the merchant generators and utilities. These interests will be important actors as New York works through the long agenda of energy needs left behind by the last set of energy policymakers in Albany. Regrettably, it leaves unaddressed the consumer and public interests which must be heard and accommodated before a new set of new energy ventures are undertaken.

President Proposes $61 Million Home Energy Assistance Cut for Low-Income New Yorkers

The proposed federal budget submitted to Congress by President Bush would reduce 2007 - 2008 funding for the Low Income Home Energy Assistance Program (LIHEAP) by $502 million, in relation to the current LIHEAP funding level.

The current level was set by a continuing resolution when Congress failed last year to pass a number of 2007 major appropriations bills, including a bill to fund the Department of Health and Human Services, which administers LIHEAP grants to the states. The continuing resolution will expire February 15, 2007 and agreement has not been reached as to the funding level for the remainder of the 2007 federal fiscal year.

If the funding for 2007 is established at the continuing resolution level, and if Congress were to reduce funding for 2008 as requested by the President it is estimated that 2008 LIHEAP funds for New YorkState's Home Energy Assistance Program (HEAP) would be reduced by approximately $61 million, or 25%.

LIHEAP grants are distributed on a first-come first-served basis until the program closes. Approximately 33% of the New York households eligible for LIHEAP receive a benefit. In the 2005 - 2006 HEAP year, New York State utilized approximately $382 million in LIHEAP funds to assist more than 850,000 low-income New York households. The President's proposed LIHEAP reductions, if approved by Congress, could result in benefit cuts, or a significant reduction in the number of low-income New York households served, or both.

The President's proposed LIHEAP appropriation for 2007 - 2008 is approximately $1.7 Billion less than the 2005 - 2006 funding level, which was increased by Congress in early 2006 in response to major energy price increases for home heating fuels. The newly proposed level would reduce federal aid to New York's low income households by $198 million in relation to the amount allocated in 2005 - 2006 to New York.

The National Energy Assistance Directors Association (NEADA) is seeking $5.1 Billion for the LIHEAP program. The President's new budget proposal for LIHEAP is less than 30% of that recommendation. NEADA estimates that the proposed LIHEAP cuts would eliminate home energy assistance to more than one million eligible low-income households.

Governor Jodie Rell of Connecticut condemned the LIHEAP cuts in the President's budget:

These cuts interfere with the fundamental responsibility of government: to safeguard the lives of its citizens,” Governor Rell said. “Whether we are helping struggling families stay warm through the harsh winter months or protecting homes and residents against terrorism and natural disasters, we expect our federal partners to carry their fair share. The cuts to these programs place extraordinary burdens on the states – and do so at a time when Connecticut’s own budget is facing severe pressures.

Governor Rod Blagojevich of Illinois called upon Congress to block the proposed cuts and restore LIHEAP funding to last year's level.

For further information see PULP's web page on HEAP in New York.

Queens Power Outage Update

DPS Staff Issues Draft Report
Since our prior post on the Queens power outage, the New York Department of Public Service (DPS) staff issued a Draft Report. The report, expected to be finalized by February 14, 2007, criticizes Con Edison for misoperation of its system, poor situational awareness, and inadequate communications with the public during the events and outages which began July 17, 2006, and recommends that the Public Service Commission commence a prudence proceeding.

A New York State Assembly Task Force on the outage issued a report critical of both Con Edison and the Public Service Commission on January 30, 2006.

PULP filed comments on the draft report on January 31. PULP identified ten matters needing further attention. Con Edison, as expected, did not agree with many of the Staff findings and recommendations. In particular, Con Edison opposed the Staff recommendation for a prudence proceeding, and opposed Staff's finding that it should have shut the network down completely for repairs instead of attempting to operate with several major feeders out of service, which Staff says exacerbated the crisis and damage when even more of the remaining overloaded feeders also failed. Con Edison's comments defend the decision not to shut down the network:

A shutdown of the entire network would have had an enormous impact on the people living, working or commuting through the neighborhoods covered by the LIC network. We preserved electric service to the many unaffected customers and the public by repairing and restoring feeders. . . .

Comments of other active intervenors in the investigation proceeding are at PULP's website page on the Queens outage.

Was there an Outage, Reactive Power Deficiency, or Grid Disturbance Just Prior to the Fire that began the Outage Events?
Discovery is still underway concerning a possible power plant outage on the afternoon of July 17, 2007 which may have occurred 25 minutes before the a distribution system feeder failed due to a fire at 3:50 PM. The substation serving the Long Island City network is located very near a number of power plants.

