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-----Original Message----- From: IssueAlert@SCIENTECH.COM [mailto:IssueAlert@SCIENTECH.COM] Sent: Tuesday, November 27, 2001 11:12 AM To: ISSUEALERTHTML@LISTSERV.SCIENTECH.COM Subject: FERC Enacts Major Constraints on Wholesale Market <http://secure.scientech.com/images/spacer.gif<;=09 <http://secure.scient= ech.com/images/spacer.gif<=09 <http://secure.scientech.com/_IA_TEST/Corner_TL.jpg<=09 <http://secure.s= cientech.com/images/spacer.gif<=09 <http://secure.scientech.com/_IA_TEST/C= orner_TR.jpg<=09 =09 <http://secure.scientech.com/rci/wsimages/ia_banner02.gif<=09=09 <http://secure.scientech.com/_IA_TEST/Corner_BL.jpg<=09=09 <http://secur= e.scientech.com/_IA_TEST/Corner_BR.jpg<=09 <http://secure.scientech.com/images/spacer.gif<;=09 <http://secure.sciente= ch.com/specialpages/Multi_Client.asp<=20 <http://secure.scientech.com/images/spacer.gif<;=09 <http://secure.scient= ech.com/images/spacer.gif<=09 =09 <http://secure.scientech.com/rci/wsimages/will100border_copy.jpg< <http://secure.scientech.com/_IA_TEST/Corner_TL.jpg<=09=09 <http://secur= e.scientech.com/_IA_TEST/Corner_TR.jpg<=09 =09 <http://secure.scientech.com/images/spacer.gif<; <http://www.thestructu= regroup.com<=20 <http://secure.scientech.com/images/spacer.gif<; <http://secure.scientech.= com/specialpages/Strategic_Planning.asp< <http://secure.scientech.com/ima= ges/spacer.gif< <http://secure.scientech.com/rci/details.asp?ProductID=3D90= 9< <http://secure.scientech.com/images/spacer.gif<;=09 <http://secure.scientech.com/_IA_TEST/Corner_BL.jpg<=09=09 <http://secur= e.scientech.com/_IA_TEST/Corner_BR.jpg<=09 November 27, 2001=20 FERC Enacts Major Constraints=20 on Wholesale Market By Will McNamara Director, Electric Industry Analysis AEP, Entergy Corp. and Southern Company told by FERC to charge cost-based p= rices instead of market-based prices for wholesale spot transactions.=20 [News item from Reuters] The U.S. Federal Energy Regulatory Commission (FER= C) voted 3-1 last week to adopt new rules to measure market power, as a con= dition for approving mergers and granting utilities the right to trade powe= r in the wholesale market. FERC commissioners said the new test would impro= ve a system that allowed a meltdown to take place in the California market = last winter, when wholesale power prices soared to record highs amid tight = supplies. FERC commissioners agreed to produce a new market power test base= d on supply margin assessments, which examines a company's importance in se= rving peak electricity loads. "If you're big enough to control the market a= t the time we look at it, you'll have mitigation put on you," said FERC Cha= irman Pat Wood.=20 Analysis: Many participants in the wholesale sector of the energy industry = are still reeling from FERC's new ruling, which may have slipped past some = radar screens considering that it was issued right before the long holiday = weekend. This is a mammoth ruling on FERC's part, however, and it holds tre= mendous impact for those companies that increasingly find the lion's share = of their profits coming from wholesale transactions. In addition, state reg= ulators have also started gauging the impact of the ruling on retail rates,= which some utilities may seek to increase as a way to compensate for shrin= king profits in their wholesale operations. While FERC has presented this r= uling as an attempt to circumvent on the national level problems experience= d in the California market, the new limits on wholesale transactions can al= so be seen as another example of the "big stick" that the commission is usi= ng to force utilities into participating in regional transmission organizat= ions (RTO). Further, the ruling is another striking indication that Chairma= n Wood is following through with his promise to monitor rampant wholesale m= arkets while still attempting to support competition. The objective represe= nts a tall order, and the new ruling from the commission is certain to prom= pt intense resistance among companies involved in wholesale trading.=20 Put into a nutshell, FERC has ruled that some companies can no longer charg= e unregulated, market-based rates for spot market wholesale transactions. I= nstead, companies identified as having market power and that aren't part of= an approved RTO must charge cost-based prices for power that isn't committ= ed in a long-term contract, and publicly disclose those cost-based prices. = Columbus, Ohio-based American Electric Power (NYSE: AEP), Atlanta-based Sou= thern Company (NYSE: SO) and New Orleans-based Entergy Corp. (NYSE: ETR) ha= ve been singled out as case studies on which FERC will be immediately apply= ing its new standards for wholesale transactions. Note that Mirant Corp., a= former subsidiary of Southern Company, has also been identified as having = to submit information to FERC in order to gauge its level of market power s= eparate from its former parent. The commission has essentially determined t= hat these three utilities hold an unacceptable level of market power in the= areas in which they operate. Under FERC's new market power "test," a gener= ator or marketer is viewed as having too much market power if its electrici= ty is "pivotal" during peak demand, which enables the company to demand a p= rice above competitive levels. Regional transmission constraints will also = be considered now as a measurement of a company's market power. This is a d= ramatic departure from previous standards, by which (under one of FERC's ma= in criterions) a company that supplied less than 20 percent of the power ne= eded in a particular region was freed from rate regulation on the federal l= evel.