Energy Industry Updates for January 2010

29 January 2010 Publication

Legal News: Energy Industry

FERC Seeking Comment Regarding the Integration of Wind, Solar, Hydro

FERC is seeking comment from the industry on the various barriers impeding the integration of variable energy resources, which it termed “VERs,” into the transmission grid.

VERs represent generation resources where the output is not directly controllable and include such generation technologies as wind, solar, and certain hydroelectric resources. In contrast to conventional electricity-generating resources, VERs may be location-constrained and are not immediately dispatchable. Because of these unique characteristics, VERs face grid-integration problems not present with conventional fossil-fueled generators.

FERC acknowledged that VERs provide important benefits such as low-marginal energy costs and reduced greenhouse-gas emissions, and that these benefits recently have driven significant generation development. FERC noted, however, that integrating VERs into the transmission grid can affect system reliability by decreasing forecasting accuracy and increasing variability. For example, wind speeds, which affect generation output, can be difficult to forecast precisely.

FERC issued the Notice of Inquiry (NOI) to explore whether “existing rules, regulations, tariffs, or industry practices within FERC’s jurisdiction may hinder the reliable and efficient integration of VERs, resulting in rates that are unjust and unreasonable and/or terms of service that unduly discriminate against certain types of resources.”

Acknowledging that many of its policies were developed when electricity was almost exclusively generated by conventional fossil-fuel plants, FERC requested comments on the following specific topics:

  • Data and reporting requirements, including the use of accurate forecasting tools
  • Scheduling practices, flexibility, and incentives for accurate scheduling of VERs
  • Forward market structure and reliability commitment processes
  • Balancing authority area coordination and/or consolidation
  • Suitability of reserve products and reforms necessary to encourage the efficient use of reserve products
  • Capacity market reforms
  • Redispatch and curtailment practices necessary to accommodate VERs in real time

Comments are due on March 29, 2010. Interested parties may access the NOI in the eLibrary on FERC’s Web site under Docket No. RM10-11-000.

CFTC Proposes Rules to Impose Position Limits on Certain NYMEX and ICE Energy Contracts

The CFTC is proposing rules that would set position limits on the size of positions that a person may hold in certain energy contracts traded on a futures exchange or exempt commercial market, subject to some exemptions. These limits would be in addition to any position limits or position accountability standards adopted by the market for its contracts. The rulemaking proposal was published in the Federal Register on January 26, 2010 and comments are due on April 26, 2010.

Under the proposal, the CFTC would set limits on the size of a market participant’s positions in futures and options on futures traded on a CFTC-regulated exchange and in comparable contracts traded on an exempt commercial market that have been designated as significant price discovery contracts, on four energy commodities: Henry Hub natural gas, West Texas Intermediate (WTI) light sweet crude oil, New York Harbor No. 2 heating oil and New York Harbor gasoline blendstock. In practical terms, the limits would apply to New York Mercantile Exchange (NYMEX) futures and options on the energy commodities at issue and to the Intercontinental Exchange (ICE) Henry Hub Financial LD1 Fixed Price natural gas contract. NYMEX is a traditional futures exchange that is regulated under the Commodity Exchange Act (CEA) as a designated contract market; ICE operates under the CEA is an exempt commercial market.

The proposal is significant because it is the first time that the CFTC has sought to impose its own position limits on contracts that do not involve agricultural commodities and to impose limits on contracts listed on both traditional futures exchanges and exempt commercial markets. Historically, the CFTC has deferred to the markets alone to adopt position limits or position accountability standards for their contracts (putting aside age-based contracts). Under the CEA framework, however, the CFTC has the authority to adopt position limits applicable to any exchange-listed futures/options contracts and also to any exempt commercial market’s significant price-discovery contracts. In July 2009, the CFTC designated the ICE Henry Hub contract a significant price-discovery contract (which was followed by ICE’s adoption in October 2009 of its own position limits and accountability standards for that contract comparable to those in place at NYMEX for its Henry Hub contract). If the CFTC designates any other ICE contracts as significant price-discovery contracts for any of the energy commodities listed above, those contracts would also potentially be covered by the proposed position limit rules.