• There are indications that voltage dropped in the Long Island City network at 3:25 PM on July 17, 2006. At about the same time
• New York City load suddenly dropped by about 95 MW (even as temperatures were rising)
• the NYISO declared a "large event reserve pickup" that required drawing upon generators to provide emergency spinning reserves of energy. (A "reserve pickup" is directed in cases where a major generator has tripped gone off line unexpectedly), and
• NYISO real time spot market prices for energy quadrupled. (A sudden spike in spot market prices may also indicate that a generator has tripped off line).
  

At the time of the outage, a major Con Edison transmission line from Westchester to Queens was out of service, making New York City more reliant on local generators for both energy and reactive power. Reactive power deficiencies are sometimes manifested by lowered voltage and overheating of distribution system facilities. See "New FERC Rules to Impose Voltage Stability Obligations on Local Utilities."

On July 12, 2006, five days before the July 2006 Queens outage, FERC and NYISO grid officials testified that due to outage of two transmission lines from Westchester to New York City, the City was at increased risk of load shedding and blackouts in the event of hot weather or another outage.

It appears that both events may have occurred, and that the predictions of the grid officials were accurate. Minutes of the New York State Reliability Council indicate that "Indian Pt. 3 and Astoria Energy East each tripped twice at near full load" in the month of July. On July 17, 2006, a very hot day, the Con Edison distribution system cascaded into failure, shortly after the apparent disturbance in the bulk power grid.

The question remains whether there was sufficient reactive power (MVARs) at all times, and whether a reactive power deficiency -- or other disturbance -- in the bulk power grid may have caused or contributed to overheating of the distribution system wires and the fire that began the outage events. The reports of Con Edison and the draft DPS staff report do not discuss this. They begin their event time lines with the unexplained cable fire and feeder failure at 3:50 PM, without examination of grid conditions preceding the fire.

In the independent investigation report of the 1977 blackout, Con Edison was criticized at p. 28 for not having its transmission lines in good repair. In that incident on July 13, 1977, lightning hit major transmission lines importing power through Westchester while another major line connecting Con Edison with a New Jersey utility was not in service, making it unavailable to provide energy to support the system:

the system was not up to its designed strength. The Hudson-Farragut connection between New York City and PSE&G in New Jersey had been out of service since September 4, 1976. . . . Each of these outages significantly weakened the capacity of the system to withstand transmission emergencies. The availability of the Hudson-Farragut tie alone would have prevented the collapse of the transmission system on July 13.

The outage of the Hudson-Farragut transmission line was a factor mentioned by the state Court of Appeals in its decision affirming a lower court and jury finding that Con Edison had been grossly negligent in 1977.

In 2006, with import capability restricted, was Con Edison's system more vulnerable to disturbances flowing from an unscheduled outage of a local power plant?

FERC Holds New Enron Hearings After Court Remands

FERC is still holding administrative hearings to determine whether wholesale electricity buyers are owed refunds from Enron due to market manipulation in 2001. The prehearing statement of issues in dispute indicates that the gap between the litigation positions of the parties is large. The buyers claim that Enron made $1.6 billion due to market manipulation; in defense Enron says at most it owes less than $1 million.

Enron trader Timothy Belden has been scheduled to testify at a FERC hearing February 5, 2006, but may take the Fifth Amendment and refuse to testify. He previously pleaded guilty to federal criminal charges of conspiracy to commit wire fraud, and entered into a plea agreement.

For a refresher, see this excerpt from The Smartest Guys in the Room, the Oscar-nominated film which contains audio tape excerpts of Enron traders urging the unnecessary shutdown of a power plant in order to drive prices higher, and cheering as fires reduced transmission import capability and made California markets more suceptible to the exercise of market power.

AARP Cautions FERC Not to Relax Electricity Market Oversight

AARP filed comments January 19, 2007 in FERC's pending rulemaking proceeding in which the agency proposes for the first time to adopt official rules to reflect its market rate experiment of the past decade. Some of the proposed rules would mirror policies contained in prior FERC orders, but other proposed measures would further relax regulation and lessen FERC's oversight of wholesale electricity sellers.

For example, the proposed rules would make it easier for sellers to obtain and retain FERC's permission to charge unfiled market rates, would reduce restrictions on transactions between holding company affiliates that produce, trade, own and buy power among themselves, and would eliminate some rate and contract filing requirements, even for companies denied market rates because they fail FERC's market power tests.

