Cleaning up FERC's mess

It is time for the Supreme Court to protect customers by enforcing the Federal Power Act as it was written by Congress
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OPINION In the late 1980s, Federal Energy Regulatory Commission member Charles Trabant warned that "the only thing that we have to fear is FERC itself." He was speaking about his agency's aggressive policy of preempting state regulatory powers — and undermining the rights of consumers — to encourage utility competition. This spring the Supreme Court will decide whether or not Trabant was right.

FERC's response to the California energy crisis was too little too late.

At the height of the crisis FERC urged the state and many utilities — desperate to reduce the immediate cost impact of the crisis — to purchase long-term power supply contracts. Energy traders call this type of transaction "blend and extend" because the contract is a mix of short- and long-term prices. During this period, California and many utilities followed FERC's advice and took advantage of this form of contract with the objective of extending the contracts long enough to keep short-term prices down. One utility, for example, tried to limit prices to a 35 percent rate increase. While the immediate effect was to reduce prices, sellers ended up gaining crisis-related scarcity profits over the longer term of the contract.

After the crisis abated FERC found that short-term prices — including those that had been used in many utilities' blended contracts — were unjust and unreasonable and ordered sellers to refund revenues that exceeded an administratively determined just price. However, FERC denied the pleas of the state of California and others for adjustments to long-term contract prices. Ironically, it did so based on a "public interest standard," a financial test that considers the welfare of sellers but not that of customers. The public interest standard evolved to enable sellers to unilaterally raise a contract price that is below cost in order to avoid financial harm. Clearly, these were not the circumstances facing those who purchased power to temper customer costs. FERC just reckoned that the price would be passed on to customers.

The federal courts overturned the FERC decision. The 9th Circuit Court of Appeals found that FERC's oversight was "fatally flawed" and "offers no protection to purchasers victimized by the abuses of sellers or dysfunctional market conditions that FERC itself only notices in hindsight."

Electricity sellers, supported by FERC, have persuaded the Supreme Court to review the 9th Circuit's ruling. Amicus briefs before the Supreme Court paint a dark picture of unwilling investors not providing the capital necessary to maintain reliable electric systems.

The merchant energy sector experienced a severe credit and liquidity crisis in 2002. According to Moody's Investors Service, the crisis was not caused by regulators' protecting customers but was due to energy trading having a flawed business model that lacked investment-grade characteristics. The market was taught an expensive lesson with the bankruptcies of Pacific Gas and Electric Co., Enron, Mirant Corp., Calpine, and NRG. During this process, however, bankrupt power generators such as Mirant, the owner of the Potrero Hill power plant in San Francisco, used bankruptcy protection to modify contracts to generate value for their creditors.

Creditors have protection in the new competitive markets. Now it is time for the Supreme Court to protect customers too, by enforcing the Federal Power Act as it was written by Congress.

Carl Pechman

Carl Pechman is an economist and the founder of the energy consulting firm Power Economics in Santa Cruz.