SPEAKERS CONTENTS INSERTS Tables
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COMPETITIVE ISSUES IN ELECTRICITY DEREGULATION
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
JULY 28, 1999
Serial No. 69
Printed for the use of the Committee on the Judiciary
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
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HENRY J. HYDE, Illinois, Chairman
F. JAMES SENSENBRENNER, Jr., Wisconsin
BILL McCOLLUM, Florida
GEORGE W. GEKAS, Pennsylvania
HOWARD COBLE, North Carolina
LAMAR S. SMITH, Texas
ELTON GALLEGLY, California
CHARLES T. CANADY, Florida
BOB GOODLATTE, Virginia
STEVE CHABOT, Ohio
BOB BARR, Georgia
WILLIAM L. JENKINS, Tennessee
ASA HUTCHINSON, Arkansas
EDWARD A. PEASE, Indiana
CHRIS CANNON, Utah
JAMES E. ROGAN, California
LINDSEY O. GRAHAM, South Carolina
MARY BONO, California
SPENCER BACHUS, Alabama
JOE SCARBOROUGH, Florida
DAVID VITTER, Louisiana
JOHN CONYERS, Jr., Michigan
BARNEY FRANK, Massachusetts
Page 3 PREV PAGE TOP OF DOCHOWARD L. BERMAN, California
RICK BOUCHER, Virginia
JERROLD NADLER, New York
ROBERT C. SCOTT, Virginia
MELVIN L. WATT, North Carolina
ZOE LOFGREN, California
SHEILA JACKSON LEE, Texas
MAXINE WATERS, California
MARTIN T. MEEHAN, Massachusetts
WILLIAM D. DELAHUNT, Massachusetts
ROBERT WEXLER, Florida
STEVEN R. ROTHMAN, New Jersey
TAMMY BALDWIN, Wisconsin
ANTHONY D. WEINER, New York
THOMAS E. MOONEY, SR., General Counsel-Chief of Staff
JULIAN EPSTEIN, Minority Chief Counsel and Staff Director
C O N T E N T S
July 28, 1999
Page 4 PREV PAGE TOP OF DOC Hyde, Hon. Henry J., a Representative in Congress from the State of Illinois, and chairman, Committee on the Judiciary
Anderson, John, executive director, Electricity Consumers Resource Council, on behalf of Consumers for Fair Competition
English, Glenn, president and CEO, National Rural Electric Cooperative Association
Fluckiger, Kellan, vice president for operations, California Independent System Operator
Glauthier, T.J., Deputy Secretary, Department of Energy
Hegemann, Kenneth, president, American Municipal Power-Ohio, on behalf of the American Public Power Association
McGlynn, Jim, president, McWilliams Electric Company, Inc., on behalf of the National Electric Contractors Association and the National Alliance for Fair Competition
Melamed, Douglas, Principal Deputy Assistant Attorney General, Antitrust Division, United States Department of Justice
Page 5 PREV PAGE TOP OF DOC Naeve, Mike, partner, Skadden, Arps, Slate, Meagher & Flom
Smith, Douglas, general counsel, Federal Energy Regulatory Commission
Sullivan, Jim, president, Alabama Public Service Commission, on behalf of the National Association of Regulatory Utility Commissioners
Thompson, Mozelle, Commissioner, Federal Trade Commission
Travieso, Michael, people's counsel, State of Maryland, on behalf of the National Association of State Utility Consumer Advocates
LETTERS, STATEMENTS, ETC., SUBMITTED FOR THE HEARING
Anderson, John, executive director, Electricity Consumers Resource Council, on behalf of Consumers for Fair Competition: Prepared statement
Conyers, Hon. John, Jr., a Representative in Congress from the State of Michigan: Prepared statement
English, Glenn, president and CEO, National Rural Electric Cooperative Association: Prepared statement
Fluckiger, Kellan, vice president for operations, California Independent System Operator: Prepared statement
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Glauthier, T.J., Deputy Secretary, Department of Energy: Prepared statement
Hegemann, Kenneth, president, American Municipal Power-Ohio, on behalf of the American Public Power Association: Prepared statement
Hyde, Hon. Henry J., a Representative in Congress from the State of Illinois, and chairman, Committee on the Judiciary: Prepared statement
McGlynn, Jim, president, McWilliams Electric Company, Inc., on behalf of the National Electric Contractors Association and the National Alliance for Fair Competition: Prepared statement
Melamed, Douglas, Principal Deputy Assistant Attorney General, Antitrust Division, United States Department of Justice: Prepared statement
Naeve, Mike, partner, Skadden, Arps, Slate, Meagher & Flom: Prepared statement
Smith, Douglas, general counsel, Federal Energy Regulatory Commission: Prepared statement
Sullivan, Jim, president, Alabama Public Service Commission, on behalf of the National Association of Regulatory Utility Commissioners: Prepared statement
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Thompson, Mozelle, Commissioner, Federal Trade Commission: Prepared statement
Travieso, Michael, people's counsel, State of Maryland, on behalf of the National Association of State Utility Consumer Advocates: Prepared statement
Material submitted for the record
COMPETITIVE ISSUES IN ELECTRICITY DEREGULATION
WEDNESDAY, JULY 28, 1999
House of Representatives,
Committee on the Judiciary,
The committee met, pursuant to call, at 10 a.m., in Room 2141, Rayburn House Office Building, Hon. Henry J. Hyde (chairman of the committee) presiding.
Present: Representatives Henry J. Hyde, George W. Gekas, Steve Chabot, Bob Barr, William L. Jenkins, Asa Hutchinson, Edward A. Pease, Spencer Bachus, Ed Bryant, and Melvin L. Watt.
Page 8 PREV PAGE TOP OF DOC Staff Present: Jon Dudas, deputy general counsel-staff director; Daniel M. Freeman, parliamentarian-counsel; Joseph Gibson, chief antitrust counsel; Sheila F. Klein, executive assistant to general counsel; Patrick Prisco, assistant to the deputy general counsel-staff director; Samuel F. Stratman, communications director; James B. Farr, financial clerk; Shawn Friesen, staff assistant/clerk; Sampak P. Garg, minority counsel; and Jim Harper, counsel, Subcommittee on Commercial and Administrative Law.
OPENING STATEMENT OF CHAIRMAN HYDE
Mr. HYDE. The committee will come to order. Good morning. I want to thank everyone for their attendance and cooperation, and I want to apologize for the sparse attendance. Today is a funeral service for a deceased member, George Brown of California, and many members are out in California, or on their way there, to participate in the commemorative service. Nonetheless, we intend to establish an important record here, which will serve as a reference point for, or a departure point for, where we go from hereif we go anywhereand that is to be determined as well; but I can't think of a more important, timely subject, and so, again, I thank you for being here.
This morning the committee begins hearings on competitive issues in electricity deregulation. This is our third one in this area. In the last Congress, we held a broad hearing on antitrust aspects of electricity deregulation similar to this one and a narrower hearing on the antitrust status of the Tennessee Valley Authority and the Federal power marketing administrations.
Page 9 PREV PAGE TOP OF DOC Since that time, States have made substantial progress in deregulation. Depending on whose speculation you believe, we may be closer than ever to moving an electricity bill through the Congress.
As I have said at our previous hearings, everyone can state the promise of competition very easily, but the details of how we get from here to there are not so easy. I am hopeful this committee and the other committees that are working on this issue are making progress and figuring how to bring together a compromise that can address the needs of everyone.
I want to reiterate my position which I stated in our earlier hearings. I am committed to moving legislation that provides full and fair competition in the retail electricity market. Beyond that broad goal, I am not committed to any details. I want to continue to learn as much as possible, and I know that our witnesses will help the committee in this regard.
With respect to committee jurisdiction, our hearing will focus on antitrust, because that is the primary part of this debate over which we have jurisdiction. Some of the issues in this debate involve antitrust and some do not. I believe we can bring a special expertise to the antitrust issues like mergers and market power. We will have our say on these and other matters over which we have jurisdiction, but we will not impinge on the jurisdiction of the Commerce Committee or impede their work in this area. We intend to have a helpful and cooperative relationship with our colleagues on the Commerce Committee as this process moves forward.
I want to thank my friends, Congressman Tom Bliley, Congressman John Dingell, Congressman Joe Barton, and Congressman Ralph Hall for the work they have already done in this area, and we certainly look forward to working with them. As I said earlier, I have an open mind, the committee has an open mind, and we are here to learn.
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I look forward to hearing from the witnesses who will help illuminate this very difficult, complicated issue for us, and I will recognize Mr. Conyers later when he gets here for an opening statement.
[The prepared statements of Mr. Hyde and Mr. Conyers follows:]
PREPARED STATEMENT OF HON. HENRY J. HYDE, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF ILLINOIS, AND CHAIRMAN, COMMITTEE ON THE JUDICIARY
This morning, the Committee begins hearings on ''Competitive Issues in Electricity Deregulation.'' This hearing is our third one in this area. In the last Congress, we held a broad hearing on antitrust aspects of electricity deregulation, similar to this one, and a narrower hearing on the antitrust status of the Tennessee Valley Authority and the federal power marketing administrations.
Since that time, the states have made substantial progress in deregulation. Depending on whose speculation you believe, we may be closer than ever to moving an electricity bill through the Congress.
As I have said at our previous hearings, everyone can state the promise of competition easily. But the details of how we get from here to there are not easy. I am hopeful that this Committee and the other committees that are working on this issue are making progress in figuring out how to bring together a compromise that can address the needs of all concerned.
Page 11 PREV PAGE TOP OF DOC I want to reiterate my position which I stated in our earlier hearings. I am committed to moving legislation that provides full and fair competition in the retail electricity market. Beyond that broad goal, I am not committed on the details. I want to continue to learn as much as possible, and I know that our witnesses will help the Committee in that task.
With respect to committee jurisdiction, our hearing will focus on antitrust because that is the primary part of this debate over which we have jurisdiction. Some of the issues in this debate involve antitrust and some do not. I believe that we can bring a special expertise to the antitrust issues like mergers and market power. We will have our say on these and other matters over which we have jurisdiction, but we will not impinge on the jurisdiction of the Commerce Committee or impede their work in this area. We intend to have a helpful and cooperative relationship with our colleagues on the Commerce Committee as this process moves forward. I want to thank my friends Tom Bliley, John Dingell, Joe Barton, and Ralph Hall for the work they have already done in this area. I look forward to working with them.
As I said earlier, I have an open mind, and I am here to learn. I look forward to hearing from the witnesses who will help illuminate this complicated issue for us. I will now recognize the distinguished Ranking Member, Mr. Conyers, for an opening statement.
PREPARED STATEMENT OF HON. JOHN CONYERS, JR., A REPRESENTATIVE IN CONGRESS FROM THE STATE OF MICHIGAN
As Congress considers deregulating the electric utility industry it is essential that we ensure that the Nation's antitrust enforcers have the power they need to protect competition. The key issues concerning deregulationmarket power, bottlenecks, and cross-subsidiesare not new to antitrust law or to the Members of this Committee.
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The current regulated utility system has given us perhaps the world's most efficient power system. Electricity service is universally available. We are the only nation in the industrialized world that has enjoyed declining electricity rates over the last 17 years. Our network is by far the most reliable of any nation. Given this success, our first imperative should be to do no harm.
In my view, before we restructure this $200 billion system, we need to consider three critical questions. First, how will deregulation impact consumers? Our goal should be reducing rates not just for the major industrial purchasers, but for small residential customers as well. If there is to be any legitimate rationale for deregulation, it must be that it will benefit consumers.
Second, what can be done about the bottleneck in electricity transmission? Transmission is the essential facility of the electricity business. Unfortunately, legal and financial barriers make it impossible to provide for meaningful competition in electricity transmission. Our job as policymakers must be to make sure that monopoly power in this line of business does not spill over and adversely impact other competitive lines of business.
Third, what is the likely effect of electricity industry consolidation? The entire power industry is undergoing a wave of merger and acquisition activity. If competition is to be more than an empty promise, these actions must undergo the closest possible antitrust scrutinyby FERC as well as the FTC and DOJ. The last thing we want is for deregulation to be an excuse for increased market power.
Page 13 PREV PAGE TOP OF DOC Although technology has made competition possible, competition is not inevitable. Unless we can be sure that deregulation will not result in increased rates, abuses of market power, or an oligopoly structure, it is not worth pursuing. By providing the antitrust agencies with the necessary authority and resources, we can go a long way toward resolving these concerns.
I commend the Chairman for holding this timely hearing and look forward to hearing the testimony of today's witnesses.
Mr. HYDE: But meanwhile, we proceed with Panel I, and our first panel consists of four witnesses who represent the various Government agencies with expertise in the electricity area.
Our first witness is Commissioner Mozelle Thompson of the Federal Trade Commission. Commissioner Thompson has a bachelor's degree and a law degree from Columbia University and a master's degree from Princeton University. Before coming to Washington, he practiced law with Skadden Arps, taught law at Fordham University Law School, and served as general counsel to the New York State Finance Agency. In 1993, he joined the Treasury Department, where he served in several important positions. He became a Federal Trade Commissioner in December 1997.
Our next witness is Mr. T.J. Glauthier, the Deputy Secretary of the Department of Energy. Mr. Glauthier is a graduate of Claremomt College and the Harvard Business School. Before coming to Washington, he was a management consultant with Temple, Barker and Sloan and also served with the World Wildlife Fund. In 1993, he joined the Office of Management and Budget as an associate director, and he has become Deputy Secretary in March 1999.
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Next we have Mr. Douglas Melamed, the Principal Deputy Assistant Attorney General in the Antitrust Division of the Department of Justice. Mr. Melamed is a graduate of Yale University and Harvard Law School. After law school, he clerked for Judge Charles Merrill of the ninth circuit. Before coming to the Division in October 1996, Mr. Melamed was a partner in the Washington law firm of Wilmer, Cutler & Pickering for many years. He has written numerous articles and taught law school courses in the field of antitrust law.
Our last witness is Mr. Douglas Smith, the general counsel of the Federal Energy Regulatory Commission. Mr. Smith is graduate of the Massachusetts Institute of Technology and Yale Law School. Before coming to the Department, he clerked for Judge Walter Stapleton of the U.S. Court of Appeals for the Third Circuit. He then spent 7 years with the Washington office of the law firm of Powell, Goldstein, Frasier and Murphy, working on energy and environmental issues. He joined the Energy Department in 1994 where he worked on a variety of issues in the Office of General Counsel. He became general counsel of the Commission in November 1997.
We welcome all of you and look forward to your testimony, and Commissioner Thompson, if you could present your statement in about 5 minutes, we will be flexible, but we have a long witness list and we want to get through everybody, and then your full statement will be received as a part of the record. Thank you, Commissioner.
STATEMENT OF MOZELLE THOMPSON, COMMISSIONER, FEDERAL TRADE COMMISSION
Mr. THOMPSON. Thank you, Mr. Chairman and members of the committee. I am pleased to be here before you today to offer comments on deregulation and competition in the electric power industry. We have submitted the Commission's full prepared statement for the record, and so my oral presentation and responses to your questions are my own and don't necessarily represent the views of the Commission or a particular other commissioner.
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The staff of the Commission has in the past commented to the Federal Energy Regulatory Commission on the importance of wholesale competition and on the appropriate analytical framework for evaluating electric power industry mergers. The Commission has also provided comments to States on the importance of considering the impact of market power as they introduce retail competition in the electric industry. In addition, the Commission has been involved in a number of enforcement actions in this area.
Finally, on September 13th and 14th of this year, the Commission will further assist States and localities by holding a public workshop on the topic of market power and consumer protection considerations in the electric power industry.
We believe that all of this information sharing will provide consumers and governments with better guidance about competition and consumer issues as energy deregulation takes place.
Now, it is no secret that technical organizational innovations over the past decade have made room for competition in the generation and sale of electricity, but the starting point for competition of this industry is not the level playing field of a newly developing market but, instead, we are starting with regulated monopolies. Ensuring that consumers receive the benefits of the deregulation may be greatly affected by the ability of the energy market to move to an open and competitive stance.
While Federal antitrust laws are not a panacea for all competitive concerns, their application can help in this transition to competition by ensuring that mergers don't exacerbate market power problems or shield incumbent companies from new competition.
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The antitrust laws can also help by preventing anticompetitive acts and practices such as predation, raising rivals' costs, and discrimination in granting access to essential facilities, and by companies seeking to inhibit competition from new entrants or suppliers.
It is important to note, however, that current antitrust laws do not directly address the current conditions in the energy market where market dominance resulting from decades of regulation are not accompanied by what I just described as unfair methods of competition. To address these conditions, I know the administration's bill proposes to give FERC the authority to assess existing market power and remedy it in the wholesale power markets. The array of potential remedies could include ordering companies to divest generation assets to several buyers in order to decrease companies' market dominance. However, remedying the existing market power in the retail segment is more problematic.
Anticompetitive conduct would be a predicate for antitrust enforcement against retail market power; yet, with deregulation, the local distribution monopolies may be able to exercise their power, to the detriment of consumers, without having to engage in clearly anticompetitive behavior.
At present all proposed energy reforms would leave States with substantial regulatory responsibilities for local energy distribution, yet regulating retail competition will likely entail reviewing the distribution and marketing of power across State lines and in regional markets. It is unlikely that States will be well-suited to protect competition in these types of scenarios.
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The Federal antitrust agencies, working in consultation with FERC, can help by contributing to assessments of existing market power, and the methods and principles that we use to analyze mergers and unfair methods of competition are equally applicable to remedying existing market power problems in the wholesale or retail markets.
Now, we are principally concerned about two kinds of market power, and they are horizontal and vertical. We can talk about that a little more as time goes on, but I also want to talk just really shortly about two cases that are in the vertical context that we have been involved in that may provide some illustration.
The Commission's PacifiCorp case contained potential threats to competition from both raising rivals' costs and from abuse of proprietary information. Our investigation concerned PacifiCorp's proposed acquisition of The Energy Group and its subsidiary, Peabody Coal. PacifiCorp provides retail service in 7 Western States. Peabody produces 15 percent of the coal mined in the United States and owned in the Navajo reservation in Arizona. These mines are the sole source of power supply for the Navajo Power Plant in Page, Arizona, and in the Mojave Power Plant in Laughlin, Nevada. A post-acquisition PacifiCorp would have had both the incentive and the ability to raise the price of coal to its competitors. Now, although the transaction was eventually abandoned, the order that we had negotiated settling the complaint would have required PacifiCorp to divest both mines and establish a firewall that would have forbidden Peabody Coal from disclosing certain nonpublic information to PacificCorp.
In a second energy convergence merger, the Commission filed a compliant against CMS Energy Corporation when they proposed acquisition of two interstate natural gas pipelines. CMS is a gas and electric utility and a subsidiary provides gas to residential and industrial consumers in Michigan. In addition, they also own and operate the only intrastate gas transmission line through which consumers can buy natural gas from other suppliers to produce electricity. The proposed acquisition raised concerns that CMS could raise prices of transporting gas through its pipeline, and the increased cost would have been passed on to retail consumers. The Commission ultimately issued an order in this matter that prohibited CMS from restricting non-CMS interconnect capacity into the CMS system.
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So what does this all mean? That means that the potential for consumer savings and increased choice, while enormous in deregulation, is not guaranteed. Vigilant antitrust enforcement will be an essential tool in ensuring vigorous competition, especially in the formative years after the regulatory grasp is loosened, and especially strong merger enforcement will be necessary.
The Commission stands ready to meet these responsibilities and looks forward to working cooperatively with FERC and the Department of Justice to protect the consumer gains that should follow with the introduction of market forces.
Mr. HYDE. Thank you very much, Commissioner Thompson.
[The prepared statement of Mr. Thompson follows:]
PREPARED STATEMENT OF MOZELLE THOMPSON,(see footnote 1) Commissioner, Federal Trade Commission
Mr. Chairman and members of the Committee, I am pleased to appear before you today to present the testimony of the Federal Trade Commission concerning the important topic of deregulation and competition in the electric power industry, and how deregulation may raise issues of market power. I will also discuss how these issues affect mergers in an industry undergoing deregulation.
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The staff of the Commission has in the past commented to the Federal Energy Regulatory Commission (''FERC'') on the importance of wholesale competition(see footnote 2) and on the appropriate analytical framework for evaluating mergers.(see footnote 3) The staff also has provided comments to a number of states on the importance of considering the impact of market power as they introduce retail competition in the electric power industry.(see footnote 4) To further assist states and localities in examining these issues, on September 13th and 14th of this year, the Commission will hold a public workshop on market power and consumer protection considerations in the electric power industry.
The FTC is a law enforcement agency whose statutory authority covers a broad spectrum of the American economy, including the electric power industry. The Commission enforces, among other statutes, the FTC Act(see footnote 5) and the Clayton Act,(see footnote 6) sharing with the Department of Justice authority under section 7 of the Clayton Act to prohibit mergers or acquisitions that may ''substantially lessen competition or tend to create a monopoly.''(see footnote 7) In addition, section 5 of the FTC Act prohibits ''unfair methods of competition'' and ''unfair or deceptive acts or practices,'' thus giving the Commission responsibilities in both the antitrust and consumer protection areas. The Commission also provides advice and guidance to states and other regulatory agencies on competition issues. Moreover, the Commission has experience in applying antitrust principles across many different industries.
The FTC's experience has taught the Commission that competition between market participants will ordinarily provide consumers with the benefits of low prices, good products and services, and innovation. We also think that these benefits should be provided in the electric power industry as a century of regulation gives way to competition. But these benefits will not be achieved without an in-depth understanding of market power impacts.
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There are huge resources at stake in this industry. Total industry revenues are estimated at $200 billion a year, and total industry capital investment is around $700 billion, or almost 10% of total U. S. capital investment. If the levels of cost savings and technological improvements in this industry approach those attained in other previously deregulated industries, many consumers likely will be substantially better off in terms of lower prices and increased choices.(see footnote 8) But, these potential savings and innovations will not appear automatically. Proper application and enforcement of antitrust principles are necessary to ensure that the benefits of competition reach consumers.
II. REGULATORY BACKGROUND IN THE ELECTRIC POWER INDUSTRY
To evaluate the impact of market power issues in the electric power industry and to better understand the role of the antitrust agencies in addressing competitive issues in a deregulating industry, it is important to review the unique history of this industry. For most of this century, the electric power industry has been heavily regulated because the industry was perceived to be a natural monopoly. In an effort to minimize costs, the industry was organized as a series of local, vertically integrated monopolies. For the most part, the power company owned the generation, transmission, and distribution systems. Each of these local monopolies had market power, but it was market power that was controlled by federal and state regulatory bodies. Mergers were allowed to take place without regard to market power considerations because regulation prevented market power abuse.
Technical and organizational innovations in the last decade may have made room for competition in the generation and sale of electric power. But, the starting point for competition in the electric power industry is not the level playing field characteristic of a newly developing market. Instead, we are starting with regulated monopolies. Ensuring that consumers receive benefits upon deregulation may be greatly affected by the ability of the energy market to move to an open and competitive stance rather than one dominated by newly unregulated monopolies. How that occurs is largely dependent on the factors present in each case. In some instances, for example, there may be no transition problem because easy entry for competitors at the generation and transmission levels will eliminate most market power. In other instances, however, competitive constraints on existing market power may be only modest at best. In all cases, a recognition of market power issues is critical to achieving the benefits of competition.
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While Federal antitrust laws are not a panacea for all competitive concerns, their application can help in this transition to competition by making sure that mergers do not aggravate market power problems or shield incumbent companies from new competition. The antitrust laws can also help by preventing anticompetitive acts and practices such as predation, raising rivals' costs, and discrimination in granting access to essential facilities that might be used to inhibit competition from new entrants or suppliers.
It is important to note, however, that current antitrust laws do not directly address the current conditions in the energy market where market dominance resulting from decades of regulation are not accompanied by the above-described unfair acts and practices. To address these conditions, the Administration proposes to give FERC authority to assess existing market power and remedy it in wholesale power markets. The array of potential remedies would include ordering companies to divest generation assets to several buyers in order to decrease the companies' market dominance. Remedying existing market power in the retail segment is more problematic.
Anticompetitive conduct would be a predicate for antitrust enforcement against retail market power, while the local distribution monopolies may be able to exercise their power to the detriment of consumers without having to engage in clearly anticompetitive behavior. At present, all proposed energy reform efforts would leave states with substantial regulatory responsibilities for local energy distribution. Yet, regulating retail competition will entail reviewing the distribution and marketing of electric power across state lines in regional markets. It is unlikely that states will be well-suited to protect competition in these markets.
Page 22 PREV PAGE TOP OF DOC The Federal antitrust agencies, working in consultation with FERC, can significantly contribute to an assessment of existing market power in the following ways. First, the analytical methods and principles that we use to analyze mergers and unfair methods of competition are equally applicable to an existing market power problem in a wholesale or retail electric market. Second, the remedies applied to merger and non-merger cases can also be applied to alleviate existing market power. In sum, concerns about existing market power in this formerly monopolistic industry are appropriate. The Federal antitrust agencies can contribute to ensuring that newly deregulated energy markets are open and competitive. The Commission looks forward to working in consultation with FERC, along with the Department of Justice, to address market power issues.
III. SOME SPECIFIC CONCERNS
Economic theory and experience with other industries tell us that the transition from regulated monopolies to competition is not an automatic processdoing it right requires actively promoting competition and guarding against practices that stifle competition. For several reasons, the previous accumulation and potential abuse of market power may blunt the competitive potential of deregulatory efforts.
To begin, industry participants have become used to a regulatory environment. As a result, some may attempt to protect or duplicate many of the comfortable aspects of that environment. Where they are accustomed to being a local monopoly and using the regulatory process to bar or disadvantage new entry, industry members may attempt to use monopolistic or cartel behavior (such as information-sharing) to protect their entrenched positions after deregulation. A monopolist will not ordinarily welcome new entry, and issues of access or structural realignment designed to promote access will have to be considered with those incentives in mind.
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Second, the transition from regulation to competition is never instantaneous or complete. Market participants may find themselves subject to inconsistent requirements. Some participants may become subject to market forces while others remain regulated, or different participants may be subject to different regulatory rules. It may be inefficient and unfair to have different regulatory rules apply to direct competitors. In the electric power industry, for example, potential anticompetitive behavior may be monitored by FERC, state public utility commissions, or the Federal antitrust agencies, depending on the pace and mix of deregulatory efforts. In a deregulatory environment, it is important to provide consistent competitive analysis and review.
Third, regulatory bodies may have policy goals other than competition that warrant consideration in the transition to a competitive environment. In the electric power industry, for example, universal lifeline service(see footnote 9) at low cost is an important public policy goal. Another important policy goal in the electric power industry is environmental protection. These considerations usually fall outside the scope of traditional antitrust analysis. Accordingly, some continuing regulation or other special provisions may be needed to ensure that other policy goals are taken into account.
Fourth, removing entry and capital expenditure controls from an industry subject to a long period of regulation will unleash pent-up demand for corporate restructuring. Resulting consolidations may be procompetitive or competitively neutral, or they may instead be an illegal attempt to acquire market power.
These four conditions imply that the antitrust laws will have to be applied flexibly to address the issues that arise in transitional, or formerly regulated, industries. Regulatory regimes are usually established in response to some market failure, perceived or actual, that makes market forces inadequate to protect consumers and promote efficiency. Even if a consensus exists that the existing regulatory schemes are unresponsive or ineffective, or that technology obviates the need for regulation, the impact of regulation on the industry structure, incentives, and expectations require that the antitrust agencies be especially sensitive in applying antitrust rules while market forces gain primacy.
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Applying the antitrust rules with special care may not, however, mean a ''hands off'' approach. The consumer and efficiency gains from deregulation could be jeopardized without appropriate antitrust enforcement during and after deregulation. The goal is to see regulation replaced with competition, not with collusion or dominant firm behavior. Here, the antitrust laws; flexibility is a major advantage. Antitrust jurisprudence unfolds on a case-by-case approach, constantly adapting to new information and new experiences. Where, as here, the deregulated world will be significantly different from the experience of most industry participants, it is difficult to know in advance what types of oversight will work best. This condition suggests that fixing government oversight policy in concrete at an early stage could be counterproductive. Accordingly, flexible antitrust enforcement may be particularly important.
Although the decision about how to proceed has potentially substantial economic consequences for consumers, we will not comment on the method and scope of regulatory reform, but will state that strong antitrust oversight of the industry will and should remain vital no matter what course of deregulation is chosen.
