Federal Energy Regulatory Commission

1
Federal Energy Regulatory Commission

• Chairman James Spencer
• Commissioner C. Davis Bradford

2

• Southern California Edison Co. (SCE)
• v.
• Dynegy, Inc.

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What is just and reasonable

• 205 of the Federal Power Act (FPA), 16 U.S.C.
  824d
• All rates and charges made, demanded, or
  received by any public utility for or in
  connection with the . . . sale of electric
  energy subject to the jurisdiction of the
  Commission and all rules and regulations
  affecting or pertaining to such rates or charges
  shall be just and reasonable and any such rate
  or charge that is not just and reasonable is
  hereby declared unlawful.

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• 206 of the Federal Power Act, 16 U.S.C. 824e
• Whenever the Commission, after a hearing held
  . . . upon complaint, shall find that any rate,
  charge, or classification, demanded, observed,
  charged or collected by any public utility for
  any . . . Sale subject to the jurisdiction of
  Commission . . . is unjust, unreasonable, unduly
  discriminatory or preferential, the Commission
  shall determine the just and reasonable rate . .
  . to be thereafter observed and in force, and
  shall fix the same by order.

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December 15, 2000 Transaction

• Facts
• Dynegy sold 5000 MWh of electricity from its Palo
  Verde plant to SCE for 130/MWh
• The recent historical fair price was only
  40/MWh (Nov.-Dec. 14)
• Dynegy had never charged more than 60/MWh for
  power from the Palo Verde plant

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Administrative Law Judge Findings

• Dynegy did not collude with other sellers to fix
  prices or manipulate the market
• None of Dynegys usual costs (gas, delivery
  costs, etc.) increased before or immediately
  after Dec. 15
• Demand for power on the CalPX reached on all-time
  high on Dec. 13 14, reducing reserve margins to
  near zero
• Dynegys high bid thus reflected scarcity rents
  based on the prediction that power from the Palo
  Verde plant would be required to meet the
  additional demand

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SCE Request

• SCE contends that the 130/MWh was not just and
  reasonable in violation of the FPA and seeks a
  refund of 450,000
• 5000MWh X 130/MWh 650,000
• 5000MWh X 40/MWh 200,000
• Difference 450,000

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SCEs Arguments

• Dynegys excessive rate was the result of price
  gouging and was an improper use of market power
  that led to the exorbitantly high prices
• Dynegys rate was outside the zone of
  reasonableness

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Rate Setting

• Rate setting since congressional enactment of the
  FPA has followed two routes.
• First, the filed rate doctrine
• The filed rate doctrine requires a whole
  wholesale rate chargers to submit a schedule of
  rates in advance
• Deviation of these rates is not permitted without
  FERC approval.
• Second, market based rates.
• Two components of a market based system are a
• Competitive market
• Particular seller may not have market power

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Rate Setting

• The prevailing price in the market place cannot
  be the final measure of just and reasonable.
• Dynegy exercised market power because they knew
  that they could charge whatever they wanted.
• The zone of reasonableness requires that rate
  be compensatory but not excessive.
• Dynegys rate is outside the zone of
  reasonableness because its costs did not
  increase.
• Dynegy was receiving compensation solely based
  scarce supply.
• Wholesale electric sellers may not charge late
  fees as a penalty to induce prompt payment.

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Dynegys Response

• Dynegy did not possess market power
• Scarcity rents are permissible to induce new
  investment in the industry
• Dynegys rate was in compliance with FERCs Nov.
  1 and Dec. 15 Orders
• Dynegys rate was within the zone of
  reasonableness

12
Market Power

• Dynegy denies any use of market power rather
  that they collected a scarcity rent. Market
  Power occurs only when
• Monopoly
• Too few producers
• Collusion among firms to set prices
• FERC has defined market power as the ability to
  significantly influence price by withholding
  supply or excluding competitors for long periods
  of time
• Dynegy has not withheld supply
• Not excluding competitors either scarcity rents
  attract them

