FERC moves to implement new energy law

FERC moves to implement new energy law

January 01, 2006 | By Robert Shapiro in Washington, DC

The Federal Energy Regulatory Commission began issuing final rules in December to implement parts of a new energy law that President Bush signed on August 8.

The new law repealed a 1935 statute, called the Public Utility Holding Company Act, or “PUHCA,” thereby eliminating restrictions that currently prevent parent companies of utilities from owning non-utility businesses or owning utilities in other regions of the United States.  Congress gave new authority to the Federal Energy Regulatory Commission over a larger group of “holding companies.” It gave FERC expanded authority over mergers, securities and asset acquisitions under the Federal Power Act, or “FPA,” and radically modified the rights of qualifying facilities, or “QFs,” under the Public Utility Regulatory Policies Act, or “PURPA.”

FERC has issued final rules relating to PUHCA and modifications to the FPA.  Under those rules, there are significant book-keeping requirements for holding companies.  Acquisitions, by public utilities and holding companies, of small voting interests in QFs and exempt wholesale generators, will now require FERC approval.  In addition, in FERC’s proposed rulemaking to revise the PURPA rules for QFs, FERC proposes for the first time to subject many existing and new QFs to rate regulation under the Federal Power Act.


The utility industry has for decades insisted that any comprehensive energy bill include PUHCA repeal because regulation of holding companies under PUHCA was so restrictive.  Under PUHCA, a company that owns or controls at least 10% of the voting securities of an electric or natural gas utility company is a “holding company.” PUHCA requires utility holding companies to obtain advance approval from the SEC for their securities issuances and inter-corporate transactions, requires all utility subsidiaries of a utility holding company to be in the same area or region of the country, restricts companies not already in the utility business from becoming active owners of utilities in more than one state, and bars companies that own utilities from engaging in lines of business other than owning utilities and related businesses.

The new energy law removed these restrictions by repealing PUHCA and replaced SEC regulation of holding companies with “books and records” oversight by FERC and state public utility commissions.  PUHCA will be repealed as of February 8, 2006.

With the repeal of PUHCA finally accomplished, holding companies had assumed that they would be relieved of the kind of regulation to which they had been subject under PUHCA, subject only to “books and records” oversight by the FERC, as required by the new law. Instead, over the objections of industry commenters and Representative Joe Barton (R-Texas), chairman of the House Committee on Energy and Commerce and a leading sponsor and drafter of the new energy law, who took the highly unusual step of filing comments, FERC in its regulations implementing PUHCA repeal subjects “holding companies,” even entities that were exempt from regulation under PUHCA, to new reporting and recordkeeping requirements.

Books and Records

FERC issued new regulations in December that require holding companies and their affiliates to maintain and make available to FERC or to state commissions books and records that show the costs incurred by affiliated electric utility and gas companies that affect rates subject to FERC’s or a state commission’s jurisdiction.

The FERC regulations exempt from books and records review any entity that is a holding company solely because it owns qualifying small power production or cogeneration facilities under PURPA, known as “QFs,” exempt wholesale generators, known as “EWGs,” or non-US utility companies, known as “FUCOs.” (Holding companies that own EWGs or FUCOs are exempted from FERC review, but not from state commission review.) FERC’s new regulations also provide for possible exemptions from its books and records regulations, upon request, for several classes of persons and transactions, including passive investors, mutual funds, collective investment vehicles, utilities subject to FERC jurisdiction without captive customers, electric power cooperatives and natural gas local distribution companies.

Beyond these statutory requirements, however, and against the urging of numerous commenters, including Rep.  Barton, FERC adopted “modified, streamlined versions” of several forms and regulations relating to recordkeeping, financial statements, accounting and reporting requirements that had been used by the SEC to administer PUHCA.  In adopting these SEC regulations as its own, FERC rejected arguments that “PUHCA 2005” — or the part of the new energy law that replaces PUHCA — does not provide the FERC with authority either to require entities to file reports or to adopt the SEC regulations.

A number of entities are exempted from the requirements of PUHCA 2005 by statute. The new regulations also allow single-state holding companies, holding companies that own generating facilities totaling 100 megawatts or less used for their own load or sales to affiliated end-users, and investors in independent transmission companies to request a waiver of the recordkeeping and reporting requirements.

The SEC forms and regulations that FERC has adopted to implement its books and records oversight of holding companies previously applied only to registered holding companies.  FERC will apply them more broadly than the SEC did.  The agency decided it would not recreate the old PUHCA distinction between “registered” and “exempt” holding companies for purposes of future books and records oversight of holding companies.  The new FERC regulations subject the new, broader category of “holding companies” that are not otherwise exempt to the books and records requirements of PUHCA 2005.

