FERC Rejects FirstEnergy’s Application To Transfer Generating Facility to an Affiliated Utility

In an order issued on January 12, 2018, the Federal Energy Regulatory Commission (“FERC” or “Commission”) rejected an application by Monongahela Power Company (“Mon Power”), a franchised public utility subsidiary of FirstEnergy Corp. (“FE”) engaged in providing electric service in West Virginia, to acquire needed generation capacity from an affiliate. Mon Power had concluded through an integrated resource plan (“IRP”) that it faced a substantial capacity shortfall which was expected to exceed 850 MW by 2027. Mon Power therefore conducted a competitive RFP to acquire upwards of 1,300 MW of needed capacity reserves. In response to the RFP, Mon Power’s unregulated affiliate, Allegheny Energy Supply Company, LLC (“AE Supply”),  submitted a bid to sell its Pleasants power station (a 1,159 MW coal-fired electric generation facility)(the “Facility” or “Pleasants”) to Mon Power.  Although other entities participated in the RFP, AE Supply’s bid was recommended by an independent RFP administrator and was accepted by Mon Power.

Mon Power and AE Supply submitted an application to FERC under section 203 of the Federal Power Act (“FPA”) for authorization for AE Supply to transfer the Facility to Mon Power, and under Section 204(a) of the FPA for authorization for Mon Power to assume a $142 million promissory note (the “Note”) to secure a line on AE Supply’s interest in certain pollution control assets at the Facility. In denying authorization under Section 203, FERC concluded that the applicants have not demonstrated that the proposed transfer is “consistent with the public interest” and dismissed as moot Mon Power’s request for Section 204(a) authorization to assume the Note.

FPA Section 203

FPA section 203(a)(4) requires the Commission to approve proposed dispositions, consolidations, acquisitions, or changes in control of generation and transmission facilities if the Commission determines that the proposed transaction will be consistent with the public interest. The Commission’s analysis of whether a proposed transaction is consistent with the public interest generally also involves consideration of three factors: (1) the effect on competition; (2) the effect on rates; and (3) the effect on regulation. FPA section 203(a)(4) also requires the Commission to find that the proposed transaction “will not result in cross-subsidization of a non-utility associate company or the pledge or encumbrance of utility assets for the benefit of an associate company, unless the Commission determines that the cross-subsidization, pledge, or encumbrance will be consistent with the public interest.”

Ameren

In Ameren,[1] the Commission explained how it would evaluate a transaction that involves the acquisition of an affiliate’s assets, noting that the Commission must assure that a public utility’s acquisition of a plant from an affiliate is free from preferential treatment.  The Commission set forth guidelines that apply four principles to different stages and aspects of the solicitation process: (1) Transparency: the competitive solicitation process should be open and fair; (2) Definition: the product or products sought through the competitive solicitation should be precisely defined; (3) Evaluation: evaluation criteria should be standardized and applied equally to all bids and bidders; and (4) Oversight: an independent third party should design the solicitation, administer bidding, and evaluate bids prior to the company’s selection.

The RFP

FERC concluded that Mon Power’s competitive solicitation did not meet the Ameren principles because Mon Power failed to demonstrate that the proposed transaction will not result in inappropriate cross-subsidization. In denying authorization for transfer of the Facility to Mon Power, the Commission noted that its finding is without prejudice to a future application resulting from a new competitive solicitation by Mon Power.

Ameren – Definition and Evaluation Principles

In finding that the RFP did not meet the Ameren principles, FERC did not offer an opinion on compliance of the RFP with the Transparency and Oversight principles. Rather, FERC limited its opinion to the Definition and Oversight aspects of the RFP.

Definition

Mon Power proposed to acquire facilities, rather than to meet its needs through power purchase agreements (“PPAs”), because of the “increased control and flexibility asset ownership affords Mon Power relative to a PPA – including greater control over operations, maintenance, fuel procurement, and capital improvements, as well as the flexibility to modify facility operations.”   However, FERC found that the product sought by Mon Power was overly narrow because the stated objective, i.e., for Mon Power to acquire needed generation capacity, could have been achieved if the RFP considered PPAs as well as generating facilities. By excluding PPAs, the RFP, in FERC’s view, unduly limited the number of potential respondents and thus products that could have met the RFP’s stated objective. FERC concluded that the justification offered by Mon Power could have instead been a factor in the evaluation of offers, similar to the score for development risk, rather than eliminating from consideration an entire class of offers that could have been used to meet the capacity shortfall identified in the IRP. FERC also noted that two non-conforming bids for PPAs were received but not evaluated.

Mon Power also limited bids to only sources within the APS zone of PJM Interconnection, LLC because of the need to minimize Capacity Performance penalty risk. Mon Power explained that, because PJM allows capacity resource owners during a Performance Assessment Hour to net performance over multiple units within the same PJM load zone, the risk of penalty to Mon Power’s portfolio units is eliminated if the units are located within the APS zone. However, FERC found that the APS zone limitation in the RFP improperly excluded resources that otherwise could meet Mon Power’s stated objective. After finding such penalty risk to be quantifiable, and rare, FERC determined that the APS zone limitation in the RFP was overly restrictive.