=20 There are some important exceptions to the ruling. First, FERC has not elim= inated the utilities' ability to charge market-based rates in areas where t= he grid and markets are controlled by a FERC-approved RTO. This is signific= ant, as I will expand upon subsequently, because it indicates that there ar= e secondary objectives in FERC's new ruling. In addition, the current rulin= g only impacts short-term sales transactions in which these three utilities= are involved. In other words, long-term contracts that the three companies= may have previously established or will establish in the future are not im= pacted by the ruling. However, the three companies named in the ruling will= have to post pricing information related to long-term contracts, and FERC = has retained the possibility that further price mitigation for long-term co= ntracts may be necessary. Also note that the Western market, which already = is under a price mitigation policy that FERC imposed in June, was not inclu= ded in the new ruling.=20 The three utilities named in the ruling now have 15 days to submit proposal= s to FERC outlining a transition to charging cost-based wholesale rates for= all power not currently committed to a buyer. Specifically, the utilities = will have to post on their open-access same-time information systems (OASIS= ) the incremental cost of producing the uncommitted power during each hour = in a 24-hour period. Moving forward, the price that the utilities can charg= e for non-committed power on the spot market will be the difference between= their cost of production and the bid of more expensive power in the region= that their power displaces. The new cost-based rates must be administered = by an independent third party.=20 The new pricing standards revert back to an older, cost-based technique kno= wn as "split the savings." The methodology for this standard can get rather= complicated, but essentially under FERC's new ruling the three companies i= dentified will have to post their cost-based, incremental costs for spot po= wer into the OASIS system for viewing by potential purchases. Purchasers wh= o want to make a bid will post their decremental energy bid for not produci= ng or buying the power on their own. The final price for the transactions w= ill be the split between the seller's incremental cost and the buyer's decr= emental bid. For instance, if Southern Company bids its incremental cost at= $20/MWh and a purchaser bids its decremental cost at $30/MWh, the transact= ion price would be $25/MWh. Assuming a midnight-to-midnight trading day, se= llers would have to submit their incremental bid by noon on the previous da= y and buyers would submit their decremental bids by 6 p.m. What this potent= ially creates is an "information advantage" for buyers who have six hours t= o evaluate and respond to the incremental bids from some sellers. Some of t= he drawbacks to this system are that it requires both parties to post price= information that may not be readily available and it potentially allows th= e purchaser to game the system by having access to the seller's original in= cremental bid and competing around the seller's price.=20 Note also that in a separate development FERC simultaneously opened a broad= investigation under Section 206 of the Federal Power Act to apply the new = market-based-sales policy to all U.S. sellers nationwide. What this means i= s that, although only three utilities are mentioned in this initial order, = it is expected that FERC will continue to take steps to constrain what it b= elieves to be erratic wholesale markets. Reportedly, some 30 companies are = awaiting similar reviews by FERC to determine if the commission believes th= ey exert market power. The 206 investigation reportedly also requires power= providers with market-based sales authority to amend their tariffs within = 60 days to provide FERC with open-ended authority to order refunds if the c= ommission determines that market manipulation has occurred.=20 I made a previous reference to the "big stick" that FERC is carrying relate= d to participation in RTOs. Remember that a few months ago, Chairman Wood h= ad threatened to deny utilities that refused to join an RTO the benefits of= charging market-based wholesale rates and swift approvals for merger appli= cations, advantages that the chairman equated with the "new world" of the d= eregulated energy market. With this in mind, note that only Southern Compan= y, Entergy and AEP are included in the present ruling (although it may be s= ubsequently expanded). Southern Company and Entergy in particular have exhi= bited some resistance in following FERC's consolidation mandate regarding n= ational RTOs, so it is probably not a mere coincidence that these three uti= lities have been singled out. This must be particularly painful for Souther= n Company, which gains a good part of its profits from wholesale trading an= d previously expressed plans to double the size of its generation assets ov= er the next five years.