What’s Happening at FERC?

What’s Happening at FERC? A presentation by: Dr. John A. Anderson President & CEO Electricity Consumers Resource Council Washington, D.C. At The: Kentucky Industrial Utility Customers 2007 Energy Conference March 29, 2007 ● Lexington, KY

What Is ELCON? • The national association for large industrial users of electricity in the U.S. • Founded in 1976 • Members from a wide range of industries from traditional manufacturing to high-tech

What I Plan To Do Today • Review recent FERC activities of particular interest to large industrial electricity consumers • Emphasize that FERC’s activities have the potential for substantial impacts, both positive and negative, on large, industrial electricity consumers • Request help • ELCON is doing its best to advocate policies and procedures favorable to industrials • But our resources are limited – We need help

FERC Is, And Has Been, Very Busy • Specific FERC actions include (but certainly are not limited to): • Implementation of EPAct 2005 • Order No. 888 reform • Establishing long-term transmission rights • Implement incentives for new transmission • Encouraging demand response • Implementing centralized capacity markets • Establishing mandatory reliability standards • Re-writing QF rules • Most recently, examining the status of competition in wholesale electricity markets • Several court actions could significantly impact FERC’s “Market Based Rate” paradigm • These (and probably other) FERC actions impact both restructured and traditionally-regulated areas • As such, they can have very significant impacts on large industrial electricity consumers

EPAct 2005 • FERC has been very active in – and has completed all – EPAct05 requirements • Although the joint FERC/DOE/DOJ/FTC/Agriculture study on the status of competition is not yet out • Not all actions are positive from a consumer standpoint • But EPAct05 was quite prescriptive • FERC generally followed the precise language of the law • The impacts of these FERC actions are just beginning to be felt • I highlight a few

A Few EPAct 2005 Implementation Actions • PUHCA repeal (RM05-32) • Revised merger authorities (RM05-34) • Market manipulations (RM06-3; PL06-1; RM06-2) • PURPA §210(n) (RM05-36) • PURPA purchase & sell mandate (RM06-10) • Incentives for transmission (RM06-4) • Interagency task force report on competition (AD05-17)

Order No. 888 Reform • FERC issued Order No. 890 on February 16, 2007 amending its regulations on the pro forma open access tariffs (OATT) requiring: • NERC and NAESB to develop consistent ATC calculation methodologies within a year • Coordinated, open transmission planning processes on both local and regional bases • Pricing reforms, including reforms to the pricing of energy and generator imbalances, to reflect the costs of correction • A conditional firm component to long-term point-to-point service • Rollover rights including a five-year minimum contract term • Transmission providers post on their OASIS all business rules, practices and standards related to transmission services provided under the pro forma OATT • However, FERC declined to address native load exemption

Establishing Long-Term Transmission Rights • FERC issued Order No. 681 on July 20, 2006 establishing guidelines for regional market operators to use in developing long-term transmission rights (LTTR) that must: • Specific quantity, source and sink • Hedge congestion costs • Be available to parties that pay for transmission upgrades and expansions • Have terms sufficient to hedge long-term contracts • Give priority to LSEs where the right is for existing capacity • Be re-assignable • Be allocated initially such that recipients are not required to participate in an auction, and • Balance adverse economic impacts • Grid operators had to respond by January 29, 2007

Grid Operators’ Filings • PJM: Proposed an extension of its existing auction reserve rights (ARR) allocation process – LTTRs based on a 10-year ARR allocation – Asserted that it will ensures transmission upgrades • MISO: LTTRs allocated as ARRs with an initial 1-year term with indefinite guaranteed and automatic rollover – Priority will be given to LSEs based on existing transmission capacity – Each market participant may obtain ARRs to meet up to 50% of its peak • ISO NE: LTTRs will have an initial term of 5 years with indefinite renewual rights for additional 5-year periods immediately prior to the expiration of the right – 25% of the ISO’s network capability for LTTRs will be reserved so market participants without supply commitments or load obligations > 5 years • NY ISO: Asserts that the existing system meets FERC’s requirements – Nearly ½ of the grid’s total capacity is grandfathered – Those holding grandfathered rights are given priority to acquire transmission congestion contracts for up to 10 years after those rights expire – the rights are renewable indefinitely as long as the LSE serves the same historical load and pays an annual charge • CAISO: Long-term congestion revenue rights will be allocated based on the annual congestion revenue rights allocation to LSEs – Monthly, 1-year and 10 year rights will be available