In its comments, AARP observed as follows regarding FERC's market rate system:

[T]he envisioned benefits of restructuring have not been borne out by experience. Deregulation of sellers has not produced the promised rate reductions and competitive sources of supply. Studies have shown that in states that have adopted retail restructuring, consumers have experienced significant price increases that cannot be fully explained by fuel cost increases; rather, market power and other factors appear to be playing a significant role in the high prices experienced by consumers once price caps expire. Headline stories about consumer outrage over huge price hikes after removal of rate caps (e.g., in Maryland) exemplify the widespread concerns about today’s electricity markets and their impact on consumers. Studies of claimed savings from competition simply don’t match the experience of consumers. In fact, increasing evidence indicates that markets are not delivering the promised lower prices. * * * *

AARP has concluded that electricity markets have generally failed to provide benefits to consumers. This grim conclusion, combined with the great risk of the exercise of market power in the electric industry and the high costs borne by consumers from such abuse, causes us to urge the Commission to err on the side of caution in evaluating market power and authorizing market-based rates. Further, we urge the Commission to ground its MBR policy on fact and experience, not theory.

AARP has over 35 million members nationally, and more than 2.6 million members in New York State.

Other consumer groups including the National Association of State Utility Consumer Advocates, NASUCA, and large industrial customers previously objected to the proposed regulations. For further information about the proposed rules and comments of other parties, see "Consumer Groups Question FERC's Market Rates."

Governor Spitzer Promises Reform of Prison Inmate Telephone Charges

The New York State Department of Corrections (DOCS) contracts with MCI for prison inmate collect call telephone service. For many families whose relatives are incarcerated in distant prisons, this is the primary means of communication.

DOCS contracts require the telephone company to collect a 57% commission for the state on call revenue received from recipients of collect calls made by inmates. Approximately $20 million per year was collected by DOCS through the commissions. DOCS asserted that the money was used for several of its programs designed to benefit inmates, but community groups pointed out that the programs could and should be funded with general state revenues, and that DOCS had implemented an administrative "tax" without proper legislative authority.

The commissions create heavy burdens for low income family members. Those who cannot afford cost of the calls suffer financial hardship if they accept them. Despite objections from community groups and broad editorial oposition from the state's leading newspapers, the commission system continued for years.

When the contract was last renewed, along with community groups, PULP objected to the commissions in its comments to the PSC.

The PSC ruled that it lacked jurisdiction over the commission portion of the rate. The PSC also rejected PULP's petition for rehearing which argued that the PSC indeed did have full power to review and modify the rates for intrastate calls.

Litigation was brought on behalf of inmate families and others by the Center for Constitutional Rights seeking a judgment that the commissions are illegal and refunds of the overcharges. The trial court opinion upheld the commission system, and this was affirmed by the Appellate Division, Third Department. An appeal was taken to the Court of Appeals, New York's highest court.

The day before the case was to be argued in the Court of Appeals, it was announced by Governor Spitzer that the commission system will soon be halted.

This prompt correction of an longstanding injustice in the first week of the incoming Spitzer administration is a very welcome turn of events. Prospectively, elimination of the commissions will correct a DOCS policy that for many years hindered communication with inmates and caused major hardship to many low income families in New York State.

The issues still being considered by the Court of Appeals concern the claims of the plaintiffs for refunds of past commissions, if the court reaches the merits and finds that the commissions are illegal, and mootness claims and procedural defenses.

For further information, see PULP's web page on inmate telephone service.

FERC Commissioner Kelly: The Purpose of the Federal Power Act is to Protect Consumers

At a recent meeting FERC adopted rules to implement a new statutory provision, Section 219 of the Federal Power Act, which authorizes, in certain situations, extra financial incentives, through higher rates, for utilities building transmission lines needed to ease congestion that limits the availability of lower cost power in some areas.

Prior to the enactment of Section 219, FERC had proposed generous "incentive ratemaking" measures to encourage construction of new transmission lines with significantly higher returns on equity allowed as part of rate computations. The National Association of State Utility Consumer Advocates (NASUCA) vigorously opposed this in its 2003 comments to FERC. Also, NASUCA opposed a proposal for broader statutory authorization of higher transmission rates than the new FPA Section 219 allows, in testimony to Congress, stating that the proposal being considered "would authorize unnecessary and costly new federal financial incentives to encourage investment in transmission facilities, beyond the level of return on investors’ equity normally sufficient to achieve reliable service and just and reasonable rates."

In New York, utilities have built more than 10,000 miles of high voltage transmission lines without the need for "incentive" rates that are higher than rates would be to provide normal rates of return on private utility investors' equity. Also, the New York Power Authority has more than 1,000 miles of transmission lines which it built at cost, without providing any return to investors, because NYPA is publicly owned. With the "restructuring" of New York's electric industry under PSC orders, however, little has been done in recent years to construct new transmission lines, with the exception of lines built to serve the Long Island Power Authority.

Commissioner Suedeen Kelly, in her talking points at the FERC meeting which adopted rules to implement new FPA Section 219 pointed out that the statutory amendment which now allows higher than normal rates specifically requires that "ultimately it is the consumer that must benefit from the rule."

