(UtiliPoint.com - Oct. 2, 2006)
 

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October 2, 2006

By George H. Campbell, III G3 Power Consulting LLC Affiliated Consultant, UtiliPoint International

The 2005 Energy Policy Act (EPAct 2005) significantly changed the regulatory risk of operating a transmission system for an Investor Owned Utility (IOU). Section 1284 establishes fines for civil penalties of $1,000,000 per violation per transaction per day. Given that an IOU will engage in thousands of transactions per year, exposure could be in the billions of dollars for an IOU. The details of what fines will be for discrete activity are yet to be established and probably won't until the fines are tested in the courts. What is known is that the regulatory risk has become significant. While the tail risk can be identified, what is not known is the probability of what the future holds. Will transmission customers who believe that they are being discriminated against and harmed by market power abuses force the issue before the FERC and the courts?

Prior to EPAct 2005, the Federal Power Act only allowed minimal penalties of $5,000 - $10,000 per violation per day. The Federal Energy Regulatory Commission (FERC) basically disgorged profits for any malfeasance in operating a transmission system. On October 20, 2005 the FERC issued a Policy Statement that discussed the factors they would take into account in determining remedies for violations, including applying the enhanced civil penalty authority provided by EPAct 2005. They stated: “Our purpose is to provide firm but fair enforcement of our rules and regulations and to place entities subject to our jurisdiction on notice of the consequences of violating the statutes, orders, rules, and regulations we enforce.” However, they decided to apply remedies on a case-by-case basis, and not to create a schedule of penalties. “Likewise, we will not prescribe specific penalties or develop formulas for different violations. It is important that we retain the discretion and flexibility to address each case on its merits, and to fashion remedies appropriate to the facts presented, including any mitigating factors.”

So who are these IOUs that are still operating their transmission systems? Most of them are located in the Southeast, Midwest and Northwest. The Northeast utilities, California and ERCOT have independent operators of their transmission systems that administer the tariffs. Two IOUs have already started to address this issue, Duke Power and Entergy. They have had conditional FERC approval and are in the process of establishing an independent entity to administer their FERC Open Access Transmission Tariff (OATT), calculate the available transmission capacity and provide for the management of their Open Access Same Time Information System (OASIS). In addition they are hiring an Independent Monitor to investigate potentially anticompetitive market behavior.

So what is this risk? It rest in two major areas: market malfeasance in the IOU's trading function and undue discrimination in operating a transmission system. Market malfeasance is a lower probability risk for these IOUs because there is no centrally organized market and thus fewer market rules and business practices established for day-to-day wholesale electric market trading activity. However, undue discrimination is at the heart of an expected rulemaking that the FERC has undertaken to revisit their original Orders 889/889 and emphasized in the Dockets title, “Preventing Undue Discrimination and Preference in Transmission Service.” The FERC will hold a Technical Conference on October 20 and will probably issue an order at the end of this year or early 2007. The rulemaking will probably implement many new changes that may be subject to the new fines.

Also, the FERC has recently made public some investigations on the utilization of network service, notably in the release of the investigation of the MidAmerican Company. While the audit identified some practices that should not be undertaken, it also opened up additional questions on the proper utilization of network service.

So how should this enterprise risk be managed? The answer starts with identifying the risk. One of the main risks centers on the benefits that native load customers receive with their network transmission service to serve their native loads. While native load rights are reinforced with EPAct 2005, the definitions of network loads and what loads qualify for these rights may result in different interpretations of the OATT. Also, the calculation of available transmission capacity and allocating their rights could be determined to be undue discrimination that favors the IOU's merchant function.

If a transmission operational risk audit is performed, it should also include the transmission Security Coordinator function. The majority of IOUs don't self supply this function. However, we mention it here because the risk can be significant. The Security Coordinator function is the NERC function that directly manages the system during times of transmission system emergencies. The August 2003 Northeast blackout demonstrated the risk of providing this transmission reliability function. For a comprehensive list of this risk you can go to First Energy's last 10K to review the numerous venues that they are defending themselves. One option for mitigating this risk is for this function be managed by an independent entity.

Evaluating different solutions is the other part of this risk assessment. We have already mentioned how Entergy and Duke Power have reduced some of this risk by using an independent entity to administer some of the functions that could be deemed to be discriminatory. In addition, reducing activities of the IOU's Merchant Function, especially as they involve network service, should be included as a potential risk mitigation measure.

The biggest challenge is creating an internal atmosphere for the IOU's enterprise risk management group to be able to conduct a viable audit of the various departments that manage transmission operations or the IOU's merchant function that uses the transmission service. These groups are subject to FERC's Standards of Conduct, requiring them to operate as totally separate functional groups and are usually represented by different corporate officers. Also some of the IOU's transmission operation's management have resisted any attempts by the FERC to force an organized wholesale electric market as part of the transmission operation. Some of these operations groups may perceive an independent entity solution as a slippery slope.

Once this transmission operational risk audit is completed and potential solutions are identified, the IOU's FERC regulatory group can then assess the best ways of implementing it. Because many of the risk management solutions will be voluntary, the regulatory group should be able to work with the FERC and receive guarantees that their risk is mitigated or greatly reduced.

Consulting services to enhance wholesale electric markets is one part of UtiliPoint's Performance Driven Utility Practice. We have a broad range of consulting and performance metric services that can assist you in these areas. Contact George Campbell (gcampbell@utilipoint.com ) for more information on this practice area. To review an article with an overview of this practice, please click on the following link: http://www.utilipoint.com/issuealert/article.asp?ID=2714.

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