IV. MARKET POWER ISSUES
As previously stated, no matter how deregulation proceeds, market power issues must be addressed if the benefits are to accrue to consumers. Two kinds of market power are of antitrust concern as we move to retail electric competition. The first is horizontal market power, permitting prices to be raised above competitive levels for an extended period, and the second is vertical market power, that could be exercised through discriminatory access to transmission, which today largely remains a monopoly.(see footnote 10)
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A. Horizontal Market Power
Horizontal market power in this context refers to the ability of one or more electric generating or retailing firms to raise prices above competitive levels for an extended period of time without a significant loss of market share. Horizontal market power results in higher prices, inefficient allocations of scarce resources, and distortions of consumer choices. Concerns about horizontal market power in generation during deregulation have been heightened by the pioneering British deregulatory experience, as well as experience with the initial efforts in the United States. Following the implementation of electric industry restructuring in the United Kingdom, researchers determined that the two private generating firms that dominated the industry were exercising market power.(see footnote 11) These findings prompted subsequent orders for divestiture of generation capacity. Very recent evidence from the initial deregulatory efforts in California indicates that market power problems in electricity generation exist there as well.(see footnote 12)
B. Vertical Market Power
In addition to horizontal market power, effective antitrust oversight will require close examination of the incentives and ability of vertically integrated transmission monopolists, whose rate of return is regulated, to evade the regulatory constraint in order to earn a higher profit. Their participation in an unregulated market may give them the means to do so, either by discriminating against their competitors in the unregulated market or by shifting costs between the regulated and unregulated markets.(see footnote 13)
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It is important to note that the vertical relationships in the electric power industry are different from those in almost all others. The important question raised by this industry structure is how to ensure that the benefits of new competition occurring in power generation actually reach the consumer. A key to effective competition is to provide independent generators open access(see footnote 14) to vertically integrated transmission and distribution systems so that lower prices in generation are passed on to consumers. The problem is that a vertically integrated transmission monopolist ordinarily would have an incentive to discriminate against independent generators. As a result, consumers might be deprived of the benefits of an independent generator's lower costs. While one solution could be requiring vertically integrated companies to be split up so that transmission entities would not be controlled by generating companies, large scale forced divestiture could prove costly in terms of complex legal liability issues for existing contracts and the sacrifice of potentially important economies of scope and vertical integration.(see footnote 15) Consequently, the method chosen by both the states and FERC to assure open access and efficient pricing in the transmission and distribution grids is to require that products be unbundled and to require that the pricing decisions of the vertically integrated firms be transparent.(see footnote 16)
Two methods of unbundling currently are being used by regulators in the electric power industry. For wholesale sales of interstate transmission of electricity, FERC requires ''functional'' unbundling, whereby it orders a utility to grant open access to its transmission grid and charge the same prices to independent generators that it charges internally to its own generator plants. FERC, however, has initiated a rulemaking proceeding to determine whether to go beyond only requiring open access to monopolists' transmission facilities in light of ''indications that continued discrimination in the provision of transmission by vertically integrated utilities may . . . be impeding fully competitive electricity markets.''(see footnote 17) In fact, numerous independent producers and large industrial users have alleged discriminatory conduct in the operation of transmission facilities.(see footnote 18)
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A number of states, on the other hand, have opted for ''operational'' unbundling.(see footnote 19) To date, this has taken the form of an entity independent of the utility operating the transmission and distribution grids to ensure open access and transparent pricing, although the monopolist retains ownership of the physical assets. The operational unbundling plan may work to preserve economies of vertical integration, internalize loop flow externalities (caused by the fact that electricity does not follow a contract path, but rather the path of least resistance), and assure transparent investment signals for potential investors(see footnote 20) while eliminating the strategic opportunities of the monopolist(see footnote 21) to favor subtly its own generating capacity.(see footnote 22)
As previously noted, the final market power issue concerns mergers. For example, mergers between generating firms may create market power that could be exercised by withholding capacity in order to drive up rates, or mergers at the retail level, between electric utilities or between electric utilities and independent retail marketers, could harm existing or potential competition. Following deregulation, horizontal mergers are more likely than vertical mergers in the electric power industry, given the current high level of vertical integration.
1. Analytical Model
The FTC's merger analysis is not industry specific; it is designed to apply across all industries. Nonetheless, the electric power industry, like all industries, has certain unique features that would require that the analysis be applied in a flexible manner. Using the analysis described in the Horizontal Merger Guidelines, jointly developed by the Commission and the Department of Justice,(see footnote 23) the enforcement agencies assess whether the proposed transaction would harm consumers of any relevant product or service through increased prices, lower quantity, quality or service levels, or reduced technological innovation.
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Defining the relevant product and geographic markets is the first step in determining where any potential anticompetitive effects will be felt. A relevant product market is one in which many consumers of the product would not switch to an alternative product if the price of the first product were increased by a small but significant amount.(see footnote 24) Similarly, a relevant geographic market comprises the locations of all of the alternative suppliers to which customers would likely turn if prices of the relevant product rose by a small but significant amount.
In many industries, the more distinctive and important inquiry concerns the relevant product market, where the consumers' substitutes are determined. In the electric power industry, both product and geographic markets may prove difficult to define with absolute precision. Within the overall electricity market, discrete electricity product markets will need to be defined, taking into account, among other things, time, reliability, and interruptibility. The more difficult issue in this industry may be defining the relevant geographic market. As open access to the transmission and distribution grids becomes the norm, consumers will be able to turn to ever more distant sources of electricity. The geographic market is unlikely to be national in scope, but may include parts of Canada or Mexico during some periods. But establishing the relevant markets may be more complicated because the elements of defining the product market also change the scope of the geographic market.(see footnote 25)
Once markets have been determined, the participants and their market shares must be identified. A market that is divided evenly among many participants will rarely have the potential for abuse of market power.(see footnote 26) The Merger Guidelines use a measure of market share distribution called the Herfindahl-Hirschman Index to determine the relative concentration of firms in the industry. In this industry, as in others, antitrust analysis goes significantly beyond the mere calculation of market shares. Certain economic characteristics may make this industry susceptible to cartel behavior at a level of concentration different from the point at which we would otherwise be concerned. A careful and thorough analysis of each transaction must therefore be undertaken once the relevant markets and market shares have been determined. If experience suggests that this industry is particularly subject to cartel behavior, or that mergers indirectly promote cartel behavior, then threshold levels of concern indicated by market shares may need to be adjusted.
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Entry and efficiencies are factors that are given considerable emphasis in the Guidelines. If entry into a market is easy, post-merger market participants likely will be unable profitably to increase prices above the pre-merger level. Entry analysis in the electric power industry poses a number of difficulties. The size of an efficient generating plant has decreased significantly but it still may take longer than the Guidelines benchmark of two years to enter at that level. Siting and environmental problems may complicate and delay entry at any level. Excess capacity and the decommissioning costs of nuclear power plants are important factors to consider. The ease of entry in this industry may vary from case to case as relevant markets change. For instance, available sites for new building may be more abundant in some areas than in others, making entry quicker and less costly.
The potential for anticompetitive effects does not end the inquiry in a typical merger investigation. Where the potential for anticompetitive effects is a close question, the potential efficiencies generated by the merger must be considered. Cognizable efficiencies may include economies of scale, integration of production facilities, plant specialization, and lower transportation costs.
The antitrust agencies have long considered efficiencies as relevant to the exercise of their prosecutorial discretion when deciding whether to challenge a transaction. In a close case, an agency may refrain from challenging a merger if it appears that the merger would generate substantial efficiencies. After a series of Commission hearings on Competition Policy in the New High-Tech, Global Marketplace indicated concern with how the antitrust agencies consider efficiencies in evaluating mergers, the Commission and the Department of Justice published a revised efficiency section for the Guidelines.(see footnote 27)
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Efficiencies may have particular significance for the electric power industry. In an industry that has been pervasively regulated for many years, efficiencies are likely to play an enhanced role in motivating restructuring after deregulation. Where capital mobility was once circumscribed by regulators, firms will now be able to pursue the most efficient, market-determined structure.(see footnote 28)
2. Convergence Mergers
One particular type of vertical merger that may cause antitrust concern in a deregulated electric power industry is a convergence merger between a power generator and a supplier of fuel, such as a supplier of natural gas or coal. The Commission has recently investigated two such mergers and in both cases found potential anticompetitive effects, including raising rivals' costs and abuse of competitively sensitive information.(see footnote 29)
A competitive concern in a convergence merger could arise if a generating company acquires market power over the supply of fuel to its generating competitors or potential competitors. Such an acquisition could enable the generating company to raise its rivals' input costs or restrict their supplies and put them at a competitive disadvantage. In turn, the now-vertically integrated generating company could either raise the price of its electricity output or sell more of its own output since its competitors now have higher costs. Thus, convergence mergers can distort the market in two ways: customers can be forced to pay higher prices, which can distort consumer choices, and the acquiring company can favor its own generating facilities while other, more efficient plants may stand idle.
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A second anticompetitive possibility is that the acquisition may give the generating company access to proprietary information about its competitors' costs. Since fuel costs are a substantial portion of generating costs, knowledge of competitors' fuel costs could give the firm an advantage in bidding situations. With access to this type of information, the firm could increase its price with confidence that it is still likely to win the bidding.
The Commission's PacifiCorp case contained potential threats to competition both from raising rivals' costs and from abuse of proprietary information. The investigation concerned PacifiCorp's proposed acquisition of The Energy Group PLC (TEG) and its subsidiary, Peabody Coal. PacifiCorp provides retail electric service in seven western states. Peabody produces 15 percent of the coal mined in the United States, and owned the Kayenta and Black Mesa mines located on the Navajo Indian Reservation in Arizona. The mines are the sole source of supply for the Navajo power plant in Page, Arizona and the Mohave power plant in Laughlin, Nevada. A post-acquisition PacifiCorp would have had both the incentive and the ability to raise the price of coal to its competitors, Navajo and Mohave. Both the Navajo and the Mohave plants have substantial off-peak excess capacity which is used to supply other utility companies in the Southwestern states. Raising fuel costs to these plants would put upward price pressure on electricity over a wide regional area.
The acquisition also would have given PacifiCorp access to proprietary information about its competitors. Through Peabody's coal supply relationships, PacifiCorp could have learned highly sensitive data about competitors' costs and generator operating conditions. Peabody provided coal to approximately 150 power plants in the Western states, many of them competitors of PacifiCorp. The order settling the complaint would have required PacifiCorp to divest the Kayenta and Black Mesa mines and to establish a firewall that would have forbidden Peabody from disclosing certain non-public information to PacifiCorp.
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In a second convergence merger, the Commission filed a complaint against CMS Energy Corporation's (CMS) proposed acquisition of two natural gas pipelines from subsidiaries of Duke Energy. CMS is a combination electric and gas utility and a CMS subsidiary provides natural gas to residential and industrial consumers in Michigan. In addition, it also owns and operates the only intra-state natural gas transmission system through which consumers can buy natural gas from other suppliers, either for their own use, or to use to produce electricity. As a pipeline customer, CMS has had an incentive to maintain competitive access into its system. But after the acquisition of the pipelines, CMS would have the incentive to restrict the other pipelines' access to its system in order to support price increases on its own pipelines. The order settling this case requires CMS to give shippers two options if they cannot deliver gas into its service area because the available interconnection capacity is less than actual capacity. CMS is required to accept gas at another pipeline delivery point at no additional cost if the shipper can deliver it there; otherwise CMS must loan gas from its own supply to the shipper in an amount equal to the volume of gas that could not be transferred through any of CMS's interconnection points. The order also requires CMS to post to an electronic bulletin board information which will let shippers know whether actual capacity is less than current capacity at non-CMS interconnects.(see footnote 30)
Deregulation in a number of industries has proven to be beneficial to many consumers and the competitive process. The deregulated industries generally exhibit lower prices, increased quality and quantity of goods and services, and heightened innovation. The electric power industry is currently experiencing substantial deregulation. While it is unclear whether that process will be driven by the states or by the Federal government, the outcome in either case should be that market forces will have an effect on firms long accustomed to the slower pace and shelter of regulated life.
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The potential for consumer savings and increased choice is enormous, but it is certainly not guaranteed. As our recent cases demonstrate, vigilant antitrust enforcement is an essential component of a market economy, especially in the formative years after the regulatory grasp is loosened. In particular, strong merger enforcement is necessary to ensure that the inevitable restructuring does not result in the accumulation and abuse of private market power. The Commission stands ready to meet its enforcement responsibilities to protect the consumer gains that should follow the introduction of market forces to the electric power industry.
Mr. HYDE. Deputy Secretary Glauthier, please.
STATEMENT OF T.J. GLAUTHIER, DEPUTY SECRETARY, DEPARTMENT OF ENERGY
Mr. GLAUTHIER. Mr. Chairman, members of the committee, thank you for inviting me here today to discuss the competitive issues associated with electricity industry restructuring. The rules and regulations that since the New Deal have defined and directed the generation and delivery of electricity to consumers are quickly disappearing. Twenty-four States have already approved restructuring proposals to allow consumers to choose among competing power suppliers. Almost every other State has the matter under consideration. What once appeared to be an experiment by a few high-cost States is now a trend that is sweeping the Nation.
The Clinton administration supports restructuring because we believe that retail competition, as provided for in our proposed legislation, will be good for consumers, good for the economy and good for the environment. Companies that had no incentive to offer lower prices, better service, or new products will now compete to earn your business. States are and should be leading the way, but Federal action is necessary for State restructuring programs to achieve their maximum potential.
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Electrons do not respect State boundaries. Electricity markets are becoming increasingly regional and multiregional. Actions in one State can and do affect consumers in another. The fact is that retail competition can't and won't reach its full potential without comprehensive Federal electricity restructuring legislation. Neither State nor Federal regulators have the necessary tools to ensure that electricity markets operate as efficiently as possible without complementary action by the Congress.
On April 15th, Secretary Richardson transmitted the Clinton administration's Comprehensive Electricity Competition Act to the Congress. This legislation lays out our vision for the role the Federal Government should play in the transition to retail competition.
Mr. Chairman, simply enacting a statute declaring that there shall be competition is not enough. Eliminating monopoly franchises and cost of service regulation for power sales still leaves in place the traditional vertically integrated utility structure, not suited for efficient and competitive markets. The transition to competition requires a proactive approach to ensure that alternative power suppliers will have a sufficient opportunity to compete for customers.
The application of the antitrust laws is not itself sufficient. The utility or other market participant may have the ability to control the price of power in a certain region without having committed a violation of the antitrust laws. Although we believe that both the Justice Department and Federal Trade Commission will play an important role during the transition to competition, the Federal Energy Regulatory Commission's familiarity with the industry necessitates that FERC be active in promoting competitive markets.
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The administration's proposed legislation contains several provisions designed to aid the development of competitive markets.
First, FERC's Orders No. 888 and No. 889, which require transmission-owning utilities to provide access to their transmission facilities to all competitors on a nondiscriminatory basis, would be codified. In addition, the application of this requirement would be extended to all transmission owners including municipal, cooperative, and the Federal utilities.
Second, FERC would have the authority to require utilities to participate in an independent, regional system operated to enhance the efficiency and competitiveness of regional transmission markets. FERC's ability to remedy concentrations of market power would also be enhanced. Mergers between utility holding companies and generation-only companies would be subject to Federal Power Act review, and Federal utilities which own transmission facilities would be subject to FERC regulation. Further, TVA's statutory monopoly over electric sales in the Tennessee Valley would be eliminated.
Mr. Chairman, while adequate market structures are vital to competition, consumers must be able to take advantage of these competitive markets. Although we expect retail competition to benefit all classes of consumers, we are mindful that small consumers must be adequately protected.
The administration's legislation contains several provisions designed to enhance the ability of all consumers to benefit from competition. For instance, electricity suppliers would be required to provide consumers with information on the price and terms of their product as well as the generation emission characteristics of the power they sell. The Federal Trade Commission would be empowered to prohibit a supplier from engaging in slamming and cramming practices and consumers would be able to aggregate their loads in order to increase purchasing power.
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Mr. Chairman, we are pleased that the Judiciary Committee is holding this oversight hearing. The administration believes that comprehensive Federal restructuring legislation is needed sooner rather than later, and we want to work with the Congress on a bipartisan basis to get the job done. I would be glad to answer any questions which you or the other committee members may have.
Mr. HYDE. Thank you very much, Secretary.
[The prepared statement of Mr. Glauthier follows:]
PREPARED STATEMENT OF T.J. GLAUTHIER, DEPUTY SECRETARY, DEPARTMENT OF ENERGY
Mr. Chairman, thank you for inviting me to testify today on the competitive issues associated with electric industry restructuring(see footnote 31). The rules and regulations that, since the New Deal, defined and directed the generation and delivery of electricity to consumers are disappearing. Since 1992, when Congress enacted the Energy Policy Act, competitive wholesale electricity markets have been developing at a rapid pace. As competition was taking shape at the wholesale level, state legislatures and regulators began to consider proposals to implement retail competition to allow individual consumers and businesses the opportunity to purchase their power from competing power suppliers.
Twenty-four states have already approved restructuring programs to provide for retail competition. Almost every other state has the matter under active consideration. What once appeared to be an experiment by a few high cost states, is now a trend that is sweeping the nation.
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States are, and should be, leading the way, but Federal action is necessary for state restructuring programs to achieve their maximum potential. Electrons do not respect state borders. The fact is that electricity markets are becoming increasingly regional and multi-regional. Actions in one state can and do affect consumers in another. States alone can't ensure that regional power and transmission markets are efficient and competitive.
The fact is that retail competition can't and won't reach its full potential without comprehensive Federal electricity restructuring legislation. Neither state nor Federal regulators have the necessary tools to ensure that electricity markets operate as efficiently as possible without complementary action by Congress.
On April 15, Secretary Richardson transmitted the Clinton Administration's Comprehensive Electricity Competition Act (CECA)(see footnote 32) to Congress. This legislation lays out our vision for the role the Federal government should play in the transition to retail competition. CECA would:
encourage states and non-regulated utilities to implement retail competition programs;
protect the reliability of the interstate electric grid;
enhance the competitiveness of regional power markets;
provide for a more efficient and competitive interstate transmission system;
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enable competition to develop sufficiently in the regions served by Federal utilities; and
promote the continuation of public benefits programs.
The Clinton Administration supports electric restructuring because we believe that retail competition, as provided for in the Administration bill, will be good for consumers, good for the economy and good for the environment. Companies that had no incentive to offer lower prices, better service, or new products will now compete to earn your business. Consumers will save money on their electric bills. Lower electric rates will also make businesses more competitive by lowering their costs of production. In addition, the development of new products and services will help expand the economy. Furthermore, by promoting energy conservation and the use of cleaner and more efficient technologies, greenhouse gas emissions will be reduced.(see footnote 33)
PROMOTING COMPETITIVE MARKETS
Enacting a statute declaring that ''there shall be competition'' is not enough to reap these benefits. Eliminating monopoly franchises and cost-of-service regulation for power sales still leaves in place the traditional vertically-integrated utility structure not suited for efficient and competitive markets. The transition to competition requires a pro-active approach to ensure that alternative power suppliers will have a sufficient opportunity to compete for customers.
Page 39 PREV PAGE TOP OF DOC The application of the antitrust laws is not, itself, sufficient. A utility or other market participant may have the ability to control the price of power in a certain region without having committed a violation of the antitrust laws. Although we believe that both the Justice Department and the Federal Trade Commission will play an important role during the transition to competition, the Federal Energy Regulatory Commission's (FERC's) familiarity with the industry necessitates that FERC be active in promoting competitive markets.
Mr. Chairman, I would like to focus the remainder of my testimony on the provisions in the Comprehensive Electricity Competition Act which promote competition and competitive markets.
Open Access to Transmission Facilities
To realize fully competitive markets, transmission must be available on a non-discriminatory basis. FERC's Order Nos. 888 and 889 took critical steps in opening electricity markets to competition by requiring jurisdictional utilities(see footnote 34) to file open access transmission tariffs which provide universal access to utility transmission facilities on a non-discriminatory basis. However, effective competition requires that electricity suppliers have access to all necessary transmission facilities, regardless of ownership. The Administration's bill would subject the transmission facilities of all utilities, including those owned by Federal, municipal and cooperative utilities, to FERC jurisdiction to provide for greater and more efficient competition. CECA would also codify FERC's open access requirements.
Independent Regional System Operators
Page 40 PREV PAGE TOP OF DOC While open access reduces a transmission owner's ability to discriminate in the provision of transmission service, the separation of the operation and control of transmission facilities from a utility's marketing functions through participation in an independent Regional System Operator (RSO) structure would greatly reduce the risk that operation of the transmission system could be distorted to favor some generators or customers over others. The benefits of independent operation of the transmission system are clear.
The establishment of RSOs addresses significant concerns about the exercise of market power by transmission owners. An efficiently dispatched and properly priced bulk-power system might not develop absent the establishment of independent regional system operators. CECA would provide FERC with the authority to require that any transmission owner, regardless of its ownership structure or FERC's jurisdiction over other aspects of its operations, participate in an RSO, and to set other requirements pertaining to RSOs as needed to serve the public interest.
Open access to transmission services, as well as independent regional operation of transmission, should largely mitigate market power associated with the control of interstate transmission facilities. However, open transmission access will not, by itself, prevent the exercise of all forms of market power in electricity markets. A utility can possess market powerthe ability to raise prices above competitive levelssimply as the result of its ownership of a significant share of the generation facilities within a market.
FERC currently has the authority to condition merger applications to remedy potential market power. Absent a merger application, FERC's only other available tool to address market power is to deny a request for market-based wholesale rates. To ensure that the development of competition is not hindered by the exercise of market power, CECA would give FERC the additional authority to remedy the concentrations of market power in the wholesale market, including the authority to order the divestiture of assets, if such market power is found.
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States would retain the primary responsibility for implementing retail competition. However, because of the regional nature of many power markets, a State may be presented with a market power problem that extends beyond its borders and its jurisdiction. CECA would provide FERC with ''backup'' market power authority if a State implementing retail competition believes that it has insufficient authority to remedy the market power and makes a request for FERC to take action.
As utilities prepare for restructuring, merger activity is on the increase. While mergers are not necessarily disruptive of the development of competition, it is essential that anti-competitive consolidations be prevented.
While the Federal Power Act gives FERC the authority to review mergers involving jurisdictional utility companies, FERC does not have clear authority over public utility holding company mergers or consolidations. In addition, FERC does not have jurisdiction over generation facilities. In a largely deregulated generation market, mergers of generation-only utilities could result in market power in the generation market. The Administration's legislation proposes to provide FERC with the authority to oversee mergers between utility holding companies, as well as generation-only companies. This is especially necessary in light of the Administration's proposal to repeal the Public Utility Holding Company Act of 1935, as part of comprehensive electricity restructuring legislation.
In performing its duties under the Federal Power Act, FERC has reviewed the impact of mergers and acquisitions on the competitiveness of wholesale electric markets but generally does not review the effect on retail markets. While a state utility commission typically has authority over mergers involving an electric utility located in the state, a neighboring state would not have jurisdiction. Since a merger between utilities located in one or more states can impact the competitiveness of retail electric markets in an entire region, it is appropriate for FERC to examine if the merger would create undue market power or other conditions that would adversely affect retail competition. As a result, CECA provides for FERC review of the impact on retail markets of a proposed merger or acquisition.
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Three of the four Federal Power Marketing Administrations (PMAs)Bonneville Power Administration (BPA or Bonneville); the Western Area Power Administration (WAPA); and the Southwestern Power Administration (SWPA)own transmission lines in the regions they serve.(see footnote 35) Bonneville is the major transmission owner and operator in the Pacific Northwest; controlling over 75% of the region's high voltage transmission capacity, with major links to Canada and other regions of the United States. WAPA is also a significant transmission owner, with over 16,000 miles of transmission located across the West. At the same time, the Tennessee Valley Authority (TVA) is virtually the sole power provider and the only transmission owner in Tennessee and parts of six surrounding states. The fact is, it is difficult to address the development of competitive markets in certain parts of the country without modifying the way the Federal utilities operate.
As I discussed earlier, we believe it is important that FERC's open access authority extend to transmission facilities owned by the PMAs and TVA. We also believe it is essential to the proper development of competitive markets that Federal transmission facilities be subjected to other regulatory requirements in a manner similar to those of other utilities. Therefore, CECA proposes to subject PMA and TVA transmission facilities to Federal Power Act regulation. Our legislation does, however, recognize that the unique obligations of the Federal utilities require slightly different regulatory treatment than that accorded other utilities. For instance, FERC, in setting transmission rates for the PMAs, would be required to ensure that amounts collected are sufficient to cover costs so that the PMAs can repay what they owe the Treasury and that TVA may recover its costs for the purposes of meeting its obligations. In addition, our proposal would allow FERC to authorize the PMAs to impose transmission surcharges in limited instances in order to pay for certain other costs, such as fish and wildlife remediation.
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Our legislation also goes further with regard to TVA. Due to statutory and contractual restrictions, TVA is essentially the sole power supplier in the TVA region, and may only sell power elsewhere under very limited circumstances. The Administration's bill would authorize competing utilities to sell power into the Tennessee Valley beginning January 1, 2003 and require TVA to renegotiate its contracts with existing customers on several matters, including the ability to purchase power from others after 2002. At the same time, TVA would be permitted to sell wholesale power outside of the Tennessee Valley in order to mitigate its stranded costs. Because TVA will be able to compete with other utilities, on a limited basis, outside of TVA's traditional service territory, the Administration bill also proposes to subject TVA to the antitrust laws. However, like municipal entities, TVA would be exempt from having to pay monetary damages.
While adequate market structures are vital to competition, consumers must be able to take advantage of these competitive markets. Although we expect retail competition to benefit all classes of consumers, we are mindful that small consumers must be adequately protected. The Administration's legislation contains a variety of provisions designed to ensure that consumers have adequate purchasing power and access to information and that electricity suppliers don't engage in fraudulent practices.
One way that consumers can increase their access to low cost electricity in a competitive marketplace is through aggregation. Aggregation is the process whereby electric consumers join their loads in order to leverage buying power. While most State competition programs will encourage aggregation, it is essential that State and Federal laws not impose barriers for an entity to participate in aggregation. The Administration's bill would make it clear that no State or Federal law can be applied to impede aggregation in a competitive market.
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Consumers will also need reliable information so that they can compare the products and prices offered by electricity suppliers and make informed choices. The Administration's bill would enable DOE to require all electricity suppliers to disclose in a uniform, easy to read ''label'', basic information on the price, terms and conditions of service, the type of generation source and generation emissions characteristics.
Certain service providers in the competitive long distance and emerging competitive local telephone markets have engaged in fraudulent practices, such as slamming and cramming(see footnote 36). There is a concern that slamming and cramming could also occur in a competitive retail electric market. As a result, CECA would empower the Federal Trade Commission to establish and enforce anti-slamming and anti-cramming provisions against unscrupulous power providers and marketers.
When we released the Administration's bill on April 15, Secretary Richardson, several other cabinet officials and members of Congress were joined on a stage by more than 20 people representing a diverse set of interests, including investor-owned utilities, municipal utilities, consumer groups, power marketers and independent power producers. While they did not necessarily all agree on the Administration bill, or any other single approach, their message was loud and clearthe time for Federal legislation is now.
Mr. Chairman, we are pleased that the Judiciary Committee is holding this oversight hearing. The Administration believes that Federal restructuring legislation is needed sooner, rather than later, and we want to work with Congress, on a bipartisan basis, to get the job done. I would be glad to answer any questions which you or the other Committee members may have.
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Mr. HYDE. Mr. Melamed.
STATEMENT OF DOUGLAS MELAMED, PRINCIPAL DEPUTY ASSISTANT ATTORNEY GENERAL, ANTITRUST DIVISION, UNITED STATES DEPARTMENT OF JUSTICE
Mr. MELAMED. Thank you, Mr. Chairman; good morning. And good morning to members of the committee. I appreciate the opportunity to speak to you about some of the issues relating to competition and market power in the electric power industry.
With sales totaling more than $200 billion annually in the United States, it would be hard to overstate the importance of the electric power industry to the American economy and to American families. All of us have a stake in eliminating obstacles to efficient and economical generation and transmission of electricity.
There is now a growing consensus that with improved technology the generation segment of electric power supply could become more efficient and economical under competitive market forces. The transmission and distribution segments, on the other hand, will likely retain their natural monopoly characteristics for the foreseeable future. The challenge then is to foster vigorously competitive generation markets within the context of regulated transmission and distribution monopolies.
Many States are moving to open their retail markets to competition. It is thus important that Congress consider the need for Federal legislation to address possible market power problems that could impede the efforts to increase competition in the electric power industry. The key to retail competition in the electric power industry is a well-functioning wholesale market.
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Although much progress has been made in this regard, there is more to be done. Because wholesale markets are regional in nature and subject to Federal regulation, legislation to remove impediments to competition in those markets should be undertaken at the Federal level.
The Department of Justice is particularly interested in certain basic components of such legislation. Because of the existing structure of the electric power industry, there are likely to remain significant market power problems in the transmission and generation of electricity even as the industry is restructured to increase the role of competitive market forces. The antitrust laws do not outlaw the mere possession of monopoly power that is a result of skill, accident, or a previous regulatory regime. Existing antitrust remedies are thus not well-suited to address problems of market power in the electric power industry that result from existing high levels of concentration in generation or vertical integration.
We believe, therefore, that regulators should be given additional tools to remedy market power problems that may be found to exist and that the provisions that would give FERC clear authority to remedy possible market power problems are an important part of the administration's proposed legislation. Let me explain why.
Owners of electric power transmission facilities in the U.S. commonly also own generation facilities, and their control over transmission gives them the ability to thwart competition in generation. Owners of transmission have the incentive and the ability to favor their own generation facilities and otherwise to restrict the access to transmission facilities by the generation facilities of competitors.