She noted that "the Final Rule does not require applicants to provide a cost-benefit analysis for incentive-based rate treatment," but still cautioned that "applicants will not receive incentives simply by asking for them, or by merely stating that incentives are needed to attract capital. Nor will applicants be rewarded just for the sake of building new transmission."

In recent years FERC has focused its efforts on deregulation and substitution of market mechanisms for its traditional mission of enforcing the Federal Power Act and reviewing rates for reasonableness. No credible study has found these measures to have lowered rates or otherwise to have benefited consumers.

In a refreshing statement, Commissioner Kelly said "we must always relate our action “to the primary aim of the [Federal Power] Act to guard the consumer against excessive rates.” Commissioner Kelly's rhetoric is in harmony with the Supreme Court's interpretation of the purpose of the Natural Gas Act (which has parallel provisions with the Federal Power Act): Congress intended the law and implementation of it by regulators to “The Act was so framed as to afford consumers a complete, permanent and effective bond of protection from excessive rates and charges.” Atlantic Refining Co. v. Publ. Serv. Com’n, 360 U.S. 378, 388 (1959).

Without a cost-benefit analysis, however, and no yardstick of reasonableness, it is difficult to imagine how FERC will know whether higher rates requested for a transmission project are reasonable or will benefit consumers.

FERC Adopts Electricity Transmission Siting Rules: Says it Can Reverse State Denials

In Section 1221(a)of the Energy Policy Act of 2005, Congress for the first time enabled the federal government to approve the siting and location of new electric transmission projects. The new law required the Department of Energy (DOE) to issue a national transmission congestion study for comment by August 2006, and every three years thereafter. Based on its study and public comments filed in response to it, DOE may designate selected geographic areas as "National Interest Electric Transmission Corridors."

Applicants for electricity transmission projects proposed within the DOE-designated "corridors" that are not acted upon by state siting authorities within one year may request FERC to exercise federal "backstop" siting authority.

The Federal Energy Regulatory Commission (FERC) issued new rules November 16, 2006 to implement the new law. In a statement issued with the new rules, FERC Chairman Kelliher stated

The final rule also clarifies the meaning of the term “withheld approval” in the statute. As indicated earlier, one of the circumstances where FERC is authorized to issue a construction permit for a transmission project in a designated corridor is where a state siting body has "withheld approval"” for a year. The question has arisen as to whether than term only means state failure to act, or means both state failure to act and denial. We interpret this term using the usual rules of statutory construction, and conclude the most reasonable interpretation is that the term encompasses both state failure to act and denial.

In dissent, Commissioner Suedeen Kelly said the new rules go too far. Under her reading of the words of the statute, the power of FERC to approve a project comes into play only if a state fails to act on a transmission siting proposal:

States have always had exclusive, plenary jurisdiction over transmission
siting.... In 2005, Congress passed EPAct, which, for the first time, carefully carves out a limited role for the federal government in the area of transmission siting. EPAct amended the FPA [Federal Power Act] to give the Commission the authority to site electric transmission facilities in five specific situations.... The majorityÂ’s interpretation of Section 216(b)(1)(C)(i) would add a sixth situation: the Commission would have jurisdiction to approve the siting of a transmission line pursuant to federal law where the State has lawfully denied an application pursuant to state law.

In Commissioner Kelly's view, if a state acts on a proposed project within a year, and denies the project, there could be no overriding federal approval. Thus, the effect of the statute would be to encourage prompt action by states on often controversial transmission projects, and a state that wants to retain its full powers over transmission would be able to do that if it handles project applications expeditiously.

Given the likelihood of litigation over siting of transmission projects, the FERC majority view - that it can approve projects rejected by a state - will probably be tested in the courts, with the Supreme Court having the last word. Or, Congress may amend and clarify the law, giving new and clearer instructions to FERC for its implementation.

Meanwhile, DOE issued its first transmission congestion study on August, 8 2006. It found "critical" congestion areas in "the Atlantic coastal area from metropolitan New York southward through Northern Virginia." DOE did not, however, designate any "national interest transmission corridors." On November 9, 2006, DOE issued a press release announcing the opportunity for further comments on its 2006 study.

Update
February 18, 2009 -- Federal Appeals Court decision rejects FERC's assertion of override authority.

APPA Study Debunks NY PSC Report on Electric Restructuring

In March 2006 the New York Public Service Commission issued a Staff Report on the State of Competitive Energy Markets lauding the claimed results of its efforts to restructure New York state's wholesale and retail electricity industry. A new study undertaken for the American Public Power Association (APPA) examines the methodology of the New York PSC report and other reports that have attempted to measure costs and benefits of restructuring. With respect to the New York PSC report, the APPA report states:

In summary, the intention of this staff report of the New York State Department of Public Service seems not to be a careful or balanced assessment of the issues. Rather, it is at best an update on changes in the electricity (and gas) markets in New York and in state policies affecting these markets. Even as an update, however, it pays inadequate attention to causation and precision in its evidence and claims.

