Who Decides How To Serve Native Load

Who Decides How To Serve Native Load?

Mar 16 - Electric Perspectives

Last December, the Federal Energy Regulatory Commission (FERC) blocked Oklahoma Gas & Electric (OG&E) from buying NRG'S 77-percent interest in the McClain Energy Generating Facility to serve its native load. In its order, FERC said that the deal presented vertical and horizontal market power issues: "OG&E, a vertically integrated utility, would be adding 400 megawatts of generation capacity to its existing transmission and generation facilities, thus increasing its incentive (it already has the ability) to use its control of transmission facilities to disadvantage its competitors in wholesale power markets."

According to the order, "the Commission has reviewed the application pursuant to the Merger Policy Statement [Order No. 592] and finds that the transaction, unless adequately mitigated, will undermine competition and thus not be consistent with the public interest."

It is part of FERC'S job to protect the wholesale market from acquisitions that would result in market power. The fact is, however, the OG&E determination is based on a series of new, arbitrary, and erroneous applications of FERC'S merger-related market power tests-they unreasonably preclude vertically integrated utilities from serving their native load using the least-cost method that would be subject to state commission oversight.

The question of how to account for native load has become a key issue in the agency's supply margin assessment-the new test FERC proposes to use to determine whether an entity has market power and whether it should be allowed the option of charging market-based rates. The utility industry has urged FERC to subtract the power needed to serve native load when it calculates how much generation a utility has in a given market. The OG&E order is an ominous sign- for utilities, generation owners, and customers-that a utility can make a decision to fulfill its requirement to serve its native load at the least cost but cannot pass the market power test. It is state law that dictates utility obligations to customers, and state commissions should determine how those obligations should be met.

The Wrong Screen

FERC'S analysis and discussion of how it came to its determination cover a mere six paragraphs in the OG&E order. The commission implicitly made significant policy decisions but provided little justification for them and no discussion of the impacts on retail customers, state retail sales obligations, or wholesale generators.

FERC relied solely on the competitive analysis screen for economic capacity (EC), which fails to exclude committed capacity and thereby precludes a realistic assessment of actual wholesale market power. FERC also treated the screen as the final test, as opposed to a screen that, if failed, would lead to a factual analysis of whether or not the applicant has actual market power.

The OG&E order says "the increase in horizontal market power is indicated by the horizontal screen failures in the analysis of the effect of the transaction on concentration in relevant wholesale markets." It also notes that OG&E concedes that the transaction failed the EC screen. Those few sentences encompass the entire discussion of how FERC determined market power. It makes no reference to the fact that the transaction passed the available economic capacity (AEC) screen (that is, according to FERC order 642, EC less the capacity needed to serve native load customers) in all time periods and only marginally failed the EC screen in just two time periods. Clearly, this is not reasoned decisionmaking.

Market power screen or wall? To serve its regulated customers, OG&E wants a share of a generating facility. To FERC, the purchase falls the market power test.

The commission's merger policy statement reguires applicants to analyze both EC and AEC. It does not specify how the tests are to be used together, but the OG&E order does not say how the commission weighted the tests in this case. If fact, it does not even mention that the tests produced conflicting results.

In order 642, the commission said that the horizontal screen is not meant to be a definitive test of the likely competitive effects of a proposed merger; and failing the initial screen does not necessarily mean FERC will reject the merger. Rather, it means only that the commission must take a closer look at the merger's competitive impacts. So, the appropriate response in case of the failure of one of the screens is to look beyond the test. In this case, the AEC screen is a better indicator of whether the purchase of the McClain facility will result in horizontal market power: OG&E would use the output with existing resources to serve native load, replacing existing contracts that will terminate in 2004. As commissioner Nora Brownell indicated, at peak OG&E had approximately 5,700 megawatts of generation to serve 5,600 MW of peak native load, which does not leave much available to sell into the wholesale market.

By relying exclusively on the EC screen, the commission failed to consider those facts.

OG&E is a regulated utility in a state without retail competition and has an obligation to serve its retail customers. Consequently, a large portion of the utility's capacity cannot be diverted to the wholesale market. Under these circumstances, it is erroneous to assume that all capacity procured to serve OG&E'S retail load is available to make wholesale sales. Yet this is what the EC screen does. In comparison, the AEC screen accounts for retail load obligations in its calculation, and OG&E passed this screen in all hours.