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FERC took an historic step toward addressing this problem by enacting Order 888, which requires that all utilities over which FERC has jurisdiction provide open and nondiscriminatory access to transmission facilities for wholesale buyers and sellers. Monitoring enforcement and compliance with such regulations against discrimination are, however, very difficult, especially considering that quality of service is time-sensitive, as it is in the electric power industry.
Because power is sold at an hourly basis, market dynamics can shift over the course of each day, making it virtually impossible to intervene before conditions have changed. Independent regional system operators, or RSOs, offer a promising solution to this problem. The administration's proposal calls for amending the Federal Power Act to clarify that FERC has the authority to require transmission utilities to turn over operational control of transmission facilities to an RSO. Such a structural remedy can eliminate the incentive and ability of the owner of monopoly transmission facilities to act anticompetitively by ensuring that transmission services are provided to competitors by a neutral entity that has no stake in a particular generation facility and thus has no incentive to discriminate.
It is critical that RSOs be large enough to operate the transmission system efficiently and reliably. The provision in the administration proposal authorizing FERC to establish minimum criteria for the approval of RSOs would allow FERC to reject RSOs that may be improvements over the status quo but are too small to operate the transmission system efficiently.
Optimally-sized RSOs can also help to mitigate market power that is the result of high concentration of ownership of generation assets. RSOs can do so by eliminating economically inefficient transmission rate pancaking and thereby enlarging geographic markets.
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Some transmission owners may decline voluntarily to turn over control of their transmission facilities to an RSO. Given the importance of ensuring that the transmission system operates in a nondiscriminatory and efficient manner, it is critical to competition in the electricity industry that legislation clarify FERC's authority to order transmission owners to join FERC-approved RSOs.
High concentrations of ownership of generation may allow the exercise of market power even if there is competition in wholesale and retail markets. The administration bill would give FERC the authority to mitigate market power in wholesale markets as well as back-up authority to remedy market power in retail markets upon the request of a State.
Consistent with the Department's strong preference for structural remedies for competitive problems, FERC would be given express authority to order divestiture of generation facilities, if and to the extent necessary, to mitigate market power in consultation with the Department and the Federal Trade Commission.
Giving FERC the necessary tools to remedy market power in generation is critical because vertically integrated electric utilities have typically had market power in their distribution areas and significant pockets of market power may remain after wholesale and retail competition are widely introduced. We do not know the extent to which this will be the case after restructuring occurs, but if it turns out that there are significant post-restructuring market power problems, FERC should be given the necessary tools to address them.
We are confident that truly competitive electricity generation will be superior to regulation in efficiently allocating resources and maximizing consumer welfare. We look forward to continuing to work with the committee on the important issue of market power, and I will be pleased to answer the committee's questions. Thank you.
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Mr. HYDE. Thank you, Mr. Melamed.
[The prepared statement of Mr Melamed follows:]
PREPARED STATEMENT OF DOUGLAS MELAMED, PRINCIPAL DEPUTY ASSISTANT ATTORNEY GENERAL, ANTITRUST DIVISION, UNITED STATES DEPARTMENT OF JUSTICE
Good morning, Mr. Chairman and Members of the Committee. I appreciate the opportunity to speak to you about some of the issues relating to competition and market power in the electric power industry.
With sales totaling more than $200 billion annually in the U.S., it would be hard to overstate the importance of the electric power industry to the American economy and to American families. All of us have a stake in eliminating obstacles to efficient and economical generation and transmission of electricity.
The electric power industry developed historically from a patchwork of isolated and vertically integrated electric utilities, each generating and distributing electric energy to consumers in relatively compact service areas. Advances in technology over time made power generation more efficient on a larger scale and made transmission of electric energy possible over long distances. These advances encouraged interconnection among utility transmission networks, initially for enhanced reliability and then for improved economy of service.
More recently, it has become possible, with improved technology, to generate electric power at efficient cost levels with much smaller generating plants. There is now a growing consensus that the generation segment of electric power supply could become more efficient and economical under competitive market forces. The transmission and distribution segments, on the other hand, will likely retain their natural monopoly characteristics for the foreseeable future. The challenge, then, is to foster vigorously competitive generation markets within the context of regulated transmission and distribution monopolies. It is in pursuit of the goal of promoting competitive generation markets that the Administration submitted its comprehensive electricity restructuring bill to Congress in April of this year.
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In thinking about restructuring, it is important to remember that the electric power industry has a number of unique characteristics that distinguish it not only from basic manufactured goods markets, but also from other network industries such as telecommunications. The productelectric energycannot be stored; and consumer demand for it varies widely from season to season, from day to day, and from hour to hour. Actual quantities generated must continuously and instantaneously match widely varying consumer demand.
In addition, the flow of energy over an electric power network cannot economically be directed through switches to follow a particular path, so in the power grid of today and the immediate future, energy will flow along the path of least resistance. Therefore, the actual physical delivery patterns for electricity may not match the contractual arrangements for sale of electricity, and successful transmission will depend on the relative output levels of all generators on the power grid.
Many states are moving to open their retail markets to competition. It is thus important that Congress consider the need for federal legislation to address possible market power problems that could impede the efforts to increase competition in the electric power industry. We believe that the bill that the Administration submitted to Congress comprehensively and adequately addresses the market power issues about which we are all concerned.
The key to retail competition in the electric power industry is a well-functioning wholesale market. Although much progress has been made in this regard, there is more to be done. Because power markets are regional in nature, federal legislation to remove impediments to competition in these markets is necessary.
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In what follows, I will outline the views of the Antitrust Division of the Department of Justice about the basic components of such legislation. I will first give a brief overview of enforcement activity by the Division in the electricity industry. I will then discuss some of the market power problems facing the industry and legislative proposals that we believe are necessary to address them. And I will conclude by discussing possible reform of the Public Utility Holding Company Act of 1935.
ENFORCEMENT ACTIVITY OF THE ANTITRUST DIVISION
The Antitrust Division has long played an important role in protecting and promoting free and open markets in the electric power industry. A seminal antitrust case in this industry was an enforcement action brought by the Antitrust Division under the Sherman Act to stop the Otter Tail Power Company from monopolizing the retail distribution of electric power in its service area in Minnesota, North Dakota, and South Dakota. Otter Tail owned the transmission lines in its service area, and one of the means it employed to monopolize the market was to refuse to transmit, or ''wheel,'' power over its lines to municipal utilities competing with it for local distribution. In 1973, the Supreme Court upheld a lower court order requiring Otter Tail to wheel power to the municipal utilities, ruling that the electric power industry was subject to the antitrust laws even though it was also subject to regulation by the Federal Power Commission.
The Division has brought two recent enforcement actions involving the electricity industry. The first was an action against Rochester Gas and Electric (''RG&E'') concerning a contract between RG&E and the University of Rochester in which RG&E promised to sell electricity to the University at reduced rates in exchange for the University's promise not to compete against RG&E in the sale of electricity to consumers.
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The case had its origin in the very high regulated electricity rates in New York in the early 1990s. In response, the New York Public Service Commission opened a proceeding to permit utilities to set prices through individual negotiations with certain customers rather than according to a tariff filed with the state.
In the meantime, the University of Rochester, a major industrial customer of RG&E, was examining ways to reduce its energy costs. The University had a decades-old facility that produced steam for heating and cooling campus buildings. The University determined that it could build a more efficient plant to meet its steam needs and also produceor cogeneratemore electricity than it needed as a byproduct. New York State law expressly permitted the University to sell the plant's excess electricity to other users, in competition with RG&E.
The new plant was never built. Instead, RG&E and the University entered into an agreement. In part, the agreement resembled a simpleand legalrequirements contract, under which RG&E agreed to supply the University with electricity at discounted rates and the University agreed to ''remain a customer of RG&E for all of its power needs'' for seven years. But the agreement did not stop there. It also contained a seven-year restriction, unrelated to RG&E's sale and the University's purchase of electricity, pursuant to which the University promised ''not to solicit or join with any other customers of RG&E to . . . provide them with electric power . . . from any source other than RG&E.''
The Division brought an action under the Sherman Act against RG&E, challenging the agreement not to compete between RG&E and the University. This action was resolved by a consent decree that prohibits RG&E from entering into agreements not to compete, with certain limited exceptions (for example, contracts to sell a business).
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The second action was a challenge of the merger of Pacific Enterprises (''Pacific''), a California natural gas utility, and Enova Corporation (''Enova''), a California electric utility. The Department was concerned that, as a result of the merger, the combined Pacific/Enova would have the incentive and ability to use its natural gas transportation monopoly to withhold gas or gas transportation from competing gas-fired electric plants that competed with Enova. Gas-fired plants are generally the most costly to operate, and they set the price for all electricity sold during times, such as summer, when electricity demand is at its highest. The complaint alleged that Pacific/Enova would, by restricting the access to natural gas of certain competing gas-fired plants, be able to raise their costs and thereby to increase electricity prices to California consumers. The complaint further alleged that Pacific/Enova would have an incentive to do so because it is a low-cost producer of electricity and would therefore stand to profit from any increase in the price of electricity.
The settlement requires Enova to divest its largest low-cost electricity plants. Once this is accomplished, the merger will no longer create incentives for Enova to raise electricity prices. Enova is also required to provide notice to and obtain the approval of the Department should it wish to acquire or manage certain California electric power facilities in the future.
Let me now turn to the issue of market power. Because of the existing structure of the electric power industry, there are likely to remain significant market power problems in the transmission and generation of electricity, even as the industry is restructured to increase the role of competitive market forces.
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The authority of the Department of Justice to enforce the antitrust laws with respect to the electric power industry does not sufficiently address the ability of electric utilities to exercise market power that can thwart free competition within the industry. The antitrust laws do not outlaw the mere possession of monopoly power that is the result of skill, accident, or a previous regulatory regime. Antitrust remedies are thus not well-suited to address problems of market power in the electric power industry that result from existing high levels of concentration in generation or vertical integration. In the Administration's electricity bill we have, therefore, granted regulators the tools to remedy market power problems that may be found to exist.
The provisions that would give FERC clear authority to remedy possible market power problems are an important part of the Administration's recently unveiled Comprehensive Electricity Competition Act. Let me explain why.
Owners of electric power transmission facilities in the U.S. commonly also own generation facilities, and their control over transmission gives them the ability to thwart competition in generation. Owners of transmission have the incentive and the ability to favor their own generation facilities and otherwise to restrict the access to transmission facilities by the generation facilities of competitors. Such discrimination can take the form of denying competitors in electricity generation access to the transmission monopolist's services or offering less favorable terms than those provided to its own generation facilities. The FERC took an historic step toward addressing this problem by enacting Order 888, which requires that all utilities over which FERC has jurisdiction provide open and nondiscriminatory access to transmission facilities for wholesale buyers and sellers.
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Monitoring and enforcing compliance with regulations against discrimination are particularly difficult, however, when quality of service is as time-sensitive as it is in electric power. Because power is sold on an hourly basis, market dynamicsand thus the incentive and ability to exploit market powercan shift over the course of each day, making it virtually impossible to intervene before conditions have changed. There is thus no way to ensure that a transmission owner will not operate its transmission assets in a manner that favors its own generation.
Independent Regional System Operators (''RSOs'') are a promising solution to this problem. RSOs are entities that operate the transmission grid independent of the interests of the owners of the generation facilities. The Administration proposal calls for amending the Federal Power Act to clarify that FERC has the authority to require transmission utilities to turn over operational control of transmission facilities to a regional independent system operator. FERC would also be given the authority to set other requirements pertaining to RSOs as needed to serve the public interest. Such a structural remedy can eliminate the incentive and ability of the owner of monopoly transmission facilities to act anticompetitively by ensuring that transmission services are provided to competitors by a neutral entity which has no stake in any particular generation facility and thus has no incentive to discriminate.
It is critical that RSOs be large enough to operate the transmission system efficiently and reliably. The provision in the Administration proposal authorizing FERC to establish minimum criteria for the approval of RSOs would allow FERC to reject RSOs that may be improvements over the status quo but are too small to operate the transmission system reliably and efficiently.
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Optimally-sized RSOs can also facilitate the use of more efficient transmission pricing, which in turn can help to mitigate market power that is the result of high concentration of ownership of generation assets. RSOs can do so by eliminating economically inefficient transmission rate pancaking. Rate pancaking occurs when a transmission customer is forced to pay separate rates for a transaction that crosses multiple transmission systems. While some forms of rate pancaking reflect efficient charges for the capital costs of the transmission network, pancaking can be inefficient if it results in total transmission prices that do not accurately reflect the actual cost associated with a particular transaction. Inefficient pancaking distorts competition both by increasing transmission prices and by tending to insulate nearby generation facilities from what might otherwise be more vigorous competition from more distant facilities.
Large regional RSOs can also internalize certain transaction costs, such as those associated with loop flows, as well as play an important role in the control and management of constrained transmission interfaces, particularly those which significantly impact competition in regional power markets. Poorly managed, competitively significant constraints can hinder transactions across the interface and invite anticompetitive manipulations of the interface. Without independent operation of the transmission grid, regulators are likely to be unable to address adequately the almost certain flood of complaints of self-dealing that will undoubtedly allege manipulations of posted available transmission capacity and abuses of the native load preference that is granted utilities under Order 888.
Some transmission owners may decline voluntarily to turn over control of their transmission facilities to an RSO. Given the importance of ensuring that the transmission system operates in a nondiscriminatory and efficient manner, it is critical to competition in the electricity industry that legislation clarify FERC's authority to order transmission owners to join FERC-approved RSOs.
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GENERATION MARKET POWER
High concentrations of ownership of generation may allow the exercise of market power, even if there is competition in wholesale and retail markets. The Administration bill would give FERC the authority to mitigate market power in wholesale markets, as well as backup authority to remedy market power in retail markets upon request from a state if the state, in the course of implementing a retail competition plan, determines that it has insufficient authority to remedy a retail market power problem. Consistent with the Department's strong preference for structural remedies for competitive problems, FERC would be given express authority to order divestiture of generation facilities to the extent necessary to mitigate market power, in consultation with the Department and the Federal Trade Commission. The authority would be implemented by requiring generators with market power to submit a mitigation plan, which FERC could approve with or without modification.
Giving FERC the necessary tools to remedy market power in generation is critical because vertically integrated electric utilities have typically had market power in their distribution areas, and significant pockets of market power may remain after wholesale and retail competition are widely introduced. We do not know the extent to which this will be the case after restructuring occurs, but if it turns out that there are significant post-restructuring market power problems, FERC must be given the necessary tools to address them.
I would like to conclude my testimony by briefly discussing possible reform of the Public Utility Holding Company Act of 1935 (''PUHCA''). During the Great Depression, a handful of large multi-state corporations that controlled a significant amount of electricity generation and transmission collapsed. Congress responded by enacting PUHCA. This legislation split up the companies and imposed certain restrictions on utilities operating in more than one state. The result has been an industry dominated by vertically integrated utilities regulated by state commissions.
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The Administration opposes standalone repeal of PUHCA. In our view, the interlocking nature of the system of federal laws regarding utility regulation, including PUHCA and the Federal Power Act, makes it preferable that these statutes be amended either as part of comprehensive restructuring legislation or concurrently with such legislation, rather than on a piecemeal basis.
The Administration's restructuring legislation includes a repeal of PUHCA. However, the bill also includes several measures designed to protect consumers from the potential for holding company abuses such as cross-subsidization. These measures should include enhanced merger review by FERC, additional state and federal access to holding company data, and the market power provisions I discussed earlier. The Administration believes that it is important to approach electricity restructuring issues comprehensively in order for Congress to be able to evaluate the context in which changes in PUHCA are to take place.
We are confident that truly competitive electricity generation will surpass regulation in efficiently allocating resources and maximizing consumer welfare. Moreover, we believe that the Administration's electricity bill comprehensively addresses the competitive issues that will arise in a restructured market, and establishes the framework through which truly competitive markets can thrive. We look forward to continuing to work with the Committee on the important issue of market power.
Mr. HYDE. Before Mr. Smith begins, I have learned that our room is over the loading dock, and so that rumbling you hear is not a structural defect. It is the trucks coming in and out and getting loaded up or loading us up. So anyway, Mr. Smith.
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STATEMENT OF DOUGLAS SMITH, GENERAL COUNSEL, FEDERAL ENERGY REGULATORY COMMISSION
Mr. SMITH. Mr. Chairman and members of the committee, good morning. My name is Douglas Smith, and I serve as the general counsel at the Federal Energy Regulatory Commission. I am here today as a Commission staff witness and do not speak for the Commission as a whole or for individual members of the Commission. I appreciate the opportunity to discuss with you today the important matter of competition issues in electricity restructuring.
The traditional regulatory approach in this industry was to accept that electric utilities were natural monopolies and to protect ratepayer interests primarily by relying on cost-of-service rate regulation. In recent years, however, we have recognized that electricity generation is not a natural monopoly. In the Energy Policy Act of 1992, Congress strongly endorsed competition in wholesale power markets with amendments to the Federal Power Act and the Public Utility Holding Company Act.
The Commission shares this overarching goal of promoting competition in wholesale electricity markets, having concluded that effective competition, as opposed to traditional forms of price regulation, can best protect the interests of ratepayers. Competition among generators and other wholesale sellers of electricity encourages the development of innovative services, expands supply options, and ultimately reduces prices for end users. Thus, the Commission has pursued pro-competitive goals by ordering open access to transmission facilities in Order No. 888 and in its policies on mergers and market-based wholesale rates.
Page 60 PREV PAGE TOP OF DOC Competition in bulk power markets can be frustrated, however, by the exercise of market power. Market power may take many forms, including most notably control of access to transmission facilities necessary to deliver electricity and concentration in generation markets. Regulation to address market power is essential to support competition in electricity markets.
Market power considerations related to ownership and control of transmission facilities are at the core of Order No. 888's open access transmission policies. Fair and open access to reliable transmission service is an essential predicate to competition in bulk power markets. Effective regulation of the relatively small transmission sector enables competition, with its consequent ratepayer benefits, in the much larger generation sector.
The Commission is seeking further improvements in the transmission arena to support fully competitive wholesale power markets. In May of this year, the Commission proposed a rule designed to promote the formation of regional transmission organizations. These regional transmission organizations would have operational control over a region's transmission grid and would be independent of the financial interests of power market participants. Such organizations can enhance competition by reducing rate pancaking, eliminating opportunities for bias in transmission operations, improving the management of grid congestion and facilitating transmission planning on a multistate basis.
Ensuring open access to a reliable and efficiently operated transmission grid should be a priority in any package of legislative reforms. In particular, legislation should: one, bring all transmission facilities in the lower 48 States under the Commission's open access transmission principles; two, reinforce the Commission's authority to promote regional management of the transmission grid through regional transmission organizations; and three, establish a fair and effective program for ensuring reliability of the transmission grid.
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In addition, any electricity legislation considered by Congress should ensure that effective tools are available to address other market power issues. The administration's proposed bill, for example, would close the gap in the Commission's jurisdiction over mergers involving generation-only facilities and would clarify that holding companies with electric utility subsidiaries cannot merge without Commission review. The administration's bill would also give the Commission explicit authority to mitigate market power outside the context of mergers.
As we continue to move toward bulk power markets in which price is set predominantly by the market rather than by regulators, we must ensure effective regulation of transmission facilities and the mitigation of market power. The Federal statutory regime should protect customers by combining pro-competitive policies with the regulatory tools necessary to constrain market power effectively.
Thank you for the opportunity to offer my views this morning. I would be pleased to answer any questions you may have.
Mr. HYDE. Thank you very much.
[The prepared statement of Mr. Smith follows:]
PREPARED STATEMENT OF DOUGLAS SMITH, GENERAL COUNSEL, FEDERAL ENERGY REGULATORY COMMISSION
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Competition is growing in bulk power markets, in response to the Energy Policy Act of 1992 and the Federal Energy Regulatory Commission's efforts to remove barriers to competition and to let marketsnot regulatorsdetermine the price of wholesale power. Competition in wholesale markets among generators and other sellers of electric energy encourages the development of innovative services and supply options, and ultimately reduces prices for end users. Targeted regulation remains important, however, because market power can be exercised to the detriment of effective competition, raising prices to customers. Market power may take many forms, including control of transmission facilities necessary to deliver electricity and concentration in generation markets.
Ensuring access to transmission services is an essential component of a policy favoring competitive wholesale power markets. In the Energy Policy Act of 1992, Congress gave the Commission effective authority to require transmission services on a case-by-case basis. The Commission, in 1996, took the next step by requiring all public utilities to offer non-discriminatory transmission services. Further statutory changes to ensure open access to a reliable and efficiently-operated transmission grid should be a priority in any legislative reform. In particular, legislation should: bring all transmission facilities in the lower 48 states within the Commission's open access transmission authority; reinforce the Commission's authority to promote regional management of the transmission grid through regional transmission organizations; and, establish a fair and effective program for ensuring the reliability of the transmission grid.
In addition, any electricity legislation considered by Congress should ensure that appropriate and effective tools are available to address other market power issues. The Administration's proposed bill, for example, would close the gap in the Commission's jurisdiction over mergers involving only generation facilities, and clarify that holding companies with electric utility subsidiaries cannot merge without Commission review. The Administration's bill also would give the Commission explicit authority to address market power outside the context of mergers.Testimony of
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Mr. Chairman and Members of the Committee:
Good morning. My name is Douglas Smith, and I am the General Counsel for the Federal Energy Regulatory Commission. I am here today as a Commission staff witness, and do not speak for the Commission itself or for individual members of the Commission. Thank you for the opportunity to appear before you today to discuss competition issues in electricity markets.
The Federal Energy Regulatory Commission (Commission or FERC) is actively promoting competition among generators and other sellers of electric energy in the wholesale or ''bulk power'' market, in furtherance of the goals of the Energy Policy Act of 1992. To achieve those goals, the Commission's fundamental regulatory objectives are: (1) to substitute competition for price regulation in wholesale power markets to the extent possible; and (2) to regulate transmission facilities so as to enable competition in power markets. Market power, however, can be exercised to the detriment of effective competition and consumer interests. Thus, the Commission regulates transmission service, mergers, and wholesale power rates so as to prevent the exercise of market power in bulk power markets.
A key Congressional goal in enacting the Federal Power Act (FPA) was to protect utility ratepayers from abuses of market power. In furtherance of this goal, Congress directed the Commission to oversee sales for resale of electric energy and transmission service provided by public utilities in interstate commerce. Under FPA sections 205 and 206, the Commission must ensure that the rates, terms and conditions of these services are just, reasonable, and not unduly discriminatory or preferential. Under section 203, the Commission must review proposed mergers, acquisitions and dispositions of jurisdictional facilities by public utilities, and must approve such transactions if they are consistent with the public interest. The Commission's jurisdiction under these sections applies only to ''public utilities,'' a category including principally investor-owned utilities and excluding the federal power marketing administrations, cooperatives financed by the Rural Utilities Service and municipal utilities.
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In exercising its statutory responsibilities, the Commission must consider the pro-competition policies that underlie the antitrust statutes. This responsibility is not found on the face of the FPA, but rather has been made clear in cases decided by the United States Supreme Court and the courts of appeal. E.g., Gulf States Utilities Co. v. FPC, 411 U.S. 747 (1973). By considering possible anticompetitive effects, the Commission serves as a ''first line of defense against those competitive practices that might later be the subject of antitrust proceedings.'' Id., at 760. The Commission does not apply or enforce the antitrust laws. Rather, consideration of effects on competition is one facet of the Commission's consideration of the FPA's broad statutory standards.
My testimony addresses three principal areas in which the Commission considers anticompetitive concerns: the rates, terms and conditions of transmission in interstate commerce; market-based rates for wholesale sales of generation; and mergers and other corporate realignments involving public utilities.
II. Competition Issues in Electricity Markets
The traditional regulatory approach was to accept that electric utilities were natural monopolies, and to address market power and protect ratepayer interests by relying primarily on cost-of-service rate regulation. In the 1980s and early 1990s, however, several developments indicated that the interests of utility ratepayers could be better protected by competition in wholesale power markets than by cost-based regulation. For example, the benefits of replacing traditional regulation with competition were increasingly evident in other industries, such as trucking, railroads, long-distance telecommunications and natural gas. In the Energy Policy Act of 1992, Congress strongly endorsed competition in wholesale power markets, by providing the Commission with effective authority to order transmission owners to deliver power for other buyers and sellers in the wholesale market, and by reforming the Public Utility Holding Company Act to eliminate a key barrier for new generators entering these markets.
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Consistent with these changes, the Commission's primary focus has shifted from cost-based ratemaking to creating the conditions for robust competition. This transition has required the Commission to pay increasing attention to issues of market power. Market power may take many forms, including control of access to transmission facilities necessary to deliver electricity and concentration in generation markets.
Market power problems can result in higher prices to customers. For example, absent regulation, a vertically-integrated utility could prevent its competitors in wholesale power markets from using its transmission facilities to deliver power to buyers. Buyers then would have fewer competitive options and, as a result, may have to pay higher prices. Similarly, a utility with a large enough share of the generating capacity in a market could raise prices by withholding supply from the market. A utility that controls enough of an input to power production (such as pipeline capacity for delivering natural gas to power plants) could achieve the same result.
A. Transmission Access
Market power considerations related to ownership and control of transmission facilities are at the core of the Commission's open access transmission policies. Fair and open access to reliable transmission service is an essential predicate to competition in bulk power markets. Effective regulation of the relatively small transmission sector (which accounts for less than 10% of overall utility costs) enables competition, with its consequent ratepayer benefits, in the much larger generation sector (which accounts for more than 60% of total utility costs).
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In the Energy Policy Act of 1992, Congress provided the Commission with effective authority under section 211 of the FPA to require transmission service on a case-by-case basis. This legislation, as implemented by the Commission, helped to expand the trading opportunities of wholesale sellers and buyers. However, the Commission concluded that competition in wholesale markets still was being inhibited by the lack of non-discriminatory access to transmission facilities. Generation sellers owning transmission facilities were stifling competition by discriminating against competing sellers that sought to use their transmission facilities, either by denying or delaying transmission service or by imposing discriminatory rates, terms and conditions for service. The Commission recognized that, if it was to fulfill the Congressional goal of developing competitive wholesale markets, it needed to act generically under section 206 of the FPA to provide for open access transmission.
Consequently, the Commission in 1996, through a major rulemaking called Order No. 888, ordered open (i.e., available to all wholesale users) non-discriminatory access to the transmission facilities of public utilities. This open access obligation prohibits public utilities from discriminating against competitors' transactions in favor of their own wholesale sales of power. Order No. 888 has enhanced competition in wholesale power markets significantly.
This open access obligation, however, applies only to transmission facilities owned or operated by public utilities. Approximately one-third of the transmission grid in the contiguous 48 States is not subject to the Commission's open access requirements. This third of the grid is owned primarily by federal power marketing administrations, cooperatives financed by the Rural Utilities Service, and municipal utilities. While some of these entities offer open access transmission service voluntarily, many others do not. These gaps in open access to the transmission grid can impede the development of full competition in wholesale power markets, and should be closed through legislation making all utilities subject to the same open access requirements.
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In Order No. 888, the Commission also encouraged, but did not require, the formation of independent system operators (ISOs) to promote broader, regional power markets and provide greater assurance of non-discrimination. Since then, six ISOs have been established (in California, the mid-Atlantic states, New England, New York, the Midwest and Texas). Four of these are currently operational.
The Commission is seeking further improvements in transmission access and grid operation to support fully competitive wholesale power markets. Of particular importance, the Commission has proposed new rules to promote the formation of regional transmission organizations (RTOs) such as ISOs and independent companies that own and operate transmission facilities (transcos). Notice of Proposed Rulemaking on Regional Transmission Organizations, 64 Fed. Reg. 31,389, FERC Stats. & Regs., 32,541 (1999). An RTO should be independent of the financial interests of power market participants, cover an appropriately configured region, and have adequate operational control over the transmission grid. If properly designed, an RTO can provide greater assurance of non-discriminatory operation of the transmission grid, eliminate pancaked transmission charges for using transmission systems owned by different utilities, reduce and better manage congestion on the transmission lines, and facilitate transmission planning on a multi-state basis. Legislation can help reinforce the Commission's authority to require the formation of, and participation in, RTOs as appropriate to promote the efficient regional management of the transmission grid.
The changes in the industry in recent years also have created a need for new tools for ensuring the reliability of the transmission grid. In the past, reliability was ensured through the voluntary cooperation of industry participants. Today, industry participants increasingly recognize that voluntary, cooperative efforts may not be sufficient, and that a mandatory system of ensuring the reliability of the grid is needed. This recognition has caused the industry to begin seeking the Commission's involvement on reliability issues, despite the Commission's lack of a clear statutory role on such issues.
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Congress should make compliance with appropriate reliability standards mandatory. There appears to be an industry consensus that it can continue to work collaboratively to develop reliability standards, using a process in which all market sectors are fairly represented. Sufficient Federal oversight will be needed to ensure that the standards maintain sufficient system reliability and are not unduly discriminatory or otherwise anticompetitive.