NY Court of Appeals Says PSC "Lightened Regulation" of New Electric Companies Justifies Local Property Tax Reductions

The New York PSC's "Light Regulation" Regime for New Electric Companies
In the 1990's heyday of electricity deregulation championed by Enron, 15 state legislatures authorized "restructuring" of their electric industries. In contrast to legislative action in other states, the New York PSC engineered the voluntary divestiture of utility power plants to new utilities through a series of agreements and orders. Retail utilities like Con Edison agreed to sell nearly all of their power plants to new companies. As a result, far more electricity must now be purchased in wholesale markets to serve retail customers. Typically these purchases are made at "market-based" wholesale rates under the jurisdiction of the Federal Energy Regulatory Commission (FERC). Residential and industrial customers have protested FERC's market rate regime, in which the benefit of the lower cost electricity from more efficient or depreciated power plants no longer flows to consumers. Today, the benefit of lower cost energy, say, from hydro, nuclear, or coal plants is reaped by wholesale utilities with "market-based" rates who are allowed by FERC to charge rates based on the price demanded by the most expensive plant running at any given time.

The New York PSC's "Realistic Appraisal" of Which Laws to Enforce
In granting certificates to the new electric companies, the PSC purported to waive many statutory requirements. The PSC asserted that it could make a "realistic appraisal" of which of the many laws applicable to electric companies, passed over the last 100 years by the legislature, should now apply to new owners of divested power plants. The PSC issued "light regulation" orders for each of the new companies, and in doing so, an alternative regulatory regime was created by PSC orders. See PULP's summary of PSC restructuring orders.

The "light regulation" orders purport to lift the PSL Section 65 utility obligation to provide safe and adequate retail service at reasonable rates to customers upon the customers' demand. They are premised upon assertions that the new electric companies intended to sell only at wholesale. It is an open question whether in the future, in recognition of the malfunctioning FERC-supervised market rate regime, the PSC could make a new "realistic appraisal" and require the new utilities to make some or all of their output available for the benefit of retail customers at reasonable cost-based rates.

Leveraging PSC "Light Regulation" Orders Into Local Property Tax Reductions
Armed with a "lightened regulation" decision of the PSC, a new electric company that bought a power plant from an older utility, Con Edison, sought to reduce its New York City property taxes. The relevant state law, Section 1801(c) of the New York Real Property Tax Law, establishes categories of taxation, and allows higher taxes upon PSC supervised utilities than upon companies engaged in general commercial activities. This higher taxation of utility property could be due to the heavy impact and burdens placed upon local land use and air quality by polluting power plants.

The definition of "utility" property in the tax law is:

c) "Utility real property" for the purposes of this article means the real property, including special franchises, of persons and corporations subject to the supervision of the state department of public service, the state department of transportation, or any other regulatory agency of the state or federal government, used in the generation, storage, transmission, distribution or sale of gas, electricity, steam, water, refrigeration, cable television, telephone or telegraph service, delivered through mains, pipes, cables, lines or wires, provided, however, that "utility real property" shall not include the types of real property, property or land described in paragraph (a) or (b) of subdivision twelve of section one hundred two of this chapter owned by such persons and corporations.

The section 102(12) (a) and (b) property excepted from the definition is ordinary land and buildings. The "utility real property" tax classification thus turns on whether the company is "subject to the supervision of the state department of public service . . . or any other regulatory agency of the state or federal government."

There can be no doubt that electric companies are under PSC "supervision." Electric companies are broadly defined by the New York Public Service Law 2(13) to include companies owning electric plants, and the PSC is broadly charged by the legislature with the power and duty to oversee all electric companies in PSL section 5:

§ 5. Jurisdiction, powers and duties of public service commission. 1. The jurisdiction, supervision, powers and duties of the public service commission shall extend under this chapter . . . .
b. To the manufacture, conveying, transportation, sale or distribution of gas (natural or manufactured or mixture of both) and electricity for light, heat or power, to gas plants and to electric plants and to the persons or corporations owning, leasing or operating the same.

The PSC "lightened regulation" orders held that all of the new companies that bought power plants from the older utilities are "electric companies" with "electric plants" as defined in Public Service Law 2(12 and (13).

A new utility's attempt to challenge its tax status as a "supervised" utility and thus escape the "utility real property" tax classification would seem to be a "no-brainer" in favor of the taxing authority, and indeed a lower court rejected the effort. But when the issue came to the Appellate Division and then to the state's highest court, New York Court of Appeals, in Matter of Astoria Gas Turbine Power, LLC v. Tax Commission of City of New York, the new electric company (AGTP) was found not to be sufficiently "supervised" by the PSC to warrant its continued taxation in the "utility" classification. Thus, the PSC's restructuring and its decision not to exercise its full powers over the new electric company leveraged a local property tax reduction. As a result, power plants must now be taxed in the same category as general commercial businesses.