All entities that meet the definition of a “holding company” under PUHCA 2005 on February 8, 2006 must file a form notifying FERC of their status as a holding company.

Furthermore, holding companies that qualify for an exemption from the books and records requirements of PUHCA 2005 must file a form notifying FERC that they qualify for an exemption.  An entity that becomes a holding company after February 8, 2006 must file a form notifying the FERC of its status within 30 days after it becomes a holding company.

Formerly registered holding companies currently subject to the SEC’s record-retention rules have the option of complying with the new FERC rules or continuing to comply with the SEC rules during 2006.  However, they must begin complying with the new FERC rules by January 1, 2007.  On the other hand, formerly exempt holding companies that currently do not follow either SEC or FERC recordkeeping requirements are not required to comply with new FERC record-retention requirements until January 1, 2007.

EWG and FUCO Certification

The new FERC regulations allow entities to continue to obtain EWG and FUCO status, but under new procedures.  EWGs and FUCOs are legislative creatures of PUHCA, in that the 1992 legislation that created these classifications did so by adding amendments to PUHCA. The benefit of EWG status under PUHCA was exemption from the requirements of that law.  EWG and FUCO status continues to be relevant under the new regulatory scheme for utility holding companies, because Congress required FERC to exempt from the new books and records requirements entities that are holding companies solely because they own QFs, EWGs and FUCOs.

The new FERC regulations establish procedures for both individual approval of EWG and FUCO status by FERC and “less burdensome” procedures for self-certification of EWG and FUCO status, similar to the options that have been available to entities seeking QF status under the Public Utility Regulatory Policies Act, or “PURPA.” A self-certification filing made in good faith provides temporary EWG status as of the date of its filing.  FERC has 60 days from the date of filing to act on the notice of self-certification; otherwise it is deemed granted.

Mergers and Acquisitions

The new energy law gave FERC broader authority to review electric utility mergers as a tradeoff for repeal of PUHCA.  FERC had authority to review sales of “jurisdictional assets” even before the new energy law.  This authority is in section 203 of the Federal Power Act. “Jurisdictional assets” include transmission lines and power sale contracts of traditional utilities, EWGs and power marketers that sell or transmit power “in interstate commerce.” However, FERC jurisdiction did not extend to Alaska, Hawaii, countries other than the United States, or to the Electric Reliability Council of Texas, or the “ERCOT” region of Texas.  Also, FERC approval was not required for the acquisition of a municipal or other utility owned by the United States, a state, or a political subdivision of a state, or of or by a cooperative with financing from the Rural Utilities Service.

FERC jurisdiction applied to transactions involving facilities worth more than $50,000.  FERC lacked jurisdiction over transactions that involve only generating facilities.  Historically, FERC has chosen to exercise policy initiatives through its “conditioning authority” by, for example, conditioning its approval of utility mergers on a commitment to join a regional transmission organization.  By structuring sales of generating plants not to require section 203 approval, utilities have been able to avoid the imposition of these types of FERC conditions as the cost of obtaining approval for a transaction.

The new energy law raised the floor for dispositions of assets requiring FERC approval.  A jurisdictional asset being sold must be worth more than $10 million in the future in order for the transaction to require FERC approval.  Applicants will have to include an explanation showing that the proposed transaction will not result in cross-subsidization of non-utility affiliated companies or encumber utility assets for the benefit of an affiliated company.  However, the most far-reaching change in the new energy law is the expansion of FERC authority to approve certain transactions not previously subject to FERC jurisdiction.

The repeal of PUHCA makes it possible for parent companies to own utility subsidiaries in different regions of the United States.  It also allows non-utility companies, from Wal-Mart to Westinghouse, to own utility companies.  In order to retain some federal regulatory supervision over these previously forbidden types of utility combinations, Congress amended section 203 to require prior FERC approval for the acquisition, by a “holding company,” of several types of assets.  Approval is required before a holding company can acquire more than $10 million worth of utility securities, including voting, non-voting and debt securities.  Note that, under the new law, the owner of 10% or more voting securities of a QF, EWG or FUCO is a “holding company.” Approval is also required before the direct or indirect merger or consolidation of a holding company with a “transmitting utility,” which is a company that owns or operates transmission facilities that are connected to the interstate grid, or an “electric utility,” defined as a person, including a corporate entity, or a federal or state agency, that sells electric energy.  Approval is also required before a holding company can acquire another holding company that has a “transmitting utility” or “electric utility” subsidiary.  Prior FERC approval is also now required for the acquisition of an “existing” power plant worth more than $10 million that is used for wholesale power sales to the interstate grid.