In summary, electricity legislation should: bring all transmission facilities in the lower 48 states within the Commission's open access transmission authority; reinforce the Commission's authority to promote efficient regional management of the transmission grid through RTOs; and, establish a fair and effective program to protect the reliability of the transmission grid. Addressing these transmission-related issues should be a priority in any legislative reform agenda.
B. Market-Based Rates for Power Sales
To promote competition, the Commission allows market-based rates for wholesale sales of electricity when an applicant shows that it and its affiliates lack, or have mitigated, market power. In evaluating horizontal market power for these purposes, the Commission distinguishes between new generating facilities and existing facilities. For sales from new generating facilities, the Commission applies a rebuttable presumption that the applicant lacks generation market power, but intervenors may present specific evidence to the contrary. For sales from existing generating facilities, the Commission uses a case-specific analysis of whether the applicant and its affiliates control a significant share of the total generation capacity that can be accessed by the utilities directly interconnected to the applicant or its affiliates.
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In evaluating vertical market power for these purposes, the Commission considers the extent of the applicant's control of any inputs to power production. Most applicants for market-based rates lack significant control of such inputs and thus present no vertical market power concerns. The Commission analyzes the control of transmission facilities separately from other sources of vertical market power and, for purposes of market-based rates, currently accepts compliance with Order No. 888's open access requirements as adequate mitigation of transmission market power.
Should the Commission identify market power problems after market-based rates have been authorized, it can revoke market-based rates and return to cost-of-service regulation. This remedy does not eliminate the underlying market power but, instead, relies on price regulation to mitigate the potential for its exercise.
C. Merger Review
Market power can be created or enhanced by mergers. Mergers can eliminate a competitor from the market and concentrate control of generating assets. Mergers can also enhance vertical market power, by giving the merged company a new or increased ability and incentive to restrict inputs to power production.
The Commission considers market power issues in reviewing applications for mergers or other jurisdictional acquisitions or dispositions of assets. In a merger policy statement issued in 1996, the Commission stated that, in assessing whether a proposed merger was in the public interest, it would consider the effects of the merger on competition, on rates and on regulation.
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The Commission adopted the Department of Justice/Federal Trade Commission merger guidelines as the framework for analyzing a merger's horizontal effects on competition. These guidelines set out five steps for analyzing mergers, based on: (1) whether the merger would significantly increase market concentration; (2) whether the merger would result in adverse competitive effects; (3) whether entry would mitigate the merger's adverse effects; (4) whether the merger would result in efficiency gains not achievable by other means; and (5) whether, absent the merger, either party would likely fail, possibly causing its assets to exit the market.
The Commission's merger policy statement also described a conservative analytical screen for quickly identifying mergers unlikely to raise horizontal market power concerns. The screen analysis focuses on the first step identified in the DOJ/FTC guidelines, i.e., whether the merger would significantly increase concentration. The screen analysis defines relevant markets by identifying suppliers that can deliver power to affected customers at competitive prices. If the screen analysis shows that the merger-related increase in market concentration is less than certain specified amounts, the Commission will not set the matter for hearing to further consider competitive effects.
The Commission's analysis of vertical market power concerns is similar. A vertical merger is unlikely to harm competition unless the merged company has the incentive and the ability to affect prices or quantities in the upstream (input) market and the downstream (electricity) market. For example, a company may be able, and have an incentive, to restrict service or raise prices for an input such as natural gas pipeline capacity and, as a result, restrict service or raise prices in supplying wholesale power.
Page 71 PREV PAGE TOP OF DOC If a merger will create market power or enhance the applicants' market power significantly, mitigation of these effects is required in order to ensure that the merger is consistent with the public interest. Section 203 of the FPA gives the Commission authority to approve a merger subject to ''such terms and conditions as it finds necessary or appropriate to secure the maintenance of adequate service and the coordination in the public interest of facilities subject to the jurisdiction of the Commission.''
The Commission's jurisdiction over mergers and acquisitions is limited in certain ways. First, the Commission has no direct jurisdiction over transfers of generation facilities. It can review transactions involving a public utility only when they involve other facilities that are jurisdictional (such as transmission facilities or contracts for wholesale sales). Thus, although concentration of generation assets may directly affect competition in wholesale markets, transactions involving only generation assets may not be subject to FPA review.
Second, the Commission lacks direct jurisdiction over mergers of public utility holding companies. While the Commission has construed such mergers to involve jurisdictional indirect mergers of public utility subsidiaries of the holding companies, or changes in control over the jurisdictional facilities of the public utility subsidiaries, the FPA is not explicit on this point.
These jurisdictional gaps could be usefully addressed in the course of legislative reform.
D. Legislative Reforms on Competition Issues
Page 72 PREV PAGE TOP OF DOC As we seek to rely primarily on competition as opposed to traditional price regulation to protect the interests of ratepayers, regulators must have the range of tools necessary to address market power problems that may threaten competition. Reforms to the Federal statutory scheme are appropriate to permit regulators to keep up with new market power challenges.
The Administration's proposed bill (H.R. 1828) addresses market power issues comprehensively. With respect to transmission, the bill would extend the Commission's open access authority to non-public utilities in the lower 48 States, would reinforce the Commission's authority to achieve efficient regional management of the transmission grid through RTOs, and would establish a fair and effective program of mandatory reliability standards. The Administration's bill also would close the gap in the Commission's jurisdiction over mergers involving only generation facilities, and would clarify that holding companies with electric utility subsidiaries cannot merge without Commission review. The bill would further authorize FERC to address market power in retail markets, if asked by a state commission lacking adequate authority to address the problem itself, and in wholesale markets by requiring a public utility to file and implement a mitigation plan. Each of these reforms would be an important tool for promoting competitive electricity markets.
Competition is growing in the electric industry, in response to the Energy Policy Act of 1992 and the Commission's efforts to remove barriers to competition and to let marketsnot regulatorsdetermine the price of wholesale electric power. Competition in electricity markets will not protect ratepayers effectively, however, if some market participants can exercise market power. Thus, as we continue to move toward more competitive power markets, we must ensure effective regulation of transmission facilities and the mitigation of market power. These issues require careful attention by the Congress, the Commission, the antitrust agencies and our State counterparts. The Federal statutory regime should protect consumers by combining pro-competitive policies with the regulatory tools necessary to constrain market power effectively.
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Thank you again for the opportunity to offer my views here this morning. I would be pleased to answer any questions you may have.
Mr. HYDE. Mr. Watt, the gentleman from North Carolina.
Mr. WATT. Mr. Chairman, I think I will pass.
Mr. HYDE. All right. Mr. Gekas, the gentleman from Pennsylvania.
Mr. GEKAS. Yes. Thank you, Mr. Chairman. The chairman accurately opened this hearing by stating that the Judiciary Committee's prime point of inquiry is on the question of mergers and antitrust, et cetera. In that context, Senator Thompson is from Tennessee; where are you from Commissioner Thompson?
Mr. THOMPSON. I am from New York.
Mr. GEKAS. All right. We will get that straight. You say in your statement that your Commission generally follows the Clayton Act guidelines or statutory language in assuming jurisdiction over potential mergers, and so does the Department of Justice, and you state that you share that responsibility. How does that work? Does a company seeking merger apply to both to be cleared by both simultaneously?
Mr. THOMPSON. Well, they submit the hard stock filings to both.
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Mr. GEKAS. Pardon me, I didn't hear you.
Mr. THOMPSON. They file with both. We have an agreement between both of us. We work cooperatively so that we don't duplicate our efforts, so there are certain times where we may have expertise in certain areas and have experience with certain of the people who are proposing an acquisition. In that case, we will get the transaction to review.
Mr. GEKAS. You decide that between yourselves, between the Department of Justice and yourself, and then if the Department of Justice feels that you have the special analytical expertise to proceed originally, then would they adopt your findings and clear, or would they conduct a separate investigation?
Mr. THOMPSON. Only one of us gets it. There is only one review and either they will review it or we will review it. So it is pursuant to this agreement.
Mr. GEKAS. We have learned that in the FCC/Justice Department cooperative ventures on merger that the Department of Justice, after its analysis, refers the matter to FCC. Does that ever happen in your jurisdiction?
Mr. THOMPSON. That is a different kind of statutory scheme. Maybe you would like to outline that a little bit.
Mr. GEKAS. That would be helpful.
Page 75 PREV PAGE TOP OF DOC Mr. MELAMED. Commissioner Thompson is right that as between the Federal Trade Commission and the Antitrust Division there is no duplicative review. The matters are allocated to one or the other of us, but not both. There are some mergers in various sectors, communications is one, in which there is concurrent oversight between the Antitrust Division on the one hand and a sectoral regulatorin the case of communications, the FCCon the other hand. That is also true in electricity mergers with the FERC and the antitrust agencies and in a couple of other sectors as well.
Mr. GEKAS. Well, does your Commission ever look into communications types of mergers?
Mr. THOMPSON. At this stage, we do not because the extent that there is statutory authority with regard to telephony, for example, that is something that the Department of Justice looks at. We have been involved in oil and gas, for example, like the cases I just outlined for you.
Mr. GEKAS. But you have separate sets of guidelines on how to approach vertical or horizontal or circular or pentagonal kinds of mergers; is that correct? You have separate guidelines?
Mr. THOMPSON. Actually, the Department of Justice and the Federal Trade Commission have joint guidelines for the review of mergers so that the standards are the same for both.
Mr. GEKAS. Well, I am pleased to hear that there is only one review then.
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Mr. THOMPSON. One review, one set of guidelines.
Mr. GEKAS. And so the original reviewer, the one that is not reviewing, succumbs to the authority of the other right from the start; is that it?
Mr. MELAMED. The other agency doesn't participate in that particular matter.
Mr. GEKAS. And it cannot veto it?
Mr. MELAMED. That is correct.
Mr. GEKAS. I think I want to yield back the balance of my time.
Mr. HYDE. I thank the gentleman. Mr. Jenkins, the gentleman from Tennessee.
Mr. JENKINS. Thank you, Mr. Chairman. I would like to start on the other end, give Commissioner Thompson a rest, Mr. Chairman, with Mr. Smith.
Mr. Smith, in essence, I guess every member of this panel has said in one way or another that competition and deregulation, as it is called, will reduce costs; and I believe you said future competition will reduce costs. One member of the panel said ''should,'' you said ''will.'' I would like to explore that just a little bit with you, whether we look at it from the competition viewpoint or other viewpoints, general business viewpoints. You will acknowledge from your advantage point that fuel costs are probably the biggest costs in the generation of electricity.
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Mr. SMITH. Yes.
Mr. JENKINS. How would the scheme outlined in either the administration bill or any of the other bills that are presented to the Congress, how would they work to reduce the cost of nuclear fuels in this country?
Mr. SMITH. I am sorry, how would they work to reduce the cost of?
Mr. JENKINS. Nuclear fuels.
Mr. SMITH. I don't know the answer to that.
Mr. JENKINS. Well, the truth of the matter is that these bills will not reduce the cost of that fuel; isn't that the truth of the matter?
Mr. SMITH. I honestly don't know.
Mr. JENKINS. How would any of these bills presented reduce the cost of fossil fuels; let us say the cost of coal?
Mr. SMITH. Well, I think the general notion is that competition will provide economic incentives for competing suppliers of electricity to search for efficiencies in their own operation and to look for a cost savings from their suppliers. By contrast, in a regulatory regime where electricity generators are subject to cost-of-service price setting, their costs for procurement of fuels will be passed through to consumers, with little incentive to hold down fuel costs.
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Mr. JENKINS. Well, you characterize that as a general notion. What I am looking for is a specific way, and I have been to several meetings, I have been to several hearings, and I would like to find a specific way that fuel costs are going to be reduced. And you really don't have an explanation as to how that is going to occur, do you?
How is it going to change the price of, let us say, electricity that is generated at hydrostationsthe regulation scheme? And this is not deregulation, this is reregulation. We are going to have more regulation in the future than we have ever had in the past with one of these schemes, but how specifically is it going to reduce the cost of electricity that is generated at a hydrostation?
Yes, sir. All right. Mr. Smith, do you want to answer or do you want to pass to the gentleman?
Mr. SMITH. I will let Deputy Secretary Glauthier answer that one.
Mr. JENKINS. All right.
Mr. GLAUTHIER. Thank you. I think the answer in short is that the fuel prices themselves are not going to change as a result of competition.
Mr. JENKINS. Let me ask you, then, another big cost is labor costs. Now, how are any of these bills going to reduce labor costs?
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Mr. GLAUTHIER. I think the way that all of these factor costs will be reduced so the overall prices will be reduced for customers is partly by having a greater range of choices, so that on the margin, the most efficient producers can supply the power.
Mr. JENKINS. Well, let me ask you this. If there are utilities in this country that are producing electricity and selling it for 5 1/2 cents per kilowatt hour and there are other utilities that are producing and selling electricity for 14 cents per kilowatt hour, which is the efficient utility? Would you say the 5.5 is fully efficient?
Mr. GLAUTHIER. Well, it depends on the history, of course, of each of the systems; but on a straight price comparison, obviously the 5-cent is preferable. And if consumers are able to choose from suppliers around the country, then that is going to tend to bring prices down. It is going to tend to bring in the more low-cost producers, the more competitive ones.
Mr. JENKINS. But if the 5.5 cent per kilowatt hour utility is selling all of the electricity that they are able to generate, how are they going to go to another section of this country and retail electricity or wholesale electricity for that matter?
Mr. GLAUTHIER. If they are selling all the power they can generate, of course they will have to build new plants, new facilities, and one of the things we expect to see is more new facilities brought on that are high efficiency that will, in fact, generate more electricity for the amount of BTUs or the energy that goes into it. In the long run, that will have the effect of using less fuel for a given amount of electricity we produce.
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Mr. HYDE. Does the gentleman desire additional time?
Mr. JENKINS. Could I have additional time?
Mr. HYDE. Yes, sir. How much do you need?
Mr. JENKINS. Oh, another 2 minutes.
Mr. HYDE. Without objection, so ordered.
Mr. JENKINS. All right. What provisions of these bills are going to bring about these efficiencies in the generation that you speak of?
Mr. GLAUTHIER. Well, some provisions are specific. For example, the support of the combined heat and power or distributed power systems where we are trying to provide more opportunity for the newer technologies to come into the marketplace. The fact of getting the rules of the game clear will provide more opportunity for people to build new generating capacity. We are concerned at the Department of Energy that currently there are people deferring decisions on new capacity additions until they understand what the rules will be, how this process will be set up. As those decisions are made, new units come in, they will be more efficient, they will tend to be lower cost and ultimately bring about these benefits.
Mr. JENKINS. Now that deferment started long before there was any talk of deregulation in the United States Congress, didn't it? And that deferment started because of construction costs, it started because of environmental costs. And in your statement you said that the retail consumer will benefit. Well, we have talked about that a little bit, and you also say that the environment will benefit. Now, how will this regulatory scheme, reregulation, how will it benefit the environment?
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Mr. GLAUTHIER. Our analysis and our modeling results have been done not only by the Department of Energy's Policy Office, but by the Energy Information Agency, and have estimated a savings of about $20 billion a year by the year 2010 when this is fully implemented for customers.
Mr. JENKINS. Twenty billion?
Mr. GLAUTHIER. Twenty billion dollars a year, that is right; and we think that that actually is a conservative estimate.
Mr. JENKINS. All right. And they do that by making the environment cleaner?
Mr. GLAUTHIER. At the same time the environment will be cleaner. We have an estimate of 40 to 60 million tons of carbon dioxide emissions that would be saved or reduced on an annual basis as well.
Mr. JENKINS. Well, now as you reduce those substances, whatever they might be, that is going to be costly, isn't it?
Mr. GLAUTHIER. Not necessarily. If it is done by saving power, for example, or it is done by substitutingyou mentioned nuclear power, for example. In some cases, nuclear power may be able to serve more markets than it currently is. The hydropower is another. We have got a lot of potential power sources if we make the market more efficient so they can actually compete effectively. There are a lot of opportunities.
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Mr. JENKINS. Well, is our utility industry in this country so lacking that, if these possibilities existed, that they would not have taken advantage of them? Why are there no new nuclear plants under construction in this entire country? Why are there no new coal plants under construction in this entire country? Why are there no new hydrogeneration stations under construction in this country? If these are all available under the present scheme, they will be available in the future, but no utility in this country, at least in the past decade, has taken advantage of any new construction. There are no generating facilities under construction now, and so you are going to benefit the environment and you are going to reduce prices at the same time?
Mr. GLAUTHIER. Most of the new generating units under construction are gas-fired and the gas-fired units are cleaner, on average, and are more efficient than the existing units.
Mr. JENKINS. Granted, and what is the size of those units generally?
Mr. GLAUTHIER. Three hundred megawatts.
Mr. JENKINS. And so compared to a big plant, then, they are very minimal in the overall scheme of things?
Mr. GLAUTHIER. Well, combinations of units will serve the same purpose. The gas-fired units are a very important part of this, but we think there needs to be a portfolio. All these fuel types are important. We do not want to emphasize just one fuel type.
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Mr. JENKINS. Mr. Chairman, there is no light on, so I assume my 2 minutes has expired. Thank you very much.
Mr. HYDE. Well, I hate to tell you that it has.
Mr. JENKINS. I hope you haven't turned my lights out completely, Mr. Chairman.
Mr. HYDE. No, sir. Dimmed them, yes. The gentleman from Arkansas, Mr. Hutchinson.
Mr. HUTCHINSON. Thank you, Mr. Chairman. I appreciate this hearing and the testimony of the gentlemen before us today. As I listened, it appeared to me that there is a theme that all of you, I believe, articulated, which is that as we go through restructuring, the traditional antitrust laws are not sufficient to address anticipated problems of market power, and that there are additional regulations that are needed particularly in the area of FERC, and that troubles me somewhat, and I wanted to explore that for a moment.
For example, if the owners of transmission facilities also acquire generation facilities, then they could engage in discriminatory access. I understand the Supreme Court has already ruled in Otter Tail Power Company that that kind of refusal to wield power over an essential facility violates existing antitrust law. Is that correct, Mr. Melamed?
Mr. MELAMED. That is correct.
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Mr. HUTCHINSON. All right. So if it is already a violation of the antitrust laws to do that, why is it necessary to grant FERC or any other regulatory body additional authority to accomplish the same result?
Mr. MELAMED. Well, Congressman Hutchinson, the Otter Tail case, as your brief summary made clear, had to do with a flat refusal by the defendant to wheel power. That kind of refusal is easy to observe and appropriate for antitrust authorities to bring proceedings against. The concern that we have, based on the experience in the 20 or 30 years since Otter Tail was decided, is that vertically integrated transmission owners that don't flatly refuse to wheel power can more subtly discriminate in favor of affiliated generation facilities and against competitors of affiliated generation facilities in ways that cannot be adequately observed, that would be very difficult to prosecute under the antitrust laws, and that in fact evade effective regulatory oversight by the FERC even under Order 888. And the proposed solution is a relatively deregulatory solutionalthough not completelyin keeping with the fundamental antitrust principle of preference for structural solutions and for market decision-making rather than for governmental regulation.
Mr. HUTCHINSON. You make a good point, and it gives me a better understanding of your point of view. It would appear to me that there would be three approaches. One would be the approach that you outlined, which is to give FERC greater regulatory authority to set guidelines in those gray areas. A second approach would be for the Department of Justice, as they have perhaps done in the Microsoft case, to push the antitrust laws to give the courts the opportunity to set standards and guidelines and direction. It appears to me what you are saying is that the antitrust law is sufficient, it is just that it has not been applied in some of these gray areas. The third approach would be for a statutory scheme in which this Congress passes such laws as necessary to address some of the gray areas that you are mentioning.
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I believe in aggressive antitrust enforcement approach by the Antitrust Division as you all have done. I think it gives us an opportunity to test these cases, see what the courts have to say. Do you wish to respond to that, Mr. Melamed?
Mr. MELAMED. Well, I appreciate your support for antitrust enforcement and certainly we too think that is appropriate under the right circumstances. I think the question that is posed in this context, however, is whether one can be confident that antitrust enforcement will be sufficient to guard against anticompetitive conduct in an industry as important as electricity, in a time of change and transition and under circumstances in which our experience, I think, has shown that it is very hard to observe, regulate, and I suspect also to prove in court the kinds of subtle discrimination that might be of enormous economic significance and that one can imagine from vertically integrated transmission and generation.
Mr. HUTCHINSON. You see, once the cat is out of the bag and Congress gives you the authority in a particular area, and you go too far afieldI am not saying you personally, I am referring in generaland there is no way to get that back. My concern is that we won't have enough influence if we go down the path of relying solely on antitrust enforcement. And so with that, Mr. Chairman, I yield back.
Mr. HYDE. I thank the gentleman. Mr. Watt, the gentleman from North Carolina.
Mr. WATT. Thank you, Mr. Chairman. I don't think I will take my whole 5 minutes, but I did want Mr. Melamed and Mr. Smith to elaborate on one concern or question that I had after hearing Mr. Melamed's testimony. I am interested in the notion that FERC would have the authority to order utilities to turn over their transmission systems to regional transmission organizations, and I wondered if you might be able to elaborate on that.
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First of all, how would you determine which regional transmission system organization would be the one that somebody would turn over their transmission facilities to? Second, is there some compensation that you assume would be associated with that? And elaborate a little bit, if you would, on how that would work. That sounded like you might be taking something that private companies currently own without the necessary quid pro quo, so to speak.
Mr. SMITH. I will take a crack at that. To address the second question first, the administration's proposal specifies a number of findings that the Commission would have to make before ordering either the formation of a regional system operator, or requiring a particular utility to participate.
Mr. WATT. Now, is requiring a company to participate the same as requiring turning it over? Are you using those terms interchangeably?
Mr. SMITH. Let me address that. There are at least two kinds of categories of regional transmission organizations. One is called an independent system operator, of which there are some examples already up and running. With an independent system operator, the current transmission owners retain ownership of the transmission facilities, but there is an independent body that actually operates them, doing the day-to-day grid operation. And in that case, there is an agreement between the operator and the transmission owners ensuring that the transmission owners get compensated for their capital costs and their costs of maintaining the transmission system. That is one structure.
A second structure which has been talked about is called a transco, or a transmission company, where the transmission assets, the ownership of the transmission assets, as well as the operation, are transferred to an independent organization. There is now at least one proposal in front of the Commission but there aren't any in operation yet.
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Mr. WATT. That would be a sale?
Mr. SMITH. That would essentially be a sale, although you can also imagine that it could be done by lease, for instance. So it might be something short of a sale of the whole fee interest.
Mr. WATT. Would the transco be a government entity or a private entity?
Mr. SMITH. A private entity.
Mr. WATT. A private entity, okay.
Mr. SMITH. There are debates about whether it should be for-profit or nonprofit or whether that should be left up to each organization. One of the findings that the Commission would have to make under the administration's proposal is that a utility that would be required to participate, either by turning over operation or ownership, would be fully compensated, that is, would receive fair compensation for those facilities.
Mr. WATT. Thank you, Mr. Chairman.
Mr. HYDE. Thank you, Mr. Watt. We have a visitor, a former member of our committee, who deserted us for greener pastures with the Commerce Committee, but the dynamics of this hearing have brought him back. Our rules do not permit visiting Congressmen to ask questions. However, one of us can take our time and yield it to the gentleman, and I am pleased to do that. So I will grant myself 5 minutes and yield to the gentleman from Tennessee.
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Mr. BRYANT. Thank you, Mr. Chairman. It is good to be back visiting. I can assure you that we are doing good work. I spent 4 to 5 hours in a hearing yesterday on the Commerce Committee, talking about commodes. But we also have a very important issue, as you pointed out in your opening statement, that we share and that is this issue of energy restructuring. As my good friend from Tennessee has said, we are trying to avoid the word ''deregulation'' now, because it is not going to be deregulation, simply restructuring. But I did have some particular questions of this panel, and I will certainly be brief in terms of the effect on TVA.
I represent people, consumers of power from TVA, and that is my first allegiance. But, as I have said many times before publicly, I also am concerned about what TVA will look like when this is over. And, Mr. Smith, in representing FERC, I am aware of the various plans out there. There are a number of plans, and maybe even more to come, that will deal with this restructuring issue. I am wondering how youor on behalf of FERC, if you can say thisto what extent would you visualize FERC regulating the TVA, in what areas?
Mr. SMITH. Well, first, I need to be clear that I am not speaking on behalf of the Commission. I can repeat, however, what the chairman has said on the subject generally, which is that one of the priorities for legislation is to apply the open access transmission rules to all transmission owners including TVA. Our open access rules currently apply to jurisdictional utilities under the Federal Power Act, which include investor-owned utilities and a few of the co-ops, but do not include the federally-owned utilities, most of the co-ops, or any of the municipal utilities.
Page 89 PREV PAGE TOP OF DOC One of the priorities he has identified is applying the open access transmission rules equally to the whole transmission grid becausethe transmission grid is integrated and the fact of who owns the particular facilities is notshouldn't be an impediment to applying open access. So that isI think that is what he would identify as the top priority with regard to TVA.
Mr. BRYANT. Would anyone on the panel suggest that in the area of antitrust that FERC or anyone else would have the authority to divest portions of the TVA? Does that make sense? Are we talking aboutas I understand divestiture, which would be out there, that some have suggested that the FERC have that abilityare you talking TVA there? Would you have the claim to power to go in there and tell them to sell off a generation facility?
Mr. MELAMED. Your question, I guess, went to FERC. The antitrust agencies would not have any power to order divestiture for the general reason that even where the antitrust laws apply, they don't prohibit the mere retention of lawfully obtained market power. So the issue is whether there would bethat would be subsumed in a new grant of authority to the FERC.
Mr. BRYANT. Somewhere I heard that mentioned FERC would have some ability to use divestiture. Are we talking about with TVA? Can you give me a quick answer because I have one more question.
Mr. SMITH. I will give you a quick answer. The administration bill contains a provision that allows the Commission, if it identifies market power in wholesale markets, to require a market power mitigation plan and to modify that plan if necessary to address market power. The way the provision is written, market power mitigation could include divestiture. What I don't remember without going and looking at the administration bill is whether it is written in a way that it would only apply to public utilities or whether it would apply to all utilities. I would have to look.
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Mr. BRYANT. In regard to this RTO concept where other folks will be controlling transmission lines other than perhaps the current owner and in developing new transmission lines which will have to be done, the requirements of obtaining the land, the sitingI know I talked a little about this yesterday in our meetinghow would FERCwhat powers would you envision FERC having in terms of being able to site new transmission lines across land and States and regard to property owners in those States? Do you envision FERC having any authority to take land?
Mr. SMITH. The chairman hasn't suggested that. It is not included in the administration's bill. The only thing I would observe is that regional transmission organizations might be able to help with transmission expansion by making a regional recommendation to each State for siting purposes as opposed to making it a State versus State discussion.
Mr. HYDE. The gentleman's time has expired. Does the gentleman desire additional time?
Mr. BRYANT. Mr. Chairman, could I have one more minute so the Deputy Secretary might respond. I believe he has an answer.
Mr. HYDE. I will yield myself one more minute and yield to you.
Mr. BRYANT. Thank you.
Page 91 PREV PAGE TOP OF DOC Mr. GLAUTHIER. On the last question, the bill that we propose does not allow the Federal Government, the FERC, to override States or other authorities to carry out the siting of transmission facilities. It defers those responsibilities to the States, where that authority rests now. It does encourage States to get together on a regional basis in those situations where there is a regional market or a regional need for new capacity for new transmission systems and the only authority it does grant is for the Secretary of Energy to convene a meeting of the parties in those States if they are not working together already to try to get them to talk together and see if there is something that can be done cooperatively.
Mr. HYDE. The gentleman's time has expired. Mr. Barr, does the gentleman choose to question at this time?
Mr. BARR. No, thank you, Mr. Chairman.
Mr. HYDE. Thank you. Mr. Bachus, does the gentleman choose to question at this time?
Mr. BACHUS. Yes, sir, I have one question. There have been suggestions that Congress give FERC the authority to order utilities to turn over their transmission lines to a regional transmission organization. I don't know if that has been covered in your other earlier questions but would FERC know which is the best transmission entity for that utility to join? And second, how does the utility that is forced to join a particular transmission organization deal with such tough issues as the pricing of its transmission system or governance of that system?
Page 92 PREV PAGE TOP OF DOC Mr. SMITH. The Commission's proposed rule making, which is ongoing now, is an attempt to move the issue of RTOs forward prior to legislation. It would provide a great deal of flexibility on what the regional configurations are, what the governing structure is, and how the pricing will work. It establishes some principles to be pursued on all three of those. On governance, the bedrock is that the transmission system would be operated independently of market participants in the generation market. On regional configuration, the idea is to take a number of factors that relate to the efficiencies to be gained by regional operation of the grid and look to those in assessing whether a region is sensibly configured. But the bottom line is it provides a great deal of flexibility for the market participants in any given region to try to work out a consensus on how to organize themselves on those issues. I would expect that if the Congress were to enact legislation along the lines of what the administration has proposed, in the first instance the Commission would look to parties in the region to try to develop a consensus on the issues identified, with some basic principles set out as guidelines for coming to those regional decisions. The proposed legislation is not specific about what criteria the Commission would use if such a regional consensus could not be developed.
