Administrative Law Overview

1. Administrative Law Overview • Congress grants authority to administrative agency through statute. • Administrative agency interprets the statute and acts according to Congress’ intent.

2. Down the Road: Judicial Review • Clear Congressional Intent • Must follow Congress • No Clear Congressional Intent • Agency allowed to interpret permissible construction of the statute • Factors • (1) Text, (2) Context, (3) More specific statutes, and (4) Common sense

3. Today’s Hearing • Before the Federal Energy Regulatory Commission • Must decide on how to interpret the Federal Power Act

4. Southern California Electric (Petitioner) V. Dynegy (Respondent) What does “just and reasonable” really mean?

5. December 15, 2000 • Dynegy sold 5000 MWh of power to SCE • $130 per MWh • From Palo Verde Facility • Largest Gas Generator in California • Dynegy made $650,000

6. Hearing Officer Findings • December 13th and 14th • Demand for power in the Cal PX market at an all-time high • Generation reserve margins near zero • Dynegy's very high price was a scarcity rent • Highest Previous Price: $60 per MWh • Average Price: $40 per MWh • Dynegy did not collude with other sellers • Dynegy’s costs of generation had not increased

7. May 29, 2001 • Dynegy sold 5000 MWh of power to SCE • $500 per MWh • From Palo Verde Facility • Largest Gas Generator in California • Dynegy made $2,500,000

8. Hearing Officer Findings • High prices for pollution credits • SCE’s credit rating had dropped.   • The Dynegy’s rate consisted of the following: • $50 per MWh = Generation Costs • $200 per MWh = Air Pollution Allowances • $250 per MWh = Risk Premium

9. Federal Power Act (FPA) • 16 U.S.C. § 824d • All rates and charges made . . . by any public utility for or in connection with the . . . sale of electric energy . . . shall be just and reasonable . . .

10. Southern California Electric • “How such compensation may be ascertained, and what are the necessary elements in such an inquiry, will always be an embarrassing question.” Smyth v. Ames

11. The FERC Does Not Have Authority to Implement a Market Based Tariff • The Supreme Court refuses to permit administrative agencies to implement market based tariffs without express statutory authority. • The notice requirement of the FPA prevents the FERC from creating a market based tariff. • The rates charged by Dynegy are invalid under the market based tariff.

12. MCI v. AT&T • “(C)hanging it from a scheme of rate regulation . . . to a scheme of rate regulation only where effective competition does not exist may be a good idea, but it was not the idea that Congress enacted into law.”

13. 11 U.S.C. § 824d (d) • Notice required for rate changes Unless the Commission otherwise orders, no change shall be made by any public utility in any such rate . . . except after sixty days’ notice to the Commission and to the public.

14. 11 U.S.C. § 824d (d) • The Commission, for good cause shown, may allow changes to take effect without requiring the sixty days’ notice . . . by an order specifying the changes so to be made and the time when they shall take effect and the manner in which they shall be filed and published.

15. 11 U.S.C. § 824d (f) • “automatic adjustment clause” means a provision of a rate schedule which provides for increases or decreases . . . without prior hearing, in rates reflecting increases or decreases (or both) in costs incurred by an electric utility.

16. Dynegy's Rates Are Not "Just and Reasonable" Because They Do Not FallWithin a "Zone of Reasonableness". • The FPA requires the FERC to ensure that generators in the energy market charge a "just and reasonable" rate for the sale of power • Courts have interpreted "just and reasonable" to permit any tariff formula only when it produces rates within a "zone of reasonableness". • Dynegy's rates are not "just and reasonable" because they do not fall within a "zone of reasonableness".

17. FPC v. Hope Natural Gas • “The rate-making process under the Act, i.e., the fixing of ‘just and reasonable’ rates, involves a balancing of the investor and the consumer interests.” • “Regulation does not insure that the business will produce net revenues.”

18. Balancing the Interests • December 15, 2000 • No increase in cost for Dynegy to generate • More than 3x price increase • May 29, 2001 • Market placed hardships on everyone • Dynegy could have easily hedged purchase of pollution costs

19. Dynegy's Rates Are Not "Just and Reasonable" Because Dynegy AttainedThem Through the Abuse of Market Power. • In a competitive market, a market based tariff creates rates within this "zone of reasonableness". • The FPA does not permit the FERC to implement a market based tariff in a non-competitive market. • In the presence of low marginal supply and inelastic demand, a generator may have market power without a large market share. • The two transactions between Dynegy and SCE demonstrate that Dynegy not only had market power over SCE, but also exploited this market power.