While flawed in its analysis, the decision is quite interesting in its misapprehension of the PSC's restructuring. The Court said

"During the past three decades, both Congress and the New York State Legislature have sought to deregulate the electric utility industry."

Actually, while utilities continue to clamor for deregulation, neither Congress nor the New York Legislature actually "deregulated" the electric industry. To be sure, Congress and the New York Legislature at times have sought to induce competition, but the new utilities, including the petitioner in the Court of Appeals case, have not been "deregulated," and they are generally subject to the same laws as the traditional utilities. For example, the core principles of the Federal Power Act and the state Public Service Law that require publicly filed rates subject to review for reasonableness have not been changed. To the extent "deregulation" has occurred, it has been due to FERC or PSC forbearance and decisions not to enforce statutes that remain on the books.

The Court of Appeals sought to distinguish the new electric company owning the power plant sold from the traditional utility, stating:

traditional public utilities are generally afforded certain economic advantages. For instance, public utilities have historically exercised monopoly power, protecting them against competition. In addition, public utilities typically are afforded governmental franchises permitting them to place equipment on public rights-of-way or otherwise use public land. Given public utilities' competitive and financial advantages, the PSC establishes rates at which they can sell their product.

Much of the rationale for FERC and PSC approach to longstanding statutes rests upon the fallacious reductionism reflected in the court decision, i.e., the only reason for regulation is to protect consumers from monopoly providers, so the statutes can be disregarded if multiple providers appear. This, however, is a spurious distinction: nowhere in the Public Service Law does the word "monopoly" occur. The rationale for PSC regulation of electric service and supervision of electric companies is that electric service is a public service and the public interest is affected. It makes no difference whether the service is provided by a monopoly utility or multiple utilities. Actually, when the New York Public Service Law was first enacted, there were hundreds of electric companies and some of them competed in the same localities without local exclusive franchises, which emerged later.

The Court of Appeals' decision posits that the same plant could be taxed higher in the past when owned by a traditional utility only because of the benefits of PSC rate regulation, and that should be changed because the wholesale prices of the plant are no longer supervised by the PSC:

In fixing a public utility's classification for tax purposes, RPTL 1802(1) and 1801(c) take into account that the public utility is virtually guaranteed to earn a reasonable rate of return. In light of the economic advantages afforded to public utilities, New York's tax scheme has treated them differently than other types of entities.

The premise that because the new utilities are "competitive" they cannot pass through their costs, including their taxes, is fallacious. Most wholesale utilities voluntarily choose to sell at market rates under FERC jurisdiction, rather than file cost-based rates or at retail under PSC jurisdiction. When they are found to have market power or manipulate markets, then they file cost-based rates. They are free, however, at any time to file cost based wholesale rates with FERC, or cost-based retail rates with the PSC, and to include their local property taxes as a cost in calculation of the rates when the file or change them. Apparently, they do not choose to file cost-based rates because their opportunities to receive greater revenues are higher with market rates . Also, one would assume that when purchasing the power plant the buyer knew what the taxes were, and had a business plan that would enable it to recover its operating costs and investment and a profit. The tax reduction is simply a windfall, particularly for power plants with low production costs whose market rates are often set by sellers with more expensive power plants.

The court decision says that fully regulated utilities are "virtually guaranteed" to earn a reasonable return. That was never the legal standard: utility rates are set to give only a fair opportunity to earn a reasonable return. There are instances in which regulated utilities fail to earn their allowed returns on capital investment, or in which their investment costs or operating expense claims are disallowed in whole or in part for being excessive, unreasonable or imprudent. When the power plant was owned by a fully regulated utility, the utility was at risk of competitive pressures that could result in "stranding" of utility investment without recovery from ratepayers if, for example, the plant was inefficient and did not run.

The Court rested its decision on a fallacious distinction between the new and old utilities:

Unlike a utility, AGTP is not assured a reasonable rate of return, but is at the mercy of volatile competitive market forces based on supply and demand. Further, AGTP possesses no governmental franchises or property interests in public streets. Thus, in conformance with the Legislature's initiative to deregulate the electric utility industry, AGTP is a competitive entity like those whose real property is properly placed in class four."

Of course, the court offers no citation to any statute reflecting "the Legislature's initiative to deregulate the electric utility industry" because there is no such law. Also, the Court's analysis does not consider the possibility that a new "lightly regulated" company might someday choose to sell at retail, and could file retail rates with the PSC subject to PSC review, or cost-based wholesale rates at FERC. Under those scenarios, the new utility could avail itself of all the perceived advantages of rate regulation.