13
Scarcity Rents

• Simple supply-demand economics
• When scarcity goes up, price goes up
• Reduces demand, increases supply by attracting
  new entrants
• Dynegy simply charged market clearing rate at
  CalPX

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FERC December 15 Order

• Blame on seriously flawed regulatory scheme
• Main thrust was to shut down spot markets
• Exposure to spot market volatility main issue
• Regulatory problem and needs public policy
  solution
• 150/MWh soft cap means 130/MWh just and
  reasonable by definition

15
Rebate

• Dont use 40/MWh use something closer to
  December 2000
• Historical rate calculated during supply-demand
  balance periods
• A good reference point would be 273/MWh from
  March 2001 FERC order

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May 29, 2001 Transaction

• Facts
• Dynegy sold 5000 MWh of electricity from its Palo
  Verde plant to SCE for 500/MWh
• The recent historical fair price was only
  40/MWh (Nov.-Dec. 14)

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May 29, 2001 Transaction

• Important Factors Affecting Price
• High demand during winter and spring caused
  plants to run longer and harder than ever before
• Plants consumed air pollution credits needed to
  run the plants more quickly
• Additional credits could be purchased on an open
  market, but increasing demand drove credit prices
  to new highs
• As the credit ratings of SCE and PGE
  deteriorated through the Spring of 2001,
  producers began charging a nonpayment risk
  premium as part of the price

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Administrative Law Judge Findings

• Approximately 50/MWh represented Dynegys usual
  costs (gas, delivery costs. etc.)
• Another 200/MWh represented the costs of buying
  air pollution credits to enable the plant to run
  that day
• The remaining 250/MWh represented the risk
  premium charged to cover the risk of nonpayment
  by SCE

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SCE Request

• SCE contends that the 500/MWh was not just and
  reasonable in violation of the FPA and seeks a
  refund of 2.3 million
• 5000MWh X 500/MWh 2,500,000
• 5000MWh X 40/MWh 200,000
• Difference 2,300,000

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SCEs Arguments

• The historical fair price is the best reflection
  of a just and reasonable price
• SCE cannot pass on its increased costs to its
  customers, therefore Dynegy should be equally
  constrained
• Air pollution credits are not usual costs
• Price gouging in the air pollution credit market

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Dynegys Position Flawed

• Dynegy asserts incorrectly that its December
  prices were just and reasonable.
• It makes two arguments in support.
• SCE did not have to buy the power
• Dynegy only charged a price the market would bear

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One SCE didnt have to buy power

• Whether SCE did not have to buy Dynegys power is
  simply irrelevant to whether
• Presence of other providers in market based
  system does mean that this providers rates are
  just and reasonable
• If FERC accepted this argument, it would
  eliminate the just and reasonable standard
• Any provider in a market with other providers
  could point to the existence of other providers
• Would be considered evidence of just an
  reasonable rates
• Dynegy argues that as long as there is a choice
  from whom to purchase, the rates are just and
  reasonable
• Illogical because other wholesale providers in
  this market have little bearing on whether a
  specific charge is just

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Two Dynegy only charged market rate

• Flawed because courts have explicitly held that
  the going market rate is not conclusive of a
  just and reasonable rate
• For example, the entire market could be charging
  unjust and unreasonable rates
• Dynegy has not submitted any information to
  support the conclusion that it did not exercise
  market power
• In reality, Dynegy is exercising market power
• No cost increase yet they marked this transaction
  up to over 200 above cost
• When regulation was in effect, the normal rate of
  return hovered around 10-15

24
Prices not just and reasonable

• Why? Because Dynegy cannot make poor business
  transactions and then pass along such high costs
  to SCE.
• Also, Dynegy has no authority to charge a risk
  premium.

25
Pollution Cost is not a normal cost

• SCE cant pass these costs along, so why can
  Dynegy?
• Some normal costs are recoverable, but
• It is far from clear that when a company overpays
  for an item that it can recover such a cost.