Rep. Barton said in comments filed with FERC that the amendments to section 203 in the new energy law “were not intended to expand significantly [FERC]’s jurisdiction” over mergers and acquisitions.  He said Congress intended only to codify existing precedent, in which FERC has held that section 203 gives FERC jurisdiction to approve “changes in control” of public utilities subject to its rate jurisdiction, such as the acquisition of a holding company that has a public utility subsidiary. Therefore, Barton said, the new authority over acquisitions by and of holding companies “should be read in light of current commission practice and precedent and not viewed as a grant of extensive new authority.” These comments were largely disregarded by the commission.

The merger authority language in the new energy law was added at the 11th hour. There are drafting inconsistencies and omissions that cast doubt on whether Congress intended the results that would occur from a literal application of the terminology, or whether these results were simply the result of inartful drafting.  Many utilities expressed concern that, read literally, the requirement for “holding companies” to obtain approval for the acquisition of public utility securities would mean that intra-system financing arrangements, such as the acquisition of notes and other evidence of indebtedness, would require transaction-specific approvals.

Private equity and hedge funds also complained that the new rules require many of them to seek prior approval for their purchases of public utility securities.  The problem is the expansion of the companies that could be deemed to be “holding companies” and thereby subject to the requirement to obtain FERC approval for many types of acquisitions that previously were not subject to FERC jurisdiction under section 203.

In December, FERC moved to address some of these concerns.  It issued regulations under section 203 giving blanket approval to certain types of transactions.

Non-voting securities in an electric utility or another “holding company” can be acquired in any amount without approval, and purchases of such securities do not have to be reported to the commission.  FERC warned in a footnote that “it is possible, in some circumstances, for non-voting securities to convey sufficient ‘veto’ rights over management actions as to convey ‘control’ that triggers” the approval requirement.

Up to 9.9% of voting securities can be purchased without seeking approval.  However, such purchases must be reported to FERC within 45 days.  FERC will publish notice of such purchases for informational purposes.

Approval is also not required for purchases of securities — voting or non-voting — of a utility — including a QF or EWG — that operates only in ERCOT, Alaska or Hawaii, or in a local distribution company that is regulated by a state commission, or in a FUCO.  However, a public utility or “holding company,” which includes the 10% or more owner of voting securities of a QF, EWG or FUCO, must now get FERC approval to acquire 10% or more of the voting securities of a QF, EWG or FUCO or another “holding company.”

Drastic Revisions to PURPA

The new energy law responded to utility concerns that FERC regulations and decisions allowed so-called “PURPA machines” — power projects that provide steam to an uneconomic or contrived use for the sole purpose of enabling the project to claim the benefits of QF status, which include the right to receive “avoided-cost” rates and exemptions from PUHCA, the Federal Power Act and state law.  It also permitted FERC to eliminate the utilities’ purchase obligation for QF power in workably competitive markets.

The new energy law amends PURPA by requiring FERC to add criteria for new qualifying “cogeneration facilities” — one of two types of QFs — to ensure that new such facilities are using their thermal output in a “productive and beneficial manner.” The electrical, thermal, chemical and mechanical output of such new facilities must also be used fundamentally for industrial, commercial or institutional purposes.  FERC is also supposed to use the QF label to encourage continuing progress in the development of efficient electric generating technology.

The new energy law also eliminates the restriction on utility ownership of QFs, so that instead of being limited to a 50% interest in the equity of a QF, utilities may now own up to 100% of the equity interests in a QF.

FERC issued proposed rules implementing the new rules for QFs in October, with final rules to be issued by February 2006.  These rules do little to advance the ball beyond the literal language of the statute with respect to new standards for new cogeneration facilities.  Moreover, FERC has decided on its own to propose rules that would subject many QFs to FERC ratemaking jurisdiction. The result is to create uncertainty both for developers of new cogeneration projects and for existing QFs as to the degree to which they will be subject to regulation, including the possibility that many power sale agreements could be subject to modification under the same standards that apply to non-QF power sale contracts.

Observers of the multi-year process that led to passage of the new energy law understood that PURPA would be largely gutted at the end of the day.  Existing QF contracts would be grandfathered from modification, but utilities would be freed from the mandatory purchase obligation, once FERC determined that certain regional markets — primarily those with mature regional transmission organizations or RTOs — are workably competitive.  In addition, industry observers understood that Congress would allow the criteria for new “small power production facilities” — the other type of QF — to remain the same, but would require FERC to make it far more difficult for new cogenerators to qualify.

