FERC Considers Tighter Regulation Of Independent Power Companies

FERC Considers Tighter Regulation Of Independent Power Companies

February 01, 2002

The Federal Energy Regulatory Commission proposed changes in late December, in the wake of the Enron bankruptcy, to the “uniform system of accounts” that investor-owned utilities must use to report their financial results each year to federal regulators. The revisions are aimed at collecting better information about the “fair value” of financial instruments, hedges and derivatives held by utilities.

FERC also asked for comments on whether to subject independent power producers and power marketers to two types of utility regulation in the future.

FERC asked whether independent power producers and power marketers that are authorized currently to sell electricity at market rates should nevertheless be required to file financial reports like the investor-owned utilities under the uniform system of accounts.

It also asked whether independent power producers and power marketers should be required to get advance approval from FERC before issuing any stock, debt or other securities or assuming any liabilities.

In the past when the commission has issued orders to independent power producers and power marketers authorizing them to sell electricity at market rates, the orders have routinely waived any need to file uniform accounts and have given a blanket authorization to issue securities and assume liabilities without having to seek the commission’s approval. Persons holding these orders would be affected by the new rules. Any change would be prospective.

The actions are part of a “notice of proposed rulemaking” that the commission issued on December 20. Comments are due by March 9.

Congressional Pressure

One of the first Congressional hearings after the Enron bankruptcy focused on whether the Federal Energy Regulatory Commission was too lax in its oversight of Enron’s power marketing activities. Section 204 of the Federal Power Act requires prior FERC approval before any “public utility” can issue securities and or assume liabilities. “Public utility” is broadly defined to include not just vertically-integrated, investor-owned utilities, but also power marketers and independent power producers. Enron’s power marketer, like others that make wholesale sales of electricity at market-based rates, enjoyed a blanket prior authorization for such securities issuances and liability assumptions, and thus did not have to seek FERC approval for its specific debt obligations or security issuances. Congress is pressing FERC, the Securities and Exchange Commission and other US regulatory agencies to explain how Enron’s securities went unregulated, even when the company was selling almost 20% of the nation’s electricity.

The notice of proposed rulemaking that FERC issued on December 20 was perhaps partly in response to the hearings.

How Enron Escaped Regulation

When Enron Power Marketing, Inc., or “EPMI,” sought approval from FERC in 1993 to sell electricity at market-based rates, it also asked the commission for waivers from various utility regulations that would ordinarily apply to the sale or purchase of electric transmission facilities, arguing that these rules should not be applied to bare contracts for the purchase and sale of electricity.

FERC refused to “waive” section 203 of the Federal Power Act for electricity contracts. That section requires prior FERC approval for any sales or consolidations of “facilities”— in this case electric contracts. The commission said that wholesale energy contracts are “facilities” and, in fact, this is what gives the commission jurisdiction over power marketers who might own nothing else. It is ownership of “facilities” that makes a power marketer a “public utility” subject to FERC regulation under the Federal Power Act.

However, FERC granted EPMI relief from section 204 of the Federal Power Act. That section requires prior FERC approval before any owner of “facilities” can issue stock or make loans. FERC had said in prior orders that a power marketer like Enron did not propose “to obligate itself to serve electric consumers” and, therefore, its financial health — and, apparently, that of every entity that sells at market-based rates — was not a concern under section 204. As a result, FERC granted blanket prior authorization for the security issuances and assumptions of liability by EPMI, provided no one protested within an initial comment period of 30 days or so. FERC reserved the right to modify this blanket authorization in the future to require a further showing that neither public nor private interests will be adversely affected by leaving the blanket authorization in place. FERC has given similar blanket authorizations to other power marketers and independent power producers whom it authorizes to sell at market-based rates.

FERC may have trouble defending the logic for blanket authorizations in the current Enron-crazed environment. The situation today bears an eerie resemblance to what led Congress to enact section 204 in the first place.

It was railroad financial scandals in the 1920s that led to enactment of a forerunner to section 204. Congress enacted section 20a of the Interstate Commerce Act in an effort to repair the damage done to railroad stocks and credit after several railroad bankruptcies. It then copied section 20a almost verbatim into the Federal Power Act in the 1930s after a series of public utility holding company financial crashes of the late 1920s and early 1930s. The Federal Power Commission, which FERC replaced, quoted an historian of section 20a in a 1962 order:

While this extension of the [Interstate Commerce Commission’s] authority was designed indirectly to protect the investing public against the dissipation of railroad resources through faulty or dishonest financing, its dominant purpose was to maintain a sound structure for the rehabilitation and support of railroad credit, and for the consequent development of the transportation system. It aimed to render impossible the recurrence of the various financial scandals, with their destruction of confidence in railroad investment, which had become notorious, and to prevent the subordination of the carrier’s stake as transportation agencies to the financial advantage of alien interests. . . .

Impact on Independent Power Companies

Assuming that FERC itself, or Congress or the courts, decide to require power marketers and generators to seek prior approval before issuing any securities or assuming liabilities, what will it mean for the power supply industry?

The independent power industry requires huge sums of capital for building generation facilities.

Although full FERC regulation under section 204 may be burdensome and intrusive to power marketers and generators who have thus far avoided it, in fact FERC generally approves such applications, rejecting the rare protests to them if FERC believes such protests are not relevant to the securities issuances themselves. For example, FERC rejected protests to a section 204 approval request by the Midwest Independent Transmission System Operator, Inc. last year and to issuance of securities by a qualifying facility called Robbins Resource Recovery Partners, L.P. in 1994.The commission usually approves section 204 applications by delegation to the staff and as quickly as the statutory hearing requirements permit, in order not to interfere unduly with financial transactions.

FERC does not have section 204 jurisdiction over a company if the state in which the company is both organized and operating already regulates the security issuances and assumptions of liability. In the past, this protected most franchised public utilities from the need for federal approval of securities issuances, but it does not provide relief for many independent generators since such generators tend to be organized outside the state or states in which they operate. On the other hand, increased federal regulation of such securities may reduce the opportunity for comparable state jurisdiction, such as that being sought to be reimposed in California over EWGs as “public utilities” under state law.

Such re-regulation of “public utility” securities may be an unavoidable consequence of the Enron bankruptcy. If FERC adopts this approach, it will be with the aim of repairing the damage done to the credit and securities of other power marketers and generation owners by Enron.

The industry should address in comments to FERC whether this is, or is not, a necessary price to pay to restore public confidence in the credit and stocks of power marketers and other sellers at market-based rates. Comments could also suggest ways to make the rules effective, while perhaps requiring less information from and regulation of non-traditional “public utilities” that sell at market-based rates.