The tax statute quoted above plainly provides for utility tax treatment if the company is subject to supervision by the PSC "or any other regulatory agency of the state or federal government. The utility in the case was under FERC rate supervision. According to a siting board decision," AGTP is wholly-owned by NRG Northeast Generating, LLC, which is held 50% by Northeast Generation Holding, LLC and 50% by NRG Eastern, LLC; the latter two companies are whollyowned by NRG." NRG Energy, Inc. is a utility subject to FERC regulation, as NRG acknowledges in its SEC Annual Report for 2005:

Federal Power Act. The FPA gives FERC exclusive rate-making jurisdiction over wholesale sales of electricity and transmission of electricity in interstate commerce. Under the FPA, FERC, with certain exceptions, regulates the owners of facilities used for the wholesale sale of electricity or transmission in interstate commerce as public utilities. The FPA also gives FERC jurisdiction to review certain transactions and numerous other activities of public utilities. . . . Public utilities under the FPA are required to obtain FERC’s acceptance, pursuant to Section 205 of the FPA, of their rate schedules for wholesale sales of electricity. All of NRG’s non-QF generating companies and power marketing affiliates in the United States make sales of electricity pursuant to market-based rates authorized by FERC. FERC’s orders that grant NRG’s generating and power marketing companies market-based rate authority reserve the right to revoke or revise that authority. . . . If NRG’s generating and power marketing companies were to lose their market-based rate authority, such companies would be required to obtain FERC’s acceptance of a cost-of-service rate schedule and would become subject to the accounting, record-keeping and reporting requirements that are imposed on utilities with cost-based rate schedules.

The court decision does not address the fact that wholesale sellers of electricity are subject to the supervision of FERC and that NRG could, if it chose to do so, or if required by FERC as a result of market rate revocation, file cost based rates that include local taxes as part of the cost of service, just as Con Edison could have done when rates for electricity from the plant were under PSC jurisdiction.

The decision only partially quotes the relevant statute and completely omits the portion of the statute which defines "utility" property as being subject to supervision of the PSC " or any other regulatory agency of the state or federal government." As a result there is no mention of the fact that the seller is still subject to full FERC supervision of its rates. That FERC has allowed companies, at their option, to seek market rates in no way diminishes the ability of the utilities to set cost based rates that will cover their expenses, including local property taxes.

In sum, this seriously flawed decision represents a victory for the new "lightly regulated" electric companies and a defeat for local taxing authorities. As a result, localities that accepted power plants and taxed them as utility property will not be able to impose taxes higher than if they were a supermarket or other commercial establishment having less environmental impact. The victory could be temporary, however, if the tax law definitions of "utility real property" and regulatory "supervision" are redefined by the New York legislature to close the loophole carved out in the AGTP case.

Recognition of Continued PSC Regulation Regarding Safety, Reliability, Infrastructure Improvement and Market Power
In an interesting turn, despite its finding that the new utilities are not "supervised" by the PSC, the Court recognized that

the PSC maintains "light regulation" over AGTP covering "matters such as enforcement, investigation, safety, reliability and system improvement . . . . This light regulation also gives the PSC authority to limit AGTP's power in the market and any actions in contravention of the public interest.

Although labeled "light regulation," these are very major matters affecting the public interest that remain subject to PSC "supervision." Over time, the decision may be overruled by the legislature to restore utility tax classifications, and its broader implications may be seen as judicial recognition that despite claims of "deregulation," the new wholesale electric companies remain subject to PSC regulation regarding matters other than their FERC-supervised rates. This is significant because the new electric companies have contended they are free to withhold their power from the market or shut down completely, for economic reasons which may include perpetuation of shortages and maintaining higher prices for other plants in their fleets.

The recognition that the PSC has oversight over market power of the new utilities is especially significant. When the old utilities divested their power plant fleets, the plants were sold to a relatively small number of companies which may be able to exert market power and maintain unreasonably high prices. As more is learned about the operation of the NYISO spot markets, and if, as is widely expected, the wholesale power generation sector consolidates further through mergers in the coming years, the Court of Appeals' recognition the New York PSC has power to review market power may become more important than the property tax break it upheld. For example, the decision could support PSC review of behavior of sellers in NYISO markets, disapproval of mergers, or conditioning mergers upon a requirement that electric companies sell only at cost-based rates.