20. The Lucky Outcome

21. Supply Glut

22. Supply Shortage

23. Dynegy’s Market Action

24. Market Abuse • December 15, 2000 • Hockey stick pricing • May 29, 2001 • Exorbitant 200% risk premium

25. Dynegy’s Counterargument

26. The FERC Does Have Authority to Implement Market Based Tariffs. • FERC has not abandoned its mandate to ensure electricity prices are “just and reasonable” • Judicial deference to an agency is very strong in complex, policy-oriented determinations • So, it is unlikely that a court would strike down FERC’s current market based rate system

27. The FERC Does Have Authority to Implement a Market Based Tariff. • The Supreme Court ruled on market based tariffs in the telecommunications market – This does not automatically apply to the energy industry. • There were not explicit changes to the FPA to authorize market based rates, but FERCs position that the Act authorizes these rates as long as they are “just and reasonable” • The notice requirement of the FPA applies to utilities not to wholesale electricity providers.

28. FERC Does Have Authority to Implement a Market Based Tariff Judicial decisions have condemned only those market pricing systems that: • Rely solely on market forces • Do not retain mechanisms of monitoring unreasonable pricing, and • Do not require mitigation of market power

29. Supporting Precedent • Hope; In re Premium Area Rate Cases • The NGA (nor the FPA) do not require a particular formula or method for ratemaking • Elizabethtown Gas • Nothing precludes the FERC from relying on market based pricing, so long as the market is competitive • California v. FERC • Market based pricing regime upheld, with caveat that there must be monitoring mechanisms enforced

30. FERC’s Approval Method of Market Based Ratemaking • Case by case approval • Seller must not have, or at least have mitigated, market power in transmission or generation • Typically, the cap is 20% of market share • Seller must comply with numerous filing requirements regarding market power and pricing methods • Changing circumstances in industry must justify the shift

31. Market Based Ratemaking We have shown that FERC has the authority to implement market based pricing. Now, we will show that our client, Dynegy, has charged SCE with prices that were set by market forces, and that remained within a zone of reasonableness.

32. Dynegy Did Not Have or Use Market Power Over SCE. • The Commission allows power sales at market-based rates if the following conditions are met: • seller and its affiliates do not have, or have adequately mitigated, market power in generation and transmission and cannot erect other barriers to entry. • Dynegy did not have controlling share of the market • There is no evidence of affiliate abuse or reciprocal dealing. • Rather, the prices it asked for reflected what Dynegy believed the market would bear, given a scarcity supply coupled with the high inelasticity of demand for electricity

33. Dynegy did not commit any fraudulent acts or transactions. • Risk premiums are not fraudulent • Risk premiums protect sellers from unacceptable financial risks due to a high likelihood of default. • Purchasing of pollution credits is a requirement, and are legitimately part of Dynegy’s costs • These are both legitimate business practices in the market

34. Dynegy’s December 15, 2000 rate was well below the average rates charged on the spot market. May rates also fell below the wholesale electricity price caps. • December, 2000 - Dynegy sold 5000 MWh to SCE at a rate of $130/MWh. • Prices in the California wholesale electricity spot markets reached monthly averages of nearly $400/MWh in December 2000 and average daily prices of nearly $1200/MWh. • May 2001 - Dynegy sold 5000 MWh to SCE at a rate of $500/MWh. • FERC set price cap on wholesale electricity $750/MWh.

35. Regional Retail Price Caps Were the Unjust and Unreasonable. • Dynegy’s prices just and reasonably represented the market. However, the state of California did not allow the market to operate effectively which made Dynegy’s rates seem unreasonable. • With price caps at the retail level, there was no reduction in demand reactive to high prices. • The best way to protect the consumer is to allow free market forces to operate at both the wholesale and retail level.

36. FERC’s Market Behavior Rules After the California Energy Crisis, the FERC issued two Orders regarding Market Behavior Rules. These Rules are not binding, nor retroactive, but are a useful tool in determining which business practices the FERC considers anticompetitive in the electricity industry. Dynegy’s actions comply with the Rules.