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GAS DEVELOPMENTS AT FERC
A Bi-Monthly Report on Matters of Interest to Gas-Fired Generators
IN THIS ISSUE:
FERC Reverses Negotiated Rate Policy and Again Permits Basis Differential Pricing
By order issued Jan. 19, 2006 (Docket No. PL02-6-001), the Federal Energy Regulatory Commission (FERC) surprisingly reversed course and announced it would again permit pipelines to use basis differential pricing for negotiated rate transactions. In July 2003, FERC had modified its Negotiated Rate Policy, under which pipelines had the flexibility to charge rates above a maximum cost of service rate. At that time, FERC disallowed negotiated rates pegged to the difference between the gas commodity price indices between two points, such as gas basins or selected receipt and delivery points (the “basis differential”). Previously, FERC had allowed such basis differential rates because it believed that the continued availability of a cost of service rate alternative, the “recourse rate,” protected shippers from the exercise of market power by pipelines and that permitting such pricing flexibility enhanced gas market efficiencies. However, in July 2003, FERC recognized that the existence of recourse rates did not provide sufficient protection from market abuse when the negotiated rate was tied to the commodity price of gas. In such cases, the difference in the commodity price between the receipt and delivery point drove the price for transportation. This gave pipelines an economic incentive to withhold capacity to manipulate the gas commodity market so as to widen the basis differential and thus increase profits. In fact, such market manipulation occurred during the California energy crisis of 2000-01 and led to FERC’s blanket prohibition of such transactions in 2003.
FERC’s January 2006 order abruptly reverses course by placing greater emphasis on the economic efficiency benefits associated with basis differential rates while downplaying the risk of market power abuses due to its enhanced emphasis on market monitoring. With respect to economic efficiency, FERC notes that since the implicit value of transportation between two points is the spot price of gas at the delivery point minus the spot price of gas at the receipt point, “gas commodity markets now determine the economic value of pipeline transportation services in many parts of the country.” In such circumstances, allowing such market sensitive rates, FERC concludes, would enhance the efficiency of gas production and distribution across the entire pipeline grid.
Yet FERC was aware of these same economic benefits in 2003, when it prohibited such transactions, finding these benefits were outweighed by the potential for market power abuse by pipelines. Its rationale for reversal here is weak, resting primarily on a greater emphasis on the same market power mitigation measures that were in effect in 2000-01, and which failed to prevent pipeline commodity market manipulation at that time. The sole new market power mitigation measure that FERC cites is the explicit prohibition on market manipulation contained in Section 315 of the Energy Policy Act of 2005 (EPAct 2005), and implemented by Order No. 670, issued the same day as this revised policy statement. However, pipelines were already prohibited from engaging in such fraudulent conduct under the FERC’s Market Behavior Rules, implemented in November 2003.
To prevent market abuses in the future, FERC will need to have much more effective market monitoring in place than it had in 2000-01, when it failed to detect unlawful capacity withholding until after the economic damage was done. EPAct 2005’s enhanced civil penalties authority may not be a sufficient deterrent alone. Nor can FERC automatically rely on the willingness of injured market participants to file a complaint after the harm has occurred, traditionally an important FERC enforcement tool. Injured parties may not have the economic incentive to bring complaint actions alleging capacity withholding since FERC has not been the most favorable forum for parties seeking economic redress in the past. At the same time, they may have no choice. Expansive language in FERC’s new Order No. 670 regarding the scope of FERC’s market manipulation authority may unintentionally make it more difficult for these same market participants to bring private antitrust or contract actions, as many successfully did following the California energy crisis. This is because language in Order No. 670 may enhance the ability of utility defendants to argue that such private claims are now barred by federal preemption or the filed rate doctrine. (see story below).
FERC Issues Rules Prohibiting Energy Market Manipulation
On Jan. 19, 2006, the Federal Energy Regulatory Commission (FERC) issued Order No. 670, promulgating rules prohibiting gas and electric market manipulation, and implementing Sections 4A of the Natural Gas Act and Section 222 of the Federal Power Act, as amended by the Energy Policy Act of 2005 (EPAct 2005). These two sections, which are virtually identical, prohibit the use or employment of manipulative or deceptive devices or contrivances in connection with the purchase or sale of natural gas, electric energy, or transportation or transmission services subject to the jurisdiction of the Commission.
The statutory language was intended to closely track the prohibited conduct language in Section 10(b) of the Securities Exchange Act of 1934 (1934 Act), and Congress specifically dictated that the terms “manipulative or deceptive devise or contrivance” were to be used as those terms are used in the 1934 Act. As a consequence, FERC modeled its new rules on Rule 10b-5, the Securities and Exchange Commission rule implementing Section 10(b) of the 1934 Act, and stated in Order No. 670 that it intends to look for guidance in the substantial body of precedent interpreting Rule 10b-5. In one critical area the two statutes differ. Section 10(b) of the 1934 Act, although silent on the matter, has been judicially interpreted to permit private rights of action. In contrast, the corresponding EPAct 2005 provisions explicitly provide that they should not be construed as creating a private right of action.
The rules specify that entities, in connection with jurisdictional transactions, are prohibited from: 1) using or employing any device, scheme or artifice to defraud; 2) making any untrue statement of material fact or omission of material fact that serves to make a statement misleading; and 3) engaging in any act, practice or course of business that operates as a fraud or deceit upon any entity. This prohibited conduct is similar to the conduct already proscribed by FERC’s Market Behavior Rules, issued in November 2003. However these prohibitions now apply to any entity, not just FERC-regulated entities. Despite this expansion of the universe of entities subject to these prohibitions, FERC does not view its new EPAct 2005 authority as broadening its jurisdiction over energy transactions. Specifically, FERC states that the new rules do not expand its jurisdiction to include previously non-jurisdictional activities, such as “first sales,” sales of imported natural gas (including LNG) and sales and transportations by intrastate or Hinshaw pipelines. Recognizing that energy markets are made up of both jurisdictional and non-jurisdictional transactions, FERC states that a complainant under the new rules would need to establish a nexus between the fraudulent conduct and a jurisdictional transaction. If an entity engages in manipulation and the conduct is found to be “in connection with” a jurisdictional transaction, the entity would be subject to FERC’s anti-manipulation authority.
Distinguishing from the securities laws’ reliance on disclosure requirements, FERC notes that there are no disclosure requirements generally applicable to energy market participants and that Order No. 670 is intended to operate as an anti-fraud provision, not a disclosure provision.
FERC disavows any intent to modify private contractual rights, stating that it “expects parties to continue to resolve most contract disputes, including those based on claims of fraud in the inducement, without the involvement of the Commission, relying on state and federal courts to apply contract law, as appropriate.” Despite this claim, the broad scope of the market manipulation rules, and, in particular, the vagueness of the “in connection with” requirement may give utility defendants a greater ability to defeat private contractual or antitrust claims on the basis that such private actions are preempted by FERC’s new authority under EPAct 2005 and/or violate the filed rate doctrine. If access to the courts is thereby reduced, albeit unintentionally, FERC’s efforts to enhance energy market transparency will not be successful unless it is able to convince injured market participants that it is in their economic interest to come forward with complaints. Encouragingly, FERC also states in Order No. 670 it believes that its new statutory authority gives it broader discretion to remedy manipulative conduct than it had in the past, including the authority to order the disgorgement of profits from unlawful activities.
The new rules took effect on Jan. 26, 2006.
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This Law Letter is a publication of the Energy Department of Davis Wright Tremaine LLP. Our purpose in publishing this Law Letter is to inform our clients and friends of recent developments in energy law. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.
Copyright © 2006, Davis Wright Tremaine LLP.
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