Under the proposal, the CFTC would adopt spot-month, single non-spot-month, and all-months-combined position limits for the covered contracts, subject to reset annually, based on deliverable supplies and open interest. Notably, the CFTC also is proposing non-spot-month position limits on the combined positions a person may hold in substantially similar energy contracts across markets, which at present would apply to the NYMEX and ICE Henry Hub contracts. The proposal also would apply a higher spot-month limit to a market participant holding cash-settled contracts, but only if such person also does not hold physically settled spot-month contracts.

The CFTC’s proposal includes certain exemptions from the position limits. In addition to a traditional exemption for bona fide hedge positions, the rules would provide a limited risk-management exemption from non-spot-month limits for swap dealers to allow them to hedge their exposure under their over-the-counter energy-swap positions with end-users. As proposed, a swap dealer’s maximum position would be capped at two times the size of the single non-spot-month or all-months-combined limit that would otherwise apply. The CFTC, though, is requesting comments on alternative approaches for a swap dealer exemption, as well as on numerous other issues listed in the rulemaking release.

Supreme Court Extends Mobile-Sierra Doctrine to Third Parties

The U.S. Supreme Court this month extended to third parties the Mobile-Sierra presumption that an electricity rate set by a freely negotiated wholesale-energy contract meets the Federal Power Act’s “just and reasonable” requirement. NRG Power Mktg., LLC v. Me. Pub. Utils. Comm’n, 558 U.S. (2010).

The challenge in NRG Power Marketing arose out of generation-capacity shortages in the New England Independent System Operator’s service territory. After several years of litigation and negotiation, FERC, New England generators, electricity providers, and power customers reached an agreement to resolve the capacity issues. The agreement established rate-setting mechanisms for sales in a Forward Capacity Market. Of particular importance, the agreement noted that the Mobile-Sierra public-interest standard would govern rate challenges. FERC approved the agreement and found that it presented a just and reasonable outcome consistent with the public interest.

Of more than 100 parties involved in the settlement agreement, eight objected and sought review in the U.S. Court of Appeals for the D.C. Circuit. The D.C. Circuit largely agreed with FERC’s decision, but did agree with the objectors that when a challenge to a contract rate is brought by noncontracting third parties, Mobile-Sierra’s public interest standard does not apply. The Supreme Court addressed this issue on appeal.

Rhetorically, the Court asked, “[I]f FERC itself must presume just and reasonable a contract rate resulting from fair, arms-length negotiations, how can it be maintained that noncontracting parties nevertheless may escape that presumption?” In response, the Court stated:

Mobile-Sierra holds sway … because well-informed wholesale-market participants of approximately equal bargaining power generally can be expected to negotiate just-and-reasonable rates, and because “contract stability ultimately benefits consumers”. These reasons for the presumption explain why FERC, surely not legally bound by a contract rate, must apply the presumption and, correspondingly, why third parties are similarly controlled by it. Id.

That is, applying the Mobile-Sierra presumption only to contracting parties — but not to consumers, advocacy groups, and state utility commissions — undermined the stability of the industry. The Court reasoned that extending the Mobile-Sierra presumption to noncontracting third parties promotes stability of supply arrangements necessary for the health of the energy industry.

As a practical matter, this decision affirms Mobile-Sierra’s presumption that rates negotiated at arms-length are “just and reasonable,” even if later challenged by third parties.

The Court did not address, however, whether the rates at issue were indeed “contract rates” that qualified for the Mobile-Sierra presumption, or whether they were rates of general applicability, and if they were rates of general applicability whether FERC had the discretion to treat them analogously to contract rates. The Supreme Court remanded that issue back to the D.C. Circuit. The distinction between contract rates and rates of general applicability is likely to control whether contracting parties can bind third parties to their contract.

