Consumer Groups Question FERC Market Rates

Restructuring Increased Reliance on Wholesale Rates Under FERC Jurisdiction
After the New York PSC encouraged Con Edison to “restructure” in its 1996 “vision order“, Con Edison agreed with the PSC in a 1997 rate/restructuring agreement to sell nearly all of its power plants to three new owners, from whom Con Edison now buys much of the wholesale energy it needs for its retail customers. The new owners of the divested power plants have “market-based rate” permission from FERC, which sets wholesale rates, and so now they can sell at privately negotiated rates or in the NYISO spot markets without publicly filing in advance their rates or any changes in rates demanded.

Similar arrangements, described in PULP’s summary of restructuring orders, were made with the other New York investor-owned utilities, with the exception of Rochester Gas and Electric, which still owns non-nuclear power plants, and is less dependent on purchases in wholesale markets.

The premises of FERC’s market rate regime are (1) rate regulation is needed to protect customers only because of the monopoly nature of traditional vertically integrated utilities, which gives them market power, (2) new market systems could be designed in which no single seller has market power, (3) the results of a market rate system would be competitive rates, (4) if markets are competitive, FERC need not require filing and review of rates because competitive rates are necessarily just and reasonable, satisfying the basic requirement of the Federal Power Act and FERC’s duty to protect consumers from any unjust and unreasonable rates.

These are controversial assumptions.

The New “Organized Markets” Promoted by FERC Can be Gamed by Sellers to Achieve Monopolistic or Oligopolistic Pricing
Sellers can can change their prices every day without filing new schedules of rates and charges. The price established by the most expensive energy needed to meet demand is paid to all sellers in the NYISO spot markets. Also, the NYISO allows “virtual” trading by sellers who do not own power plants.

Mathematical game theory analysis and empirical studies have shown that by strategic bidding of their output, sellers can achieve a “Nash equilibrium” that effectively manipulates spot market prices upward without overt collusion. According to a New York Times article:

critics of the current system have found ammunition in a study at Carnegie Mellon University by Sarosh N. Talukdar, who used computer models to simulate a market in which 10 utilities bought electricity and 10 producers sold it.

In that experiment, the buyers and sellers learned to manipulate the price within 100 rounds of bidding, capturing from 50 percent to 90 percent of the prices an unregulated monopoly would have charged. Instead of falling, prices soared.

Earlier experiments at Cornell University and George Mason University found the same thing, with simulated trading by students, professors and even members of Congress.

Such high prices suggest collusion, which is illegal in real markets, but collusion was impossible in Professor Talukdar’s experiments because the trades were made by simple computer programs, not humans.

My studies show it is easy to learn from the signals given by others how to get the benefits of colluding without breaking the law,” Professor Talukdar said.

“Economists have this faith in markets, this blind faith that markets are always a good thing,” the professor said, “but the design of markets matters a great deal and the design must be verified to see if it really works as a free market.”

FERC currently allows sellers to demand progressively higher amounts as they near the maximum output of a power plant, and NYISO allows sellers to bid increments of power plant output at sharply increasing prices.The cumulative effect of such “hockey-stick” bidding, if done by several sellers, can result in economic withholding of power from the market, so that higher priced energy must be called for by the NYISO. The Wall Street Journal reported on August 4, 2006 that during the recent heat wave, “In New York City, the price of wholesale power paid by Consolidated Edison Inc. rose as high as $1.33 a kilowatt hour during the afternoon, more than 10 times an average price.”

Consumers Question FERC’s Proposed New Rules for Market Rate Sellers
Consumer groups filed comments August 7, 2006 regarding FERC’s proposed new rules to codify for the first time and modify further its system of market-based rates, which is now based on a series of orders rather than official rules. The comments of the National Association of State Utility Consumer Advocates (NASUCA) raise concerns about FERC’s tests for assessing market power, proposed relaxation of rules governing energy contracts between sellers with market rates and their affiliates with retail customers, and sufficiency of FERC’s legal authority to adopt the proposed rules. Once supportive of electricity deregulation, large industrial customers commented that the system is not working and that rates are neither competitive nor just and reasonable. Other organizations, including state utility consumer advocates from Rhode Island, Colorado, New Mexico, and Utah, and private consumer advocates including Public Citizen, the National Consumer Law Center, and PULP, maintain that the entire market based rate system as it currently operates is out of compliance with longstanding Federal Power Act rate filing requirements. No bona fide consumer organization has supported the further relaxation of FERC oversight proposed in the new rules

Judicial Challenges to FERC Market Rates
Under traditional regulation, utility rates for power from plants owned by vertically integrated utilities would be set by the state regulator so that the utility had a fair opportunity (not a guarantee) to recover the cost of energy production or purchase and a fair return on their capital investment, taking into account prudent original cost and depreciation. Once set, only the filed rate could be charged, and before changing the filed rate, the utility was required publicly to file new schedules of rates and charges in advance, subject to public scrutiny and possible agency review before taking effect.

In the states that restructured, like New York, most of the energy must now be purchased for end users at wholesale market rates under FERC jurisdiction. In contrast to the public filing and opportunity for administrative review of rates before they could be changed, the FERC market rate system allows wholesale utilities privately to change the rates without public filing. This is being challenged in court by some consumer groups. FERC has made efforts to avoid judicial review but recently the court issued an order restoring the case to the argument calendar and argument was held March 14, 2007. At argument, FERC argued that the legality of its market rate system should not be decided in this aprticular case because FERC did not deem that issue to be within the range of issues it was considering when it found all market rate tariffs to be illegal and adopted certain behavior rules (now repealed) to correct the perceived illegality. Consumer advocates argued that more needed to be done to fix legal rates as required by the Federal Power Act, and that once the tariffs were declared unreasonable, it was within the parameters of the case for intervenors to propose additional measures, including compliance with longstanding rate filing and public notice requirements.

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