BILL ANALYSIS 1 1 SENATE ENERGY, UTILITIES AND COMMUNICATIONS COMMITTEE DEBRA BOWEN, CHAIRWOMAN SB 2000 - Dunn Hearing Date: May 21, 2002 S As Amended: May 14, 2002 FISCAL B 2 0 0 0 DESCRIPTION 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 penalties. This bill prohibits persons engaged in the business of generating, selling, distributing, transferring, marketing, or trading electricity or natural gas from engaging in the following 17 specified practices to increase prices: 1. Physical withholding 2. Economic withholding 3. Using reliability information 4. Using or providing false or misleading information 5. Creating, prolonging or using shortages or outages 6. Selling to another state to reduce supply 7. Refusing transmission operator dispatch orders 8. Scheduling with the intent to create congestion or false impression of congestion 9. Intentionally over-scheduling to receive payments for reducing congestion 10. Selling in another control area and repurchasing in original control area to avoid market rules 11. Withholding from a market with a price cap to sell into a market without a price cap 12. Misrepresenting availability 13. Misrepresenting supply 14. Misrepresenting the reason for generation outages 15. Selling between subsidiaries of the same company 16. Creating an artificial increase in natural gas demand 17. Any other strategies, acts, or conduct resulting in pricing above the "reasonable price" in a "fair and competitive market." This bill requires persons violating the above provisions to disgorge the increment charged above the "reasonable price" in a "fair and competitive market," and makes violators liable for treble damages, the costs of a civil action brought to recover those damages, and attorneys' fees. This bill authorizes injunctive relief to prevent the unlawful conduct described above. BACKGROUND The Federal Energy Regulatory Commission (FERC) permits power sales at market-based rates if the seller and its affiliates do not have, or have adequately mitigated, market power in generation and transmission and cannot erect other barriers to entry. The majority of wholesale power transactions are conducted pursuant to market-based rate authority. Under its original "hub and spoke" analysis, if an entity had a market share of 20% or less of installed and uncommitted generation in a defined geographic market, the entity would not be considered to possess market power. With regard to transmission, an entity could demonstrate the requisite absence or mitigation of market power if it had an approved open-access transmission tariff. Despite well-known regional and local transmission constraints in California, the entire Independent System Operator (ISO) control area has been considered a single market for purposes of FERC's market power analysis. In an order issued November 20, 2001, FERC announced a new generation market power screen and mitigation policy aimed at preventing the exercise of market power in energy markets. The new policy was adopted on an interim basis while FERC reviews new methods to analyze market power. In the November 20 order, FERC noted that its historic hub and spoke analysis worked relatively well when markets were essentially vertical monopolies trading on the margin, with retail loads only partially exposed to the market. FERC concluded that the hub and spoke analysis no longer adequately protects electric customers against generation market power and adopted a Supply Margin Assessment (SMA) screen to be used pending completion of a rulemaking addressing electric markets and market power. The new screening mechanism changes the hub and spoke analysis in two ways. First, it considers transmission constraints in determining the geographic market. This feature allows the analysis to more accurately determine what supply can reach buyers to compete with the entity seeking market-based rate authority. Second, in determining the size that triggers generation market power concerns, the new screening method establishes a threshold based on whether an applicant is "pivotal" in the market, i.e., if at least some of the entity's capacity must be used to meet the market's peak demand. FERC explained that an entity will be considered a pivotal supplier if its capacity exceeds the market's surplus of capacity above peak demand (the market's supply margin). A supplier would fail the test if the amount of its capacity exceeds the market's supply margin. The new screen, therefore, is intended to prevent a supplier from withholding supplies in the market in order to raise prices during periods of peak demand. FERC has postponed implementation of the SMA screen and exempted suppliers within an ISO or Regional Transmission Organization (RTO). While several suppliers in the California ISO would likely fail the SMA screen, according to FERC, ISOs and RTOs already have procedures in place to prevent the exercise of market power. Consequently, the SMA screen will not be applied to sellers in the California ISO. Once a seller has been permitted to sell at market-based rates, FERC has no regular system to monitor transactions and ensure charges are "just and reasonable," as required by the Federal Power Act. FERC has taken the liberty of presuming that wholesale power transactions conducted pursuant to market-based rate authority are "just and reasonable" until proven otherwise. According to a paper prepared by this committee for an April 29, 1999 hearing: Addressing market power issues is essential to successfully developing a competitive market for electricity generation and related services in California. Market power can be exercised when market participants, through consolidation or collusion, control enough of a given market that they are able to strategically influence prices for their own benefit. The early experience with a competitive electricity market indicates that at times of peak demand, a few large participants may have sufficient leverage to manipulate the market and control prices? ?The natural cure for market power abuse is robust competition. Lacking robust competition, market power abuse can potentially be deterred or mitigated through regulatory disincentives, although sophisticated participants who are clever in their exercise of market power may be able to avoid clear evidence of abuse. Recent revelations of trading practices employed in California by