Mr. BACHUS. Do you think you could suggest some? Do you think it would be important to develop some guidelines or principles?
Mr. SMITH. Well, as I say, the Commission right now, in the context of this rule making, is trying to provide some guidance. I am not sure whether that guidance would be appropriate statutory language once it is developed. It might be, but because of variations among regions in the country, I think they would need to be set out as principles, guidelines or policies, and not detailed strictures about how these organizations are going to work.
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Mr. BACHUS. Let me ask you a second question. With electricity demands growing, we are having some shortages throughout the Nation. And I understand part of that problem is the lack of being able to build transmission lines. What if you were building a transmission line, a transmission line was necessary not to benefit a particular State but in transmitting power from one region to another yet that did not benefit the State where you were trying to site the transmission line. Do you have any suggestions for Congress to encourage the States to allow these transmission lines to be located?
Mr. SMITH. As I think we have touched on briefly before, the administration bill has a couple of tools that might help. First, creating regional transmission organizations could provide a forum for multistate discussions of what transmission expansion is sensible from a regional point of view. Second, as the Deputy Secretary pointed out, the administration bill would authorize multistate compacts among State government officials to work on issues such as that.
Mr. BACHUS. What if you had a power company and it was not to their benefit to agree to the location or the building of a transmission line nor to the consumers in that State but it would be to the benefit of consumers in other States? What would you suggest to Congress as to how we would encourage those States to allow the building of those lines?
Mr. MELAMED. If I may, our bill does not have any provisions in that sort of case which would override States' rights, and we have various provisions that would encourage the States to work together. The parties ought to try to find a way to negotiate something that is in the interest of all the States involved, but at this point we do not recommend any legislation that would actually give a Federal override in those cases.
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Mr. HYDE. The gentleman's time has expired. I want to thank this panel for very instructive, learned, and productive testimony. We will feel free to call on you again either in writing or otherwise if we need your help, as I am sure we will. Thanks so much.
Our second panel consists of eight witnesses who represent various industry and State government perspectives in the electricity debate. Our first witness is Mr. Kenneth Hegemann of American Municipal Power-Ohio. Mr. Hegemann is a graduate of the University of Dayton. Before coming to AMP-Ohio, Mr. Hegemann served with the Ohio Department of Transportation, the City of Dayton's Highway Department and the City of St. Mary's, Ohio. Since then, he has been with AMP-Ohio in a number of positions, becoming its president in 1987. He appears today on behalf of the American Public Power Association.
Our second witness is the Honorable Glenn English, the president of the National Rural Electric Cooperative Association, and a former colleague in this body. He was first elected to the House from Oklahoma's 10th District in 1974. He served 10 terms in the House, during which time he chaired subcommittees of the Agriculture Committee and the Government Operations Committee. He became president and chief executive officer of the association in March 1994.
Our next witness is Mr. Mike Naeve, a partner with the Washington law firm of Skadden, Arps, Slate, Meagher & Flom. Mr. Naeve has a bachelor's and a master's degree from the University of Texas and a law degree from George Washington University. He served in the office of Senator Lloyd Bentsen and as a Federal Energy Regulatory Commissioner. After leaving the Commission in 1988, he joined Skadden, Arps as a partner in its energy practice, where he represents a number of major utility clients.
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Our next witness is Mr. Kellan Fluckiger, the vice president of Operations of the California Independent System Operator. Mr. Fluckiger is a graduate of Ottawa University. Before taking his current position, he worked at Pacific Gas and Electric, the Arizona Public Service Company, and the Idaho Power Company. He became the first employee of the California Independent System Operator when it was formed in May of '97 and took his current position in January '99.
Our next witness is Mr. Jim Sullivan, president of the Alabama Public Service Commission. Mr. Sullivan has a bachelor's degree from the University of Mississippi, a master's degree and a law degree from the University of Alabama. He was in the private practice of law before being elected to the Commission in '83 and he has served continuously in that position since that time. He also is president of the National Association of Regulatory Utility Commissioners and he appears here today on behalf of that organization.
Our next witness is Mr. Jim McGlynn, president and chief executive officer of McWilliams Electric Company in Schaumburg, Illinois. I might add it is one of the garden spots of the globe, Schaumburg, Illinois. It happens to be right next to my district. A classic American success story, Mr. McGlynn began with the company in '59 as an apprentice and worked his way to become owner of the company with 200 employees and 22 million in annual sales. He is active in numerous organizations within the electrical contracting industry and the greater community. He appears here today on behalf of the National Electrical Contractors Association and the National Alliance for Fair Competition.
Next we have Mr. Michael Travieso, the people's counsel for the State of Maryland. Mr. Travieso is a graduate of Washington College and University of Maryland Law School. Prior to his appointment as people's counsel, he served as an assistant U.S. attorney in Baltimore and as an assistant State attorney general. He also practiced law in Baltimore for 11 years and took his current position in August 1994. He appears here today on behalf of the National Association of State Utility Consumer Advocates.
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Our final witness is Dr. John Anderson, the executive director of the Electricity Consumers Resource Council. He holds a master's and a doctor's degree from the University of Florida. Dr. Anderson joined ElCon in 1980 and became its executive director in '84. He has spoken extensively on electricity issues from the consumer's point of view. He appears here today on behalf of Consumers for Fair Competition.
We do welcome all of you and look forward to your testimony. May I repeat my oft-violated prayer that you can hold your comments down to about 5 minutes. Don't leave anything that is indispensable out, but if you could, it gives everybody a chance to question. And so we will start with Mr. Hegemann.
STATEMENT OF KENNETH HEGEMANN, PRESIDENT, AMERICAN MUNICIPAL POWER-OHIO, ON BEHALF OF THE AMERICAN PUBLIC POWER ASSOCIATION
Mr. HEGEMANN. Thank you, Mr. Chairman and members. Good morning. I am Ken Hegemann, president of American Municipal Power of Ohio, here today representing the American Public Power Association, or APPA. My agency supplies power and services to 78 Ohio community-owned electric systems as well as two in Pennsylvania and two in West Virginia.
APPA represents the interest of over 2,000 community and State-owned electric utilities that serve one in every seven electricity customers in the U.S.
I am pleased to know of this committee's interest in what we believe to be perhaps the most important policy issue related to restructuring of the electric industry. That is, it is the question of how we can develop effectively competitive markets out of today's monopoly industry.
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Existing antitrust laws are insufficient to support this market transformation. The antitrust laws focus on the correction of abuses of a competitive market structured by those who would attempt to create a monopoly. In the case of electricity, a monopoly has existed and has been sanctioned by the State, and the first need is to eliminate the monopoly structure through the creation of a competitive market. Since today's vertically integrated utility companies will bring much of this existing market dominance into the restructured electric industry of the future, there will need to be a Federal regulatory agency that can detect and address market power in order to create an environment where competition can develop and be sustained.
There are seven issue areas that are related to market power and competitiveness that the Federal electric industry restructuring legislation must address. The first is strengthening FERC's merger review process to prevent further concentration of control in the Nation's electric generation transmission and subtransmission resources. Mergers should be denied unless the benefits to consumers outweigh the cost of losing a potential competitor from the marketplace. Secondly, strong structural remedies are needed to guard against horizontal generation market power, including FERC authority to intervene where market power develops and the ability to order divestiture of generation or transmission assets as a last resort remedy.
Third, broad and truly independent regional transmission organizations, or RTOs, must be created to address vertical market power. FERC should have the ability to establish RTOs and mandate participation by transmitting utilities. The hard lesson we have learned from efforts to develop competitive wholesale electric markets is that that is the only way to create an effective competition and to ensure that the entire transmission system is in the hands of a truly neutral entity that would treat all competitors the same. The Public Utility Holding Company Act, or PUHCA, should be repealed only as part of a comprehensive electric industry restructuring package that reserves the underlying consumer protection goals of the statute. Reliability rules must be enforced on an equitable basis. Reliability rules and their enforcement can have a significant competitive impact. It is essential that the reliability be maintained and enhanced in transition to a competitive market.
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Market information must be made available to guard against market power abuses. Market information is necessary to guard against abusive market power in the form of predatory pricing and to ensure that retail customers do not pay disproportionate rates as a result of deals made to secure lucrative commercial or industrial contracts. Preferential transactions between affiliates must be prevented. New competitors will not stand a chance in a restructured electric industry if the relationships between utilities and their affiliates are not guarded carefully.
Twenty-three States have enacted legislation or regulation to bring competition to the electric industry. APPA strongly supports the important role that States play in the driving industry restructuring process and believes consumers are best served if such decisions are made at the State or local level. The issue of market power is an exception in this area. While some States have taken action to address market power, the regional nature of electricity markets makes this uniquely a Federal issue. For State restructuring plans to work effectively, to enable competition to develop out of today's monopoly system, and to protect consumers during a transition to competitive markets, strong Federal protections against market power abuse are needed.
Thank you for the opportunity to appear today before you. APPA looks forward to working closely with you as you continue to consider these competitive issues in our restructuring efforts. Thank you.
[The prepared statement of Mr. Hegemann follows:]
Page 99 PREV PAGE TOP OF DOCPREPARED STATEMENT OF KENNETH HEGEMANN, PRESIDENT, AMERICAN MUNICIPAL POWER-OHIO, ON BEHALF OF THE AMERICAN PUBLIC POWER ASSOCIATION
61% of Americans live in the 23 states that have enacted legislation or regulation to bring competition to the electricity industry. APPA strongly supports the important role that states play in driving the industry restructuring process, and believes consumers are best served if such decisions are made on the state and local level. The issue of market power is an exception in this area. While some states have taken action to address market power, the regional nature of electricity markets makes this a uniquely federal issue. For state restructuring plans to work effectively, and to enable competition to develop out of today's monopoly system, strong federal protections against market power abuses are needed.
The electric utility industry in the United States today is dominated by private, vertically-integrated, regulated monopolies, with approximately 80% of our nation's generation resources controlled by incumbent utilities and their affiliates. These same utilities also own about 70% of transmission lines of 138 KV or greater. Since such levels of market power and concentration are antithetical to competition, it is evident that we have a long way to go from where we are today to achieve structural competition in this industry. Competitive markets do not require heavy regulatory or antitrust scrutinybut electricity is not a competitive market, at least not yet.
APPA member utilities are consumer-owned, and our policies are shaped by our strong interest in ensuring that the stated goal of competition is achievedthat all consumers benefit from lower prices and more choices. Any federal policy intended to foster competition in the electricity industry will fail in this regard if it does not provide the foundation for a new market structure upon which competition can be developed and sustained. To achieve this goal, policies must be enacted to:
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Strengthen FERC's merger review process to prevent further market concentration.
Create strong structural remedies to guard against generation market power, including FERC authority to intervene where market power develops; authority to order divestiture of generation facilities when necessary to address the abuse of existing market power, and authority to order divestiture of transmission facilities where a strong and effective Regional Transmission Operator is not in place that resolves transmission market power concerns.
Develop and encourage creation of regional, properly structured Regional Transmission Organizations (RTOs). Because RTOs exceed state borders, federal authority will be needed to establish RTOS and mandate participation by transmitting utilities.
Repeal the Public Utility Holding Company Act only as part of a comprehensive electricity industry restructuring package that preserves the underlying consumer protection goals of this statute.
Enforce reliability rules on an equitable basis in accordance with the North American Electric Reliability Council's consensus legislative language on reliability.
Provide for the provision of market information to guard against abuse of market power.
Prevent preferential transactions between affiliates, including discriminatory access to essential information, below cost transfer pricing, or other anticompetitive arrangements.
Page 101 PREV PAGE TOP OF DOCSTATEMENT
Good Morning, Mr. Chairman and members of the subcommittee, I am Kenneth Hegemann, President of American Municipal Power-Ohio, in Columbus, Ohio.
American Municipal Power-Ohio, or AMP-Ohio, is a nonprofit wholesale power supplier and services provider for municipal electric utility systems, including 78 of Ohio's 85 community-owned electric utilities, two public power communities in Pennsylvania and two in West Virginia. Our organization has 183 employees between our headquarters and power plant operations, and total operating revenues of more than $182 million. Ohio municipal electric systems receive their power supply from a diversified resource mix, including: wholesale power purchases through AMP-Ohio and on the open market; energy produced at the 213-megawatt, coal-fired Richard H. Gorsuch Generating Station operated by AMP-Ohio; individual community-owned generation facilities; and municipal generation joint ventures such as the 42-megawatt, run-of-the-river Belleville Hydroelectric Project. In 1998, the non-coincidental system peak for AMP-Ohio member communities was 1,848 megawatts, and our energy control center handled arrangements to move power across 18 different transmission systems.
For more than 15 years, AMP-Ohio has been involved in the competitive purchase and delivery of wholesale power as an aggregator for its members. Through interventions in regulatory proceedings involving Ohio investor-owned electric companies, Ohio municipal electric systems gained access to transmission wheeling and the ability to shop for electricity generation services long before the federal Energy Policy Act of 1992 required the wheeling of wholesale power. As a result, Ohio has experienced the benefits of a competitive wholesale electric market for many years, and Ohio municipal electric systems have played a key role in this arena. By the same token, our experience in the competitive market has provided us with first-hand examples of the presence of market power and underscores our position that market power must be addressed for retail competition to be a success.
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I am here today on behalf of the American Public Power Association (APPA). APPA is the national service organization representing the interests of over 2,000 municipal and other state and local government-owned utilities throughout the U.S. While APPA member utilities include state public power agencies, and serve many of the nation's largest cities, the majority of our members are located in small and medium-sized communities in every state except Hawaii. APPA members serve about fourteen percent of all kilowatt-hour sales to ultimate consumers in the U.S.
Market Power Policies Are the Foundation of Competition
Our association greatly appreciates the opportunity to testify before your committee today regarding market poweran issue that is at the very heart of the debate over electricity industry restructuring. A discussion about market power policy is really a discussion of how to develop an effectively competitive marketplace. As public power utilities purchase nearly 70% of the power used to serve their ultimate customersnearly 40 million people in the U.S.the competitive future of the electric power industry is critical to us.
The key ingredients for effective competition in any market include the existence of many buyers and sellers, freedom of entry and exit for competitors, and access to available market information. However, the presence of market power and concentration means that none of these criteria can be fully achieved. In fact, true competition can be defined as the absence of market power, for when a competitor can also set the rules for the game, you cannot have true competition.
Page 103 PREV PAGE TOP OF DOC Yet, high levels of market power are exactly what we have in our industry today. The electric utility industry in the United States is dominated by private, vertically-integrated, regulated monopolies, with approximately 80% of our nation's generation resources controlled by incumbent utilities and their affiliates. These same investor-owned utilities also own about 70% of transmission lines of 138 KV or greater. Since such levels of market power and concentration are antithetical to competition, it is evident that we have a long way to go from where we are today to achieve structural competition in this industry.
Some have said that Congress and regulators should let the market determine its future structure. What they really mean is: let the monopolists determine the market's structure. APPA disagrees. Competitive markets do not require heavy regulatory or anti-trust scrutinybut electricity is not a competitive market, at least not yet.
A transition from today's industry to a workably competitive marketplace will not just happen with the stroke of a pen signing state or federal restructuring legislation. As Federal Energy Regulatory Commission (FERC) Chairman James Hoecker has said, ''Good markets don't just happen, they are developed, structured, created.'' If we want to change the structure of this industry from monopoly to competition, the regulatory regime implemented by the federal government and the states must change as well. Not only do we need to guard against increased market dominance by today's incumbents, but it is also vitally important that we work to eliminate existing levels of market power that are certain to limit or inhibit the development of competition. A successful transition will require strong protections against market power abuses for consumers as well as rigorous oversight and enforcement that can transform the highly concentrated industry we have today into a vigorously competitive marketplace that offers meaningful benefits to electricity customers.
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A Challenge for Congress
Some states have taken steps toward addressing market power within their borders. For example, the State of Texas has enacted legislation that takes an important step toward addressing generation market power by mandating that a power generation company cannot own and control more than 20 percent of the installed generation capacity within a qualifying power region. In my home state, Ohio lawmakers recently passed electric industry restructuring legislation which addresses market power, including mandating participation in regional transmission organizations as a condition for receiving payment for ''stranded costs''. While such actions, alone, are very important, there is still a clear federal role in fostering competition that extends far beyond what individual states can accomplish.
Ultimately, the role of federal legislation should be to facilitate state decisions to implement retail competition by addressing issues that are necessary for retail competition to work, but which cannot be completely resolved by a single state or even a group of states. Transmission in interstate commerce, for example, has been regulated by the federal government for decades. Regional generation markets extend far beyond state boundaries. As a practical matter, an individual state cannot regionalize transmission, nor can states comprehensively address the generation market power of large multi-state or multi-national utilities. It is clear that these issues fall squarely within the purview of federal legislation.
Antitrust Laws Alone Are Not Enough
Why do we need new federally-implemented market power protections at all? Because we are talking about transforming an industry made up of state-sanctioned monopolies into an industry with many competing sellers. Existing antitrust laws are insufficient to support this market transformation. The antitrust laws focus on the correction of abuses of a competitive market structure by those who would attempt to create a monopoly. In the case of electricity, the monopoly has existed and been sanctioned by the state, and the first need is to eliminate the monopoly structure through creation of a competitive market. Since today's vertically-integrated utility companies will bring much of their existing market dominance into the restructured electricity industry of the future, there will need to be a regulatory agency that can detect and deal with abuses expeditiously in order to create and maintain an environment where competition can develop.
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The problem of moving from a monopoly structure to a competitive market is made more complex by the importance and unique characteristics of electricity. Electricity, because of its unique public service element and pervasive nature is not like other infrastructure industries that have been deregulated. First, electricity is an essential service for which there is no substitute. Consumers need electricity at virtually all times for health and safety and to enable businesses to operate. Second, the provision of electric service is a ''real time'' business. With minor exceptions, electricity cannot be purchased in times of surplus and stored for times of potential shortage. This fact substantially increases opportunities for market manipulation. Third, the generation and transmission aspects of this industry are highly interdependent. The way in which generation facilities are operated can significantly affect the capacity of transmission lines to allow electricity to be imported into an area.
These factorsthe lack of substitute products for many, the real-time nature of the business, and the interdependence of transmission and generationcombine to create numerous and frequently difficult-to-detect opportunities to exercise market power at particular locations, during particular seasons or times of day. The fact that the transmission system is often controlled by the same vertically integrated utilities that also control substantial amounts of generation makes manipulation of the system virtually inevitable.
For these reasons, addressing market power issues in the electricity industry presents unique challenges related to recognizing and addressing market power abuses that we believe FERC is best positioned to deal with in a new competitive environment. To succeed, however, FERC's authority under the Federal Power Act must be expanded. While the antitrust laws should remain in effect to allow for longer-term review, FERC also needs augmented authority to prevent anticompetitive activities from occurring, and to deal with them as they develop.
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In the past, FERC has focused on regulating the prices of monopoly providers of wholesale electric service to protect consumers. This oversight was necessary because vigorous competition has not existed to control prices. For deregulation to work and consumers to benefit, we must be sure that competitive pressures will, in fact, exist. As we move to competitive markets, FERC's mission must change from setting reasonable rates to a responsibility to establish and maintain workably competitive electricity markets. This major change in focus will require clarifying the authority of FERC to take a number of actions to eliminate existing market power, to prevent the development of increased market power, and to act swiftly to prevent market power abuses.
Strengthened Merger ReviewConsideration of the Effects on Emerging Competition
One important area where consumers need more protection relates to the merger review process. Rather than streamlining filing requirements, we should expand the scope of merger standards to ensure that today's mergers do not thwart tomorrow's competitive markets.
Concentration in ownership of electric resources in this country is increasing at an unprecedented rate as today's utilities engage in mergers to assure themselves a strong position in a competitive marketplace. The rapid pace of this trend toward consolidation is clearsince 1997, 33 mergers were proposed, and 22 completed. In contrast, only nine were proposed during the three years prior to that, 19941996.
Mergers are a defense against the advent of competition, and today's merger-mania is in direct conflict with the objective of creating competitive generation markets out of a highly concentrated industry. If competition is the goal, then mergers need to be considered in a way that prevents them from setting back the emergence of competition. Toward that end, newly proposed mergers should thus be denied, unless the benefits for consumers not otherwise obtainable through alternative means are shown to outweigh the adverse impact of eliminating a potential competitor from the marketplace. Where significant concentration in ownership of generation already exists without a merger, FERC should have authority to require divestiture or to solve the problem through other measures.
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Early last year, Joel Klein, Assistant Attorney General for the Antitrust Division of the U.S. Department of Justice, addressed concerns about the impact of the increasing trend toward mergers in a presentation before FERC. He noted that, ''. . . utilities may see this as a time when they have a window of opportunity in which to consummate mergers. Mergers with little immediate anticompetitive effect can nonetheless frustrate the emergence of competition. For example, incumbent dominant firms could pick off competitors in their infancy, or even before they become competitors . . . Missed opportunities for the emergence of competition at the outset of the transition are forever lost, with potentially substantial social costs.''
These considerations have been echoed by FERC Chairman James Hoecker, who has explained, ''While the Commission has aggressively encouraged a more competitive industry . . . it must ensure that mergers are not a vehicle to enhance market power.''
Perhaps the best and most visible example of how today's merger proposals can lead to anti-competitive future market dominance is the proposed merger of American Electric Power Company (AEP) headquartered in my State of Ohio, and Central and Southwest Corporation (CSW). The combination of these companies would create one private utility serving 4.6 million customers across eleven states, from Virginia and Michigan to Oklahoma and Texas, in a swath nearly spanning the entire Eastern Interconnection. It is no understatement to say that this merger would have far-reaching structural effects on bulk power markets. If approved, it may well set off a chain reaction of new electric utility mega-mergers as smaller competitors seek to merge to match or exceed the size of the AEPCSW combined company.
Page 108 PREV PAGE TOP OF DOC Such proposed mergers, if approved, will have the effect of predetermining the structure of the industry before state and federal regulators can implement a coordinated strategy to foster and enhance competition in the electric industry at the wholesale and retail levels. FERC and other regulatory agencies will have little power to turn back the clock to ensure a competitive environment, and the available options for defining and protecting the public interest will then be limited.
Because it is difficult at times to project what the impacts of today's decisions will be on an unknown and still-developing future market structure, APPA has suggested that a temporary moratorium on the largest electric mergers may be in order. In the absence of such a moratorium, it is important at a minimum to recognize that today's merger decisions are integrally related to the goal of competitive marketsand that FERC's merger review process must begin to take this fact into account by fully examining the effect of proposed mergers on competition.
Continued Concentration in Generation Markets Will Prevent the Emergence of Competition
Enhanced merger review authority is designed to address further concentration of control of the nation's electric generation resources. However, much must be done to address the existing control over generation that is now largely in the hands of a relatively small number of privately-owned utilities.
State policies that restrict the amount of generation that can be owned by a single corporate entity are a very important step in the right directionbut the next step has to be to ensure that the company that purchases the generation, a company located over state lines for exampledoes not then exercise the generation market power that the state statute was designed to guard against. Simply transferring ownership from one entity to another does not do enough to achieve the goal of a less concentrated market that is more conducive to effective competition. Because electricity markets are regional, state restrictions on the ownership of generation can go a long way. Yet, unless each state throughout the entire region enacts the same type of policy, ownership of generation in that market will remain highly concentrated, and consumers throughout that region will face limited choices and pay higher prices for power.
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Clearly, those who control the market today will seek to maintain their control at the expense of potential competitors. If our goal is a truly competitive marketplace, the face of today's monopolistic industry has to change. That is why there must be strong structural remedies to guard against both new and existing market concentration. This includes FERC authority to intervene where market power develops, and if needed, cause the corporate separation of generation from for-profit transmission companies. In addition, FERC should be able to prevent increased concentration in power markets when generators are sold by one utility and acquired by another. Without rigorous oversightand divestiture authority as a last resortmarket power abuses will choke competition before it can get a toehold in this industry. Again, because these markets are regional in nature, federal regulatory involvement is needed to protect consumers from the anticompetitive effects of market concentration throughout each region.
Market Power Resulting From Vertical Integration: Transmission Facilities Must Be Managed by Truly Neutral Entities
Private utilities that control vast amounts of the nation's transmission systems have a long history of denying municipal utilities access to their systems, or providing access at highly discriminatory rates and unfair terms. Despite congressional and regulatory actions to open up the nation's transmission grid and produce a competitive bulk power market through enactment of the Energy Policy Act of 1992 and the issuance of FERC Orders 888 and 889, private transmission owners continue to control essential transmission facilities in ways designed to prevent competition. They are able to exercise control over these facilities to favor their own generation resources, placing power generators and bulk power purchasers, including consumer-owned utilities, at a competitive disadvantage.
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One of the lessons of the Energy Policy Act is that the only way to ensure that the nations' transmission assets are managed in a way that facilitates the development of retail competition is to ensure that the entire transmission system is in the hands of truly neutral entities that will treat all competitors the same. Achieving this end will require enabling FERC to mandate that all transmission owners participate in an independent Regional Transmission Organization, and beyond that, to mandate divestiture of transmission from generation if necessary. In fact, the Federal Trade Commission has proposed the latter to FERC, suggesting that transmission operations be separated from ownership of generating plants in order to eliminate the incentives that exist for transmission owners to favor their own economic interests and evade regulatory constraints.
Clear evidence of abusive transmission practices can be seen in the June, 1998 price spikes in my State of Ohio and other parts of the Midwest, which caused spot market prices for electricity to soar from their normal level of about $25 per megawatt-hour to as much as $7,500 per MWh. In response, FERC Chairman James Hoecker later said that part of the answer to the kind of market confusion that occurred in the Midwest is the creation of independent system operators. This finding was amplified in the Ohio state regulators' report on this topic issued on November 19, 1998. The Ohio regulators contend that such price spikes are likely to recur unless institutions essential to a fair and competitive market are put in place. Large independent regional transmission organizations and separate independent power exchanges to provide real-time price information are the essential ingredients, they go on to explain.
There is no question that it is becoming increasingly difficult to have power transmitted from one utility's control area to another. For example, as recently as this past Friday, July 23, 1999, as illustrated on the attached print-outs from the Open Access Scheduling Information System (OASIS) bulletin board, there was no available transmission capacity across the Allegheny Power interface (the electrical connections between two systems) with First Energy. The same situation existed at the American Electric Power interface with First Energy. This lack of firm transmission availabilitywhether actual or notportends serious problems in electric supply and illustrates the necessity for separation of generation and transmission ownership. Restructuring the electricity industry without permitting access to the transmission systems is similar to deregulating the trucking industry and at the same time selling the interstate highway system to a handful of incumbent trucking companies. How does a trucking company compete without access to the interstate?
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Another example of transmission market power abuse occurred in the State of Wisconsin where Wisconsin Public Service Corporation and Wisconsin Power and Light Company used their control of significant transmission resources in the area to prevent one of our members, Wisconsin Public Power Incorporated (WPPI) and other smaller utilities from importing low-cost power from outside the state. In doing so, Wisconsin Power and Light even disregarded an earlier FERC directive to more equitably recalculate its available transmission capacity. In the end, not only did WPPI have to incur significant costs to gain access to the grid, but these private utilities enjoyed the benefits of their unfair actions for over a year before a FERC ruling brought these blatantly anticompetitive practices to an end.
Let me emphasize that APPA does not support the development of private, investor-owned utility (IOU) affiliated or controlled Transcos as an answer to these problems. Despite the arguments advanced for private, for-profit, Transcos either affiliated or otherwise controlled by IOU generators, they will not achieve the desired end of a truly competitive, economically efficient, lower cost, fair and open transmission grid, and should be rejected. They will not be truly competitive because they will lack the requisite independence from the parent corporation. They will not be economically efficient because they will not encompass a sufficiently broad geographic area. And, they will not produce a fair and open transmission grid because they will not incorporate the transmission facilities of publicly-owned and consumer-owned utilities.
APPA could support large, private, and investor-owned Transcos that have no affiliationabsolutely nonewith generation and marketing interests. However, even these truly independent Transcos would be natural monopolies that must be overseen by FERC to prevent transmission market power abuses. A better option, in our view, would be publicly-owned, not-for-profit, regional transmission organizations.
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In addition, it is important to note that public power utilities will be restricted from participation in future independent transmission organizations unless Congress enacts legislation to address the private use restrictions on our bonds. Municipal electric utilities that have issued tax-exempt bonds to finance their facilities under the old regulated monopoly framework face tough and potentially costly options for operating in the new restructured legal environment. If municipal utilities enter the competitive arena and violate the private use restrictions, tax-exempt bond financing on facilities utilized by private parties becomes retroactively taxable, leading to immediate bondholder lawsuits. The Bond Fairness and Protection Act, a bill introduced in the House as H.R. 721 by Representatives Hayworth (RAZ) and Matsui (DCA), and in the Senate as S. 386 by Senators Gorton (RWA) and Kerrey (DNE), is a compromise solution to the private use problem. If enacted, this legislation will accomplish two objectives: 1) Clarify existing tax laws and regulations regarding the private use rules so that they will work in a new competitive marketplace, and; 2) Provide encouragement for public power utilities to open their transmission or distribution systems, thereby providing choice to more consumers. These bipartisan bills have gained strong support in Congress, garnering 61 co-sponsors in the House and 25 co-sponsors in the Senate since introduction earlier this year. Congressional action in this area is urgently neededparticularly to address the needs of municipal systems in states that have already adopted restructuring plans.
