Market Monitoring’s Key Role in Modern Economic Regulation

1. Market Monitoring’s Key Role in Modern Economic Regulation William F. Hederman, DirectorOffice of Market Oversight and Investigations Federal Energy Regulatory Commission Presented to:University of Virginia Law SchoolCharlottesville, VAMarch 25, 2004 WFH-3/25/04

2. Outline 0. Ground Rules • FERC’s Strategy • Evolution of Energy Regulation • Market Monitoring • Key Initiatives • Next Steps (Opinions: my own, not the Commission’s)

3. FERC has a 3-pronged strategy. Infrastructure Effective Rules Competitive Markets Just & Reasonable Outcomes Strategic Approach Rules Enforcement

4. Significant changes have taken place in energy regulation. • Franchised Monopoly - exclusive service (franchise) area - obligation to serve - cost-of-service regulation -- price caps -- return of rate base • Transition to Competition - trucks (ICC) - airlines (FAA) - oil - natural gas (FPC/FERC) - electricity (FERC/PUCs)

5. Evolution FERC Standard Market Design for Electric Markets • Goal: one set of rules throughout the nation would reduce transaction costs and regulatory uncertainty • NOPR: July 31, 2002 (Remedying undue discrimination through open access transmission service and standard electricity market design) -- extensive outreach (pre- and post-NOPR) -- explicit state role

6. Evolution (continued) • Key Elements of SMD: -- independent transmission provider -- new transmission tariff -- transmission pricing reform -- organized markets: day-ahead and real-time -- mitigation of market power -- resource adequacy -- regional planning -- market monitoring • Extensive Controversy -- state opposition (NW, South) -- Congressional objections

7. As SMD is transforming, a new consensus is developing. • Regional differences are important • Market transparency and integrity matter • Market monitoring and FERC enforcement help whatever the policy

8. Office of Market Oversight and Investigations (OMOI) - Knowledge/Skillsets - • Planning • Perf. Mgmt. • Budgeting • Facilitation • Speaking • Knowledge of • industry • Partnering • Career Dev. • HR • Recruiting • Contracting • Writing/Editing • Web design • Graphics • Presentation • development Division of Management & Communication Director Deputy Director Market Oversight & Assessment Deputy Director Investigations & Enforcement Market Scanning Hotline • Public Speaking • ADR • Phone answering • Strategic Analysts • Library Science Division of Energy Market Oversight Division of Financial Market Assessment Division of Integrated Market Assessment Division of Information Development Division of Enforcement Division of Operational Investigations Division of Technical Investigations • Forensic Auditors • Analytic ability • Statistical sampling • Documentation • Industry experience • Investigators • Examiners • Gas Engineer • Electric Engineer • Mechanical Engineer • Quantitative Economist • Electrical Engineers • Pipeline Engineers • Economists • Deep Industry • Expertise • Information Analysis • Modeling • Operations Research • Market Design & • Operation • Financial Analysts • Accountants • Understanding of • Investment • Derivatives Markets • Energy Trading • Engineers • Economists • Broad Industry • Experience (Cross- • Industry, Scenario, • Regulatory Analysis; • Market Microstructure • Issues) • Operations Research • Writing/Presentation • Skills • Policy Analysts • Information Analysis • Energy Industry • Expertise • Software Applications • (Large databases, • Data Analysis, • Statistical, • Presentations • (including Mapping) • Web Experience • Questionnaire & Survey • Design • Statistical Analysis • Attorneys • Litigation • Investigation • Knowledge of • financial markets • Enforcement • ADR Training • Paralegal

9. Natural Gas & Electric Market Space Nat Gas & Electric Derivatives Nat Gas & Electric Clearing Trading Venues Futures (NYMEX) Electronic Platforms Physical Nat Gas Phys Electric Power Voice Brokers Bilateral Trading RTO’s & ISO’s Generation Gas Supply Players Transmission & Pumped Storage Pipelines & Storage • Price Contributors • Fixed price • buyers & sellers • Speculators Price Takers -Indexed price buyers & sellers Delivered Market Delivered Market Gas to fuel power generation Source: FERC-OMTR&OMOI