=20 Interestingly, Commissioner Linda Key Breathitt represented the single diss= enting vote in the ruling. Breathitt's concern was that the ruling had been= pulled together too quickly and not enough time had been provided to evalu= ate the impact on wholesale markets. This issue will undoubtedly be contest= ed, and to a certain extent the utilities impacted by the ruling appear to = have been caught off-guard. AEP, Entergy and Southern Company all issued st= atements to the effect that they were uncertain about the extent to which t= he ruling would impact them, and that they were reserving the right for pos= sible litigation.=20 Moreover, to summarize the commission's rulemaking, I think there are a han= dful of important points that should be considered. First, the ruling illus= trates the steps that FERC is taking to revoke market-price authority that = was for the most part unrestricted prior to the time that Pat Wood assumed = his post as chairman. Second, FERC is implementing cost-based prices on the= spot market only, and in only very defined circumstances. However, this co= uld be an indication that the commission may extend cost-based pricing to o= ther wholesale transactions, including long-term contracts, at a later time= . Third, the "split the savings" cost-based formula could become fraught wi= th its own problems. Its requirements are rather complex and it offers the = potential to give power purchasers a market advantage on the spot market ov= er power sellers, which will now be required to post incremental costs in t= he bidding process. Finally, one of the inherent drivers of FERC's new ruli= ng is its desire to have large utilities join the RTOs that the commission = has approved. It is very significant that the new ruling immediately impact= s AEP, Entergy and Southern Company, utilities that have not only been deem= ed by the commission to have market power in their regions but which have a= lso not yet joined an approved RTO. However, even though only three compani= es are immediately impacted by this ruling, it should not be overlooked tha= t the ruling holds impact for the market as a whole as other sellers now wi= ll gain important pricing information about the major suppliers in certain = areas. Thus, overall this is a very significant ruling and one that could s= ubstantially change the manner in which transactions in the wholesale power= market are conducted.=20 An archive list of previous IssueAlert articles is available at www.scientech.com <http://secure.scientech.com/issuealert/<;=20 _____ =20 We encourage our readers to contact us with their comments. We look forward= to hearing from you. Nancy Spring <mailto:nspring@scientech.com< Reach thousands of utility analysts and decision makers every day. Your com= pany can schedule a sponsorship of IssueAlert by contacting Jane Pelz <mai= lto:jpelz@scientech.com<at 505.244.7650. Advertising opportunities are also= available on our Website.=20 _____ =20 Our staff is comprised of leading energy experts with diverse backgrounds i= n utility generation, transmission and distribution, retail markets, new te= chnologies, I/T, renewable energy, regulatory affairs, community relations = and international issues. Contact consulting@scientech.com <http://consulti= ng@scientech.com< or call Nancy Spring at 505.244.7613.=20 _____ =20 SCIENTECH is pleased to provide you with your free, daily IssueAlert. Let u= s know if we can help you with in-depth analyses or any other SCIENTECH inf= ormation products. If you would like to refer colleagues to receive our fre= e, daily IssueAlert articles, please register directly on our site at secur= e.scientech.com/issuealert <http://secure.scientech.com/issuealert/<;.=20 If you no longer wish to receive this daily e-mail, and you are currently a= registered subscriber to IssueAlert via SCIENTECH's website, please visit = <http://secure.scientech.com/account/<; to unsubscribe. Otherwise, please se= nd an e-mail to IssueAlert <mailto:IssueAlert@scientech.com<, with "Delete = IA Subscription" in the subject line.=20 _____ =20 SCIENTECH's IssueAlert(SM) articles are compiled based on the independent a= nalysis of SCIENTECH consultants. The opinions expressed in SCIENTECH's Iss= ueAlerts are not intended to predict financial performance of companies dis= cussed, or to be the basis for investment decisions of any kind. SCIENTECH'= s sole purpose in publishing its IssueAlert articles is to offer an indepen= dent perspective regarding the key events occurring in the energy industry,= based on its long-standing reputation as an expert on energy issues.=20 Copyright 2001. SCIENTECH, Inc. All rights reserved. <http://infostore.consultrci.com/spacerdot.gif?IssueAlert=3D11/27/2001<;
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