Opposition to Stand-Alone PUHCA Repeal
APPA strongly believes that future repeal of the Public Utility Holding Company Act (PUHCA) must take place only in the context of a comprehensive electricity industry restructuring bill. PUHCA was enacted as a companion to the Federal Power Act in 1935 to, among other things, plug regulatory gaps created by multi-state holding companies that hadand still havethe ability and incentive to manipulate their books. Because of the interrelatedness of these statutesany legislation regarding PUHCA should be fully coordinated with changes in the Federal Power Act to protect consumers.
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Stand-alone repeal of the consumer protections afforded by PUHCA will unleash today's vast multi-state holding companies from public accountability before the structure of a competitive market is developed. It will enable today's monopolies to garner even greater amounts of market power through mergers and widespread diversification, and the existence of such significant concentrations of market power is sure to inhibit, if not prevent, the advent of structural competition in the electricity industry.
In addition, stand-alone PUHCA repeal presents unacceptable risks for captive electric consumers who do not have alternative service options if their utility's diversification efforts fail, or worse, non-regulated ventures are subsidized with captive ratepayer funds, and they are left to pay the price.
While many argue that PUHCA is an imperfect and perhaps outdated statute that is in need of reform, it is clear that the statute's goals of preventing market power abuses and harmful utility interaffiliate and diversification activities have great relevance to developing markets today. Even though the statute is ineffectively enforced by the Securities and Exchange Commission (SEC), it still provides valuable passive restraints on the formation of holding companies that extend the effect of the law far beyond the 15 multi-state holding companies that now fall under its direct purview.
Far from being irrelevant, PUHCA has recently provided channels through which to challenge the anti-competitive and anti-consumer effects of the proposed AEP/CSW merger. APPA and the National Rural Electric Cooperative Association have filed a Motion to Intervene with the SEC regarding the proposed merger on the grounds that it has failed to meet three important tests of PUHCA, which require that the merged company, 1) have its assets physically interconnected or capable of physical interconnection; 2) be confined in its operations to a single area or region, and; 3) not be so large as to impair the advantages of localized management, efficient operation and the effectiveness of regulation. These requirements have helped bring to light meaningful questions about the market dominance the merger would create, and its potentially devastating effects on the emergence of competition across several regions of the country.
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The reliability of the integrated and interdependent electric system is extremely important to health and safety and the viability of our economy. In the monopoly paradigm of the past, reliability has been protected by mutual back-up arrangements among utilities, and a regional reliability council structure. However, this system of cooperation and mutual assistance lacks both clearly enforceable rules and sanctions and competitively neutral entities to determine and enforce the rules on a non-discriminatory basis. This voluntary approach to reliability will not work in an increasingly competitive market. Reliability rules and their enforcement can have significant competitive impacts, and it is essential that reliability be maintained and enhanced in the transition to competitive markets.
APPA supports the North American Electric Reliability Council's (NERC's) Consensus Legislative Language on Reliability, which will create a self-regulating reliability organization that would be overseen by FERC. The mission of this new organization would be to ensure that reliability rules are applied equally to all electricity providers. APPA urges Congress to incorporate this language in any future restructuring package.
Restructuring legislation must also account for the importance of market information in a competitive marketplace. Private utilities' efforts to maintain confidential rate agreements threaten to place serious restrictions on the availability of market information in the electricity industry. Market information is necessary to guard against abuse of market power in the form of predatory pricing, and to ensure that retail customers do not pay disproportionate rates due to deals made to secure lucrative commercial or industrial contracts. Informed consumer choices depend on the availability of market informationit is a vital component of any competitive market.
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Protections Against Anti-Competitive Affiliate Transactions
Another role for FERC in protecting consumers should involve the prevention of preferential transactions between affiliates, including discriminatory access to essential information, below cost transfer pricing, or other anticompetitive arrangements.
If there is any doubt that anti-competitive affiliate deals will occur with seriously anti-competitive results, consider a recent case where a utility instructed its power marketing affiliate to check its OASIS Web site the following day at a certain time. At the appointed time, the utility posted an offer to sell a certain quantity of installed capacity and energy for a specified term at a particular price. The utility posted the offer for thirty minutes, and its affiliate requested all of the megawatts posted. In response, FERC issued a clarification on its rules barring affiliate favoritism, and said, ''Such a tip is market information that a utility cannot selectively disclose to an affiliate.'
New competitors will not stand a chance in a restructured electricity industry if the relationships between utilities and their affiliates are not guarded carefully.
In the end, market power policy is comprised of the many elements that are required to create the market structure upon which competition can be developed and sustained. Without strengthening merger review, prohibiting undue concentration in the ownership of generation, providing for neutral management of our nation's transmission resources, ensuring that reliability rules are enforced fairly, ensuring the availability of market information, and preventing harmful interaffiliate transactions, we believe that federal legislation to provide for competition in this industry is certain to fail. The consequences to consumers will be severeand the overriding goal of providing lower costs and more choices in the electricity industry will never be realized.
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APPA is a member of a broad coalition that includes organizations representing large and small utility consumers, small business and environmental interests that has been working to educate policymakers about the importance of market power issues in the debate over electricity industry restructuring. Our coalition, the Consumers for Fair Competition, represented here on the panel today, has developed a detailed proposal related to many of the issues I have raised today that we would be glad to share with you, Mr. Chairman, as your subcommittee proceeds with its review of market power issues.
Again, thank you for the opportunity to testify before you here today, and allowing us to share our view that market power policy is the key to a successful transition to effective competition in the electricity industry.
IN SUPPORT OF EFFECTIVE COMPETITION
Concentration of control over generation and transmission assets presents opportunities for dominant players in the electric utility industry to exercise market power in relevant markets. In order to limit opportunities for such anti-competitive abuses, statutory and regulatory safeguards have been used over time to prevent certain anti-competitive activity or provide regulatory remedies.
As the industry embarks on a dramatic restructuring, some have suggested that these safeguards are no longer necessarycompetition will serve to check potential market power abuses. Such wishful thinking is unfounded. Reconsolidation, formal and informal collusion, price manipulation, and affiliate favoritism has occurred in other formerly monopolistic industries. Similarly, there are reasons for continued market power concerns in the electric utility industry:
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The unprecedented wave of utility mergers suggests greater consolidation and resulting concentration of control in various regional and product markets;
In an open market environment dominant players are positioned to use their control of essential generation and transmission facilities to disadvantage competitors and distort market prices;
The Public Utility Holding Company Act provides significant antitrust and consumer protections. While its repeal may open doors to increased competition, it would create opportunities for self-dealing and other anti-competitive practices that must be addressed simultaneously with any such repeal;
Continued vertical integration presents an opportunity for transmission and distribution owners to game the system to advantage their own generation sales; and
Continued proprietary control of essential information disadvantages smaller market participants seeking to provide a competitive alternative.
The advent of retail competition is likely to present expanded (and more subtle) opportunities for market power abuses. Consequently, market power mitigation must be a central component of any federal legislation restructuring the electric utility industry. In order to protect consumers and promote effective competition, federal legislation must address opportunities to exercise existing market power, not simply prevent it from increasing.
Page 118 PREV PAGE TOP OF DOC NOW, THEREFORE, BE IT RESOLVED: That the American Public Power Association urges Congress, in any effort to restructure the electric utility industry, to take aggressive steps to mitigate market power in order to promote effective competition and protect consumers. Congress must establish effective guidelines for assessing the presence of market power and provide the Federal Energy Regulatory Commission (FERC) with all necessary authority to ensure its mitigation. Such actions must include, at a minimum:
A revised merger standard, in which mergers are rejected if they are inconsistent with effective competition or fail to produce net benefits not achievable absent the merger. The revised merger standard should provide FERC with clear authority to condition proposed mergers on divestiture of such generation and transmission facilities as necessary to prevent market power in any relevant geographic or product market. FERC should establish benchmarks, and retain ongoing oversight, to allow for post hoc relief if warranted by a merged utility's market performance needed to mitigate market power in any relevant regional or product market;
Authority to order divestiture of generation facilities when necessary to address effectively the abuse of existing market power.
Authority to order divestiture of transmission facilities where a strong and effective ISO is not in place that resolves transmission market power concerns.
Authority to prevent preferential transactions between affiliates, including discriminatory access to essential information, below cost transfer pricing, or other anticompetitive arrangements; and in the event of repeal or reform of the Public Utility Holding Company Act, the transfer to FERC of provisions under that Act necessary to prevent preferential or anticompetitive activities among and between affiliates;
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Authority to require that pricing information for all providers of services and products must be public and transparent.
Authority to ensure that reliability standards and requirements are adopted and enforced in a non-discriminatory and competitively neutral basis.
Provisions to prevent market manipulation and other anti-competitive practices, including, but not limited to: manipulation of dispatch of generation to create artificial constraints; failure to fairly and timely calculate and post available transmission capacity (ATC); refusal to engage in coordinated transmission planning; refusal to credit transmission facilities that are part of the integrated transmission grid; and prevention of predatory pricing by any provider of service or products; and
Clear and specific authority to require the creation of strong, truly independent ISOs in order to facilitate the development of vigorously competitive regional power markets.
BE IT FURTHER RESOLVED: That APPA will seek to assure that any federal restructuring legislation addresses adequately these core concerns.
IN SUPPORT OF EFFECTIVE INDEPENDENT SYSTEM OPERATORS
In order to assure that restructuring of the electric utility industry provides greater competition for the benefit of consumers, many utilities, state regulators, wholesale customers and other interested parties in the United States are considering the creation of Independent Transmission System Operators (ISOs) to control and operate regional transmission grids and to administer and provide transmission services under grid-wide tariffs. The primary purpose of ISOs is to separate control and operation of transmission facilities and the provision of transmission services from ownership and control of generation, so that transmission is available and provided on a truly neutral basis to all generation competitors. ISOs are also intended to provide a means to form regional transmission grids and eliminate rate pancaking in order to facilitate operation of regional power markets.
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The Federal Energy Regulatory Commission (FERC) has encouraged the creation of ISOs in its Order No. 888, and refined in Order 888A and various cases, and has set forth principles to govern the creation of ISOs.
In October 1996, a group of state utility regulators from 10 states issued a Declaration of Independence stating why transmission system operation must truly be independent from ownership of generation in a restructured industry. This Declaration of Independence call for the creation of strong, truly independent ISOs as part of industry restructuring and finds that such ISOs are essential to the creation of vigorously competitive power markets for the benefit of consumers. In this connection, the state of California has required the creation of an ISO in connection with its restructuring activities that will lead to retail competition. Several other states are considering this same issue.
NOW, THEREFORE, BE IT RESOLVED: That the American Public Power Association (APPA) supports the creation of strong, truly independent, regional ISOs consistent with the principles set forth in the state regulators' Declaration of Independence and FERC Transmission Access Orders.
Important elements of such ISO principles include:
An ISO should be independent of any individual market participant or any one class of participants. Its rules of governance should prevent control and appearance of control of decision-making by any class of participants.
Page 121 PREV PAGE TOP OF DOC An ISO should provide open access to the transmission system and all necessary services under its control, operated as a regional transmission grid at nonpancaked rates pursuant to an unbundled, grid-wide tariff that applies to all eligible users in a non-discriminatory manner.
An ISO should develop mechanisms to coordinate with neighboring control areas and to coordinate power scheduling with other entities that operate transmission systems.
An ISO should make transmission system information publicly available on a timely basis via an electronic information network.
An ISO and FERC-approved regional transmission groups (RTGs) should have authority to require construction, or to construct, new transmission facilities necessary to eliminate bottlenecks or preserve or enhance reliability.
BE IT FURTHER RESOLVED: That APPA supports effective Independent System Operators and FERC-approved RTGs that are responsible for the coordination of power supply operations and planning as necessary for the purpose of maintaining and improving reliability.
BE IT FURTHER RESOLVED: That APPA supports the inclusion of provisions in federal restructuring legislation that give the FERC clear and specific authority to require the creation of strong, truly independent ISOs in order to facilitate the development of vigorously competitive regional power markets.
IN OPPOSITION TO PRIVATE, IOU AFFILIATED OR CONTROLLED ''TRANSCOS''
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The transmission access provisions of the Energy Policy Act of 1992, and their implementation by the Federal Energy Regulatory Commission (FERC) through the issuance of Orders 888 and 889, were intended to open up the nation's transmission grid and produce a healthy, competitive, bulk power market.
Despite the congressional and regulatory actions, private transmission owners have continued to control essential transmission facilities in ways designed to prevent competition. They are able to exercise control over these facilities to favor their own generation resources, placing power generators and bulk power purchasers, including consumer owned utilities, at a competitive disadvantage. By mid-1998, allegations of abusive practices by private power company owners of transmission facilities began to surface, prompting members of the FERC to question whether functional unbundling of transmission assets was sufficient to prevent such practices.
Late in 1998, FERC announced its intent to take the next step forward to achieve the congressional goal of a competitive bulk power market by exploring what additional steps needed to be taken by the commission to establish a more competitive bulk power market, including in particular the creation of truly independent regional transmission organizations.
As concerns were mounting over anticompetitive abuses of transmission facilities, various private power companies came forth with their preferred solutionprivate, for-profit, affiliated or subsidiary transmission companies, or companies that were not truly independent because they would be tied closely by contracts or interlocking boards of directors to the former owner. Proponents of these transcos dismissed not-for-profit independent system operators as bureaucratic, inefficient, and incapable of managing or expanding the transmission grid in the public interest.
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Despite the arguments advanced for private, for-profit, transcos either affiliated or otherwise controlled by investor owned utility (IOU) generators, they will not achieve the desired end of a truly competitive, economically efficient, lower cost, fair and open transmission grid and should be rejected.
They will not be truly competitive because they will lack the requisite independence from the parent corporation. They will not be economically efficient because they will not encompass a sufficiently broad geographic area. And they will not produce a fair and open transmission grid because they will not incorporate the transmission facilities of publicly owned and consumer-owned utilities. Higher costs will occur because the IOU owners of transmission hope to spin off their transmission facilities to newly created transco companies at market value, not at book value. The owners of these facilities would reap windfall profits from such transactions that would be paid for by all electric consumers.
Many public power systems have suggested that the transmission solution most in the public interest is the creation of truly independent system operators or other institutions that are controlled by the public and operated on a not-for-profit basis. Such entities will not just be independent from market participants, but just as importantly, will be responsive to the concerns of all stakeholder groups. Such institutions, whether they simply control the transmission grid or own the transmission facilities, would enjoy the trust and confidence of the public, act in the public interest to pursue the most cost-effective solutions to deal with transmission constraints, and provide the lowest cost for consumers.
NOW, THEREFORE, BE IT RESOLVED: that the American Public Power Association opposes the creation of IOU transcos, whether established as affiliates or subsidiaries of the parent corporation, or tied to the parent through contractual arrangements or interlocking boards of directors, because they would not and could not be truly independent of their corporate parent, would perpetuate-not eliminatethe ability of these IOUs to manipulate their transmission assets to favor their own corporate goals of higher profits at the expense of consumers, would not be of sufficient size to capture the benefits of a broad geographic market, would not lend themselves to light handed regulation, could be used as a vehicle to increase the total cost of transmission, would not have an open governance structure, and would not and could not incorporate the facilities of consumer-owned electric utilities; and
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BE IT FURTHER RESOLVED: that the American Public Power Association strongly urges the FERC to reject proposals advanced by IOUs to create transcos that are affiliated with the parent company or otherwise controlled by it as the solution to current problems regarding open, fair and non-discriminatory transmission access that will promote competition in the bulk power market for the benefit of all electric consumers; and
BE IT FURTHER RESOLVED: that based on over a century of low-cost, highly efficient operations by the nation's publicly owned utility systems, the American Public Power Association categorically rejects the proposition that publicly owned, not-for-profit transmission institutions controlling or owning regional transmission grids would not or could not manage the grid effectively and efficiently, including taking steps to eliminate transmission constraints in the most cost-effective manner to protect both the public interest and the interests of electric consumers.
Approved by the American Public Power Association 6/22/99
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Mr. GEKAS. [Presiding.] We thank the gentleman and we turn to Congressman English.
STATEMENT OF GLENN ENGLISH, PRESIDENT AND CEO, NATIONAL RURAL ELECTRIC COOPERATIVE ASSOCIATION
Mr. ENGLISH. Thank you very much, Mr. Chairman. I appreciate the opportunity to visit with you today about restructuring the electric utility industry. Let me just say very quickly it is my understanding that the focus is on one narrow aspect of restructuring or what may come from restructuring; namely, market power. And certainly I think this committee is to be commended for looking at this particular issue.
First of all, a word about who the electric cooperatives really are. A lot of people who don't deal with this don't have a very good understanding of who electric cooperatives are and what we are all about. We are some 1,000 privately, consumer-owned electric utilities. The consumers themselves actually own the utility and it is some 32 million consumers in 46 States all across this country that make up the electric cooperative family.
Page 126 PREV PAGE TOP OF DOC Mr. Chairman, electric cooperatives were born out of bad things, bad things that happened because of market power, market domination back in the 1930's. In fact, before we had regulation, and the product of regulation after all came out of an unregulated marketplace, was the situation in the 1920's in which we had some 13 holding companies actually having 75 percent of the Nation's utilities in their control. Only three holding companies back in the 1920's controlled 45 percent of the Nation's generating capacity, and it is for this reason that we had regulation that came about in the electric utility industry.
We had, as a result of some of the abuses that were taking place back in those days, the issue of the Public Utility Holding Company Act as a way of protecting consumers. It is a consumer protection device and it was meant to deal with market power abuses and it was mainly to protect small residential and small business consumers of this Nation.
Now we are talking about changing that, changing the rules once again, and we are talking about bringing competition back into this industry and we are already seeing some signs of some of the gathering of market power similarly to what we had back in the 1920's. And in fact, many of the utility mergers that have been accelerating very dramatically here in the last two or 3 years are obviously aimed at garnering market power in this country.
The electric cooperatives, as I mentioned before, are the little guys. Two-thirds of our load are to residential small business consumers. With regard to the big power companies, it is the exact reverse of that. Two-thirds of their load are industrial and large commercial. And certainly under electric utility restructuring, this whole concept of market power would shift from a consumer side to the large commercial and industrial loads; that is, to people who obviously have been trying to sell to just as they did over 60 years ago. So the benefits of any kind of restructuring are in no way guaranteed for residential or small business consumers in this country. They don't have the market presence. They don't have the purchasing power that many in large industries and large commercial affairs will obviously have. And they are going to be subject to a much greater price and supply of volatility.
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Mr. Chairman, this is, summed up, an indication of what kind of shift that we can expect in restructuring and in response to an employee inquiry from the president of the Energy Services Business Unit of Cinergy who wrote this in an employee newsletter that was published. He says, in a restructured environment, we can't protect all the consumers and we shouldn't try to. We shouldn't try to keep all the consumers and not all the consumers are profitable for us today. And that is true of both the commercial industrial consumers as well as retail customers. Currently we have an obligation to serve, which we do very well but under deregulation or I should say after deregulation is a reality and we no longer have an obligation to serve, we can't afford to hang on to lost customers or even marginally profitable ones. Our resources will be focused on consumers who give us a targeted rate of return expected by our shareholders.
Now, that is a very candid and a blunt assessment of what the situation is, but I would suggest it is also a very honest assessment, Mr. Chairman, and also an indication of the concern that must be focused on regarding what happens to the residential and small business consumers who no longer are served by people who don't have an obligation to serve and in this kind of competitive environment, there is no obligation to serve and certain Members of the Congress, I think, must come to grips with that.
I would suggest, Mr. Chairman, the whole issue of restructuring is not clear cut and Mr. Jenkins and certainly Mr. Hutchison, I think, were alluding to that in their questions. They got at the fact that this is not a very simple easy call and it is not a case in which it is all going to fall to the good with no bad. It is going to be very murky and very cloudy and there will be those people who simply will fall by the wayside and will not benefit because of these kind of changes just as took place 60 years ago.
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After all, that is how a group of farmers, people who no one wanted to serve, no one would provide electric power for, the people who didn't have the purchasing power, the people who weren't in areas where there was a market power concentration, those are the people that had to go out and do it themselves, and they found this device, this business model, cooperative business model and they found it was something which individual citizens could come together, join together and do it themselves and they were highly successful, Mr. Chairman. And 60 years later, I think most people would say that it is probably one of the great accomplishments in the 20th century and I know many in government have said the partnerships that they formed with those individuals through RUS Government loans that made it possible to build those systems certainly, that was one of the better government programs we have seen in the 20th century.
So it is something that benefited everyone, but in this kind of environment once again we are going to find people that are dispossessed, and certainly given some of the questions I have heard this morning, and I think accurately so, it may not all be solved by simply more government regulation and some may be surprised to hear me say that because I am extremely concerned about market concentration, but I am not convinced that a great increase in government regulation, especially when we are talking about deregulation in a restructuring piece of legislation, makes a whole lot of sense in itself.
So I would suggest to you, Mr. Chairman, there may be another alternative that can compliment whatever government regulations either this committee or other committees feel are necessary, and that is empowering the people, empowering the people just as those people 60 years ago were empowered and given the opportunity to do it themselves. I would suggest that it makes a lot of sense to make sure that the people of this country who may not be satisfied, who may not be happy with the electric provider that they have, who may feel that in some way they are abused or taken advantage of, who may be victims of market power, let them come together and aggregate. Let them form their own electric cooperatives, let them provide themselves with their own electric power and make sure there are no obstructions in the way. Clear the way and let the people do it themselves.
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That in the end, Mr. Chairman, may be one of the finest actions that this committee or any other committee can take is to recognize that to empower individual consumers and to make sure that there is no government obstruction that would discourage or prevent them from carrying out activities similar to what those farmers did 60 years ago. That may indeed may be one of the best actions that this committee can take.
So in the end, Mr. Chairman, I would simply point out to you that already we have seen two new electric cooperatives formed that are doing just that, one in New York City who are dissatisfied with the electric provider they have, Consolidated Edison. They formed their own electric utility and they are in the process now of providing power to those people who own that utility, the consumers.
In California we have a different kind of electric cooperative made up of small businesses, mainly agribusinesses, who have come together and are providing electric power for themselves. Neither receive any kind of government funding. Neither receive any kind of benefit from the State. It is simply a group of citizens who have done it themselves.
I would urge this committee to make sure there is nothing that would discourage consumers in the future from doing this in a restructured environment. In fact, I would urge this committee to make sure every encouragement is made to those citizens to take care of their own needs. Thank you.
[The prepared statement of Mr. English follows:]
Page 130 PREV PAGE TOP OF DOCPREPARED STATEMENT OF GLENN ENGLISH, PRESIDENT AND CEO, NATIONAL RURAL ELECTRIC COOPERATIVE ASSOCIATION
Chairman Hyde, members of the Committee. For the record, I am Glenn English, Chief Executive Officer of the National Rural Electric Cooperative Association (NRECA). NRECA is the Washington-based association for the nation's nearly 1,000 consumer-owned, not-for-profit, privately owned electric systems. These systems provide electric service to more than 32 million consumers in 46 states.
I appreciate the opportunity to appear before the House Judiciary Committee to discuss the risks that increasing consolidation and market concentration pose for consumers in the electric utility industry and to make some suggestions as to how Congress can address those risks.
As the Committee knows, the electric utility industry is in a period of dramatic transformation, with new competitive markets developing at both the wholesale and retail levels.
For more than 60 years, the electric utility industry was characterized by large vertically-integrated monopolies. During that time, consumers were protected from market abuse by a network of state and federal regulatory structures, including comprehensive state regulation of retail markets, comprehensive federal regulation of wholesale markets and interstate transmission pursuant to the Federal Power Act, and federal limitations on the structure of the industry pursuant to the Public Utility Holding Company Act.
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The changes now being made by the states and being debated by Congress would remove many of those consumer protections. Unless Congress acts aggressively to replace that web of regulation with new market and consumer protections, restructuring will lead to unregulated monopolies not competition, and consumers will see only higher rates, worse service, increased market volatility, and reduced innovation.
NRECA believes that there are several specific measures that Congress can and should take to protect consumers and competition from undue market concentration:
Congress should protect consumers' right to protect themselves, by:
Guaranteeing all consumers the right to join and purchase power from a cooperative. Where that option is not available, they should have the right to form their own cooperative.
Removing outdated and unnecessary legal barriers that make it more difficult for cooperatives to compete, including unnecessary restrictions in cooperative incorporation laws, tax laws, and antitrust laws.
Refraining from imposing costly new layers of federal regulation on electric cooperatives, including expanded environmental regulation and new regulation by the Federal Energy Regulatory Commission (FERC).
Congress should slow the consolidation of the electric utility industry to ensure that the competitive market has time to grow strong without undue influence from a few large utilities. Congress should:
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Impose a 2-year moratorium on electric utility mergers involving more than 1-million meters.
Clarify FERC's authority to review mergers between public utility holding companies;
Clarify FERC's authority to review acquisitions of natural gas pipelines and gas utilities by public utilities;
Strengthen FERC's merger review standards for electric utility mergers involving more than 1 million meters, while streamlining FERC's merger review process for mergers between small entities that create more viable competitors;
Refrain from repealing PUHCA unless Congress replaces it with new strong market and consumer protections.
Congress should encourage voluntary regional transmission organizations and should remove artificial barriers to full participation.
Congress should preserve FERC's authority to regulate public utilities' wholesale Congress sales of electric power.
Congress should require FERC, the Department of Justice, and the Federal Trade Commission to conduct a joint study of market power issues in the electric utility industry and to come up with suggestions to better define, measure, and prevent the acquisition and abuse of market power.
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Chairman Hyde, members of the Committee. For the record, I am Glenn English, Chief Executive Officer of the National Rural Electric Cooperative Association (NRECA). NRECA is the Washington-based association for the nation's nearly 1,000 consumer-owned, not-for-profit, privately owned electric systems. These systems provide electric service to more than 32 million consumers in 46 states.
I appreciate the opportunity to appear before the House Judiciary Committee to discuss the risks that increasing consolidation and market concentration pose for consumers in the electric utility industry.
Changes In The Industry
As the Committee knows, the electric utility industry is in a period of dramatic transformation, with new competitive markets developing at both the wholesale and retail levels.
This process began in 1992, with Congress' enactment of the Energy Policy Act (EPAct). With EPAct, Congress encouraged the development of a wholesale market for electric energy by opening the transmission system to competition and by allowing the formation of independent, non-utility power generators.
NRECA was a strong supporter of EPAct. For the first time, EPAct's open access provisions and the competitive wholesale market that it engendered freed cooperatives from the monopoly power of investor-owned utilities.
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To explain, please allow me to provide some background about rural electric cooperatives. Electric cooperatives are the original aggregators. In the early 1930s, most urban consumers had access the benefits of electricity, but the investor-owned utilities were unwilling to extend their lines to rural areas. They considered rural consumers to unprofitable. Those rural consumers that the investor-owned utilities would not serve formed their own electric cooperatives to bring power to their communities. Those consumers strung up their own distribution lines across tens of thousands of miles of rural America.
But, as independent as these rural consumers were, and are, they were still dependent on their neighboring investor-owned utilities for generation and transmission service. Nationally, electric cooperatives generate only about half of the power they need. And, even where they generate their own power, most electric cooperatives are ''transmission dependent,'' they rely on their neighboring investor-owned utility to transmit power from their generating plants to their distribution networks.
Prior to EPAct, those neighboring investor-owned utilities forced many cooperatives into expensive wholesale power contracts at prices far above competitive levels. Those investor-owned utilities denied cooperatives the transmission service they needed to reach other lower cost power supplies. Where cooperatives wanted to build some generation of their own, those neighboring investor-owned utilities refused to wheel the power unless the cooperatives took their remaining power requirements from the investor-owned utility at inflated prices.
EPAct, and then Order 888, allowed cooperatives to go to the market for their energy requirements or build their own generation and be certain that they would be able to transport that lower cost power to their members.
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Now, we are watching competition move from the wholesale level to the retail level. Twenty-two (23 if Oregon acts soon) states have adopted laws or regulatory regimes that will eventually result in customer choice for electricity and related services. Virtually every other state is seriously reviewing whether retail choice is the right fit for their particular circumstance.
And, as you know, Congress is also looking at legislation that would require or encourage the states to implement retail competition. Your colleagues in the Energy and Power Subcommittee have been extremely busy all spring holding hearings on restructuring issues, including market power.
As it did at the wholesale level, retail competition could bring substantial benefits to many consumers. Effective competition properly implemented brings most consumers lower prices, improved service, and greater technological innovation.
