Energy Markets:

FERC Chairman Kelliher seeks to mend fences with Congress, lays out agenda

As energy bill conferees move towards a final bill, the new chairman of the Federal Energy Regulatory Commission says the agency will be heavily involved in helping Congress finish the long-stalled legislation. Joe Kelliher, who replaced former chairman Pat Wood last month, says he wants to improve the relationship between FERC and members of Congress. Plus, Kelliher explains why FERC officials should have final say in approving utility industry mergers, and how commissioners will make sure the Enron debacle never happens again.

Transcript

Mary O'Driscoll: Welcome to OnPoint, I'm Mary O'Driscoll. Our guest today is Joe Kelliher, the new chairman of the Federal Energy Regulatory Commission. Chairman Kelliher, thank you so much for joining us.

Joe Kelliher: Thanks for inviting me.

Mary O'Driscoll: You're taking over the agency at a crucial time, with worries about the potential for a heat related outages on the West Coast, the conference has just started on the energy bill, and after the chairmanship of Pat Wood, who I guess could best be described as a polarizing figure when it comes to Congress and the debate about electric power markets and competition in electric power markets. I'm wondering, you know, is it difficult looking at the energy bill going on right now, is it difficult to follow in his footsteps? Did he get a bad rap or do critics of FERC have a point when they talk about the penchant for overreaching on a regulatory sense at the agency?

Joe Kelliher: First of all, I think Pat was a very good chairman. He was chairman at a very difficult time. He came in right at the time of the California crisis and while he was chairman, we dealt with the Enron bankruptcy and all the market manipulation schemes. And he acted very aggressively to try to get market power under control, and try and clean up after the California crisis and try to make sure it can't happen again -- not just in California, but elsewhere in the country. So he dealt with a set of very difficult issues and made some tough calls and some of them were controversial.

Mary O'Driscoll: OK. Do you agree that maybe FERC has overreached a little bit? You've talked about the need to mend some fences with Congress. I think your specific quote when you talked with reporters last week was, "There's a need to improve the Commission's standing with Congress and to improve the confidence Congress has in us." So there is a recognition that there has been a problem and you're trying to mend fences. In fact, you were actually -- I think the first time in anyone's memory that a FERC chairman has attended a conference committee meeting and clearly there is a need to do that. Is that what you're doing right now? Are you working to mend those fences? Is that what all that part is about?

Joe Kelliher: Well, I do want to work closely with Congress for a couple of reasons, good reasons. We are dealing with the most significant proposed changes in electricity law in 70 years. Our basic electricity law, the Federal Power Act was written in 1935, August of 1935, next month it will have its 70th birthday. It was written to regulate an industry that has changed dramatically since then and Congress is poised now to make the most significant changes since 1935 and I think FERC has to be actively engaged. This is actually a result of a multi-year process. Some of this debate began 10 years ago, and I agree with the president that the time to debate has ended and the time to act has come. I think Congress is very close. I'm more optimistic now then at anytime in the past five years. So I think it's natural for the FERC chairman to be involved. When I worked on the Hill, I would always ask the views of FERC, and I talked with the FERC chairman, the FERC general council, someone who used to work on the Hill, so I like the environment, and I'm comfortable in it. I met with Chairman Barton this morning, the chairman of the conference, and talked to him about what some of our positions are, and you're right, I did go to conference yesterday. I'm told that no FERC chairman has ever done that before, so we made a little bit of history, I guess. It was a little bit different, but I thought it was symbolic just to show that FERC respects the views of Congress. We're going to work with Congress, we're going to listen to them and we're going to be engaged.

Mary O'Driscoll: I wanted to talk a little bit more about the energy bill in just a second. One more question though, just because this has been something that people have been really focused on for so long, was this kind of conflict between FERC and Congress over this whole competitive market structure and that kind of thing. Both you and Pat Wood had expressed similar views on these issues about the need for RTOs and that kind of thing. Do you think that giving Congress and state regulators, who had opposed the commission's work, the same kind of message but from a different person, will that change their attitude in anyway? Is FERC taking a different tact under you? Because I mean, you and Chairman Wood, when he was leaving, both said you're on the same page on a lot of these issues. So what is different and in light of that how do you expect Congress to react?

