Energy Legal Blog

Earlier this month, Maryland Governor Erlich (R) proposed the Maryland Clean Power Rule (“MCP Rule”), which would mandate constant emission controls and greatly diminish nitrogen oxide (NOx), sulfur dioxide (SO2) and mercury emissions from Maryland power plants, years ahead of the U.S. Environmental Protection Agency's Clean Air Interstate Rule (CAIR) and Clean Air Mercury Rule.  Under the MCP Rule, by 2010, NOx emissions would be reduced by 45,000 tons per year (69%); SO2 emissions would be reduced by 205,000 tons per year (85%); and mercury emissions would be reduced by 1,400 pounds per year (70%), with a second phase of controls reducing mercury emissions by 90% by 2018.  The limits imposed by the MCP Rule also would help cut fine particulate matter emissions and help the state to meet federal standards, as called for in CAIR by 2010.

The MCP Rule's emission limits would have the biggest impact on Maryland's six largest coal-fired power stations, three of which are owned by Constellation Energy and three by Mirant. According to the Governor's office, these six stations produce 95% of the state's power plant emissions.   Under the MCP Rule, plants would have to add pollution controls to meet the emission reductions instead of buying out-of-state emissions allowances.  Companies would be permitted to average emissions among their plants, but would not be able to trade with other companies.

The MCP Rule is expected to be published in the Maryland Register sometime in early 2006 and hearings on it will be held in the spring by the state's Department of Environment.

In a November 18 notice of rulemaking FERC proposes to implement the incentives mandated in the Domenici-Barton Energy Policy Act of 2005 (EPAct 2005) for investing in electric transmission infrastructure that benefit consumers by increasing grid reliability and reducing the transmission costs caused by congestion.   The rulemaking posits that Transcos — stand-alone companies that sell transmission services at wholesale or otherwise unbundled from retail electricity sales — are the preferred vehicle through which transmission investments are made and, accordingly proposes additional financial incentives for forming, participating in, and funding Transcos.  Incentives are also proposed in the rulemaking that would encourage transmission owners to participate in transmission organizations that would operate their systems.  To be considered by the agency, public comments on the rulemaking must be submitted electronically or in hard copy by January 11, 2006.

The transmission provisions of EPAct 2005 and the proposed rulemaking respond to a recent and untenable history characterized by declining investment in transmission infrastructure, on the one hand, and burgeoning demand for electricity service, on the other.  According to industry sources, in order to assure system reliability and support competitive wholesale markets, the current $4 billion level of annual transmission investment in the US must increase to $5 billion annually.  In particular, the rulemaking implements Congress’ directives in new Federal Power Act (FPA) § 219 that FERC (1) establish incentive-based (including performance-based) rate treatments to induce investment in new and upgraded transmission systems that improve reliability and reduce congestion, and (2) provide to each transmission owner incentives to surrender operational control of its system to some form of independent operator.

Central to achieving both directives are proposals to allow returns on transmission investments that are at the top end of a zone of reasonableness, recognizing that nothing in EPAct 2005 removes or diminishes the long-standing FPA requirement that all transmission rates be just and reasonable.  This could be achieved not only by authorizing high returns on invested equity but also through the flexible use of hypothetical capital structures in setting returns.  Shortening the depreciable life of transmission investments to 15 years could also be use to accelerate the recapture of investment.  In addition to creamier returns and more rapid depreciation, the rulemaking also addresses investment risks peculiar to electric transmission infrastructure and the tax consequences of spinning off transmission to a Transco.

Aspects of the proposed rulemaking would recognize that long lead times attend designing and constructing new transmission before the new facilities become operational and begin earning revenues, and that unforeseeable things can go wrong in the meantime.  To address long lead times, the rulemaking would (1) allow l00 % of funds spent on transmission construction work in progress (CWIP) into a transmission owner’s rate base, and (2) permit the investor to expedite recovery of costs incurred before commercial operations begin by expensing rather than capitalizing those costs.   FERC solicits public advice on what pre-commercial operations costs should be eligible for expensing. 

In the event that occurrences beyond an investor’s control cause a transmission investment to be abandoned, the rulemaking would allow complete recovery of those costs.  In the past, the costs of an abandoned project typically have been split between the investor and transmission customers, but under the rulemaking could be recovered 100 cents on the dollar from customers.  FERC points to the recent example in which Southern California Edison was allowed to recover all prudently incurred costs to build transmission to interconnect a proposed wind farm.  FERC reasoned in that case that the wind farm developer’s decision to cancel its project would be beyond Edison’s control and justified complete recovery of pre-termination investments in transmission.  The rulemaking also addresses the investment deterrent confronting public utilities operating under retail freezes or moratoria.  These utilities would be unable to recover current transmission investments.  To lessen this burden, FERC proposes a deferred cost recovery program under which such a utility would begin recovery of new transmission facility costs in transmission rates as soon as the freeze or moratorium expired.