That presumes, however, that there will be strong competition in the electric utility industry for all consumers. If a few dominant companies are permitted to keep or acquire undue control in any market, or if competition fails to develop for less attractive consumers, deregulation could instead bring unregulated monopolies, higher prices, supply volatility, and restrictions on innovation.
We aren't yet where we need to be. As the Federal Trade Commission (FTC) has said in testimony before the Energy and Power Subcommittee, ''the starting point for competition in the electric power industry is not the level playing field characteristic of a newly developing market.'' For more than sixty years, the electric utility industry has been characterized by large, vertically integrated monopolies formed with the blessing of state and federal regulators. During that time, utilities were allowed to merge and grow without concern for market power because regulation prevented market power abuse.
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Given that existing structure, states and Congress cannot presume that a competitive market will form automatically as soon as the industry is deregulated. In two states, for example, Utah and Colorado, restructuring has been delayed in part out of concern that the single dominant utility operating in each state would be able to stifle competition. Chairman Hoecker of the Federal Energy Regulatory Commission (FERC) was right when he said, ''Good markets don't just happen, they are developed, structured, created.''
And, as Ronald Binz, Director of the Competition Policy Institute has said, ''We have only one chance, at the beginning of electricity restructuring, to get things right . . . The United States Congress and state and federal regulators need to use this opportunity to make sure consumers actually see the benefits of competition by eliminating significant market power.''
For that reason, I applaud this Committee for holding this hearing.
In this testimony, I would like to discuss each of the reasons why market concentration poses a particular risk in the electric utility industry and propose some approaches Congress may take to address each of those underlying risks.
Dominant Players Can Abuse Market Power In Many Ways
First, let me define what I mean by market power. Market power is the ability of a market participant to raise and maintain prices above a competitive level, that is, above the marginal cost of production. Even where prices are held at existing rates, market power can permit a provider to reduce the quality or variety of services and to exclude new technical and other innovations from the market.
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Thus, by definition, market power denies consumers the benefits that restructuring and competition are intended to bring. Market power denies consumers the lower prices, improved services, and increased innovation that they have been promised by proponents of restructuring.
Economists talk about two types of market power: vertical and horizontal. Vertical market power can be exercised in the electric utility industry when an owner of both transmission and generation operates its transmission system to favor its own generation. Transmission owners can reduce the transmission available to competitors, by strategically operating their transmission system, by manipulating their dispatch of generation on the system, by manipulating their calculation of transmission available on the system, and by giving themselves and affiliates preference either in reserving available transmission capacity or in the price paid for service.
Transmission owners can also reduce the reliability of transmission available to competitors by interrupting competitors' transactions before their own. A customer need only be interrupted a few times before they get the lesson that they are better off purchasing power from the transmission owner, even if it is a little more expensive.
Public utilities engaged in both regulated utility functions and unregulated activities, such as generation, can raise prices for captive transmission and distribution customers to subsidize their competitive power sales.
Vertical market power can also be exercised by owners of necessary inputs for power generation, such as natural gas or gas pipelines. Such companies can impose higher costs on competitors by increasing prices, restricting available resources, or reducing the reliability of service for these inputs.
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Horizontal market power in the electric utility industry can be exercised by dominant owners of generation. A single dominant player, or several players working together, can set prices in the market. Such companies can raise costs simply by withholding generation from the market. When prices for reserve services in California climbed from a normal price of well under $100 MWH to $9,999 MWH in 1998, the California ISO suggested that prices spiked because a few dominant suppliers withheld capacity from the market until prices had reached astronomical levels.
Dominant owners of generation can also engage in predatory pricing: lowering prices to drive competition out of business and then raising prices above competitive levels. Just the risk of predatory pricing can keep potential competitors from entering the market.
Utilities May Not Compete To Serve the Less Attractive Residential and Rural Consumers
Effective competition presumes that there are many competitors seeking to serve the same customers. The Federal Trade Commission has stated that competition requires at least six, and preferably 50 competitors all offering customers the same product. It appears unlikely that we are going to see that happen for all customers in a restructured environment.
In states that have already implemented retail competition, we have generally seen at least that number of companies offering electricity and energy services to large commercial and industrial (C&I) customers. But, we have not seen anywhere near that number of competitors willing to serve residential customers.
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In Rhode Island, there are many competitors willing to serve C&I customers, but not one willing to serve residential customers. In Massachusetts and California, there are only a few competitors willing to serve residential loads, and those competitors are offering only a premium servicegreen power. No one is competing on price for those residential customers.
In Pennsylvania, there are actually several competitors offering a variety of electric service plans to residential customers in Pittsburgh and Philadelphia. Unfortunately, rural customers have not seen the same choices. Pennsylvania's electric cooperatives voluntarily opened their territories to competitors ahead of schedule on January 1, 1999. They wanted their member-consumers to have the benefits of competition. But, there is not even one alternative energy supplier willing to serve those cooperatives' residential customers.
Why aren't electricity suppliers competing for residential consumers? Because it costs more to recruit, keep, and serve residential customers. They simply are not as profitable to serve as C&I customers and investor-owned utilities and power marketers want to serve only the most profitable customers.
In an internal newsletter for employees Cinergy, a large investor-owned utility, the president of Cinergy's Energy Services Business Unit stated:
we can't protect all the customers. We have limited resources and must use them to ensure we hang on to the highest value customers. . . . After deregulation is a reality and we no longer have an obligation to serve, we can't afford to hang on to loss customers and even marginally profitable ones. As any company in a competitive environment, we'll focus our resources on those customers who will give us the targeted rate of return expected by our shareholders.
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There is nothing ''wrong'' with Cinergy's approach. As an investor-owned utility, they have an obligation to their shareholders to make a profit. But, it does suggest that effective competition may not develop in the short term in the retail market for rural and residential consumers.
That has certainly been the experience for rural and residential customers in each of the other industries that Congress has deregulated in the past decade. Ask yourself whether you pay less today as a residential consumer for cable service than you did before deregulation. Most residential consumers pay more today and experience worse service.
The same is true for those who fly into rural communities. Airline deregulation has brought lower prices for consumers that fly into larger cities served by multiple carriers. But, consumers flying into or out of cities served by only one or two providers, including most rural communities, now pay considerably more for less service. There are far fewer flights into such communities, and little jet service.
The same is also true in the railroad industry. Deregulation of the railroad industry has led to the deterioration of service to rural communities. Railroads have abandoned many lines serving rural communities and have reduced service to communities they still serve. Many farmers who could once ship their crops to market by rail must now pay much more to ship by truck.
Even telecommunications deregulation has been hard on residential consumers. It is true that prices are down for long-distance service, and that consumers have many new service choices, such as call-waiting and caller i.d. But competition has never developed for local exchange service, and the cost of that basic local service has increased considerably. The millions of small consumers that do not make many long-distance calls and do not need fancy new gee-gaws are worse off under competition. They have to pay more for the one simple service they need and they have to put up with annoying and intrusive dinner-time calls offering them long-distance services they do not want.
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So, how does Congress protect residential consumers in a non-competitive but deregulated market for retail electric energy. How can Congress protect consumers from unregulated monopolies?
That is where I believe the cooperative option plays a key role. Electric cooperatives, as consumer-owned not-for-profit utilities, have long provided service in rural areas where investor-owned utilities were unwilling to serve. When the market would not provide for them, consumers provided for themselves. With the help of the Rural Electrification Administration and now the Rural Utilities Service, consumer formed their own electric companies to provide them with electric service.
Because the competitive market today may not well serve residential customers it is more important than ever that consumers have the ability to protect themselves by choosing the cooperative option.
That option is important today not just in rural areas, but everywhere in the country. In New York City, for example, housing cooperatives have joined together and formed the 1st Rochdale Electric Cooperative to increase the buying power of residential consumers in a competitive market place.
There are a number of concrete steps Congress can take to protect consumers' ability to protect themselves from imperfect markets. First, Congress should guarantee all consumers the right to join and purchase power from a cooperative. Where that option is not available, Congress should guarantee consumers the right to form their own cooperative.
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Second, Congress should remove outdated and unnecessary legal barriers that make it more difficult for cooperatives to compete. Congress should remove restrictions on the types of services that consumers can provide themselves through a cooperative and eliminate tax rules that would penalize cooperatives that provide open access to their transmission and distribution systems.
Finally, Congress should refrain from imposing costly new layers of federal regulation on not-for-profit consumer-owned electric cooperatives in the restructuring process. For example, Congress should reject those restructuring proposals that would dramatically expand environmental regulations. Because of cooperatives' smaller size, and because they have no shareholders to share to cost, the burden imposed by new environmental regulations would have a disproportionate effect on the competitiveness of cooperatives.
Congress should also reject restructuring proposals that would subject electric cooperatives to significantly expanded regulation by FERC. Those proposals are unnecessary either to protect reliability or the market for electric energy. Their only effect would be to dramatically increase the regulatory cost incurred by electric cooperatives, imposing a punitive burden on consumers that choose to provide for themselves through the cooperative form.
Instead of increasing regulatory costs, Congress should protect and encourage consumer-owned, not-for-profit electric cooperatives as a critical response to the risks that market power poses to residential consumers in the electric utility industry.
The Electric Utility Industry Is Rapidly Consolidating
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The competitive market for electric energy is also threatened by the rapid trend towards consolidation in the industry. The trade press in the past two years has been inundated with reports of mergers between electric utility companies. In those two years, at least 33 mergers were proposed of which FERC has already approved at least 22. In fact, well over 1/3 of private companies' asset base has been subject to mergers in the last three years. New mergers are announced so fast, it is hard to be sure any tally is up to date. Yet, in the three years before that, only 9 mergers were even proposed.
In addition to traditional mergers between electric utility companies, we are also seeing increasing ''convergence mergers,'' that is mergers between the natural gas and electric industries. We are troubled by such mergers when they reduce the number of competitors in a local market, creating mega-utilities providing the same customer base two energy distribution services, natural gas and electricity, so fundamentally important to our nation's consumers: two energy services that have traditionally competed with one another.
Where will all of this consolidation lead? Several pundits have predicted that there will be as few as five or ten companies owning all of the generation in the United States. And, not all of those generating companies will compete in every region or market. So, there could be fewer than a handful of ''competitors'' left in the industry. That is not competition. And, unless Congress acts soon, those predictions will be self-fulfilling.
Because they are afraid that the market will be dominated by a few large generators, some utilities such as GPU and Consolidated Edison are divesting all of their generation. They have concluded that they will never be big enough to handle the risks of the market and have chosen to concentrate on providing regulated wires services.
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Rather than increasing competition, that divestiture is leading to further concentration in the market. The Electric Power Daily announced on July 13 this year that just five companies bought about half of the 75,000 MW of generating capacity sold in the United States since August 1997. Just one company, Edison Mission Energy bought 1 in 7 megawatts of generating capacity, or 11,310 MW.
As I have already mentioned, the Federal Trade Commission has said that competition requires at least six and preferably more than fifty competitors in every market. With only five or ten generating companies, they will have tremendous capacity individually or together to reduce output, increase prices, and reduce the quality of service provided to consumers. The last time the market was that concentrated was in the time of Samuel Insull, when 16 corporate ''families'' controlled more than 85% of the nation's power supply. Congress acted aggressively then to break up the monopolies and protect consumers by enacting the Federal Power Act, the Public Utility Holding Company Act, and the Rural Electrification Act.
Congress can and must act again now to protect the developing competitive market from such consolidation, and it must act now. If Congress waits too long, a few giant utilities will be able to kill the market in its infancy.
Congress should start by imposing a two-year moratorium on electric utility mergers involving more than 1 million meters. That moratorium will give the market some time to develop, give new competitors the opportunity to get a foothold, and will give regulators time to gain a better understanding of competition in the electric utility industry so that it can better detect market power risks in merger proposals. Only then will the regulators be able to construct the appropriate market and regulatory structures needed to protect the market and consumers from undue market concentration.
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Congress should also clarify FERC's authority to review mergers between public utility holding companies and to review acquisitions of natural gas pipelines and gas utilities by public utilities. By making these minor clarifications, Congress can ensure that mergers with an enormous potential to harm the market for electric energy do not slip through regulatory cracks.
Congress can also help close the cracks by removing the political pressure FERC now feels to keep the trains rolling, approving mergers quickly with inadequate review. Instead, Congress should pressure FERC to look carefully to ensure that there aren't any consumers on the tracks. FERC listens to what you say and will know whether you are telling it to go fast or to go carefully.
At the same time, Congress should strengthen FERC's merger review standard for electric utility mergers involving more than 1 million meters. FERC should not approve such a large merger unless the merging entities can demonstrate that the merger will be pro-competitive. Even if it were competitively neutral, FERC should not approve such a large merger unless the applicants can demonstrate that the merger would create significant efficiencies that cannot be achieved absent the merger. FERC should not approve any merger that tends to lessen competition.
FERC should also be encouraged to read the Federal Power Act's public interest standard more broadly. It does the public no good if FERC merely applies the DOJ and FTC's merger guidelines mechanically. FERC must look beyond those guidelines to examine the effect the merger will have on the ability of the states effectively to regulate the new entity, the effect that the merger will have on consumers, and the merger's place within broader market trends. FERC should ask whether the merger will tend to discourage new market entrants, whether the merger will lead to excessive industry consolidation by forcing other utilities to merge to ''keep up,'' and whether the new entity would be likely to have excessive market power in the industry as it will look in the future. The answers to those questions will have a significant impact on the public interest.
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Congress should also require FERC to streamline its merger review process for mergers between small entities that create more viable competitors. Some mergers are pro-competitive. They take two small companies that cannot compete effectively on their own and create a single larger, more efficient company that can survive in a competitive environment. FERC and Congress should encourage such mergers.
Finally, Congress should think twice before repealing PUHCA. PUHCA was enacted to break up the giant utility families that had become too big and too complicated to regulate. If efforts to repeal Congress move through the legislative process, Congress should replace PUHCA with legislation that takes a more practical approach to control of market dominance by focussing on the substance of consumer protection and market power abuses.
I would also like to respond to the proposal some have made to eliminate FERC review of mergers. Some have suggested that FERC review of mergers is an unnecessary and costly barrier to efficient mergers. They believe that the FTC's and DOJ's review of mergers under the Hart-Scott-Rodino Act is adequate to protect the markets and consumers.
In fact, as representatives of FERC, the FTC, and DOJ have all testified before the House Energy and Power Subcommittee, continued FERC review of mergers is critical. FERC brings to merger review critical resources, experience with the industry, and a unique statutory obligation to protect the public interest.
There Are Numerous Barriers to Entry in the Electric Generation Business
Page 147 PREV PAGE TOP OF DOC Some have asked why we need to worry about market power. If a generator charges too much for electricity, won't new entrants build new generating capacity at lower costs? In fact, there are a number of barriers to entry in the electric generation business that serve to exclude new competitors and entrench dominant providers. The FTC presumes that barriers to entry facilitate market power when it takes two years or more for a new competitor to enter the market.
First, it takes a long time to build generation capacity required to enter the generation market. Although the new gas turbines are faster to site and build than older technologies, it still takes several years to get a new plant sited, built, and running. And, that assumes that a plant is available. There is currently a two-year wait list just to get a new gas generator. There is not enough manufacturing capacity to catch up with demand for new plants. A dominant supplier can make enormous profits from captive consumers during the four years it takes to get a generator and build a plant.
Second, it is extremely difficult for a new entrant to site its plant in constrained markets. Plants must be near water, fuel sources, and transmission facilities with available capacity and the load to be served. Most such sites have already been acquired by incumbent utilities. Efforts to site plants in the remaining spots will encounter opposition from environmentalists, community activists, and incumbent utilities.
Finally, new entrants face an enormous barrier in the financial markets. Almost all new generation is built by incumbent utilities or their affiliates. The reason is that they have access to much less expensive financing because of their existing place in the market and their existing generation assets. A new entrant seeking to start up a generation company will pay so much more in interest that they will have trouble competing.
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What can Congress do about these barriers to entry? Not much. The best thing that Congress can do is preserve existing competitors. As I have already discussed, Congress must slow the pace of consolidation in the industry and preserve consumers' ability to choose the cooperative option.
Generation Market Power Is Easy to Acquire and Mask
Some have argued that the existing authority of the Department of Justice and the Federal Trade Commission to enforce the antitrust laws of the United States is sufficient to preserve competition in the electric utility industry.
Those folks are right that the antitrust laws are an important consumer protection. Congress must encourage the DOJ and FTC to act aggressively to create and then preserve competition in the electric utility industry and must provide them the resources they need to do their job. But, unfortunately, that's not likely to be enough to guarantee robust competition. More will be needed because the electric utility industry is so complex that market manipulation and collusion are extremely difficult to detect and prove.
First, electric energy cannot be stored. The actual quantity generated must exactly match the amount consumed on a moment-by-moment basis. Electricity cannot be stockpiled to help meet times of high demand or to ease constraints on transmission.
Second, electric energy is a necessary service for which there is no short-term substitute and little demand elasticity. Jeff Skilling of Enron has suggested that electricity is like other commodities and that consumers can easily reduce consumption when prices rise. He said that when prices for beef rise, he buys less beef and buys more chicken. But in a heat wave, consumers with electric air conditioners, electric irrigation pumps, and electric lights cannot suddenly switch to another energy source if electric prices rise. They can either pay the high cost of power or they can sit in a hot, dark home and let their crops die.
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Third, electric markets are highly fractured by region, season, day, hour, and the type of service provided. For example, FERC's merger policy statement recognized at least four separate electric power products: on-peak firm energy, off-peak non-firm energy, short term capacity, and long term capacity. There are also several additional generation products provided in conjunction with transmission services, called ancillary services, including a variety of different types of reserve services, and certain services required to maintain the voltage level of the transmission system. Even if there are hundreds of suppliers nationwide, there may be only a single provider offering a particular service in a particular region during a particular hour.
Fourth, there is only one way to get electricity to a market, and that is the transmission system. But, that system is not an open grid that allows a free flow of power from any one point in the country to any other. The grid is actually a patchwork of local and regional systems that have been linked together with high voltage interties that were generally built only for reliability purposes. These interties have only limited capacity, and thus limit energy sales between regions and break energy markets into smaller areas.
Commerce between regions in further complicated because the actual physical delivery patterns of electricity follow the laws of physics, not contractual arrangements or tariff requirements. Successful delivery of power between regions will depend on the relative output of generation units all over the power grid.
Because of these problems, some areas are almost completely isolated from the grid in load pockets. These are areas with insufficient intertie capacity to permit the import of significant amounts of power. There may be only one or two providers capable of delivering generation within the load pocket. In fact, it is not uncommon for an incumbent utility to own more than 40% of the generating capacity within a transmission defined market, twice FERC's general benchmark for triggering concerns about market concentration.
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Fifth, prices for energy in any particular market are set by a limited number of ''marginal'' generation plants. Generation is typically dispatched on an economic basis. The least expensive plants operate almost all the time. The most expensive plants operate only when demand is extremely high. It is the plants in the middle, at the edge of the dispatch order that set the price everyone receives for their generation. Even if there are dozens of competitors, ownership of these key plants that set the price of power may be concentrated in a few hands. That was certainly true during 1998 in the California ancillary services market. That was why California was permitted by FERC to impose price caps on certain ancillary services.
And finally, as I have already explained, there are a lot of ways in which owners of transmission, generation, or inputs to generation such as natural gas, may exercise market power. Some of these are extremely difficult to detect or prosecute under the antitrust laws.
For example, an owner of both transmission and generation can operate their transmission to favor their own generation. All it may take in some cases to obtain an advantage is to open one switch and close another, rerouting power and changing the transmission capacity available in different parts of the transmission system. The DOJ or FTC would be hard pressed to ever learn of such an action, or to prove that it was a violation of the antitrust laws even if they did discover it.
There are a couple of things that Congress can and should do to address these problems.
Page 151 PREV PAGE TOP OF DOC First, Congress should preserve FERC's authority to regulate public utilities wholesale sales of generation. One restructuring proposal in the Senate would remove FERC's jurisdiction over future wholesale sales. Such action would remove FERC's primary means of protecting consumers from market power abuses in the wholesale markets. FERC has increasingly permitted public utilities to sell wholesale power at market-based rates on a showing that the public utility lacks market power. Nevertheless, FERC has retained the right to revoke market-rate authority from utilities that demonstrate that they do, in fact, have and abuse market power. In those cases, FERC can require the utility to go back to selling wholesale power at regulated cost-based rates.
Without the ultimate authority to regulate wholesale rates, FERC would lose the power to protect consumers from excessive rates. FERC would also lose its primary lever for pushing public utilities to take pro-market and pro-consumer actions, including providing open access transmission service and joining RTOs.
Second, Congress should encourage voluntary regional transmission organizations. By putting control over the operation of transmission in the hands of an independent organization, properly structured RTOs reduce most opportunities to engage in vertical market power, i.e., abusing their ownership of transmission to benefit their own generation.
Congress should also remove artificial barriers to full participation in RTOs by cooperatives. That will require several fixes to the tax code that penalize electric cooperatives that provide open access to their transmission systems to third parties and that turn control over their transmission systems over to another entity.
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Finally, Congress should require FERC, the Department of Justice, and the Federal Trade Commission to conduct a joint study of market power issues in the electric utility industry and to come up with suggestions to better define, measure, and prevent the acquisition and abuse of market power.
Mr. HYDE. Thank you, Mr. English.
STATEMENT OF MIKE NAEVE, PARTNER, SKADDEN, ARPS, SLATE, MEAGHER & FLOM
Mr. NAEVE. Thank you, Mr. Chairman. I appreciate the opportunity to testify today. I would like to begin by pointing out that not all is gloom. Market power issues are legitimate concerns. The best way to address market power issues, however, is through vigorous competition, and a great deal of positive developments are occurring. Markets are becoming increasingly competitive.
I always assumed it to be inevitable that electric markets would one day be competitive, at least for many services, but the rate at which competition is increasing is much greater than I ever anticipated. FERC has led the way by adopting a great many programs to expand competition in wholesale markets. The States recently also have begun to expand competition in retail markets. Many States have adopted programs to provide their customers the opportunity to choose their electric suppliers. Not all customers have that choice today, but we are heading in the right direction.
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The independent power business is flourishing now. We have a great deal of competition in the construction of new generation, and indeed today the vast majority of new generation facilities, are constructed by independent companies, not vertically integrated investor owned utilities.
A thriving independent marketing business has come out of virtually nowhere. The volume of sales by independent marketers has increased over a hundredfold in the last 5 years. Independent marketers add liquidity to the market. They provide alternative sources of supply for wholesale and retail buyers. They provide alternative purchasers of power for generators. And more than anything else, they are active and aggressive agents for change.
The electric industry is responding and itself is changing in reaction to the new regulatory paradigm. In the last 3 years, we have seen over 23 utilities auctioning off their generating assets. Over 50,000 megawatts of assets have been sold. Some of these sales have been in response to State requirements. As States adopt retail restructuring programs, they are concerned about horizontal market power (generation concentration) in their regions, and as a precondition to their restructuring programs, have required utilities to divest generating assets. Other generation auctions have been self-initiated by generation owners. Utilities have seen the high prices paid in these generating auctions and have decided to sell while prices are high.
Competition is forcing utilities to reexamine whether they want to be in the generation business, the delivery business or both. Many have decided they want to be in the delivery business and are selling off their generating assets. These generation auctions, whether driven by State requirements or self-initiated, have the effect of both reducing the concentration in the ownership of generating assets and reducing the potential for vertical market power.
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We have also seen a great many mergers in recent years in response to the changing regulatory climate. These mergers are not necessarily bad and indeed many of them are positive. There are a great many utilities in the United States that perhaps are too small to provide electric service efficiently. Combining these utilities into larger more efficient organizations is not necessarily a bad thing. Indeed, the size of the average utility in the United States is much smaller than in most other countries.
It is certainly the case that as we restructure the electric power industry by substituting competition for regulation, we must be cognizant of potential competitive issues. Some of these are legacy issues. The incumbent suppliers who previously were regulated monopolies may have inherent market power because of the assets they have accumulated as regulated suppliers. And another type of competition issue is that raised by utility mergers.
I have worked on a variety of State restructuring programs and utility mergers. I have been a regulator myself and am familiar with the Federal statutes. Although I believe that there are indeed serious horizontal and vertical market power issues raised by utility restructuring, but I also believe that the existing statutory framework is adequate to address these issues.
I explain in my filed testimony my basis for this conclusion. I also make some recommendations for statutory changes to improve the competitive landscape, and I make recommendations for the more efficient Federal review of utility mergers.
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[The prepared statement of Mr. Naeve follows:]
PREPARED STATEMENT OF MIKE NAEVE, PARTNER, SKADDEN, ARPS, SLATE, MEAGHER & FLOM
I am pleased to testify today before the House Judiciary Committee on electric utility market power issues. I served as a Commissioner of the Federal Energy Regulatory Commission (''FERC'') from 1985 to 1988, and have represented a wide variety of clients in the electric utility industry in the 11 years since then. While at FERC I was actively involved in numerous initiatives to make natural gas and electric markets more competitive. Currently, I represent a number of electric utilities, independent power producers, power marketers and other participants in the electric power industry. These clients have diverse views on market power and electric restructuring issues. My testimony represents my own views, and cannot be ascribed to any other person or entity. In addition, I have not received any federal grant, contract or subcontract in the current and preceding two fiscal years.
Many previously regulated utility services currently are being offered for the first time on a competitive basis. The substitution of competition for regulation should significantly benefit consumers through lower rates, improved services and greater innovation. The transition to competition also presents, however, new antitrust and regulatory challenges.
Page 156 PREV PAGE TOP OF DOC After reviewing these new antitrust and regulatory challenges, I conclude that federal antitrust and utility regulators currently have sufficient statutory authority to address the issues that are raised by the transition to competition. Various legislative changes, however, could improve the competitive landscape. These changes include granting FERC eminent domain and siting authority over interstate electric transmission facilities, and expanding FERC's transmission jurisdiction to include transmission facilities owned by so-called public utilities (municipal utilities, electric power cooperatives, TVA, BPA and other federal power authorities). In addition, TVA, BPA and federal power marketing authorities should be required to transfer control over their transmission facilities to a FERC-approved RTO by a date certain. Finally, the duplicative federal review of electric utility mergers by DOJ/FTC and FERC should be eliminated. Although either DOJ/FTC or FERC could be given the responsibility for evaluating the competitive implications of such mergers, FERC may be the preferred agency due to its technical expertise. However, FERC should be authorized to utilize a more informal process to review mergers (much like the DOJ/FTC process) rather than the inefficient adjudicative model which the statute currently requires FERC to use. In addition, statutory time limits should be established for FERC merger review so that commercial transactions are not unnecessarily delayed.
III. THE ELECTRIC INDUSTRY IS UNDERGOING A RAPID TRANSITION TOWARDS COMPETITION
My focus today is on market power issues that arise in connection with the restructuring of the electric power industry and the introduction of competition for many of the services traditionally provided by vertically integrated electric utilities. First, however, I would like to provide some perspective on the transition towards competition that has occurred in the last few years in the industry.
Page 157 PREV PAGE TOP OF DOC This transition has been the result of legislative and regulatory programs that have given the electric industry strong incentives to rethink and restructure the way that they do business. The first step was the passage of the Public Utilities Regulatory Policy Act of 1978 (''PURPA''), but most of the steps have been taken in this decade. These steps include:
The passage of the Energy Policy Act of 1992 (''EPAct''). This Act (1) created the Exempt Wholesale Generator (''EWG'') exemption from the Public Utility Holding Company Act (''PUHCA''); (2) granted FERC more explicit authority to order access to transmission facilities under Sections 211 and 212 of the Federal Power Act; and (3) created the Foreign Utility (''FUCO'') exemption from PUHCA.
The issuance by FERC of Order No. 888, which requires utilities to provide nondiscriminatory open access to their transmission facilities. FERC has taken a number of other procompetitive actions on a case-by-case basis, frequently relying upon its conditioning authority in mergers.
The efforts by the SEC to provide more flexibility under PUHCA, which have been limited by the strict confines of this antiquated statute.
The enactment of restructuring legislation and regulations by a number of states.
In response to these important policy changes, the traditional vertically integrated structure of the industry has started to come undone. Regulators and industry participants are beginning to view the electric utility industry as consisting of at least five distinct lines of business: (1) generation; (2) wholesale sales; (3) retail sales; (4) transmission; and (5) distribution. Some of these business activities, such as transmission and distribution, must continue to be regulated in some fashion as natural monopolies, at least until technological advances permit greater competition. Under the right circumstances, however, other business lines, such as generation and wholesale and retail sales, can be carried out on a competitive basis. Indeed, the generation business already is very competitive, and the wholesale sales sector is not far behind. The retail sales market also is becoming increasingly competitive as the states implement restructuring.
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In response to the programs implemented by state and federal legislators and regulators to facilitate and encourage competition, the utility industry has changed rapidly. Four significant changes in the traditional industry structure have emerged:
First, as generation and sales markets have been opened up to competition, a number of utilities have begun the process of disaggregation and separation of their regulated wires businesses from the other businesses that can operate in competitive markets. This process also has been spurred by state and federal regulations to prevent owners of wires businesses from using their natural monopolies in those regulated businesses to benefit themselves unfairly in the competitive markets.