Updates
Chuck Bennett, Shocking and Tricky Power Play: Firms Call Selves Factories to Finagle Tax Break, N.Y. Post, April 6, 2011

Hannah Northey, New York City and FERC Square Off, E&E Reporter, April 4, 2011

David Seifman and Bill Sanderson, Mike to rate-$lapped NYers: Turn down A/C, N.Y. Post, April 2, 2011

William Pentland, New York City's Electricity Prices May Double by 2014, Forbes, April 4, 2011

Devlin Barrett, Electricity Reversal Sought, Wall Street Journal, April 2, 2011 ("the expected hike in power bills . . . was first reported in the New York Post").

Bill Sanderson, New York Electric Bills to Soar 12%, N.Y. Post, April 1, 2011.

NYISO Compliance Filing, March 29, 2011, ("The NYC Demand Curve included in the compliance filing reflects the addition of property taxes. Consistent with the findings reported in the NYISO Demand Curve Report,12 inclusion of property taxes results in a 41% increase in the NYC Demand Curve.)"

FERC Order Accepting Tariff Revisions Subject To Modification, Suspending For Five Months, And Directing Compliance Filing, Jan. 28, 2011("Property taxes are legitimate costs that are normally included the cost of new entry; NYISO has not shown that they will not be incurred by
peaking units that will be constructed in New York City....Accordingly, because of the questionable eligibility of a peaking unit and the fact that such abatement is discretionary, we direct NYISO to exclude tax abatement from the calculation of net CONE for NYC").

Yertle the Turtle? AT&T Now "Two Mergers Away" from Reintegration

AT&T was divided into seven regional bell operating companies (RBOCs) as a result of protracted antitrust litigation that ended in the 1980's. The RBOCs basically were confined to local phone service and they were barred from the lucrative long distance business, where AT&T was to compete with newer long distance service providers such as MCI.

The goal of promoting competition, however, now seems more distant. In the Telecom Act of 1996, Congress allowed the RBOCs to re-enter the long distance business if the FCC found that the industry was competitive. The RBOCs were granted permission by the FCC to re-enter the long distance business, resulting in the demise of the newer and smaller long distance companies.

Instead of competing against one other, the RBOCs merged with other RBOCs (e.g., NYNEX and Bell Atlantic merged to form Verizon), and now the merged RBOCs are acquiring smaller companies and former long distance competitors (e.g., Verizon's acquisition of GTE and MCI).

Now, AT&T, the once broken-up monopoly, is merging with SBC, a large RBOC.

UTEX Communications Corporation, a disgruntled small competitor using voice over internet protocol technology (VOIP), in comments filed with the FCC, analogizes AT&T to Dr. Seuss' Yertle the Turtle: "I’m figgering on biggering and BIGGERING and BIGGERING and BIGGERING.” According to UTEX, "[w]e are only two mergers away from re-vesting AT&T with its old empire...."

Meanwhile, local phone competition from companies leasing wholesale network elements from the RBOCs is dying as a result of FCC and court decisions. Nevertheless, the New York PSC continues to deregulate more of Verizon's local service, despite Verizon's dominant position. This is being done on the ground that "intermodal" competition between alternative phone technologies such as cable and wireless justifies dispensing with regulation. The New York PSC erroneously assumed the only reason for regulation was the monopoly nature of phone service. Regulation exists not because of the number of providers but because of the importance to society of universal communications services at just and reasonable rates, no matter who provides it.

Today's local phone choices really boil down to two sources, cable and telephone. VOIP services still must go over a phone line (DSL) or a cable line to the home. A duopoly dividing the consumer market between a dominant phone company and a cable company is hardly likely to result in competitive prices and services over time. Once market shares are established, the companies are likely to have monopoly prices and not to undercut one another.

Wireless phone service is sometimes claimed to be additional competition to cable telephone service, justifying less regulation of Verizon. But wireless service is not a full substitiute for landline service, and in any event, Verizon is the major wireless provider in New York state. In opposition to relaxed regulation of telephone companies based on "intermodal" competition, PULP submitted comments showing that in recent years New York has lost ground in its effort to achieve the goal of universal telephone service.Telephone availability in low income households has declined. PULP recommendations that measures be taken to increase affordability of service through reform of the federal-state telephone Lifeline program were rejected by the New York PSC. Now there has been a steep reduction of participation in the lifeline rate program due to overly stringent eligibility requirements and defects in administration of the automatic enrollment program.

Also, Verizon is rapidly acquiring local cable franchises to provide television service in New York, in competition with cable. To the extent Verizon succeeds in replacing cable TV service, the availability of cable telephony as a competitor is reduced.

The Telecom Act of 1996 also adopted new measures to promote universal service, affordability, broadband service to rural and inner city areas, lifeline and link-up service, and broadband for schools and libraries across the country. The results in these areas are also disappointing. For example, the number of New York households without access to any phone service is going up, and the number of low income households receiving lifeline discount service has declined by more than 200,000, effectively raising their rates by more than $24 million per year. For more information, see PULP's web page on universal service.