Did Scott Brown Change the National Energy Debate?

The election of Massachusetts State Sen. Scott Brown to the U.S. Senate changed the political and legislative landscape in Washington, D.C. like no political event in a generation. And even though the Democrats still control the presidency for at least three more years and both houses of Congress by healthy margins until the 2010 mid-term congressional elections, House and Senate leaders are re-tooling their entire legislative agendas with an urgency not seen on Capitol Hill in years. But the fact that one vote in the Senate could overturn an entire legislative agenda suggests that there may never have been strong consensus for President Barack H. Obama’s ambitious green energy program in the first place.

The original energy/cap-and-trade legislative proposals were linked in the House of Representatives and passed by the narrowest of margins in June 2009. But even up to Mr. Brown's election on January 19, 2010, very little progress had been made in the Senate. Some of this was related to an overflowing legislative agenda in the Senate, including health reform, highway bill reauthorization, and the normal press of fiscal year 2010 authorization and appropriations bills. The Senate committees with jurisdiction over cap and trade and energy, Environment and Public Works, and Energy and Natural Resources, were booked all of 2009.

The cap-and-trade formulas were controversial, but elements of the supposedly less controversial energy bill, including the renewable energy standards (RES) also were controversial and remain so — now more than ever. There was never more than a one-or-two-vote margin in the Senate Energy Committee for the RES even before the election of Mr. Brown.

No one knows what this means for the green agenda. The dust has hardly settled on Mr. Brown’s election — he hasn’t even been sworn it yet. Even before Mr. Brown's victory in Massachusetts, some moderate Democratic senators had written off cap and trade, some as early as last fall. For instance, moderate Democratic Sen. Byron Dorgan (D-N.D.), a senior Democrat on the Senate Energy Committee, who recently announced his retirement in 2010, said the Senate would not consider climate change legislation in 2010.

Rather, Mr. Dorgan noted it would focus on the separate energy legislation that would include the RES that would require more electricity supplies to be generated from renewable sources, and expand offshore drilling into the eastern Gulf of Mexico. Mr. Dorgan said it would be difficult for the Senate to turn to controversial climate-change legislation after it just had to deal with the health care bill. That now seems to be an understatement given the Brown political tsunami. In many ways, cap and trade is more controversial than the health care debate, and for the general public, less understandable.

So where does it leave energy policy? It does remain a top priority for President Obama and Congress ? but there is now a serious question as to whether the bill will be as sweeping and transformational as it was once expected to be, or if it will be a bill more incremental in nature. Those doubts had been sown last fall, and the January 19 election brought them full circle.

In his State of the Union Address, President Obama did little to resolve this issue. He called on Congress, again, to enact the cap-and-trade bill along with the rest of his green agenda, but he also advocated the building of a new generation of nuclear power plants and renewed the debate concerning the opening up of new offshore areas to oil and gas development, two issues not previously part of President Obama’s green energy initiative. He made these proposals in an effort to cross the aisle to foster a more bipartisan national energy policy. President Obama, however, provided few details about the nuclear or off-shore initiatives. It remains to be seen whether his plan will be bold enough to entice support from legislators who have been lukewarm to his energy proposal and in particular to his cap-and-trade proposal.

The coming days and weeks will determine whether the United States will take small incremental steps on energy or whether it will lead the world to a green future as the president’s rhetoric trumpeted. As President Obama put it, "Do we want to be the dominant player in the future green world, or do we want to finish in second place?" Even the Republicans were applauding his statement that the United States does not finish second.

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.

Thomas McCann Mullooly
Milwaukee, Wisconsin

Joseph L. Colaneri
Washington, D.C.

Philip G. Kiko
Washington, D.C.

Trevor D. Stiles
Milwaukee, Wisconsin

Kathryn M. Trkla
Chicago, Illinois

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