Implement Incentives For New Transmission • EPAct05 directed FERC to develop incentive-based rate treatment for new transmission • FERC issued a NOPR in November 2005 • FERC’s goal is to increase transmission spending by 25% annually • FERC’s final rule contains 6 specific incentives: • Incentive ROE • Up to 100% CWIP • Hypothetical capital structures • Accelerated depreciation schedules – 15 years • Recovery of all prudent costs • Defer cost recovery if under a rate moratorium • All incentives can be awarded • Although FERC did say in January 2007, on rehearing, that it would require the applicant to show the total package of incentives and grant a ROE appropriate to the package

Encouraging Demand Response • FERC will hold a technical conference on April 23, 2007 on integrating demand response in wholesale markets • Commissioner Wellinghoff is a very strong supporter of DR and will lead the conference • DR has the potential to significantly reduce both the level of clearing LMPs and price volatility • Some ISOs and RTOs presently say that they allow equal treatment of DR and generation • But they don’t provide symmetrical payments (equal compensation) • Example: PJM stated that DR produced $650 million in savings in one day last summer, but only paid $5-7 million • And they often put significant road blocks in place • Example: ELCON filed a protest on February 23, 2007 opposing PJM’s restrictions on consumers’ ability to participate in a DR program • Generators know very well the impact of DR • And while they publicly say that support DR, they spend many resources making it very difficult for consumers to actually participate – The latest “mission money”?

Implementing Centralized Capacity Markets • The ISOs and RTOs assert that it is politically impossible to allow scarcity pricing • But without scarcity pricing, they say that mandatory “forward capacity markets” (FCM) are required to assure resource adequacy • So far, FERC has approved: • NY ISO: Demand Curve • ISO NE: LICAP (followed by a settlement) • PJM: RPM (followed by a settlement) • ELCON protested the Demand Curve in the DC Circuit Court • We lost because FERC said that the demand curve was only an experiment • However, four years later, and after billions of dollars have been extracted from consumers, absolutely no new generation has been incented by the demand curve • FCMs are very expensive and growing experiments • However, they simply don’t work • But we have been unable so far to effectively oppose them • Generators keep raising what they call “mission money” problems

Establishing Mandatory Reliability Standards • EPAct05 allowed FERC to approve a Electricity Reliability Organization (ERO) • The ERO could establish mandatory reliability standards • FERC approved NERC as the ERO • FERC then approved 83 of 107 reliability standards proposed by NERC • Now mandatory, violations of these standards can result in fines of up to $1 million/day • NERC is now in the process of “registering” all “owners, operators and users of the bulk power system” that have a material impact on the bulk-power system • If registered, an entity is subject to various NERC requirements such as training, audits, etc. • ELCON has argued, largely successfully, that no end-user should be required to be on the registry list • ELCON has been very active in all aspects of NERC for over a decade

Re-writing QF Rules • FERC Issued a NOPR in January 2006: • To implement new PURPA §210(m) provisions that allow the termination of the mandatory purchase requirements under 3 separate conditions • Among other things, FERC interpreted that simply being in an “organized market” was sufficient to terminate the provisions • ELCON filed comments strongly opposing the NOPR • FERC issues a final rule in October • The final rule is substantially better than the proposed rule in that it contains a “rebuttable presumption” rather than an automatic exemption

Re-writing QF Rules • ELCON filed for rehearing: • The applicant for relief has the burden of proof • FERC must impose a searching inquiry to determine whether there is meaningful access to transmission • The factors that QFs can employ to rebut must be enhanced • FERC erroneously assumes that Day 2 markets provide access to long-term markets • FERC’s review of the showings that are required for utilities to be relieved of the purchase obligations must take into account that a competitive market cannot be found when there is no transparency or no retail access • Electric suppliers should not be relieved of their obligations to provide standby and backup power • FERC has not issued a response to our request for rehearing