On top of these inducements, the rulemaking singles out Transcos for even further favors.  The distinguishing characteristic of a Transco is that the entirety of its business is providing transmission services (not coupled or commingled with generation) for which FERC alone sets the price.   In this respect, a Transco stands to benefit from the incentives of the rulemaking more so than an integrated public utility that sells a service of bundled power and transmission that is priced, at least in part, by state regulators.  Moreover, FERC finds in Transcos the preferred vehicle for transmission investments because it would not confront the tradeoffs that a traditional integrated utility confronts when its investment in transmission may well reduce the value of its other investments in generating plant.  Higher equity returns may accordingly be justified for Transcos because they have a history of reinvesting those returns more completely in needed new transmission infrastructure.

The rulemaking proposes also to remove a barrier to Transco formation.  As much of the nation’s existing transmission infrastructure that could be spun off to form a Transco has been depreciated to a book value far below its market value, the seller would incur accumulated deferred income taxes (ADIT) on its sizable capital gain.  Under this scenario, the seller can be expected to adjust upward the price it charges for its transmission system to cover these taxes.  FERC proposes in the rulemaking to continue its recent practice of allowing a Transco to recover in its transmission rates the increased purchase price that it pays to cover ADIT.

While clearly less enthusiastic about transmission organizations — ones with transmission systems still owned and controlled in part by traditional integrated utilities — than it is about a Transco, the rulemaking proposes to ensure that utilities that join such organizations fully recover the cost of their participation.  The rulemaking also implies and one Commissioner flatly suggested that the returns that transmission organizations earn on transmission investment should be directly proportional to how independent they are from the owners of the transmission systems that they operate.

Lastly, the rulemaking turns itself to the often controversial topic of performance-based pricing of transmission service.  FERC asks for public advice on how performance should be measured and rewarded.  Two noteworthy topics are raised.  FERC first asks whether the participation of public power entities in transmission-investment consortia should be rewarded for the low-cost debt financing they can provide through interest-free bond issues.  Second, FERC asks whether it should ask applicants for performance-enhanced rates for a statement of the innovative transmission technologies that they propose to implement.   [Promoting Transmission Investment Through Pricing Reform, 113 FERC ¶ 61,182 (2005)]

Congress in the Domenici-Barton Energy Policy Act of 2005 (EPAct 2005) and FERC in proposed implementing regulations looked to the Securities Exchange Act of 1934 and its anti-fraud provisions to put in place parallel new prohibitions against and heightened penalties for manipulation and deception in connection with the wholesale natural gas and power transactions that FERC regulates.  [See FERC Looks to Past for Future Anti-fraud Enforcement and FERC Explains Its Policy on New Penalty Authority]   Not surprisingly, in a November 18 interpretation of its rules, FERC has looked again to the practices of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) under the securities laws to adopt a process for educating and guiding the natural gas and power industry on complying with the new prohibitions.  Specifically, through its staff FERC will now issue discretionary ‘no-action letters’ similar to those that the SEC and CFTC staff issue.

Presented with a specific transaction that an applicant for a no-action letter proposes to undertake, FERC will have the division of its staff with relevant expertise examine the transaction for compliance with FERC’s Standards of Conduct, Market Behavior Rules, and (once they are finalized and implemented) new rules implementing the anti-fraud provisions of EPAct 2005.  If the contemplated transaction passes muster under these strictures, then the FERC staff can issue a no-action letter indicating that the staff will not recommend any enforcement action in connection with the transaction.  While not binding on FERC itself (just as no-action letters are not binding on the SEC or CFTC), they almost always have this effect since they represent the consensus view of those on the staff most familiar with the subject matter of and rules pertaining to the proposed transaction at issue.  Unlike FERC’s earlier procedures for obtaining the informal advice of its staff, which ordinarily commanded a fee, the new no-action letter procedures will be free of charge, at least initially.

Because of ambiguities in FERC’s Market Behavior Rules and the newness of the anti-fraud provisions, access to the no-action letter process should prove a welcome development.  Use of the process should be integrated into the compliance program of every prudent participant in wholesale natural gas and power markets.  Requests for issuance of no-action letters should be addressed to FERC’s general counsel and should be submitted on a non-public basis.  They will remain confidential until answered, at which time, absent extraordinary circumstances, both the request and answer will become public.  The request must particularize in detail the parties to the proposed transaction and the requester’s role.  If FERC staff finds the transaction too speculative or vague, it can either request additional information or decline to respond.  [Informal Staff Advise on Regulatory Requirements, 113 FERC ¶ 61,174 (2005)]

FERC asked on November 21 whether it should repeal its Market Behavior Rules in light of its new authority under the Energy Policy Act of 2005 (EPAct 2005) to prevent market manipulation.  FERC adopted the Market Behavior Rules approximately two years ago, and required them to be a part of all electric and gas market-based rate tariffs, in an effort to curb market manipulation.  The cornerstone is Market Behavior Rule 2, which prohibits “actions or transactions that are without a legitimate business purpose and that are intended to or foreseeably could manipulate market prices, market conditions, or market rules.”  Public comments on whether repeal is in order are due 30 days after publication of FERC's proposal in the Federal Register, probably sometime in late December.