Joe Kelliher: Well, I don't want to compare and contrast myself with Chairman Wood. I'll just let other people make those comparisons and they can do so based on the policies that we advance and the votes that we've cast. I have never supported mandatory RTOs, I support voluntary RTO formation, and that has been the commission's policy. The commission proposed to change that in the SMD rulemaking, but the commission policy, going back to order 2000, the RTO, order has been voluntary RTO formation and I'm perfectly comfortable with that approach. I think one thing that's important to recognize about U.S. electricity markets is that we don't have a national electricity market. We have regional markets and there's very important differences among those regions. Some regions have decided to organize their markets in the RTOs. I don't see that is a necessary structure for all regions, but I have supported RTO development. I voted to establish an RTO in New England, something they requested and they filed with us. I voted to establish an RTO in the Southwest power pool, southcentral U.S. and I voted to expand PJM. So I do support RTO development, but in all those instances, those are voluntary filings by the RTO's or the transmission owners themselves. Again, I don't want to compare and contrast myself to Pat, but I support voluntary RTO formation, I don't see any reason to go beyond that.

Mary O'Driscoll: I want to make sure, you know, FERC tends to talk in its own code, so RTOs are the regional transmission organizations around which regional markets are based, and then the SMD, which is the standard market designâ?¦I just was trying to explain it in 30 seconds or less, was kind of a market structure under which those regional markets operate.

Joe Kelliher: It was a proposed market structure that regions would have to adhere to.

Mary O'Driscoll: Right and so you're not going to go along with the SMD? I mean, Congress, in part of the energy bill debate with the Senate said they're closing the door on SMD completely. Are you doing the same?

Joe Kelliher: We will not vote to finalize the SMD proposed rule.

Mary O'Driscoll: OK, OK. I wanted to talk about the energy bill a little bit. You'd mentioned just a few minutes ago that this is the most significant change to the electric regulatory policy in 70 years. What are some of the significant provisions in the energy bill from FERC's perspective?

Joe Kelliher: First of all, it's important, I think, to look at the Federal Power Act, and what charges did it give FERC? What are our duties under the Federal Power Act? And if you boil it down, our basic duty in the Federal Power Act is to prevent the exercise of market power in the sale of electric energy and also transmission in interstate commerce or electric energy. So transmission markets and wholesome power sales we are obligated to prevent market power exercise. Now the industry has changed dramatically since 1935. In 1935, there was very little interstate commerce in electricity. There was a view that all electric generation was a natural monopoly; it had to be vertically integrated. There was no interstate transmission grid. Now, 70 years later, we see most generations being built by non-utilities, by independent power companies, at least that's been the case for the past 20 years. The transmission network isn't just interstate. It's international, extending into Canada and parts of Mexico. So the industry has dramatically changed. I think the goals that we were given in the Federal Power Act are the exact right goals, prevent market power exercise, but I think we need some different regulatory tools to exercise them. One of the things that's in the bill that I support is the express probation of market manipulation and that's designed to give us authority to prevent manipulative schemes like those that Enron advanced. There's other provisions that would give FERC some additional authority in the area of mergers over acquisitions of generation facilities. I think that's also important, so that we can discharge our long standing duty to prevent exercise of market power.

Mary O'Driscoll: OK, that merger authority was something that caused a bit of consternation in the Senate when it was brought up because it was brought up as, a quid pro quo for lack of a better term, for a repeal of the Public Utility Holding Company Act, that in exchange for that, that FERC would get additional authority over these kinds of mergers. Why is it controversial? I mean, you support it but why did it create such a stir among lawmakers?

Joe Kelliher: Well, that is one that the controversy puzzles me a little bit too, because that's actually been in bills for many years. When I worked on the House side for the Energy and Commerce Committee, that was an element in the Energy and Commerce Committee bill, and there was not a single voice of criticism directed against it. So, I don't know why controversial now, it hasn't been controversial for years. FERC does review some generation acquisitions, but some are non-jurisdictional, and that's a concern, because sometimes these generation sales are huge in size. Last year, Duke sold over 5,000 megawatts of generation. Now that is a massive amount of generation. It was regional scope, it was in the southeast United States, so it's really something that, given the amount of generation, given that it was located in many states and given that the market is regional, I think it's something that really has to be reviewed at the federal level. Now states also do review these transactions from the point of view of the utility and they typically look at is a good price, does the utility need a generation and are they getting a good purchase price? The federal review is completely different. Does the acquirer end up with too much generation market power? Can they charge above market rates to other sellers in a region? I think state review is appropriate and I don't second guess states when they review these transactions, but we look at it from a different perspective.

