BILL ANALYSIS SENATE JUDICIARY COMMITTEE Martha M. Escutia, Chair 2001-2002 Regular Session SB 2000 S Senator Dunn B As Introduced Hearing Date: April 23, 2002 2 Civil Code 0 GWW:cjt 0 0 SUBJECT Unlawful Electric Power and Natural Gas Pricing DESCRIPTION This bill would make it unlawful for any person engaged in the business of generating, selling, distributing, transferring, or marketing electricity or natural gas to possess and exercise market power. The exercise of market power would be defined as charging prices above the competitive benchmark. A violator would be liable for disgorgement of excess profits, treble damages, costs of suit and attorneys' fees. The bill would create a rebuttable presumption affecting the burden of proof that market power was exercised in any case in which prices above the competitive benchmark were charged. The bill would also permit an action for specific or injunctive relief and would authorize the court to make any order necessary to enjoin any unlawful conduct or proposed unlawful conduct, or to restore a person's money or property. In addition, the court would be required to disgorge any profits from the unlawful conduct and establish a fluid recovery fund for the return of the funds. BACKGROUND In the winter of 2000 through the summer of 2001, wholesale electricity prices reached all-time highs. Even though consumption only increased 4% from 1999 to 2000, energy (more) SB 2000 (Dunn) Page 2 costs rose almost $20 billion dollars. In May 2001, the state, at one point, paid $1,900 per megawatt hour (mwh), far more than the average $58/mwh in May 2000. According to a March 2001 study prepared by Eric Hildebrandt of the California Independent Systems Operator (ISO), "Further Analyses of the Exercise and Costs Impacts of Market Power in the California Wholesale Energy Market," the average wholesale costs for 1 mwh of electricity, not cost of production, rose from $23/mwh in April 1998, to $25/mwh in April 1999, to $31/mwh in April 2000, and then to $58/mwh in May, to $147/mwh in June, to $167/mwh in Aug., to $156/mwh in Nov., to $395/mwh in Dec., $307/mwh in Jan. 2001, and $361/mwh in February 2001. In his study, he concluded that about 31% of wholesale energy costs over the 12- month period ending with Feb. 2001 can be attributed to the exercise of market power. His study also stated that the exercise of market power was not limited to hours when a shortage of operating reserves requires the Cal ISO to declare a System Emergency (Stage 3). Of the $6.8 billion in additional costs, about 80% of it were incurred in non-emergency hours. Over half of these additional costs were incurred when no system alert was in effect. (In other words, the exercise of market power operated to raise prices at all levels of delivery.) He repeated his unfortunately prescient forecast of November 2000 in which he stated that "the exercise of significant market power can be expected to continue - if not worsen - over the next two years absent action to more effectively mitigate system-wide market power." CHANGES TO EXISTING LAW Existing law prohibits anti-competitive behavior under the Cartwright Antitrust Act (Business and Professions Code Section 16700 et.seq.) and prohibits acts of unfair trade practices and unfair competition under Business and Professions Code Sections 17000 et. seq., and 17200 et.seq., respectively. Remedies and penalties for a violation of the Cartwright Act include injunctive relief as well as treble damages and the assessment of attorneys' fees and costs in a civil action. Remedies and penalties for a violation of Section 17000 or 17200 include injunctive relief and damages or restitution and/or civil SB 2000 (Dunn) Page 3 penalties. This bill would prohibit any person engaged in the business of generating, selling, distributing, transferring, or marketing electricity or natural gas from possessing and exercising market power, as defined. A violator would be required to disgorge the profits from that unlawful conduct, and be liable for treble damages, as measured by the amount of disgorgement, and attorneys' fees and costs This bill would also make the possession and exercise of market power subject to an action for specific or injunctive relief. Any person who engages in, has engaged in, or proposes to engage in any unlawful conduct may be enjoined and the court would be authorized to make any order necessary to prevent a person's use or employment of unlawful market power or to restore a person's interest in money or property. The bill would require the court to disgorge any profits from the unlawful conduct and to establish a fluid recovery account for the return of the funds. The bill would permit an action under the bill to be brought by the Attorney General or by a person acting on its own behalf, its members, or the general public. In any such action, there would be a rebuttable presumption that market power was exercised in any case in which prices above the competitive benchmark were charged. The bill would define the key terms "competitive benchmark," "exercise of