Energy Industry Updates for December 2009

30 December 2009 Publication

Legal News: Energy Industry

Solar Rooftop Victory in New Mexico

Solar rooftop and other distributed generation developers won a victory this month in New Mexico. There, the state regulatory commission (Commission) upheld a previous ruling by a hearing examiner that exempted certain electricity sales under third-party power purchase agreements (PPA) from state public utility regulation. The PPAs allow renewable energy developers that installed generation systems on customers’ properties to sell electricity directly to end-use customers. New Mexico public utilities opposed the change and argued that the decision could expose customers to extra risk and expense.

Renewable energy advocates argued that the third-party PPA model enabled entities without tax liabilities — such as municipal governments, schools, and other nonprofits — to partner with third parties to take advantage of state and federal tax credits. The Commission determined that regulating third-party arrangements as public utilities would unduly burden small-scale entities and discourage renewable energy development in the state. The Commission held that third-party PPAs are legal and service to a single customer does not create a state-regulated public utility.

The Public Service Company of New Mexico, the largest utility in the state, has indicated that it may appeal the decision.

Biomass — “Clean” Fuel Alternative Stirring Controversy

With the focus on renewable energy, combustion of biomass is receiving increased interest as a clean fuel alternative. In theory, biomass combustion uses a renewable resource (such as wood) and is carbon neutral. However, recent permitting-related actions show that biomass combustion can be as controversial as the use of other fuels and questions are being raised about its carbon-neutrality claim.

The issue of whether biomass combustion is, in fact, carbon neutral recently arose in the recent U.S. EPA Advisory Committee addressing greenhouse-gas air permitting under the Clean Air Act. The principle of carbon neutrality is based on the notion that trees and plants remove carbon through photosynthesis, and the stored carbon is then released when biomass is combusted. Thus, no new carbon is added to the atmosphere when biomass is burned. Recent “life cycle” calculations brought forward by environmental groups question this notion of carbon neutrality, and U.S. EPA is re-evaluating whether to grant biomass combustion an automatic exemption as part of its new greenhouse-gas permitting requirements. If the automatic exemption does not apply to biomass, those facilities will have to assess best available control technology for greenhouse-gas emissions, like other combustion units, and face an uncertain and potentially difficult task.

The use of biomass as a fuel also is creating significant divides between those using biomass (such as wood) as part of the forest products industry (paper, construction materials) and utilities that combust wood for energy. The paper industry intervened in a state public utility commission proceeding in opposition to a proposed biomass utility unit in Wisconsin. While the unit was eventually approved, the proceeding demonstrates that approval of a new biomass facility requires careful consideration of the fuel source and the adverse affects combustion may have on other users of wood materials.

New FERC Policies Related to Investigations

Entities that become the target of FERC investigations are the subject of two new policies announced by FERC in separate orders this month. First, pursuant to the Policy Statement on Disclosure of Exculpatory Materials, FERC enforcement staff will now be required to disclose to respondents in Section 1b investigations and enforcement actions under Part 385 of FERC’s regulations any exculpatory evidence or information “material to guilt or punishment” of the respondents and that the respondents do not already possess. The policy originates from the U.S. Supreme Court case Brady v. Maryland and has been applied by several governmental agencies in their enforcement proceedings, including the SEC and the U.S. Commodity Futures Trading Commission (CFTC).

The policy does not require FERC enforcement staff to search for materials other than the materials it receives through discovery or its investigations. The policy also does not entitle respondents to disclosure of FERC enforcement staff’s strategies, legal theories, or evaluations of evidence. Respondents in an enforcement hearing may request the presiding judge to order disclosure of any materials that the respondents “have a reasonable basis to believe” are exculpatory in their cases. FERC stated that its adoption of this policy is intended to promote maximum fairness, administrative efficiency, and transparency in enforcement investigations.