Mary O'Driscoll: And this perspective, as you said, is necessary.

Joe Kelliher: I think so. We are charged with preventing unjust and unreasonable rates in wholesale power sales and being able to review generation acquisitions that might result in the accumulation of market power and in the ability to charge above market rates I think is something that is fully consistent with our legal duties.

Mary O'Driscoll: Now there's been some stirring on Capitol Hill that maybe FERC should be out of the merger business altogether. This was something that was big a few years ago and then the commission really didn't have many mergers to deal with over the past five years or so, there really hasn't been much. If you consider all the merger activity that happened along the 1990s, in the early part of this decade there really weren't that many. I think the only one actually was actually a hold over from the 1990s, which was the American Electric Power merger with Central and Southwest Corporation. But now there are more mergers coming on, and there have been a few calls around Congress for getting FERC out of the merger business. Is that something you think should be done or do you think FERC really has a role to play in that?

Joe Kelliher: I think FERC does have a role, and we actually have been steadily approving mergers. We, last year, approved Public Service Company of New Mexico, or it might have been early this year, but we approved Public Service Company of New Mexico's acquisition of Texas New Mexico power, we had an Amarin merger that we approved. There was an acquisition of Tucson electric power in Arizona. We actually have steadily been reviewing mergers. I agree that they haven't been very big mergers until the Exelon decision last month, but we have steadily approved mergers and last five years. Now we act on them quickly. Our average is 114 days. Going back five years, we act on a merger within 114 days. So that's quick action. Now I do think we need to be able to review mergers. There have been proposals in the past, as you said. This was something that was hotly debated in the late '90s, who should review who. I don't there's any question, there should be some federal view of mergers, given the nature of power markets, they're regional. There has to for review, I really don't think anyone debates that. Who at the federal level should review it? Should it be an anti-trust agency like the Justice Department, or should it be FERC? The preponderance of opinion, even in Congress, is that FERC should do it. The Justice Department doesn't want to do it. Now, if the Justice Department were to do it, they would have one shot at it, at the point of the merger, and typically they would require massive divestiture. Divestiture is kind of the standard remedy for an antitrust agency in a merger. Now, we're a regulatory body. We can set rates, so we have more than one shot at it. We can condition a merger on divestiture. The Exelon merger had very significant divestiture.

Mary O'Driscoll: Right, that's the sale of power generation.

Joe Kelliher: Right, the merger ultimately was conditioned on the sale of over 6,000 megawatts of generation, both a physical divestiture and a virtual divestiture. That's unusual. We usually don't have much divestiture in a merger, but that's the standard remedy for an antitrust agency. Now the antitrust agencies don't want the authority. They prefer that we review mergers, because they think we're more familiar. We're an expert agency that focuses on that industry. I'm not sure it's quite a lot of an issue, but that has been some discussion about it.

Mary O'Driscoll: Now, I'm going to change gears a little bit. Now in becoming chairman of FERC, you set out what could be called a reform agenda. There are several things that you want to reform to kind of bring the market structure rules and that kind of thing into kind of the reality of how the market operates today. Can you outline some of the high points of your agenda?

Joe Kelliher: Sure. I mean come its initial agenda, because I'm still working with my colleagues to see if they agree. FERC is not a single administrator agency, so arithmetic governs in the end. The chairman can bring something to a vote, but there has to be a majority in favor of what the chairman proposes to be successful. So I want to work my colleagues first and get some agreement on policy agenda before I really unveil it. But there's a couple of things I do want to pursue, and I think there is a rough consensus among the commission to pursue. One is reforming our transmission access rules. They were issued in 1998. They haven't changed one word since then. Lots have changed in the markets though. There's been a course of complaints by transmission customers that our rules do permit undue discrimination in transmission service. So I do think we have an obligation to look at it and reform our rules. Also another area is California refunds. I think we need to accelerate the California refunds. The California crisis began in May of 2000. Here it is more than five years later, and we are still deliberating on refunds.

Mary O'Driscoll: Now what's the cause of that, why is it taking so long?