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Dynegy cant charge a risk premium

• Dynegy is in the business of providing power and
  not collecting bills
• Essentially they have charged 100
• If a credit card company did this, no one would
  stand for this.
• They havent given SCE a chance to pay
• To charge a late fee requires a showing that such
  a fee is not a penalty to induce payment, but is
  part of a cost.
• Dynegy has made no showing.
• Dynegy seeks to exact double payment, on the
  assumption that we would default.

27
50/MWh Portion for Costs

• These costs are not just and reasonable since
  they are 25 higher than the historical fair
  average

28
200/MWh Portion for Pollution Credits Costs

• Increased costs for air pollution credits is not
  a usual cost that should be passed on to the
  consumer
• The high price of these credits was the result of
  price gouging in the air pollution allowance
  market and therefore not just and reasonable
• Since SCE cannot pass on its increased costs for
  wholesale energy to customers, why should Dynegy
  be allowed to pass on its increased costs for
  pollution credits to us?

29
250/MWh Portion for Risk Premium

• Dynegy has never before charged a risk premium
• Dynegy is simply trying disguise market power or
  excessive scarcity rents as a risk premium
• The risk premium doubles the wholesale price

30
Dynegys Response

• The 50/MWh portion of the rate was just and
  reasonable as a cost-of-service
• The 200/MWh portion for air pollution credits
  was just and reasonable as a legitimate cost of
  doing business
• The 250/MWh portion for the risk premium was a
  necessary charge to protect the financial
  integrity of the company

31
50/MWh Portion for Costs

• It is always just and reasonable for a utility
  to recover its costs of operation
• The 10/MWh increase in costs over the historical
  fair price was the result of higher natural gas
  costs
• The administrative law judge found this portion
  of the rate was an adequate approximation of
  Dynegys usual costs

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50 Operating Expense Charge

• Fuel, delivery costs, etc.
• Usual operating costs always charged to consumer
• Firms that stay in business have to do this
• Demand was there to do it
• Even utilities under regulation could do this!!

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200/MWh Portion for Pollution Credits Costs

• These were also recoverable as costs of doing
  business
• Environmental issues that cause a utility to
  incur costs should be a part of the Commissions
  rate calculation
• Dynegy is required by law to possess the air
  pollution credits to enable the plan to run
• Analogous to natural gas costs

34
200 Pollution Credit Charge

• Credits Another flawed CA regulatory regime
• Dynegy has no control over this market
• It must pass these costs on to buyers in order to
  stay in business
• Dynegy must continue to sell power FERC order
• Interests of producers viability prong of just
  and reasonable

35
200/MWh Portion for Pollution Credits Costs

• Any price gouging in the air pollution credit
  market is a dispute between SCE and the credit
  vendors, not Dynegy
• As a natural cost of doing business as a
  gas-fired power plant, charges for air pollution
  credits can be passed on to the customer

36
250/MWh Portion for Risk Premium

• Dynegy is permitted to protect the financial
  integrity of the company
• SCEs credit had substantially deteriorated
  during the spring
• PGE filed for Chapter 11 bankruptcy in April
  with 18 billion in unpaid debts
• Recent price trends, FERC March 9 Order set the
  breakpoint for February 2001 at 430/MWh

37
250 Risk Premium

• Also just and reasonable
• Threat of default real PGE and SCE defaulted
  in January results in CalPX shutdown
• PGE files Chapter 11 Bankruptcy in April
• California has bond rating downgraded
• In this climate, rational producers would begin
  to exit

38
250 Risk Premium

• But, Dynegy forbidden by FERC order to exit
• So if Dynegy cannot account for the risk in
  price, which market demand would allow, it is
  also threatened with bankruptcy
• Viability prong of JR implicated
• Not allowing risk premium creates perverse
  incentive in market will not attract new
  producers but rather will keep them away so has
  the same effect of not allowing scarcity rents

39
Rebate

• 40/MWh would be preposterous Dynegy should at
  least be able to recover costs
• March FERC order ordered rebates based on
  273/MWh should be something higher than this
• Bottom Line Dynegy charged what market would
  bear