Energy Industry October 2008 Updates

FERC Spells Out Criteria Considered When Assessing Civil Penalties for Violations

Stating that its goal is to achieve compliance with its regulations, not to assess penalties, FERC announced last week that companies developing “rigorous compliance programs” that provide effective accountability for compliance will be able to minimize, and in some cases eliminate, civil penalties should they violate FERC’s requirements. The clarification was contained in a Policy Statement where FERC enunciated four factors that it will evaluate in assessing whether a party that violated FERC’s regulations had a sufficiently rigorous compliance program in place to warrant mitigation of the civil penalty: (1) the role of senior management in fostering compliance; (2) effective preventive measures to ensure compliance; (3) prompt detection, cessation, and reporting of violations; and (4) remediation efforts.

The Commission stated that these factors constitute “compliance-related credit factors” that, if adopted by a company, would mitigate the severity of the civil penalties that would otherwise be imposed when they violate the Commission’s statutes, regulations, and orders. When assessing the first factor, the Commission stated that it would consider whether management:

• Provides adequate funds and resources for compliance
• Communicates its commitment to compliance frequently to employees
• Sets aside the time to address compliance issues as they arise (both to vet proposed actions to avoid violations and to address misconduct)
• Actively encourages employees to raise questions and obtain the views of supervisors or designated compliance personnel
• Assures that independent compliance personnel with access to the Board of Directors or a committee of the Board are actively included in the development of new transaction structures or business initiatives

Under the second factor, the Commission stated that it would give credit to companies that invest in systematic preventive measures, with appropriate accountability and review mechanisms, to keep the company in compliance with FERC’s requirements.

Perhaps no factor is more important than the third factor: prompt detection of violations resulting from a high-quality and comprehensive internal monitoring system or actively promoted company hotline. Noting that there is no specific amount of time within which a company must find and report a violation, FERC stated that violations that are discovered, corrected, and reported as a result of systematic internal auditing and supervision programs will normally be given substantial credit.

The final factor involves a fact-specific analysis of the steps taken by a company to end violations and remedy misconduct when it occurs, including disciplinary action of employees, and whether new or modified prospective controls are imposed, when needed, to prevent a recurrence of the violation.

FERC will apply these factors on a case-by-case basis based upon the totality of the facts and circumstances of each case. For complete elimination of a civil penalty to occur, a company must affirmatively demonstrate that its violation was not serious, and that all four of the above factors have been followed. Where a company meets some but not all of the factors, the Commission stated that it would reduce — but not completely eliminate — the civil penalty. Finally, FERC made clear that civil penalties complement but do not eliminate the possibility that disgorgement of illegal profits and other sanctions also could be imposed in certain situations.

The Policy Statement is the latest in a series of ad hoc and generic orders that FERC has issued since the 2000 – 2001 California energy crisis in an attempt to garner increased compliance with its rules, and to make it increasingly painful for gas and electric companies that violate FERC’s rules. FERC’s effort on this was assisted by the increased penalties available to it under the Energy Policy Act of 2005.

The House of Representatives, not the Senate, is likely to take the first crack at debating and voting on comprehensive climate change legislation in 2009 according to Rep. Rick Boucher (D-Va.), the chairman of the House Energy and Commerce Subcommittee on Energy and Air Quality. Boucher and full committee chairman Rep. John Dingell (D-Mich.) recently released a draft climate change bill that addresses concerns that carbon caps could hurt the economy. The Boucher-Dingell proposal offers relatively modest reductions in greenhouse gas emissions in the initial years of the emissions trading program: six percent by 2020 from 2005 levels.

While speaking at a recent environmental conference, Rep. Boucher pointed out that the House proposal was more sensitive to the recent economic downturn and, therefore, more politically realistic than some other, more ambitious, proposals such as the bill that was introduced but defeated earlier this year by Senators Joseph Lieberman (I-Conn.) and John Warner (R-Va.), which would have auctioned the power plant permits. Rep. Boucher is looking at a variety of options for distributing the emissions allowances in an effort to reduce compliance costs to industry. One option would be to distribute emissions allowances freely to power plants and other stationary resources rather than have those resources pay for them through a government auction.

Rep. Boucher indicated that his subcommittee will take up the climate legislation in early 2009. Environmental organizations view 2009 as the best opportunity in years for getting comprehensive global climate legislation passed. Thus, Rep. Boucher has already met with the energy advisors for Senator Barack Obama (D-Ill.). Both Sen. Obama and Senator John McCain (R-Ariz.) support mandatory emission caps, but Sen. Obama’s global warming plan favors the auction approach. Rep. Boucher has indicated that there is room for discussion with Sen. Obama, and that it was possible for them to reach agreement over key concepts that take into account the changing circumstance of the economy.