Joe Kelliher: Well, a lot of it is the California ISO and the PX are making certain calculations. It's not pending at the commission. But the calculations that will be necessary for the commission to make a decision are still being worked through at the ISO level and the PX. Now I have a lot of confidence in the new California ISO management and leadership and they took some very decisive action last week with respect to costs. So I think FERC needs to work closely with the ISO and see what can we do to accelerate the refunds? I think it's time to close out the California proceedings and focus on getting the market rules fixed so that we won't see a recurrence of those problems. Gas storage pricing is another area where I think we need to reform our policies. The commission has two kinds of pricing it approves for gas storage: market based pricing, cost base pricing. I think we need to look at reforms in both areas, with the goal being to expand storage capacity and to encourage more efficient use of whatever capacity we have. Last year we saw record levels of gas storage. We also saw very high levels of volatility. Seeing those two things in tandem, to me, means we don't have enough storage capacity. So if we are successful in that area, we could produce less volatility in gas prices. RTO costs: I think that's a final area, on kind of an initial cut of an agenda, a top priority to have some initiative to control RTO costs. There's a lot of complaints with RTO costs, that they're not under control, that they're escalating, and there's been some criticism of the commission for not acting to --

Mary O'Driscoll: Right, now the commission did an initial review of the RTO costs, but that was only just the very initial start of the review of the initial startup costs. When everyone has been complaining that it's been the secondary, I guess the day one as they call it or day two when they start doing the actual market work, where the costs are really coming in. Is the commission reviewing those costs right now?

Joe Kelliher: We are reviewing the costs, and we took action earlier this spring, we approved an accounting rule so that there would be more transparency in RTO costs and a greater ability to compare RTO costs from one to the next. I think that was a good step. It was a necessary step, but I don't think that we can stop there. I think we need to look at what we can do to limit the rise in RTO costs and ensure that our RTO costs are just and reasonable.

Mary O'Driscoll: OK, then finally I wanted to get into reliability a little bit, especially since it's been a very hot summer so far and there's been concerns about Southern California in particular about reliability out there, that they could have some blackouts because the heat and because of the increasing demand. People wanting to use electricity to cool their homes and there might be a problem with some of the delivery of electricity out there. Have you seen any problems out there yet? It's been pretty hot out there this past week.

Joe Kelliher: It has been pretty hot and I think I got three or four e-mails last night providing updates on exactly what the reserve margin was and I think yesterday the reserve margin was -- last week the reserve margin was 6-and-a-half percent, so a little bit close. Southern California has the worst electricity supply situation in the entire country and that's incredibly discouraging that five years after the crisis we're still worried about the adequacy of electricity supply in Southern California.

Mary O'Driscoll: Yeah, weren't some market reforms and I guess, Path 15, the construction of Path 15, wasn't that supposed to take care of it all?

Joe Kelliher: Well, Path 15 helps the movement of power within the state from the north to south and reverse, but it doesn't increase the amount of electricity supply, so there is a need to expand generating capacity in Southern California.

Mary O'Driscoll: OK, well finally one last question. Does this say anything about our vulnerability on the national grid scope? I mean come are things working well now? Are we still vulnerable when it comes to that? I know the energy bill has mandatory reliability language that you and many others in the industry have been waiting for, but what's the situation with the national grid this summer?

Joe Kelliher: Well, in terms of the electricity supply, it's adequate in most regions. There's some load pockets where there's problems with supply. In terms of grid, the basic problem is that we rely on voluntary compliance with unenforceable rules. Now those rules have been made more clear and I do want to credit the North American Electric Reliability Council for improving the rules. They're clear enough now that they can be fairly enforced. The problem is there's not an enforcer and I think there needs to be one. The past three major blackouts that occurred in the U.S., the one in August of '03, and the two that occurred in the West in July and August of '96. One common cause of all three of those was violation of voluntary reliability standards. Now we need to enforce them. It's a lesson that we've learned three times now and I hope the third time's a charm and that Congress enacts legislation. Legislation would give FERC the authority to enforce reliability standards and I think that's desperately needed and I hope we don't get a fourth lesson.

Mary O'Driscoll: OK, well, we'll have to end it on that note. I hope you'll be able to come back and maybe we can update the situation in a little while.

Joe Kelliher: OK.

Mary O'Driscoll: I'd like to thank Joe Kelliher, the chairman of the Federal Energy Regulatory Commission as our guest today, I'm Mary O'Driscoll, stay tuned for another edition of OnPoint.

[End of Audio]

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