Enron, among others, confirm the existence and use of misleading and manipulative tactics intended to increase energy prices and manufacture false transmission congestion, supply scarcity and trading revenues. Among the practices detailed in the Enron memoranda: "Death Star" - Scheduling energy for transmission opposite of the prevailing direction in order to collect payments for then relieving the congestion created. According to the memoranda, "the net effect of these transactions is that Enron gets paid for moving energy to relieve congestion without actually moving any energy or relieving any congestion." "Get Shorty" - "Shorting" ancillary services, i.e. selling the commitment to provide ancillary services day-ahead, then canceling the commitment in the real-time market and buying replacement ancillary services at a lower price. In this scheme, the scheduler never had the ancillary services it sold day-ahead. The scheme relied on reporting a false source of ancillary services. "Inc-ing" - Scheduling generation which is known to be in excess of what is required to meet the scheduling coordinator's load, in order to receive payment for the excess generation in the real-time market. "Ricochet" - Purchasing energy day-ahead in California, selling it to an entity in another state, buying it back, plus a fee, from the out-of-state entity, and selling it in the real-time market to avoid price mitigation or competition. According to the memoranda, "it is clear that Enron's intent under this strategy is solely to arbitrage the spread between the PX and the ISO, and not to serve load or meet contractual obligations." This strategy is also commonly known as "megawatt laundering." "Wheel Out" - Scheduling transmission on a transmission inter-tie that is completely constrained and therefore unable to accept additional transmission, in order to collect a congestion payment, with no intention of actually delivering energy via that inter-tie. COMMENTS 1.Shocking behavior? The practices described above may be indicative of inherent defects of market-based electricity service that may be impossible to prevent. Market participants with private capital on the line can be clever and opportunistic. If they don't succeed in creating a market structure that advantages them, they'll likely either find a way around it or abandon it. Neither outcome is conducive to producing enduring consumer benefits, such as reasonable prices or reliable service. Trying to resist these tendencies by regulating market behavior and mitigating the damage caused by misbehavior (e.g. establishing civil liability as this bill does) may be less "efficient" and more expensive for consumers than traditional utility regulation. That has certainly been the experience in this state, where the market-based structure has failed consumers. These failures have long since eclipsed inefficiencies inherent in cost-of-service utility regulation. 2.What is the "reasonable price?" The level of liability imposed for unlawful conduct under this bill hinges on a court's determination of the "reasonable price" in a "fair and competitive market." While a judge or jury certainly could make such a determination based on evidence presented at trial, market participants may have some difficulty determining their liability risk on a day-to-day basis outside the courtroom. FERC's presumption that wholesale power transactions conducted pursuant to market-based rate authority are "just and reasonable" has obscured its obligations to clearly define just and reasonable rates and ensure such rates are observed without exception. This policy has destroyed the notion of a known standard for the reasonableness of prices in wholesale energy markets. Benchmarks that reflect the daily market price of electricity are limited. Most electricity is now sold at regulated rates or through fixed-price contracts. What limited daily electricity market there is lacks the confidence of many customers that it is fair, competitive, and will yield reasonable prices. 3.Does the bill cast the net too wide? This bill describes a variety of supplier tactics that could be described as anti-competitive or manipulative behavior, but may cast the net too wide to include legitimate market behavior. For example: The bill prohibits refusing dispatch orders from any transmission system operator (such as the ISO) regardless of whether the operator is otherwise entitled to dispatch that generator or whether such conduct resulted, or was intended to result, in increased prices. Selling electricity in another state which results "in a reduction of supply to increase the price" is prohibited. This provision may apply to commonly accepted practices of exporting surplus power to neighboring states and could violate the U.S. Constitution's Commerce Clause. Any conduct that results in prices above the reasonable price for electricity or natural gas in a fair and competitive market is prohibited. This would include each of the other unlawful practices described in the bill, and more - any act that resulted in a price above the reasonable price, regardless of intent or significance. As a practical matter, plaintiffs seeking damages under this bill would be unlikely to pursue insignificant acts, since the damages would also be insignificant, but these provisions appear broader than necessary or desirable to remedy market manipulation which is harmful to consumers. The author and the committee may wish to consider whether this bill should be amended to clarify that the conduct described is unlawful if it results, or is intended to result, in a significant or sustained increase in electricity or natural gas prices or a significant or sustained decrease in electric or natural gas system reliability. A draft of suggested clarifying and technical amendments is attached. POSITIONS Sponsor: Author Support: California Public Interest Research Group Congress of California Seniors Lieutenant Governor Cruz M. Bustamante Office of Ratepayer Advocates Utility Consumers' Action Network Oppose: California Chamber of Commerce California Cogeneration Council California Independent Petroleum Association California Manufacturers & Technology Association California Municipal Utilities Association City of Riverside Dynegy Imperial Irrigation District Independent Energy Producers Association Modesto Irrigation District Pacific Gas and Electric Company