Against the States

In the OG&E case, the Oklahoma Corporation Commission (occ) had approved a plan for the utility to purchase not less than 400 MW of new generation facilities to meets its retail load; occ also retained the right to review the utility's decision to purchase an existing plant instead of other alternatives. FERC has jurisdiction under Section 203 of the Federal Power Act (FPA)-but only because OG&E decided to purchase an existing generation facility. In fact, no FERC approval would be required if the utility had decided to build a plant or acquire capacity by contract. In this case, OG&E projects that the acquisition of the McClain facility would save its retail customers $75 million.

FERC'S exclusive reliance on a particular market power test to the exclusion of other evidence does not take into account a utility's legal and contractual obligations to sell power to retail customers. Moreover, that reliance will distort future capacity decisions in a manner that harms vertically integrated utilities, their customers, and generators seeking to dispose of generating plants. Such a policy would directly conflict with state decisions to retain vertically integrated utilities and require them to maintain sufficient generation to serve retail load, which is within the scope of authority that the FPA reserves for the states.

In a market power analysis, any decision to ignore the sales a utility must make (whether by state law or contract) to its own customers creates an unwarranted hurdle to any utility seeking to purchase generation. When such sales are ignored, the analysis will consistently overstate the utility's capacity to sell electricity in wholesale markets.

Market power screen or wall? To serve its regulated customers, OG&E wants a share of a generating facility. To FERC, the purchase fails the market powertest.

Moreover, any approach that consistently increases the likelihood of such false "market power" findings creates uneconomic conditions. First, by relying exclusively on the EC screen, FERC discourages utilities from purchasing existing plants instead of building plants or signing long-term contracts-this encourages utilities to pursue those other options, even if they are not the lowest-cost options. The effect is that customers that would have purchased power from the utility are harmed.

On the other side, generators that seek to dispose of surplus generation will be deprived of a whole class of potential bidders. This is particularly important now when many generators face financial difficulties, and integrated utilities have both the resources and the need to secure additional capacity. There are many more potential sellers of power-plants than there are buyers today. The OG&E order, discouraging their purchase by utilities, decreased the plants' value.

Reasoned Decisionmaking Lapses

According to Order 642, the concern with vertical market power is not that it would "directly eliminate a competitor, but may create or enhance the incentive and/or ability for the merged firm to adversely affect prices and output in the downstream electricity market and to discourage entry by new generators." The OG&E order states, "Both the ability and incentive to raise prices by restricting access are necessary for a vertical market power problem to exist."

The order fails, however, to explain how replacing expiring contracts with a similarly sized acquisition to serve native load will create or enhance OG&E's ability or incentive to restrict transmission access and thereby profit. Nor is there any discussion of how replacing existing contracts for power with a physical asset that does not provide the utility with control over any additional transmission assets will increase its vertical market power.

The OG&E order states, "In this case, we find that OG&E hasthe ability, and the acquisition of 400 MW of generation will increase OG&E's incentive, to use its transmission system to frustrate competition in wholesale markets by denying rival suppliers access to the market." FERC makes this vertical market power finding even though the acquisition is required to serve native load, not competitive market needs. Other than noting that OG&E's analysis showed "highly concentrated relevant markets" and citing the preamble of Order 2000, there is no discussion of any evidence that supports the commission's conclusion that OG&E has the both the ability and incentive to raise prices in wholesale markets by restricting transmission access.

Too Important

In previous proceedings, FERC's policy has been to accept a commitment to join a regional transmission organization (RTO) and the existence of an open-access transmission tariff (OATT) as sufficient to show a lack of a utility's transmission market power. Contrary to previous commission decisions, FERC did not consider OG&E's commitment to join the Southwest Power Pool's RTO to be mitigation. This seems inconsistent with the commission's overall effort to encourage utilities to join those organizations.

In the OG&E case, FERC should have accepted the OATT and RTO commitment as a sufficient showing of a lack of vertical market power. The OG&E order states that fere is "not convinced that the OATT will fully mitigate the increase in OG&E's vertical market power." But again, there is no explanation and no reference to evidence in the record.

The accurate analysis of market power issues is too important to do without thorough analysis and reasoned explanation. The commission must implement a fair market power test that respects state commission decisions about serving native load without belittling the value of joining an RTO or diminishing the market value of generation.

It is state law that dictates utility obligations to customers, and state commissions should determine how those obligations should be met.

FERC's exclusive reliance on a particular market power test to the exclusion of other evidence does not take into account a utility's legal and contractual obligations to sell power to retail customers.

Melissa Lauderdale is director of industry legal affairs at Edison Electric Institute.