In the second order, FERC adopted a new policy of issuing a public Notice of Preliminary Violations after the subject of an enforcement investigation has had the opportunity to respond to the FERC staff’s preliminary findings of violations. The public disclosure notice will include the following information: (1) identity of the entities that are subject to the enforcement investigation, (2) time and place of the alleged conduct, (3) rules, regulations, statutes, or orders that were allegedly violated, and (4) a concise description of the wrongful conduct.

If FERC enforcement staff decide to terminate an investigation after the public notice has been issued, FERC will issue another public notice announcing the investigation termination. Although FERC noted that accelerated public disclosure of alleged violations might adversely affect an investigated entity’s reputation, FERC concluded that this new policy strikes a balance between an investigated entity’s need for confidentiality and the public interest in additional transparency in FERC investigations.

OTC Derivatives Legislative Developments

Over-the-counter (OTC) derivatives legislation passed the U.S. House of Representatives this month. Specifically, the Derivatives Markets Transparency and Accountability Act of 2009 was included as Title III in the Wall Street Reform and Consumer Protection Act of 2009 and establishes a framework for regulating OTC derivatives.

Title III represents a compromise between the competing bills for OTC derivatives regulation approved back in October 2009 by the House Financial Services Committee and the House Committee on Agriculture , respectively. (See Foley's Legal News: Energy for October 2009 at http://www.foley.com/publications/pub_detail.aspx?pubid=6553.) Title III is intended to provide comprehensive regulation of OTC derivatives markets, swap dealers, and major swap participants through amendments to the Commodity Exchange Act (CEA) and federal securities laws.

For purposes of defining Title III’s reach, “swaps” do not include “any sale of a nonfinancial commodity for deferred shipment or delivery, so long as such transaction is physically-settled.” This appears to be a narrower formulation of the CEA’s existing “forward contract exclusion” from the scope of futures contracts subject to regulation under the CEA.

Title III includes provisions for mandatory clearing and centralized trading of standardized swaps. However, commercial end users that enter into OTC swaps to hedge, reduce, or otherwise mitigate their commercial risks would generally be excluded from those requirements, unless the end-user also is a major swap participant. The end-user would be a major swap participant if it has a substantial net position in swaps that are not held for hedging/risk management or if its total outstanding swap positions create substantial net counterparty exposure. The CFTC and SEC would determine what constitutes a “substantial” net position or net counterparty exposure, to be set at levels considered prudent to protect the financial system from systemic risk.

Notably, Title III gives the CFTC, SEC, and banking regulators the authority to impose margin requirements for swaps that are not cleared. However, the regulators are not required to exercise that authority when one of the parties to the swap is a not a swap dealer or major swap participant, which would generally cover commercial end-users. If the regulators were to exercise that discretionary authority, the margin requirements would have to allow for the use of non-cash collateral. That latter element is apparently an effort to mitigate concerns that mandatory, government-imposed margin requirements could greatly increase end-users’ costs to engage in legitimate hedging using OTC swaps.

Title III does not appear to resolve potential jurisdictional overlap and conflict between the CFTC, on the one hand, and FERC or the Public Utility Commission of Texas, on the other hand, over markets for transmission rights instruments that are cash-settled (versus those settled by physical delivery).

Government Ownership of Intellectual Property Under ARRA

Intellectual property (IP) rights for recipients of funding under the American Reinvestment and Recovery Act of 2008 (ARRA) are receiving increased attention and concern, particularly as such funding is reaching entities that have not previously received government funding. For example, under the ARRA Smart Grid Investment Grant Program managed by the U.S. Department of Energy (DOE), the recipient will be subject to government ownership of IP. There are two exceptions. First, non-profits and small businesses retain their rights under the Bayh-Dole Act to seek IP ownership, albeit with the government retaining certain rights including the right to “march-in” and take title to the IP at a later date. Second, the DOE may choose to waive all or any part of its rights in funded inventions, although no guidance has been provided as to how the decision to waive or not waive ownership rights will be made.