Questar Southern Trails Pipeline Riverside Public Utilities Sempra Energy Sacramento Municipal Utility District Western States Petroleum Association Lawrence Lingbloom SB 2000 Analysis Hearing Date: May 21, 2002 SB 2000 Suggested Amendments (May 14, 2002 version) TITLE 3.6. UNLAWFUL ELECTRIC POWER AND NATURAL GAS PRACTICES 1883. (a) For purposes of thischaptertitle , "person" means and includes a natural person, corporation, firm, partnership, joint stock company, association, or other organization or entity of persons. (b) A person engaged in the business of generating, selling, distributing, transferring, marketing, or trading electricity or natural gas may not engage inany of the following unlawful acts or practicesconduct which results, or is intended to result, in a significant or sustained increase in electricity or natural gas prices or a significant or sustained decrease in electric or natural gas system reliability, including, but not limited to : (1) The physical withholding of electricity fromthe generation, sale, distribution, transfer, marketing, or trading of electricity, resulting in increased electricity prices or the creation of a scarcity of supply inany electricity market. (2) The economic withholding of electricity by submitting bids above the reasonable price for that electricity in a fair and competitive market, resulting in any bid not being accepted so as to force an increase in electricity prices or create a scarcity of supply in any electricity market.(3) The acquiring, using, or disseminating of electric system reliability informationin connection with the generation, sale, distribution, transfer, marketing, or trading of electricity, resulting in increased electricity prices by the manipulation of the generation, sale, distribution, transfer, marketing, or trading of electricity. (4) The using or providing of false or misleading informationin connection with the generation, sale, distribution, transfer, marketing, or trading of electricity, resulting in increased electricity prices. (5) The creating, prolonging, or using of shortages oroutages to increase the price of electricity. (6) The selling, distributing, transferring, marketing, or trading of electricity in any other state, resulting in a reduction of supply to increase the price of electricity.(7) The refusing of any lawful dispatch order of any transmission system operator to generate electricity. (8) The scheduling of electricity into the electricity transmission system with the intent or knowledge that the schedule will create congestion or the false impression of congestion in that system. (9) The overscheduling of electricity generation into the electricity transmission system with the intent of knowledge that the actual load will be lower and system, result in congestion counterflow payment, or compensation to reduce congestion. (10) The selling, distributing, transferring, marketing, or trading of electricity to any person in any other control area with the intent or knowledge that a similar amount of electricity will be repurchased in the original control area for the purpose of avoiding applicable market rules. (11) The intentional or knowing withholding of electricity from any market subject to a price cap with the intent to sell, distribute, transfer, market, or trade the electricity to a market not subject to a price cap. (12) The misrepresentation of the availability or supply of electricity or natural gas.(13) The misrepresentation of the supply of electricity or natural gas.(14) The misrepresentation of the reason or reasons for electricity generating facility closures, outages, or maintenance. (15) The selling, distributing, transferring, marketing, or trading of electricity or natural gas between subsidiaries of the same company, resulting in increased electricity or natural gas prices. (16) The creation of an artificial increase in demand for natural gas, or refusal to sell natural gas, in order to raise the market price or cause any of the prohibited conduct set forth in this subdivision.(17) The engaging in strategies, acts, or conduct in the sale, distribution, transfer, marketing, or trading of electricity or natural gas, that results in prices above the reasonable price for that electricity or natural gas in a fair and competitive market.(c) A person may not knowingly facilitate conduct prohibited by subdivision (b). 1883.1. A person who violates Section 1883 shall, in addition to other damages, be required to disgorge the profits of that unlawful conduct. As used in this section, "disgorgement" shall be measured by the difference in the actual price charged for the electricity or natural gas in the course of the unlawful conduct and the reasonable price for that electricity or natural gas in a fair and competitive market. In addition, a person found to be in violation of Section 1883 shall be liable for three times the amount of damages sustained, as measured by the amount of disgorgement, because of the act or acts of that person. A person found to be in violation of Section 1883 shall also be liable for the costs of a civil action brought to recover those damages and attorney fees. 1883.2. (a) Specific or preventive relief may be granted to enforce a penalty, forfeiture, or penal law in any case of a violation of Section 1883. (b) A person who engages, has engaged, or proposes to engage in any of the conduct set forth in Section 1883, may be enjoined in any court of competent jurisdiction. The court may make these orders or judgments, including the appointment of a receiver, as may be necessary to prevent the use or employment by a person of a practice or conduct set forth in Section 1883, or as may be necessary to restore to a person in interest money or property. The court shall order the disgorgement of the revenue from the use or employment of any act or practice prohibited by Section 1883, and shall establish a fluid recovery fund for the return of the funds. 1883.3. Actions for relief pursuant to this chapter shall be prosecuted exclusively in a court of competent jurisdiction by the Attorney General, or by a person acting for the interests of itself, its members, or the general public. 1883.4. Unless otherwise expressly provided, the remedies or penalties provided by this section are cumulative to each other and to the remedies or penalties available under all other laws of this state.