Many observers expected FERC to spell out in the new rulemaking what new standard it would expect new cogenerators to meet.  For example, the operating standard might have been increased from 5% to 20%, or perhaps no more than 40% of the electric output could be sold to an electric utility.  FERC did not do this; instead, it simply adopted the statutory language in its proposed regulations and said it would look at each potential project on a case-by-case basis.  FERC’s failure to promulgate specific new criteria does not allow the developer of a new cogeneration project to know the rules ahead of time and, consequently, hinders new project planning.

As if the new requirements would not be stringent enough, FERC now proposes to permit utilities to challenge the presumption of usefulness of the thermal output of a project.  Under current precedent, if a particular thermal use has been established by FERC generally as “useful,” then the thermal use could not be challenged in a particular project.  Under the new rules that FERC proposed in October, assuming that a new cogeneration facility can get past the “fundamentally not for utility sale” test, and provided that FERC has not determined that the regional market is competitive enough to eviscerate the utility’s obligation to buy QF power, the would-be purchasing utility can still tie-up the prospective QF seller by challenging the thermal use as unproductive and getting the FERC to set the matter for hearing.

Why QF Rate Regulation?

Even though the new energy law says absolutely nothing about eliminating the federal or state exemptions from utility regulation that existing QFs now enjoy, FERC took it upon itself to propose that certain QFs — those without long-term contracts blessed by a state as containing avoided cost rates — should be subject to FERC ratemaking jurisdiction. The rationale offered by FERC for its proposal is that “a large number of QFs make market-based sales, which are often referred to as ‘non-PURPA sales.’” FERC also noted that the removal of the restriction on utility ownership of QFs would make it possible for a utility to obtain market power by acquiring 100% of a QF project.

The “large number of non-PURPA sales” assertion was made without any support whatsoever.  In proposing to subject QFs to rate regulation, FERC has overlooked the fact that there are hundreds of QF contracts that have not received the avoided cost blessing of state commissions and that did not have to receive such a blessing under the current FERC regulations.  Indeed, the FERC regulations expressly authorize QFs to enter into negotiated contracts, but allow the QF to petition the state commission to impose an avoided-cost rate on a utility as a “last resort.”

Since most QFs were required to enter into long-term power sale agreements in order to obtain financing, and most QF investors and lenders relied on the QF’s exemption from rate regulation when decisions to invest or lend were made, the FERC’s proposal to impose rate regulation on existing projects is at best puzzling.  Further, by proposing to remove exemptions to existing QFs in a new rulemaking, the FERC would appear to be applying a new rulemaking retroactively in violation of the Administrative Procedure Act.

In its proposed rule, FERC also suggests that rate regulation is warranted because Congress gave FERC new authority in the new energy law to address market misconduct.  But that legislation did not signal to FERC that it needed to modify preexisting exemptions from FERC regulation. Allowing QFs to remain exempt from FERC regulation would put QFs in no different position than other currently exempted entities, like municipal utilities, cooperatives and federal power agencies, which are far more numerous and have far more generating capacity and market penetration than do QFs.

FERC also suggests it has market power concerns now that the new energy law removed the QF utility ownership limitation and will give traditional utilities the right to own 100% of a QF.  If that is FERC’s real concern, it could limit the requirement of section 205 and 206 filings to QFs owned by traditional utilities, that is, utilities with franchised service territories.  Even that requirement, if implemented, could be limited to QFs that are selling within the region of the service area of that franchised utility to address any market power concerns.

The result of these proposals, if fully implemented, will be to increase transaction costs for both existing and new facilities in order to comply with FERC rate filing requirements, and to create uncertainty for existing QF investors and lenders as to the rate recovery for power sales from projects that were always exempted from FERC rate regulation.  It will also create uncertainty for developers of future cogeneration projects that believe they may be able to satisfy the new Congressional standards but have received no guidance from the implementing agency.

If FERC sticks to its guns and imposes ratemaking requirements on QFs, then there will be little reason for QFs to exist as a separate category of power producers.  PURPA was originally designed to provide two specific benefits to QFs: first, encouraging utilities to buy QF power and, second, encouraging QF development by exempting them from federal and state regulation.  The combination of the reluctance of most state commissions to enforce the utility purchase obligation in recent years, and the new law’s authorization to FERC to eliminate the purchase obligation in workably competitive markets, effectively eliminates the first benefit.  The creation of EWGs in 1992 and the repeal this year of PUHCA altogether, combined with FERC’s proposal to regulate the rates of QFs, effectively eliminate the second benefit.  State commissions (other than Texas, Hawaii and Alaska) generally do not regulate wholesale sales, and, in particular, most states do not deem wholesale-only generating entities to be utilities subject to regulation.