Similarly, under both 42 U.S.C. §5908 (for large entities) and 35 U.S.C. §202 (for small entities and non-profits), the government receives rights in inventions that were conceived of or actually reduced to practice “under” the relevant funding grant. Thus, even where the invention has been previously conceived, and potentially even where a patent application has been filed, government rights may attach. “Actual reduction to practice” occurs when an invention is embodied in tangible form and its practical utility for its intended purpose is demonstrated, which can easily be envisioned, for example, with an electrical transmission or distribution systems may not be practical to actually build absent the government funding. Further, if the recipient is a regulated public utility receiving smart grid funding, there may be competing interests involved where ratepayers are being asked to pay for expenses relating to research for which the utility will not retain the IP rights.

IP rights should be included among the numerous issues considered prior to deciding to seek government funding. For example, the extent of the government’s rights may be managed through earlier actual reduction to practice or narrowly tailoring the funded activities to protect vital inventions from government rights.

Expedited Examination for Certain Green Technology Patent Applications

The United States Patent and Trademark Office (USPTO) announced this month that it will implement a Pilot Program to expedite examination of certain green technology inventions patent applications. While eligibility is currently limited to applications filed before December 8, 2009, the USPTO has hinted about expanding the program if successful. Expedited examination will reduce the time it takes to patent these inventions by an average of one year, compared to the current average time of 40 months to a final decision for green technology inventions.

The announcement was made by U.S. Secretary of Commerce Gary Locke during a press conference timed to coincide with the UN's Climate Change Conference in Copenhagen, Denmark and was tied to job creation and growth in the clean energy sector. The Pilot Program will be limited to the first 3,000 of the “most promising inventions” and could be expanded if proved successful. Examples of promising discoveries that may benefit from the Pilot Program include a “light-weight battery for automobiles,” “a safe and affordable way to capture carbon from coal plants,” and “a cheap and effective way to store power from the wind and sun.”

There are numerous petition requirements, and requirements for eligible patent applications include:

  • The application must be a non-reissue, non-reexamination, and non-provisional utility application
  • The application must be classified in one of 79 “green technology” patent classifications
  • The application must contain three or fewer independent claims and 20 or fewer total claims, without any multiple dependent claims
  • The claims must be directed to a single invention that materially 1) enhances the quality of the environment, 2) contributes to the discovery or development of renewable energy resources, 3) contributes to the more efficient utilization and conservation of energy resources, or 4) contributes to greenhouse-gas emission reduction

There are about 25,000 patent applications eligible for consideration under the Pilot Program. While the popularity of the Pilot Program is yet to be determined, applicants interested in the Pilot Program should consider whether any pending applications could qualify as one of the 3,000 expedited applications. Some applicants will want to file the petition to make special as soon as possible to obtain maximum benefit from the faster pace of the “special” status provided by the Pilot Program. Applications that fall into this group may describe inventions that are directed to more mature commercial areas or inventions that are directed to particular products and well-defined feature sets. Other applicants, however, will choose not to participate in the Pilot Program. Some applications, for example, may describe inventions that are directed to more forward-looking commercial areas or inventions that are not yet directed to any particular product.

One possible strategy to leverage the Pilot Program, particularly if the application on file currently includes more than three independent claims, 20 total claims, or claims directed to multiple inventions, is to file a preliminary amendment to cancel some claims and to file a continuation directed to the cancelled claims. Because the first claimed invention may be constructively elected by the examiner if the applicant is unavailable to make a telephone election, a preliminary amendment also may be used to reorder the claims or to otherwise ensure that the applicant's favored invention is claimed first. Further, because the application is removed from the special docket after the first office action under the Pilot Program, one strategy might be to cancel the broadest and most forward-looking claims while petitioning for the relatively narrow claims or claims directed to a particular commercial product to be considered for the Pilot Program. The continuation would be filed toward the cancelled broad or forward-looking claims. The narrow claims might have a better chance at a reduced number of office actions and prompt allowance, maximizing the usefulness of the Pilot Program. Similarly, an application that was accepted into the Pilot Program might be a good candidate for early examiner interviews, making narrowing amendments early, or taking other steps that might reduce the number of office actions. An opposite strategy might be to prosecute the broad claims under the Pilot Program to obtain an expedited appeals process.