Evaluation

In holding that the RFP did not meet the Evaluation principle, FERC explained that in its view, the use of a 15-year net present value (“NPV”) calculation excessively favors existing, older generation resources with low up-front costs but potentially high maintenance costs in subsequent years. While acknowledging that the estimates of future expenses and revenues become more uncertain the further into the future that they are projected, FERC concluded that ignoring years beyond 15 in the NPV calculation gives an advantage to a facility with a low purchase price and higher future costs, such as the affiliated Facility. FERC recommended that an NPV calculation that considers the total value of the proposal, including a terminal value, would more closely capture the comparable economics of each proposal in order to satisfy the Evaluation principle.

Mon Power included an “ease of integration” factor as part of the non-cost evaluation protocol, but FERC rejected this factor as dampening participation by other bidders and establishing an inappropriate preference for Mon Power’s corporate affiliates. Finally, FERC found that the RFP did not properly disclose the scoring criteria upfront. In FERC’s view, the Evaluation principle requires that “RFPs should clearly specify the price and non-price criteria under which the bids are to be evaluated. Price criteria should specify the relative importance of each item as well as the discount rate to be used in the evaluation.” While the RFP explained what the price and non-price criteria were, the weights of the criteria were not clearly articulated in FERC’s view. The Commission recommended that the RFP administrator should have allowed all parties to see how each price and non-price factor would be weighted in scoring the bids, including what discount rate would apply to the NPV calculation.

Safe Harbor

As an alternative to demonstrating compliance with the Ameren principles, a party can show that it comports with one of the safe harbor transactions reflected in FERC’s regulations that do not raise cross-subsidization concerns. One class of transaction that qualifies as a “safe harbor” are transactions that are subject to review by a state commission. Mon Power asserted that it qualifies for this safe harbor because the West Virginia Public Service Commission (“WVPSC”) regulates all aspects of Mon Power’s retail rates, facilities, and service (including the IRP), and the proposed transfer of the Facility required WVPSC approval.

FERC rejected Mon Power’s contention, noting that the mere fact that a state commission regulates an applicant and must approve the transaction at issue does not meet the standard established for the safe harbor. FERC determined that the applicants provided no evidence that any ratepayer protections regarding cross-subsidies were proposed in the proceeding before the WVPSC. In addition, the Commission observed that it would recognize the safe harbor “absent concerns identified by the Commission or evidence from interveners that there is a cross-subsidy problem based on the particular circumstances presented.” Because FERC noted that such concerns have been identified in this proceeding, it found that the proposed transfer did not fall within the safe harbor.

Guidance for Future Solicitations

As a general observation, FERC noted that properly designed competitive solicitations should provide non-affiliate competing suppliers with the same opportunity as an affiliate to meet the utility’s needs. In the interest of providing guidance for a future competitive solicitation by Mon Power, FERC noted that it disagreed with arguments questioning the need for generation or the accuracy of the load forecasts in Mon Power’s 2015 IRP, as it is the role of the WVPSC to make such determinations. FERC also disagreed with challenges to the independence of Mon Power’s RFP administrator by noting that, despite protestor arguments to the contrary, a repeated business relationship does not by itself indicate a lack of independence. Finally, the Commission rejected arguments that the RFP time-line to submit pre-qualification paperwork may have been restrictive and could have resulted in limiting the participation of potential bidders by observing that nine potential bidders submitted pre-qualification documents.

Ramifications

Mon Power will need to consider whether, and how, to engage in another RFP to meet its forecasted capacity deficiency. Unfortunately, the Commission’s order presents a mixed set of guidance for the company. FERC’s resolution of the state commission “safe harbor” issue against Mon Power appears to be based on a narrow reading of its regulations, particularly given the comprehensive jurisdiction the WVPSC asserts over Mon Power’s activity and its authority to approve the proposed transfer. Additionally, the Commission failed to describe appropriately why the company’s presentation of the basis for there being no prospect of cross-subsidization (in Exhibit M of the 203 application) was deficient.

Adding to the regulatory uncertainty related to conducting another solicitation, FERC too easily dismissed cogent justifications for RFP elements (e.g., the APS zone requirement for which 25 generation facilities – existing and in development – qualified), and the Commission provided minimal guidance on whether the RFP met the Transparency and Oversight principles under Ameren. While there are concrete recommendations in FERC’s order for another solicitation that Mon Power will undoubtedly assess, and FERC has enunciated its disagreement with some of the intervener arguments (e.g., as the RFP administrator’s alleged lack of independence), it remains to be seen whether these recommendations will be sufficient to overcome the uncertainty that the order has understandably cast over proposed acquisitions of affiliated generation, particularly for a company like Mon Power who had previously acquired an affiliated generation facility (with FERC’s approval).

[1] Ameren Energy Generating Co., Opinion No. 473, 108 FERC P61, 081 (2004)(“Ameren”).