market power," and "market power." COMMENT 1.Stated need for bill According to the author's office, SB 2000 "is necessary for the purpose of controlling certain market conduct described as market power, which was one of the many causes of California's energy crisis. While market power is a foundational block in proving antitrust behavior, it is unclear whether it applies under California's unfair business practices. This bill clarifies that the possession and exercise of market power in California's electricity and natural gas markets is, in fact, SB 2000 (Dunn) Page 4 illegal." With warnings from energy distributors that California still faces the potential of future blackouts due to insufficient supply, proponents of SB 2000 argue that adoption of this measure is critically needed to prevent energy sellers and traders from again gaming the market to drive up California's energy prices in order to maximize their profits. Proponents assert that California's unfortunate and expensive experience with energy sellers and traders using their market power to drive up prices to collect exorbitant profits, is ample evidence of the need for this bill, and that SB 2000 is urgently needed as a defense to new acts of market manipulation. 2.Proposed work in progress The author candidly admits that SB 2000 is a "work in progress." Key terms may need fine-tuning or narrowing (see Comments 3 and 4). The rebuttable presumption, intended as one affecting the burden of proof, is also very controversial. (See Comment 5.) 3. Key definitions "Market power" would mean the ability to profitably maintain prices above competitive levels for a period of time. As used in the bill, a person may also possess market power with respect to significant competitive dimensions other than price such as quality, service, or innovation. "Exercise of market power" would mean charging prices above the competitive benchmark. "Competitive benchmark" for assessing market power would be determined as the short-run marginal costs of the highest cost unit needed to meet demand. According to the author's staff, these definitions are derived from various works that analyzed the dysfunctional electricity market in California and concluded that high prices were caused by the possession and exercise of market power by various players in the SB 2000 (Dunn) Page 5 California energy market. See, particularly, "Further Analysis of the Exercise and Costs Impacts of Market Power in California's Wholesale Energy Market," Eric Hildebrandt, Ph.D., Department of Market Analysis, CA Independent System Operator, March 2001, page 5. As noted above, some of the definitions may need fine-tuning or narrowing. For example, the definition of market power depends in turn on the undefined phrase of "above competitive levels for a short period of time." Opponents contend that this and other definitions are seriously flawed. See next comment, below. 4. Opposition to proposal Opponents write that SB 2000 would establish a flawed market power test and would infringe upon the responsibilities of the Federal Energy Regulatory Commission (FERC) to exercise exclusive jurisdiction over wholesale electricity ratemaking. Sempra Energy argues that SB 2000's definition of market power is flawed and ambiguous, and may therefore have a chilling effect upon the provision of power in the state. It argues that regulators now identify market power as existing when an entity has the ability to increase prices above a competitive level, for a sustained period of time in the relevant product and geographic market. Sempra argues that under SB 2000, any price above the competitive benchmark price for a short unspecified period of time would be presumed to be an unlawful exercise of market power. It writes: "Simply because price in a volatile market are at times above a competitive benchmark does not in itself indicate that market power has been exercised. In competitive markets, prices often go above the marginal costs for reasons (such as scarcity) other than market power." Opponents thus argue that SB 2000's flawed definition of market power will inappropriately catch innocent violators, and would discourage many distributors from entering the California market. Rather than help to ease the energy crisis, opponents say, the bill would impose additional risk and threaten the future of investment in energy generating facilities. SB 2000 (Dunn) Page 6 The Western States Petroleum Association (WSPA) specifically argues that the proposed definition of "competitive benchmark" would impose a pricing mechanism on cogeneration and Qualifying Facilities (QFs) that is in direct violation of the Federal Public Utility Regulatory Policies (PURPA). WSPA argues that under federal law, QFs are entitled to receive an incentive price for their power -- the QF is to be paid what the utility would have charged to secure power to serve incremental load absent the availability of the QF's, commonly termed "avoided costs." WSPA contends that SB 2000's application to QF's is preempted by PURPA, and that, on a policy level, it