Summary of FERC 2009 Enforcement Activity

The regulated community can always learn of potential compliance pitfalls by watching where FERC has concentrated its enforcement and investigative resources. The following is a summary of an important December 17, 2009 FERC report on its enforcement activities.

Division Of Investigations

This fiscal year, the FERC Division of Investigations (DOI) focused on enforcement of reliability standards, including the publicly disclosed investigation into the February 2008 Florida blackout. The event, which originated on the Florida Power and Light Company (FPL) system, led to the loss of 22 transmission lines, 4,300 MW of generation, and 3,650 MW of customer service or load. In September 2009,  NERC and FPL agreed to a $25-million settlement, which, among other things, required FPL to undertake numerous specific reliability-enhancement measures, including enhancing its compliance program and training and certification requirements for operating employees.

Illustrative Self-Reports Closed With No Further Action

  • Transmission service practices. A public utility company violated its Open Access Transmission Tariff (OATT) and Business Practices. DOI closed the matter with no further action because the company was acting in the interest of reliability by serving customers who would have been stranded and because the violations were limited in volume, self-reported/corrected and resulted in no harm to the market.
  • Disclosure of transmission information. A natural gas transmission company, whose employee inadvertently sent an e-mail with a non-public capacity posting to a marketing affiliate employee, quickly recognized the mistake and took action to correct it. DOI closed the matter with no further action because it concluded that the incident was inadvertent, the company immediately took steps to prevent further occurrences, and there was no harm or unjust profits.
  • Filing of jurisdictional transmission agreements. A public utility company identified several jurisdictional transmission and interconnection agreements that the company had failed to file with FERC under section 205 of the FPA. DOI staff closed the matter with no further action because there was no harm to the market; no evidence of fraud or intent to avoid compliance with FERC’s regulations; and the company quickly conducted an internal investigation, self-reported the violations, and voluntarily adopted a satisfactory compliance program.
  • Misuse of Natural Gas Policy Act Section 311 facility. A company with limited pipeline operations failed to file an application to authorize service through its compressor station. The company self-reported its failure to file the application and also filed a certification application. DOI closed the matter with no further action because some documents indicated that at least some services rendered through the compressor station met the “on behalf of” requirement and because FERC granted the requested certificate authority.

Illustrative Self-Reports Converted to Investigations but Closed With No Action

  • Tariff violation. An electric utility company self-reported that it failed to convert a one-year experimental study review process to permanent status. DOI staff conducted an investigation but subsequently closed the matter with no further action because FERC granted a tariff waiver submitted by the company and retroactively approved the studies that were erroneously completed while the review process was not FERC-approved.
  • Posting violations and oversubscription of firm capacity. Company A submitted a self-report to DOI staff acknowledging that it participated as a replacement shipper in certain capacity release transactions. Company B, the releasing shipper in these transactions, also submitted a self-report to DOI staff. DOI closed the matter with no further action after concluding that the violations did not result in unjust profits or harm to the market and because both companies put adequate compliance measures in place to ensure that no other similar violations would occur in the future.

Illustrative Investigations Closed With No Action

  • False or misleading communication to RTO. DOI closed the matter with no further action after concluding that, while a communication from an electric company to an ISO that provided a specified capacity commitment turned out to be inaccurate, the company had good reason to believe that its communication was correct when made.          
  • Federal Power Act (FPA) Section 203 violation. DOI closed the matter with no sanctions after determining that an electric company’s failure to make timely filings pursuant to Section 203 of the FPA was corrected, presented no demonstrable financial harm to the market, and generated no unjust profits.
  • Flipping violations. A natural gas company self-reported two sets of flipping transactions. DOI closed the investigation with no sanctions because the company acted proactively after the violations were uncovered, and the total volume transported by the replacement shippers through the flipping releases was approximately two-thirds of a billion-cubic-feet.

