FERC Reviewing Its Approach to Market Power Determinations

FERC Reviewing Its Approach to Market Power Determinations

On September 22, 2016, the Federal Energy Regulatory Commission (FERC or the Commission) issued a Notice of Inquiry (NOI) to explore whether it should revise its current approach to "identifying and assessing" market power in electric utility transactions. FERC defines market power as "[t]he ability of any market participant with a large market share to significantly control or affect price by withholding production from the market, limiting service availability, or reducing purchases."

FERC's rationale for the NOI arose from the different ways market power can be analyzed under its rules. For example, under a Federal Power Act (FPA) Section 203 transaction, FERC reviews industry mergers and other transactions, while under a FPA Section 205 filing, FERC can consider requests to sell wholesale electric energy and related attributes at market-based rates. The Commission notes that while differences in the analyses may be appropriate, it wants to gather comments from the NOI on the question of whether "increased harmonization of the two analyses is warranted and feasible." The NOI is also seeking comment on potentially simplifying FERC's market power determinations by developing a de minimis test for certain transactions whereby "a full competitive analysis is unnecessary." FERC is accepting comments on the NOI through November 28, 2016.

Market Power and Market Manipulation

It should be noted that the exercise of market power is differentiated from simply having market power. Electricity consumers are not harmed (i.e., by artificially high electricity rates) without the exercise of market power. In a competitive market, prices for electricity should essentially reflect the underlying forces of supply and demand. FERC authorizes sellers of wholesale electricity to charge market-based rates if they have demonstrated that they or their affiliates "lack or have adequately mitigated horizontal market power (percent of generation owned relative to total generation available in a market), and vertical market power (the ability to influence the cost of production for competitive electricity suppliers)." Alternatively, FERC may authorize cost-based rates for sellers of electricity in wholesale markets.

Competitive electricity markets have enabled a variety of wholesale electricity products and services to facilitate the sale and transmission of power. (See CRS Report R43093, Electricity Markets—Recent Issues in Market Structure and Energy Trading.) These involve both physical transactions (i.e., electricity is generated, and sent to or taken off the grid), and financial transactions (i.e., the purchase and sale of electricity, and contracts for future delivery). Services have also arisen to provide transaction flexibility, and to manage (or hedge) the risks of various transactions. Some purchasers of electricity as a commodity do so solely for financial gain.

The 2000-2001 Western energy crisis showed that electricity markets were (and are still) susceptible to market manipulation, especially when the motive is to make as much money as possible. With the passage of the Energy Policy Act of 2005 (P.L. 109-58), Congress gave FERC new authority to prevent manipulation in natural gas and electricity markets. FERC's investigation of the Western energy crisis concluded that specifically Enron (and several other companies) had engaged in market manipulation. FERC views market manipulation as a "significant threat" to energy markets since energy consumers are likely to bear the burden of losses from such activity. Additionally, the noncompetitive activity can result in a loss of market transparency or otherwise impair the efficiency of energy markets, and thus FERC seeks to prevent fraud or market manipulation. Ten recent cases (brought by FERC in the 2012 to 2014 period) alleging energy market manipulation concluded in settlements with $448 million in civil penalties, and total "disgorgements" (i.e., refunds to rate payers) ordered of $243 million.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA or Dodd-Frank, P.L. 111-203) was passed largely as a response to the recent U.S. financial crisis. DFA initiated a number of reforms intended to strengthen oversight of the U.S. financial sector. Dodd-Frank addresses issues related to market manipulation from fraud, stating that "specific intent" or "recklessness" would trigger a rules violation. FERC for its part indicates that its focus is on anti-competitive "conduct that threatens market transparency." Some might argue that the recent spate of settlements at FERC leads to a lack of clarity about what constitutes market manipulation, and what does not. It remains to be seen whether FERC will take the next step in the NOI toward improved clarity on market manipulation.

A Role for Congress

Some observers argue that the electric power industry is in the process of change due to regulatory and market pressures, resulting in industry mergers and acquisitions, and new entrants. (See CRS Report R43742, Customer Choice and the Power Industry of the Future.) Others argue that new technologies may lead to a distributed generation future for customers, possibly supported by utility base load generation and infrastructure. Given that the impetus for change is coming from drivers both within and from outside the industry, a question that may be asked is whether further changes to the Federal Power Act will be necessary. Under Section 203 of the FPA, FERC is also responsible for determining whether merger and corporate applications are consistent with the public interest, requiring the Commission to examine the merged entity's effect on competition, rates and regulation, and the potential for cross-subsidization of entities (unless it is deemed consistent with the public interest). Congress has already initiated hearings into the evolution of the FPA with a special emphasis on electricity markets.