Examining The Status Of Competition In Markets • FERC held the first of a planned series of public conferences on February 27, 2007 • The stated objective is to evaluate the state of competition in wholesale power markets • We certainly hope (and expect) that this FERC initiative will lead to significant changes in the organized markets • We emphasize that just holding the conference was a major step forward • We are cautiously optimistic, but not at all confident, regarding the results • The all-day conference included a wide range of advocated positions • But very few unanticipated remarks • The importance of the process will be demonstrated overtime through actual FERC actions in the future – if any

Examining The Status Of Competition In Markets (Cont.) • ELCON’s testimony at this conference again listed seven conditions we believe are essential for competition – none of which are presently implemented: 1. Prices must be established through an interaction of supply and demand 2. New capacity must be “incented” through market forces – not through administrative re-regulation 3. Market entry and exit should be determined by market forces 4. Consumers must be able to hedge future prices with long-term bilateral contracts

Examining The Status Of Competition In Markets (Cont.) • ELCON’s Essential Preconditions (Cont.): 5. There must be an adequate transmission infrastructure 6. Market power must be mitigated 7. Finally, and in conjunction with all the above conditions necessary for competitive markets being met, wholesale price caps and bid mitigation measures may be relaxed

Examining The Status Of Competition In Markets (Cont.) • ELCON recommendations included: 1. FERC should recognize that the Day Two construct is not working for the benefit of end-user consumers as required by the Federal Power Act. LMP is not robust enough to compensate for inadequate infrastructure and never should have been implemented without additional transmission and the elimination of major load pockets. LMP will not work unless enough infrastructure is in place to sufficiently mitigate the consequences of joint generation-transmission ownership of incumbent utility holding companies. Price signals are clearly not stimulating, and are probably discouraging, new infrastructure investment. Federal and state regulators do not share the same vision for the industry, which accounts for both a lack of demand response and a disagreement about how resource adequacy should be determined.

Examining The Status Of Competition In Markets (Cont.) • ELCON recommendations (Cont.): 2. FERC should initiate an inquiry into whether today’s RTO platform, with LMP, can be made a viable market model. ELCON questions whether the necessary preconditions are achievable and capable of delivering net benefits to end-use consumers 3. Simple technical fixes or additional regulatory intervention will not correct the inherent problems. FERC must be ready to substantially change the basic underlying structure and implement tariffs that provide consumers just and reasonable rates. Additional “patches” will not fix the problems. 4. If conditions necessary to implement LMP cannot be achieved, the policy debate must shift to what form of regulation is appropriate for jurisdictional utilities: state, federal or a combination of the two.

Court Actions Could Significantly Impact FERC’s MBR Paradigm • The 9th Circuit issued two decisions on December 19, 2006 stating: • The fundamental purpose of FERC’s authority under the FPA is to protect consumers • FERC must protect retail consumers from prices that are derived from dysfunctional markets • FERC abdicated its statutory responsibility to assure that rates are J&R when pre-approving MBR rates • Public Citizen has claimed in the DC Circuit that any J&R standard requires rates to be tied to COS • FERC’s MBR paradigm cannot meet this standard • Public Citizen will argue this case in spring 2007 • FERC is acting as though these cases do not exist

Conclusions • FERC has been very active over the past few years • Many very significant actions have been taken • These actions can (will?) have substantial impacts on large industrial electricity consumers • There will be more (perhaps many more) FERC actions in the near term • ELCON is doing its best to represent large industrial electricity consumers before FERC (and also the US Congress and the Administration) • But our resources are very limited • We need help

Questions?

To Contact ELCON Phone: 202-682-1390 E-mail: elcon@elcon.org Web site: www.elcon.org Address: 1333 H Street N.W., 8th Floor, West Tower Washington, DC 20005

What’s Happening at FERC?