Most Notable Audits in FY2009

  • Southern Star Central Gas Pipeline, Inc. The Southern Star audit found noncompliance with respect to filing with FERC contracts with material deviations. As a result of this noncompliance, DOI developed a list of frequently asked questions to address contracts containing material deviations from the forms of service agreement in pipeline’s tariffs to help jurisdictional companies and industry officials to comply with FERC’s requirements.
  • Southwest Power Pool Regional Transmission Organization. The Division of Audits (DA) discovered some weaknesses with certain aspects to Southwest Power Pool’s compliance with its OATT, standards of conduct, and administrative policies for travel. As a result of the weaknesses, the Commission required Southwest Power Pool to adopt corrective measures to strengthen and develop its policies and procedures for notifying customers and market participants of tariff-related problems, market participant audits, travel, board member selection, and nonmonetary gratuities.
  • New York Independent System Operator (NYISO). In the NYISO audit, DA staff addressed concerns about the independence of NYISO’s internal Market Monitoring Unit (MMU), due to its reporting relationship and responsiveness to NYISO’s CEO. This audit also disclosed that NYISO failed to consistently notify FERC and market participants, on a timely basis, when NYISO discovered tariff-related problems. FERC required NYISO to address independence concerns with the MMU as well as the problems with NYISO not timely notifying market participants and FERC of tariff-related problems.

Division of Financial Regulation (DFR) Significant matters

  • Annual Report on Natural Gas Transactions. DFR staff focused on providing guidance to assist the gas industry in complying with FERC’s requirements established in Order 704 on Transparency Provisions of Section 203 of the NGA and developed a list of frequently asked questions regarding Form No. 552 to provide details on reporting requirements, fixed price trades, energy management agreements, exchange for physical transactions, cash-outs, unprocessed gas, pre-bidweek transactions, and take-or-release contracts.
  • Quarterly reporting requirements for intrastate natural gas companies. In August 2006, FERC issued a notice requesting comments on proposed standardized electronic information collection on contract-reporting requirements to be used by NGPA Section 311 and Hinshaw pipelines. As a result of this rulemaking, DFR developed a new form that is intended to capture the data and make it easily accessible to the public with the information presented in a clear and transparent manner.


Legal News is part of our ongoing commitment to providing legal insight to our energy clients and our colleagues.

Please contact your Foley Energy attorney if you have any questions about these topics or want additional information regarding energy matters.

Authors and Editors:

Ronald N. Carroll
Washington, D.C.
202.295.4091
rcarroll@foley.com

Thomas McCann Mullooly
Milwaukee, Wisconsin
414.297.5566
tmullooly@foley.com

Andrea J. Chambers
Washington, D.C.
202.295.4770
achambers@foley.com

John M. Lazarus
Milwaukee, Wisconsin
414.297.5591
jlazarus@foley.com

Svetlana V. Lyubchenko
Washington, D.C.
202.672.5492
slyubchenkop@foley.com

Trevor D. Stiles
Milwaukee, Wisconsin
414.319.7346
tstiles@foley.com

Karl F. Reichenberger
Milwaukee, Wisconsin
414.319.7347
kreichenberger@foley.com

J. Steven Rutt
Washington, D.C.
202.672.5351
srutt@foley.com

Mark A. Thimke
Milwaukee, Wisconsin
414.297.5832
mthimke@foley.com

Kathryn M. Trkla
Chicago, Illinois
312.832.5179
ktrkla@foley.com

Ann L. Warren
Washington, D.C.
202.945.6105
awarren@foley.com

Related Services