EPAct 2005 amended the Federal Power and Natural Gas Acts to grant FERC broader authority to prohibit any entity from using or employing “any manipulative or deceptive device or contrivance” in connection with the purchase or sale of wholesale electricity or natural gas and jurisdictional transmission or transportation services.  Pursuant to that authority, FERC initiated procedures last month to implement this new authority in rulemakings aimed at preventing market manipulation [see FERC Seeks Comments for Competition Task Force] and establishing new audit procedures [see Rulemaking to Establish Procedures for Challenging FERC Operational Audits], and a policy statement interpreting FERC's enforcement authority [see FERC Explains Its Policy on New Penalty Authority].  In these rulemakings, FERC has proposed to adopt a more specific intent or “scienter” standard of proof, which is modeled on the SEC's enforcement of Rule 10b-5 under the Securities Exchange Act of 1934, and has been interpreted by courts as requiring a showing of knowing, intentional or reckless conduct with intent to manipulate, deceive, or defraud.

In light of FERC's new EPAct 2005 authority, some commentators have suggested that the Market Behavior Rules are redundant, if not superfluous.  In particular, these critics point to the fact that the new anti-fraud rules of EPAct 2005 may be enforced against “any entity,” including entities not usually subject to FERC's jurisdiction, while the Market Behavior Rules are applicable only to public utilities possessing market-pricing authority.  But notwithstanding this broader coverage, the Market Behavior Rules and specifically Market Behavior Rule 2 impose a stricter standard than the more-punitive new rules under EPAct 2005:   They proscribe actions or transactions that “foreseeably” could manipulate market prices, conditions, or rules, while the EPAct 2005 rules will require proof of intent.  [Investigation of Terms and Conditions of Public Utility Market-Based Rate Authoriziations, 113 FERC ¶ 61,190 (2005)]

FERC recently reaffirmed its policy permitting competitive discounting of natural gas transportation charges, upholding the practice against charges that competitive discounting shifts costs unfairly to captive customers of the discounting pipeline.  According to FERC, allowing pipelines to adjust throughput to reflect increased sales at discounts remains an important tool for maximizing system usage of interstate pipelines, benefiting all users.

FERC's current policy is to allow pipelines to discount transportation charges on a nondiscriminatory basis, to meet competition from all other forms of transportation.  Before late 2004, FERC allowed discounting only for the purpose of meeting competition from capacity release or from intrastate pipelines.  FERC opted to allow discount adjustments for any of these competitive reasons.   But following an inquiry in late 2004, the agency stated that discounting to meet competition from all alternative transportation options lowered costs to all users by spreading pipeline costs over an increasing number of units of throughput.  

The Illinois Municipal Gas Agency, together with the Northern Municipal Distributor Group and the Midwest Region Gas Agency had asked FERC to reconsider its discounting policy.  They argued that the discounting does not benefit the captive customers of the discounting pipeline, and generally they claimed that low elasticity of demand for natural gas transportation prevented discounts from materially increasing demand and throughput.  As a consequence, the complainants charged that discounting often shifts more costs to captive customers than it saves all customers generally from increased throughput.

Not so, countered FERC.  The evidence is that discounting more than offsets any shift in fixed costs on most systems.  FERC qualified, however, that if presented with circumstances on an individual pipeline that warrant additional protections for captive customers, such protections could be considered in individual rate cases.  In a noteworthy partial dissent, Commissioner Suedeen Kelly argued that pipelines should be required to post on their websites the reasons for providing a discount to a particular shipper.  [Policy for Selective Discounting by Natural Gas Pipelines, 113 FERC ¶ 61,173 (2005)]

FERC approved a $1.5 billion settlement between Enron and the plaintiff group known as the California parties, as well as the attorneys general of Oregon and Washington, and FERC staff.  The settlement resolves claims and matters arising from transactions in the western energy markets from January 16, 1997, through June 25, 2003.   

The settlement includes an $875 million unsecured claim against Enron in the bankruptcy proceeding, a $600 million civil penalty in favor of the California, Oregon and Washington attorneys general, and cash or cash equivalence of $47.4 million.  Ominously for others who did business with the disgraced energy giant, the settlement also requires Enron to cooperate with the settling parties in their claims against other entities related to events in the Western energy market.  

The settlement has also been approved by the California Public Utilities Commission and the United States Bankruptcy Court for the Southern District of New York, which is adjudicating Enron’s bankruptcy.  FERC’s order noted that the value and timing of the settlement’s $875 million unsecured claim in the bankruptcy proceeding is uncertain due to the ongoing bankruptcy litigation.  

FERC Chairman Joseph Kelliher called the Enron settlement a turning point in the agency’s efforts to bring closure to the 2000-2001 Western energy crisis.  He also attributed the settlement to FERC’s “strong enforcement posture.”  Combined with the Chairman’s recent statements in support of FERC’s Office of Market Oversight and Investigations, its seems clear that the agency intends to emphasize its market oversight and enforcement roles.