10. Key Initiatives • Behavioral Rules • Standards of Conduct • Audits • Empowering Key Players

11. New Market Behavior Rules Highlights (Electricity Markets) • Unit operation must comply with Commission-approved rules of applicable market power. • Actions/transactions without a legitimate business purpose and that are intended to or foreseeably could manipulate prices are prohibited; no wash trades/false information/artificial congestion relief/collusion • Provide accurate information to FERC/ISO/RTOs and MMUs. • Voluntary price reporting must follow Price Index Policy Statement and sellers must tell Commission whether they report. • Retain relevant pricing records for 3 years. • Do not violate code of conduct or Order 889 Standards of Conduct.

12. Highlights (continued)(Natural Gas Markets) • Actions/transactions without a legitimate business purpose and that are intended to or foreseeably could manipulate prices are prohibited; no wash trades/collusion. • Voluntary price reporting must follow Price Index Policy Statement and sellers must tell Commission whether they report. • Retain relevant pricing records for 3 years. See 18 CFR 284.288 (pipelines) 18 CFR 284.403 (blanket marketing certificates) For first time: sellers relying on blanket market certificates must ID themselves.

13. Highlights (continued)Remedies • Disgorgement of illegal profits • Suspension or revocation of authority • Other civil penalties await Congressional action

14. Highlights (continued)Other Provisions • 90-day limit on complaints (from end of quarter in which transacted or when party knew/should have known) • FERC limiting self (action within 90 days of learning of violation) • Compliance with approved RTO/ISO rules = compliance with behavior rules (absent broad scheme) • OMOI to review effects annually

15. Highlights (continued)Market Monitoring Units • MMUs: an extension of Commission staff • MMUs can enforce matters - expressly set forth in tariff - involve objectively identifiable behavior - subject seller to consequences expressly approved by Commission and set forth in tariff • Commission responsible to enforce other matters • MMUs – OMOI to forge close working relationships • Clear RTO/ISO rules to assist compliance with behavior rules • MMUs: a work in progress

16. Standards of Conduct GOAL: One set of standards of conduct to apply uniformly to natural gas pipelines and electric utilities or “transmission providers” PRINCIPLES: • The transmission function must operate independently from its marketing and sales functions and energy affiliates; and, • Transmission providers must treat all transmission customers, affiliated and non-affiliated, in a non-discriminatory manner, and cannot operate their transmission system to preferentially benefit an energy affiliate.

17. Standards of Conduct (continued) Key Elements: • Independent functioning requirement • Emergency exception w/reporting to FERC • Affiliates identified on OASIS • Organization charts and job descriptions posted on OASIS • Employee transfers posted on OASIS • Codes of Conduct submitted to FERC • Non-discrimination requirement • Information sharing prohibitions • Discounts posted on OASIS

18. Standards of Conduct (continued) Important definitions - transmission provider (TP) (not including RTO) - energy affiliate (EA) - marketing affiliate (MA) Independent functioning - of TP and MA/EA - exceptions (e.g., certain personnel, emergencies) Important postings (on OASIS/Internet) - names, titles, job descriptions - certain employee transfers - potential merger partners

19. Standards of Conduct (continued) Restrictions on information disclosure - TP cannot share with MA/EA - e.g., transmission, price, curtailment, storage, balancing, ancillary services, ATC, maintenance or expansion information Tariffs - non-discriminatory application - must post discounts Chief Compliance Officer

20. Audits • Targeted - Complaint-based (informal/formal) - Company-specific - Issue-specific • Random

21. Key Initiatives OMOI is working to empower key market participants to contribute to market integrity. • State commissions • State consumer advocates • Energy engineers • Members of energy company boards • Compliance officers

22. OMOI Next Steps • Continuous improvement - market surveillance reports - oversight meetings - seasonal look-aheads - definitions of market power, abuse, etc. • Enhanced auditing - targeted - random • Empowering key market participants • Rapid response to observed anomalies • More intense scrutiny of less transparent markets • Expanded teaming - MMUs - states - other federal agencies - North American colleagues

23. Market Integrity is Everyone’s Business FERC Hotline: 1-888-889-8030