Swap Gets Wholesale Generator Into Trouble

Swap Gets Wholesale Generator Into Trouble

April 10, 2010

By David Evans and Karen Zachary

KeySpan Corporation, an electric and gas utility in New York, agreed to pay the federal government $12 million in damages in February 2010 for entering into a swap that the government charged kept electricity prices high in New York City.

KeySpan made the payment to settle a civil antitrust suit brought by the US Department of Justice. The government claimed that KeySpan’s conduct violated a section of the “Sherman Act” that prohibits conduct that unreasonably restrains interstate commerce.

The Federal Energy Regulatory Commission declined in 2008 to take action against the utility after the FERC staff concluded that the swap did not contravene the tariff the utility had on file with FERC and did not violate FERC regulations aimed at preventing manipulation of the wholesale power market.

Bid the Cap

From May 2003 to March 2008, KeySpan was one of three pivotal suppliers of electricity in the New York City area. The electricity grid in New York is managed by an “independent system operator” called the NYISO. The NYISO requires retail providers of electricity to New York City customers to purchase 80% of their capacity from generators in that region. Prices are set through auctions by having the suppliers offer price and quantity bids, subject to certain caps.

Virtually the entire generating capacity in the region was fully dispatched during the period from June 2003 to the end of 2005 to meet local demand, which meant that KeySpan could sell almost all of its capacity at the top price. The company owned a 2,400-megawatt power plant in Queens called Ravenswood.

New generating capacity was expected come on line in 2006. As a result, KeySpan could no longer be confident that its bid-the-cap strategy would remain profitable after 2005.

The Department of Justice charged that KeySpan considered three responses to these changed market conditions.

First, the utility could withhold capacity from the market to keep prices high, but this would reduce its revenues by an estimated $90 million a year.

Second, it could compete by bidding more capacity at lower prices, which might produce higher returns than bidding the cap but also might result in losses if the competition undercut its bids and took away sales.

Third, KeySpan could acquire one of two other power plants that were also bidding to supply electricity to the grid from Queens. One of the plants, owned by Astoria Generating Company, was 1,800 megawatts.

Owning the Astoria facility would have given KeySpan enough capacity to make continuing to bid the cap its best strategy. KeySpan decided not to pursue the purchase directly after concluding that acquiring its largest local wholesale competitor would raise market power issues and could be challenged by regulatory agencies. However, it acquired an indirect financial interest in the capacity from the Astoria plant by entering into a derivative transaction with Morgan Stanley Capital Group Inc.


Under this so-called “KeySpan swap,” if the market price for capacity was above $7.57 per kw-month, then Morgan Stanley would pay KeySpan the difference between the market price and $7.57 times 1,800 megawatts. If the market price was below $7.57, then KeySpan would pay Morgan Stanley.

KeySpan understood that Morgan Stanley would need to enter into an agreement with another wholesale supplier in order to offset its payments to KeySpan and that Astoria was the only supplier with enough capacity. Morgan Stanley entered into a hedge agreement with Astoria where if the market price for capacity was above $7.07 per kw-month, then Astoria would pay the difference times 1,800 megawatts; if the price was below $7.07, then Morgan Stanley would pay Astoria the difference times 1,800 megawatts.

The Department of Justice charged that, via Morgan Stanley, “KeySpan would pay Astoria a fixed revenue stream in return for the revenues generated from Astoria’s capacity sales in the auctions.” It said the competitive effect was the same as if KeySpan had purchased the output from the Astoria plant directly and kept it off the market.

Once the swap went into effect, KeySpan consistently bid the cap, even though a large portion of its capacity was going unsold. During this period, significant additional generating capacity in New York City was brought on line, but the market price for electricity did not decline.

The swap deal ended in March 2008 when the NYISO forced KeySpan to sell the Ravenswood generating plant as a condition for approving the takeover of KeySpan by National Grid plc. National Grid cooperated with the federal investigation and no longer owns the Ravenswood plant. Since the swap deal ended, the market price for capacity in the NYISO auctions has declined.

The case is the first in which the Department of Justice sought the legal remedy of “disgorgement” in a civil antitrust action. Typically, the government would ask only for an injunction to prevent future antitrust violations, but given the facts of the case, that remedy would have been meaningless. KeySpan no longer owns the plant and without the disgorgement remedy, KeySpan would retain the benefits of its anticompetitive conduct.


Does the case suggest that there are potential antitrust implications any time a wholesale generator enters into an electricity hedge or swap? Probably not, given that this swap involved a unique market, produced no counterbalancing efficiencies and clearly affected prices.

Nevertheless, generators entering into swaps should be cautious if the swap involves a competing company in the same market.

There is no indication that the Department of Justice is targeting the heavily-regulated electricity generating sector, but it is notable that Justice brought this case even after FERC declined to take any action. This could signal an increased interest by the antitrust team in tackling anticompetitive conduct within regulated industries.

Finally, a crucial factor may have been the suggestion that KeySpan was attempting to avoid the antitrust questions that inevitably would have arisen had it attempted to acquire the Astoria facility.