would have a chilling effect on capital investment and on efficient and needed generation supply. To avoid a federal conflict, WSPA argues that QF's should be exempted from the bill. Pacific Gas & Electric Company argues that it and other utilities regulated by the California Public Utilities Commission (CPUC) should be exempt because they are not able to exercise market power to set prices as unregulated firms may. Finally, opponents argue that SB 2000 is pre-empted by the Federal Power Act which delegates to FERC, the exclusive responsibility for setting prices. The author responds that his bill only seeks to control conduct, which is not pre-empted by FERC 5. Proposed rebuttable presumption affecting the burden of proof Proposed Section 1833.1(b), on page 2, line 20, would create a rebuttable presumption that market power was exercised in any case in which prices above the competitive benchmark were charged. The measure does not specify whether this presumption is one affecting the burden of proof or one affecting the burden of producing evidencing evidence. According to the author's staff, the intent to affect the burden of proof. Under Evidence Code Section 605, a presumption affecting the burden of proof is a presumption that is established to implement some public policy other than, or in addition to, the policy to SB 2000 (Dunn) Page 7 facilitate the determination of the particular action in which the presumption is applied. In SB 2000, proponents argue that public policy supports the shifting of the burden when, as here, recent events have shown that power generators and sellers have exercised market power to increase energy prices to California, and where, as here, a threshold showing is made as to the harm suffered by a plaintiff. As in the case under the common law doctrine of res ipsa loquitur, the defendant is in the best position and has the best access to the evidence to disprove his liability. Proponents also argue that particularly in an arena in which at least one major energy trader suspected of market manipulation has not been hesitant to shred its documents, leaving the burden on the injured party would dull any threat of enforcement for a violation of the law. Opponents argue that establishing a rebuttable presumption that market power was exercised any time a price above short run marginal costs was assessed is the pastiche of textbook economic babble. Too many variables account for why one generator's price may be higher than other generators; inefficient production facilities is just one legitimate reason. SB 2000's imposition of such a burden on a legitimate generator or distributor to disprove his exercise of market power would impose liability unfairly and would result in discouraging sellers and generators from entering the California market. Indeed, there may be cases in which a generator running on demand is legitimately charging a price above the competitive benchmark, perhaps because of extraordinarily high production costs for that cycle due to loss of emissions credits. In that case, the generator will not be able to rebutt the presumption and would face treble damages and attorneys' fees. 6. Establishment of fluid recovery fund for disbursement of recovered funds Under proposed Section 1883.3(b), the activities of any person who engages, has engaged, or proposes to engage in any unlawful conduct may be enjoined and the court may SB 2000 (Dunn) Page 8 make any order or judgment, including the appointment of a receiver, as may be necessary to prevent the person's unlawful conduct or practice, or as may be necessary to restore to a person's money or property. The bill would further require the court to order disgorgement of the revenue from the unlawful act or practice, and to establish a fluid recovery fund for the return of the funds. This provision is intended to specifically provide for the use of a fluid recovery fund in all cases in which disgorgement is ordered. Without this express authorization, there may be some doubt where this mechanism could be used in all cases. See, e.g., Kraus v. Trinity Management Services, Inc. (2000) 23 Cal.4th 116. (The use of a fluid recovery fund is necessary only when a defendant is ordered to disgorge proceeds but has not paid out the funds to all the persons who are owed the monies. Instead of allowing the wrongdoing defendant to keep the profits that had been ordered disgorged when a person to whom it is owed cannot be found, the monies are instead paid over to a fund for distribution as determined by the court.) 7. Technical amendment needed On page 2, beginning line 39, strike out "(i)." It is unnecessary and improper usage. Support: Lt. Governor Bustamante; TURN; Office of Ratepayer Advocates, CPUC; Congress of California Seniors Opposition: California Independent Petroleum Association; Dynergy; Independent Energy Producers; Pacific Gas & Electric Company; Sempra Energy; Western States Petroleum Association; HISTORY SB 2000 (Dunn) Page 9 Source: Author Related Pending Legislation: None Known Prior Legislation: None Known **************