On October 15, 2008, Governor Edward G. Rendell signed legislation that requires the 11 utilities in Pennsylvania to reduce their electricity usage by at least one percent by May 31, 2011. Each utility must file a plan with the Pennsylvania Public Utility Commission by July 1, 2008 that outlines how it will achieve this reduction. The law provides for increasing cuts in the usage of electricity in the future: by at least three percent by May 31, 2013 and by 4.5 percent during the 100 highest-use hours of the year. Utilities can bill their ratepayers up to two percent of their 2006 revenue levels for the cost of the conservation efforts. However, utilities must be able to show that savings from the cuts in electricity usage are able to pay for the costs associated with these efforts within a 15-year time frame. The law provides up to $20 million in penalties for the failure of a utility to reach the required cuts in electricity usage.

Pennsylvania utilities have not revealed their plans for meeting the required electricity cuts. However, industry experts have suggested that if the utilities merely provide education programs to consumers to help them meet the required usage cuts, they will not be able to do so. More will be required such as enacting demand-response programs that send price signals to consumers to curb electricity consumption during peak demand times, in order to meet the law’s objective. 

A particularly novel approach to the climate change crisis — the harnessing of the vast power of the oceans — has been gaining currency in recent years. As with many emerging technologies, different agencies often compete over jurisdiction to regulate the new resource until the matter is clarified by Congress or the courts. Here, FERC and the U.S. Department of the Interior (Interior) are vying for jurisdiction over the oceans. Rejecting arguments by Interior, FERC recently determined that it has jurisdiction over hydroelectric projects located on the Outer Continental Shelf (OCS).

This controversy arose when Pacific Gas and Electric Company sought two preliminary permits to develop wave energy projects located partially on the submerged lands of the OCS off the coast of California. Interior had argued that FERC’s jurisdiction applies only to “navigable waters” within the traditional three-mile boundary of the U.S. territorial sea, which does not include the OCS. FERC rejected Interior’s interpretation, stating that the Federal Power Act authorizes and requires it to license and regulate the development of hydroelectric projects in “navigable waters,” without limitation, on Commerce Clause streams and other bodies of water as well as on U.S. reservations, all of which include the OCS and the waters above it. Thus, FERC concluded that it has jurisdiction over hydropower projects on the OCS, its submerged lands, and the waters above it.

On October 17, 2008, FERC issued new rules in Order No. 719 that provide three much-needed enhancements to its regulations to strengthen the operation and responsiveness of the organized wholesale electric markets: First, finding that long-term contracts can be promoted through greater transparency, the new rules required each regional transmission organization (RTO) and independent system operator (ISO) to dedicate a portion of its Web site to market participants so that they can post offers to buy or sell power on a long-term basis, defined as contracts of one year or longer.

Second, RTO and ISO market monitors will now be required to share information with each other through the submission of quarterly reports; an expansion in the number of report recipients; participation in regular conferences among the Market Monitoring Units (MMU), FERC, the RTO or ISO, and interested state commissions, state attorneys general, and market participants; and through the reduction in the lag time for the release of offer and bid data by the RTO and ISO.

Lastly, and perhaps most importantly, the new regulations require each RTO and ISO to ensure that it is responsive to the needs of its customers and other stakeholders by providing them with direct access to the RTO or ISO board of directors, and to consider fully and take action in response to legitimate issues raised by market participants. For some market participants, who have found the staffs of RTOs and ISOs to have a paternalistic approach to the operation of the grid, this addresses a long-standing concern. Each RTO or ISO will be required to submit a compliance filing with FERC that demonstrates that it has or will adopt practices to ensure that its board of directors is responsive to its customers and other stakeholders. The compliance filings will be assessed on the basis of four factors: (1) inclusiveness; (2) fairness in balancing diverse interests; (3) representation of minority positions; and (4) ongoing responsiveness.

In July 2008, PacifiCorp filed a petition for declaratory order with FERC to receive incentive rate treatment for its Energy Gateway Transmission Expansion Project (Project). PacifiCorp argued the Project provides a platform for integrating and coordinating future regional and sub-regional electric transmission projects being considered in the Pacific Northwest and the Inter-Mountain West. The Project, consisting of eight interdependent line segments, will expand PacifiCorp’s transmission network by 2,000 miles of extra-high voltage transmission lines. PacifiCorp sought a 250 basis point adder to its base return on equity (ROE) and the assured recovery of prudently incurred abandonment costs if the Project is cancelled due to factors beyond its control. PacifiCorp stated that the total package of requested incentives is necessary to compensate for the substantial risks posed by the Project.

On October 21, 2008, FERC partially granted PacifiCorp’s request, finding that PacifiCorp had shown, consistent with evolving FERC policy, that ROE incentives are justified here to address the demonstrable risks faced by the Project. FERC found that granting the ROE incentive, together with abandoned plan recovery, will encourage greater participation from potential equity partners. However, FERC felt its approval of a 200 basis point adder — rather than the requested 250 point adder — was appropriate because it believed the 200 basis point adder was a sufficient incentive for investors.

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