Entry of Non-Utility Participants
Second, hundreds of new entities, such as independent power producers and power marketers, have entered the competitive generation and sales markets. While some of these entities are affiliates of utilities formed as part of the disaggregation process, many are completely new players with no previous connections to the electric utility industry.
Third, in the last few years there have been a flurry of mergers of electric utilities, independent power producers, power marketers and other market participants. These mergers are a natural response to the onset of competition. In the old regulated cost of service regime, utilities had less incentive to be efficient, given that all prudently incurred costs could be recovered through rates charged to customers who had no alternative suppliers. As markets have become more competitive, utilities and other market participants have vastly increased incentives to explore all alternatives for reducing costs and improving services. Mergers frequently create the opportunity for scale economies that make suppliers more competitive in the new cut throat world. Even small savings, when applied to high sales volumes, can result in significant benefits both to shareholders and customers.
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Mergers also are a natural response to the disaggregation of vertically integrated utilities. Absent a merger, smaller utilities that divest their generating assets can become too small to finance their remaining transmission and/or distribution business on reasonable terms and conditions. A merger between utilities that are divesting generation provides the combined entities with greater financial strength, as well as with scale economies.
Regional Control Over Transmission
Finally, there has been a change in the operations and control of the regional transmission grids. Transmission systems are most efficiently and reliably operated on a regional basis. Several utilities have placed the operations of their transmission systems under the control of an independent system operator (ISO). Other utilities have begun the process of creating incentive-driven independent transmission companies (Transcos). FERC has actively encouraged the formation of both ISOs and Transcos, as well as other forms of regional transmission organizations (RTOs).
The statistics tell the story of this dramatic evolution of the electric utility industry:
Since 1997, 23 utilities have divested generation facilities representing more than 50,000 MW of generation capacity, and several other utilities have announced their intent to follow suit.
Through the end of 1998, FERC has issued 560 power marketers' authorizations.
Page 160 PREV PAGE TOP OF DOC Since 1997, 6 ISOs have been formed, covering the transmission systems of California, Texas, the eastern United States from Maryland north through New England, and a large part of the Midwest. Several other ISOs and Transcos are in various stages of development.
Since 1995, almost half of all states have enacted statutes or promulgated regulatory schemes requiring restructuring. Many more states currently are considering electric restructuring in regulatory proceedings or proposed legislation.
Since 1995, there have been 23 electric utility mergers consummated, and over a dozen more have been announced and are in the process of obtaining the necessary regulatory approvals. There have been numerous other combinations involving independent power producers, power marketers and other industry participants.
Since 1995, total wholesale sales by power marketers have increased from 27 million MWh to 2.3 billion MWh in 1998.
These steps all are pro-competitive, and they all have taken place under the current federal statutory regime. The challenge for the future is to make sure that the transition continues while at the same time protecting against abuse of market power that may arise from the transition.
IV. PRE-EXISTING MARKET POWER
It is important to remind the Committee that not all utility services can or should be opened to competition. For certain services, such as the delivery of power through transmission and distribution wires, utilities still retain the attributes of natural monopolies. These services can be provided to consumers most efficiently by a single franchised supplier that is able to capture the significant economics of scale that are present in the electric power delivery business.(see footnote 37)
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To prevent franchised single suppliers from abusing their preferred position as sole source suppliers, government must regulate both the price and the terms and conditions of the services they provide. This approach allows society to reap the economies of scale present in certain utility-type businesses, while ensuring that those economic gains are transferred to consumers rather than being retained by the suppliers.
Unfortunately, in our zeal to regulate natural monopolies, we historically have not discriminated carefully among the types of services for which we have granted regulated monopoly franchises. More often than not we have foreclosed competition in lines of business that do not present the significant economies of scale that are characteristic of natural monopolies. Without much forethought we provided telephone companies with the exclusive franchise to manufacture telephones and switching equipment, natural gas pipelines with the exclusive power to market natural gas to their distribution customers, and electric utilities with the exclusive power to generate electricity for resale.
In the past two decades, however, we have begun to take a more discriminating view toward the character of each service provided by traditionally regulated companies, and have introduced competition into those services that are not true natural monopolies. When this principle is applied to the electric power industry, it suggests that we should look at each of the various services provided by integrated electric utilities, and continue to regulate only those services that truly are natural monopolies. Thus, for the foreseeable future, we should continue to require utilities to provide transmission and distribution services on a regulated, sole-source basis. At the same time, we no longer should grant utilities exclusive rights to own or operate generation, purchase and resell electric power, or provide many of the ancillary services needed to maintain system reliability. Instead, these and many other services should be unbundled from delivery services and supplied separately on a competitive basis, with appropriate regulatory changes to permit competition to flourish.
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As each new utility service is opened for competition, it is important to inquire whether the incumbent suppliertypically the franchised utilityis in a position to exercise market power in that service by virtue of the resources that it had accumulated when it was the sole-source supplier. Incumbent suppliers most likely would be able to exercise market power in one of two fundamental ways. First, the incumbent's share of the region's generation facilities might be so great that the utility could influence power prices to a significant degree on a sustained basis. This would be a case of horizontal market power. Second, the utility might be able to use its control over transmission and distribution facilities to favor its own generation over competitors to a degree that consumer prices are adversely affected. This would be a case of vertical market power. I address each of these separately below.
A. Horizontal Market Power
Broadly speaking, horizontal market power can occur in at least two different contexts: (a) excessive concentration of generation ownership or control in relatively unconstrained, regional geographic markets, and (b) control over generation in smaller geographic markets defined by constrained transmission facilities (so-called ''load pockets'').
1. Horizontal Market Power in Regional Markets
The scope of geographic markets for various generation products is influenced by a variety of factors including the availability of transmission capacity, the cost of transmission service, and the marginal operating costs of available generating facilities. Most generation markets are broad, spanning multiple states and numerous utility systems. In such broad regional markets, generation ownership commonly is sufficiently diverse that there is little opportunity for any single supplier or group of suppliers to exercise generation market power. Although each individual utility in the regional market may control the majority of generating facilities within its respective service area, there usually are enough separate utilities competing within the regional market to reduce the potential for the exercise of market power to levels that are comparable to other competitive markets.
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In certain regional generation markets, however, the potential may exist for the exercise of horizontal market power. In such cases a variety of remedies currently are available to mitigate the problem, including wholesale rate regulation, state action, construction of new generation, and expansion of geographic markets through either a reduction in transmission costs and/or an elimination of transmission constraints. Each of these is discussed below.
a. Wholesale Rate Regulation. Nearly sixty-five years ago Congress provided the Federal Power Commission (now FERC) with a powerful tool to prevent the abuse of market power in wholesale power markets: rate regulation of wholesale sellers. FERC's authority to regulate wholesale rates extends to the vast majority of sellers in wholesale markets, including all investor-owned utilities, exempt wholesale generators (EWGs) and power marketers. Rate regulation remains the primary weapon wielded by FERC to mitigate against the exercise of market power.
In recent years, FERC has been willing on a case-by-case basis to supplant cost-of-service rate regulation with competition in wholesale electric markets. If sellers of wholesale electricity can demonstrate to FERC's satisfaction that they do not have market power in the relevant geographic and product markets, FERC will waive cost-of-service regulation and allow such sellers to collect market-based rates. Although FERC has granted a large number of market-based rate authorizations in recent years, the ability to collect market-determined rates is an exception to the general rule that the rates charged by all wholesale sellers must be capped by cost-based rate.
An important but subtle point should be made here. Rate regulation can be used by FERC as more than simply a failsafe market power mitigation tool to be employed when competition proves to be insufficient. Rate regulationor the threat of re-regulation for companies that previously have been authorized to collect market-determined ratescan create a powerful incentive for generation owners to implement structural changes to reduce their potential to exercise market power.
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FERC historically has established cost of service rates for wholesale sales by, roughly speaking, dividing the annual cost associated with the service by the expected volume of sales. This produces an average rate which, if collected from all such sales, allows the seller to recover its costs. In competitive markets, however, sellers can never count on receiving the same rate for all sales. Wholesale electric prices change from hour to hour and season to season, as electric loads rise and fall in response to electric consumption patterns, weather conditions and other factors.
When prices are low, the revenues received by generation owners may not be sufficient to cover all of their fixed costs (i.e., prices are below an ''average'' rate that would allow the generator to recover all fixed and variable costs). Thus, during low price conditions, sellers may experience a short-fall in the recovery of fixed costs. When market prices rise above a seller's ''average'' cost, the seller, if allowed to collect the market price, has the opportunity to make-up this short-fall in recovery of fixed costs. However, only sellers that can demonstrate to FERC that they do not have market power are permitted to collect market prices for all their sales. The rates for all other sellers will be regulated by FERC, and capped at the sellers' average rate. Thus regulated sellers will be limited to collecting the lower of the market price of power or their regulated rate. As a consequence, regulated sellers will have a strong incentive to take whatever steps are required by FERC to reduce their market power and thereby escape wholesale rate regulation.
Evidence of this strong incentive to avoid rate regulation can be seen in the recent generation asset auctions. Many bidders have conditioned their bids on FERC authorizing market based rates for wholesale sales from the purchased generation facilities. These bidders do not want to acquire additional generation facilities if doing so will cause them to become subject to FERC cost-of-service rate regulation.
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b. State Requirements. State regulators also have demonstrated substantial willingness and power to reduce the potential for the exercise of horizontal market power by incumbent generator. Several states, including California, Texas, Massachusetts, Maine, Nevada, New York, Connecticut, Rhode Island and New Hampshire have required utilities to reduce their ownership of generation facilities significantly as an essential component of their respective state utility restructuring programs. The resulting decrease in the concentration of generation ownership has enhanced competition not only in the states that have required it, but also in neighboring states that participate in the same regional power markets.
c. Generation Construction. The ability to exercise horizontal market power in generation markets also is reduced by the construction of new generating facilities. As new generators enter the market, the market share of the incumbent owners is decreased. The PURPA and EPAct eliminated many of the artificial regulatory barriers that previously limited the construction of new generation facilities. New technologies and abundant fuel supplies also have facilitated the rapid development of new generation facilities. Today a new gas-fired combustion turbine can be planned, permitted and constructed in as little as two years.
As a consequence, it is relative easy for new generators to enter the market. For example, there currently are plans to construct 28,000 MW of new generation facilities in New England and 26,000 MW in Texas. This relative ease of entry acts as an important curb on any single entity maintaining market power over the long term.
d. Reducing Transmission Rates. The marginal cost of moving power over the transmission grid is very low (usually equal to a transmission loss factor of approximately 3%). Current FERC transmission rate policies, however, require transmission owners to recover their fixed costs through volumetric usage charges, driving up the apparent marginal cost to transmission users. In addition, FERC allows each owner of grid facilities that are utilized in a fictitious ''contract'' transmission path to charge separate rates for transmission over their facilities. The so-called ''pancaking'' of multiple transmission charges can, by raising transmission rates to very high levels, foreclose potential suppliers of generation products, thereby increasing the potential market power of the remaining competitors.
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Rate pancaking can be eliminated through the formation of large, Regional Transmission Organizations (''RTOs'') that charge a single rate for the transmission of electricity through multiple transmission systems. In addition, FERC has allowed some RTOs to adopt transmission rate designs that provide for the recovery of nearly all fixed transmission costs through demand charges rather than through volumetric usage charges. The combination of these two measures has the effect of significantly reducing marginal transmission charges and thereby expanding the geographic scope and number of competitors in markets for generation products. With more competitors, there is a corresponding decrease in the potential for the exercise of market power. The growth of RTOs pursuant to current FERC policies and proposed rules (which I discuss in greater detail later in my testimony) should significantly improve competition in generation markets. Competition will be further enhanced if FERC requires RTOs to adopt efficient, non-pancaked rates for the delivery of power from one RTO into another.
e. Eliminating Transmission Constraints. The geographic boundaries of generation markets frequently are defined by constraints on transmission facilities. Transmission constraints can come and go as electric loads fluctuate and generation dispatch patterns change. When constraints appear, generation facilities become separated from load that is located on the other side of the constraint, thereby increasing the market share of the unaffected generating units.
Transmission constraints can be reduced or eliminated in a variety of ways. The most obvious approach is to construct new transmission facilities. A maze of state and local siting and permitting requirements, however, makes the construction of new transmission facilities a nearly insurmountable task. The current interconnected transmission grid was designed primarily to deliver generation to local load and to interconnect utilities with their neighbors to enhance reliability. With the growth of competition in wholesale markets, the use of the interconnected transmission grid for interregional power transfers has increased significantly. It is noteworthy, however, that notwithstanding the ever increasing burdens being placed on the grid, transmission construction is in a decline. The North American Electric Reliability Council (NERC) reported in 1998 that the level of planned transmission additions is significantly lower than five years ago despite an overall increase in load growth and transmission activity.
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The drought in electric transmission construction is all the more remarkable when compared to the impressive expansion of the interstate natural gas pipeline network during the same period. I believe the primary reason for the difference in facility additions between these two industries is that Congress has given FERC eminent domain and siting authority for construction of interstate pipeline facilities but not for construction of high-voltage electric transmission facilities.
Construction or enlargement of transmission facilities also could be facilitated by FERC under its existing powers by providing greater financial incentives for new transmission investment. The current regulated returns on transmission investment obviously have not been sufficient to attract investment capital. Again, the rates of returns for electric utilities have been lower than comparable returns approved by FERC for the natural gas industry.
2. Horizontal Market Power In Load Pockets
The owner of even a single generation facility can have market power if the facility is essential to providing reliable electric service to a particular load. For example, the transmission import capability into a geographic area may be significantly less than the peak load. In such situations, as soon as load rises above import capability, all additional power needs must be supplied by local facilities. If there are a limited number of generation facilities within the load pocket, the owners of those facilities may be able to exercise market power to the detriment of local customers.
Load pocket market power problems may be fairly common within some utility control areas. Historically when utilities were confronted with the problem of serving growing loads, the utilities had the option of either adding generation near the load or expanding the capacity of the transmission system to deliver power into the area. Typically the decision was based on economics, mixed with practical considerations such as the comparative difficulty of siting and permitting new transmission or generation facilities. Little or no concern was given to the competitive implications of the alternatives because at the time no one could foresee that the load might someday be given the option of purchasing electricity in a competitive market. Frequently the decision was made to serve the load with the construction of generation located near the load rather than through transmission upgrades. Today, as a result of that decision and the advent of retail choice, the owners of the local generation facilities may have a vestige of market power under certain load conditions (i.e., when total loads within the load pocket rise above the limited transmission import capability).
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One important difference between load pocket market power (also referred to as ''locational market power'') and other forms of horizontal market power is that in many cases load pocket market power cannot be cured through divestiture of control over generation facilities within the affected geographic market. The ability to exercise market power within a load pocket frequently is unrelated to the ownership of generation resources outside the load pocket. If control over the generation resources within the load pocket is transferred to another party, the ability to exercise market power will be transferred as well.
Because load pocket market power may not be cured through a change in control over generation facilities, other forms of mitigation must be utilized. Two particular mitigation measurestransmission expansion and rate regulationare the most practical alternatives. Transmission expansion mitigates load market power by increasing the amount of generation that can sell into the load pocket. Where economically feasible, transmission expansion should be the preferred fix because competitive solutions almost always are better than regulatory patches.
B. Vertical Market Power
With many utility services being opened for competition, anti-trust and traditional utility regulators are presented with the classic problem of preventing utilities from using their market power over regulated facilities to earn excessive profits in their unregulated businesses. Utilities can use a variety of techniques to leverage their market power over ''bottleneck'' facilities to benefit unregulated affiliates, including:
Page 169 PREV PAGE TOP OF DOC providing affiliate preferential access to bottleneck facilities
providing affiliates with valuable information derived from operating regulated facilities or from customers served by those facilities
cross-subsidizing unregulated businesses by including the costs of such businesses in rates charged for regulated services
Each of these techniques for exercising vertical market power, and the need if any for federal legislative changes, is discussed below.
1. Preferential Access for Utility Affiliates
The issue of preferred access to regulated facilities and services presents itself in all regulated industries where the regulated company is permitted to engage directly, or indirectly through affiliates, in unregulated businesses that are related to the regulated activities. Regulators historically have addressed the problem of preferential access with both structural and regulatory fixes. Structural fixes typically impose limits on the business activities of the regulated company and its affiliates. For example, unregulated affiliates of a transmission owner could be precluded from directly or indirectly engaging in activities that require transmission services over the regulated transmission facilities. The formation of RTOswhere control over transmission facilities is transferred to an independent operator that does not have a financial interest in the electric generation or marketing businessis another example of a structural solution.
Page 170 PREV PAGE TOP OF DOC Regulatory fixes to preferential access problems typically involve prophylactic rules, reporting requirements, codes of conduct and Chinese walls. FERC Orders No. 497 (natural gas marketing affiliate rules) and 889 (separation of electric utility marketing and transmission operations) are examples of regulatory fixes.
The choice between structural and regulatory fixes often involves a subjective balancing of burdens and results. Structural fixes frequently are considered to be more effective than regulatory fixes, but may impose greater burdens on regulated businesses. Further, the effectiveness of regulatory fixes can vary significantly from one regulated industry to another, depending on a variety of factors such as the complexity of industry operations, the availability of timely data, the transparency of decisions, and the sophistication and economic clout of customers. In the natural gas industry FERC relied primarily on regulatory fixes to address preferential access issues because FERC perceived structural fixes to be unduly burdensome (pipeline marketing affiliates were critical to pipelines managing their excessive take-or-pay exposure), and because regulatory fixes were perceived as being enforceable (a pipeline's transmission capacity is relatively constant and easily measured).
In the electric power industry, FERC has proposed on a mix of regulatory and structural fixes. In Order Nos. 888 and 889, FERC ordered transmission providers to provide open-access transmission services. In addition, FERC ordered the ''functional separation'' of transmission and generation operations. The employees operating transmission facilities are separate from employees selling power, and communications between the two groups are prohibited unless such communications contemporaneously are made public.
FERC also has concluded that structural fixes, namely the formation of RTOs to separate control of transmission from generation and marketing activities, may be necessary. FERC has expressed concern that its regulatory fixes may be difficult to enforce due to the complexity of transmission operations. FERC also has concluded that the burdens of imposing RTOs on transmission owners are likely to be within acceptable levels. Transmission revenues account for only ten percent of the average utility's investment, and transmission operations can be carried out more effectively on a regional basis.
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I believe that FERC is headed in the right direction by encouraging the separation of control over generation and transmission through the formation of RTOs. I also believe that FERC has sufficient powers under its current statutory authorization to cause the companies it regulates to dedicate their transmission facilities to properly structured independent transmission organizations. If ongoing FERC efforts falter, however, Congress should be prepared to augment FERC's RTO authority and mandate.
2. Preferential Transfers of Information
The operators of transmission and distribution facilities have access to information about their customers and their system operations which could convey a competitive advantage to their generation or marketing affiliates. FERC and State regulators have adopted a variety of regulatory fixes to restrict preferential information transfers, including codes of conduct, Chinese walls, and disclosure obligations. In addition, with the implementation of RTOs, utility employees will have reduced access to transmission information which otherwise might be transferred to unregulated affiliates.
3. Cross Subsidization of Unregulated Activities
At the outset it is important to draw a distinction between cross subsidies and the investment of profits earned in one business into another business. Any company, whether or not it is a regulated monopoly, may elect to invest some of its profits from its primary business to fund an alternative business venture. As long as such investments do not allow the alternative business venture to engage in predatory pricing, no legitimate antitrust issue is raised. Indeed, the diversion of profits into new ventures frequently is pro-competitive because it is an important means of financing new market entrants or new technologies.
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In contrast to such investments, cross subsidies occur when a company is able to pass on to the customers of its primary business the cost of operating its alternative business. If the primary business operates in a competitive business climate, the prices charged to customers are determined by the market and not by the cost to provide services to those customers. Therefore in competitive industries there should be no practical way for any company to cross subsidize alternative business ventures by increasing charges to the customers of its primary business.
In regulated industries, however, it theoretically is possible for a company to pass higher costs through to customers, because frequently those customers are not permitted to switch to other suppliers who offer to provide services at lower prices. The primary weapon used by regulators to protect against cross subsidization is traditional cost-of-service rate regulation. Regulators require regulated utilities to provide detailed justification and support for all costs that are included in establishing a utility's rates. In my opinion, the traditional tools that have been employed by regulators for decades are highly effective at detecting and preventing cross subsidization. Further, I see no reason why the current restructuring of the electric power industry makes the potential for cross subsidization any more severe than it has ever been. Indeed, the deregulation of many utility services arguably reduces the opportunity for cross subsidization by shrinking the regulated operations through which utilities would attempt to recover unrelated costs.
C. Need for Legislation
As I explain above, there is no need to expand federal regulatory powers to address potential abuses of existing market power. I believe FERC has adequate authority over generation owners and wholesale sellers to protect electric consumers from the exercise of pre-existing horizontal market power. FERC's power to regulate rates can be used not only to prevent generation owners from collecting excessive rents from power sales, but also as a powerful incentive for generation owners to maintain their market shares below the level that would give rise to FERC market power concerns. FERC's issuance of Order Nos. 888 and 889 and its demonstrated ability to move the industry towards participation in RTOs also constitute adequate protection against pre-existing vertical market power. There are two steps that can be taken, however, to remove barriers to further necessary restructuring.
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First, Congress should give FERC eminent domain and siting authority over the construction of high-voltage transmission facilities that serve the interstate market. As I previously discussed, the current maze of permitting requirements makes the construction of new transmission facilities extremely difficult and expensive. FERC already has eminent domain and siting authority for natural gas pipeline facilities, which has facilitated in the construction of considerable new pipeline capacity in recent years. Granting FERC similar authority for electric transmission facilities should help create an efficient national transmission grid.
Second, Congress should expand FERC's transmission jurisdiction to include facilities owned by what are commonly referred to as public power entities: municipal utilities, electric cooperatives, TVA, BPA and other federal power marketing authorities. Jurisdiction over these entities currently is balkanized in several federal and state entities, and consolidation of jurisdiction in one entity again should greatly assist in the formation of a national transmission grid. I also would recommend that control over all transmission facilities owned by TVA, BPA or other federal authorities be transferred to a FERC-approved RTO by a date certain.
III. REVIEW OF ELECTRIC UTILITY MERGERS
A second area of concern in the electric industry is the review of electric utility mergers for competitive issues that may arise as a result of the merger. The recent wave of electric utility mergers is a reaction to the advent of competition. The trend towards consolidation in the industry has been combined with other types of restructuring such as divestiture and represents utilities' efforts to prepare for competition. This consolidation is typical of other industries that have emerged from the deregulation process.
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There currently are at least three major reviews conducted of electric utility mergers: (1) FERC review under Section 203 of the Federal Power Act; (2) DOJ/FTC review under the Hart-Scott-Rodino Act; and (3) State public utility commission review under state law in all affected states. In addition, other federal agenciessuch as the SEC or the NRCmay also consider competitive issues for those types of mergers that fall under their jurisdiction.(see footnote 38)
In my view, the current dual federal review is highly inefficient. Hart-Scott-Rodino review can take from 30 days if there is no second request to several months if there is a second request. FERC's review of utility mergers can take from about six months if FERC determines that there are no competitive issues to well over a year is competitive issues are raised and a hearing is ordered. These reviews are conducted on an independent basis and each one can require a huge expenditure of time and resources by the merger applicants.
There should be only a single federal review of electric utility mergers. This is not an extremist position. Many unregulated industries today are required to undergo only Hart-Scott-Rodino review and not a dual federal analysis of the competitive effects of their mergers. There is no reason why the electric utility industry should be any different from other unregulated industries in this regard.
Nor is it a matter of federal policy that regulated industries undergo dual federal review of mergers. The Hart-Scott-Rodino Act specifically provides exemptions from its reach for certain types of transactions involving financial institutions that are reviewed by regulatory agencies. The Act also permits Congress to remove other industries from its reach by so providing in the statutes governing those industries. Furthermore, other industries regulated by FERC, such as the oil pipeline and natural gas pipeline industries, are not required to apply to FERC for merger review, but instead are subject solely to Hart-Scott-Rodino review.
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My current view is that FERC, rather than DOJ/FTC, should be assigned the sole responsibility for electric merger reviews because FERC has significant technical expertise about electric operations, transmission systems and regulatory policies. However, there are benefits and detriments to assigning the merger review responsibility to either FERC or DOJ/FTC. My chief point is that federal review should be streamlined so that competitive issues may be spotted and addressed efficiently without imposing wasteful costs and delays that prevent appropriate mergers from going forward on a timely basis.
Finally, if FERC is given the responsibility for merger review, Congress should consider eliminating the formal adjudicative process imposed on FERC by the Federal Power Act. An informal process such as that utilized by DOJ/FTC is more conducive to the type of technical analysis that is required of these mergers. Adjudication is time consuming and inefficient. It restricts communications between parties, limiting the ability of the reviewing agency to engage in a dialogue with the applicants and intervenors, and limiting the ability of the applicants to respond to the issues identified by the agency. An informal process also makes it easier to reach settlements that allow mergers to go forward with mitigation measures that adequately resolve market power concerns without imposing unnecessary costs on the applicants. Any such review, however, should be accompanied by time deadlines in order to ensure that the process moves forward.
In conclusion, I believe that the restructuring of the electric utility industry is proceeding in a way that should not require the need to legislate extensive new regulatory powers to prevent market power abuses. Instead, the goal should be to eliminate barriers to the creation of efficient transmission networks and to the entry of new competitors into the market. I also believe that streamlining of federal merger reviews into a single review will allow for efficient restructuring of the industry while still allowing market power concerns to be addressed.
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Mr. HYDE. Thank you very much, Mr. Naeve.
STATEMENT OF KELLAN FLUCKIGER, VICE PRESIDENT FOR OPERATIONS, CALIFORNIA INDEPENDENT SYSTEM OPERATOR
Mr. FLUCKIGER. Good morning, Mr. Chairman, members of the committee. My name is Kellan Fluckiger. I am the vice president of operations of the California Independent System Operator, and I appreciate the opportunity to come and speak with you today.
California Independent System Operator was formed as the result of legislation in California in 19the end of 1996. We went operational at the end of March 1998. We have been operational now for almost a year and a half. The model of the California ISO is one where the transmission owners still own the asset. They have turned control of that asset over to the independent nonprofit public benefit corporation, California Independent System Operator, in order for us to operate it to ensure nondiscriminatory open access and to ensure that the retail access programs of the State are carried out.
California opened its markets to full retail competition at the same time and allow all customers to choose their electric supplier. In that year and a half, we have had a number of learning experiences and a number of good opportunities to see the success of markets. We have set two new record peaks, each a thousand megawatts over the previous year, and have stressed our operating abilities in a good way, demonstrating that reliability, which is a fundamental cornerstone of restructuring, can be maintained and is being maintained in the new deregulated environment. I believe that as we move forward, as this deregulation moves forward across the country, a couple of things are really important. One, it will be very important to learn from the successes and adjustments that need tothe success that has occurred and adjustments that we have had to make also in the California market so that there can be learning that takes place as deregulation moves across the country. As earlier speakers indicated, that is moving rapidly and probably will continue at a more rapid pace.
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As legislation is contemplated to move this deregulation process forward, there are, out of experience, a couple of things that I would observe that I believe are very important.
First, legislation that intends to accomplish this needs to be comprehensive in nature. What I mean by that is all entities that offer transmission service must be included in this deregulation umbrella. Since transmission and distribution services likely will remain monopoly services, it is important that we not operate in an environment where we have lots of holes in Swiss cheese.
Specifically in the California experience, many municipals and other agencies were not initially parts of the experiment and that presents operational and other problems, thus robbing us of the full potential of efficiencies and cost savings that could accrue to customers. So I would urge that any legislation that gives additional power to the Federal Energy Regulatory Commission be structured so that all utilities and all providers of service come under that legislation and that there are no exemptions or holes.
The second important aspect that I believe must be considered in that legislation is that the essential functions of reliability, the essential functioning of markets that are open, and the essential function of transmission planning all should be addressed comprehensively and those should be addressed in a single regional organization and not separately. Our experience tells us that you cannot address the essentials of system planning and reliability along with the integration of the competitive markets separately. It must be done together.
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The last issue I wish to address today is that of market power. Current market power analysis for mergers, which is done in terms of market concentration and market share analysis, is adequate for those purposes. However, we have determined that in the competitive market, there are a number of market power issues which occur so close to the ground that it is essential that the regional transmission organization or the ISO have a market analysis function and be able to take actions in that regard. I need to give you an example to give a feeling for how that can occur.
Generation concentration and transmission access are not at all the only market power issues that need to be addressed and that we have seen examples of. If you owned a car that needed gasoline every two blocks, you could not effectively have a gas tank, and you had to have gas every two blocks, you would have to have gas stations positioned strategically in order for you to make necessary trips. Think of electricity as a grid like that and as the ancillary services are the corner gas stations every two blocks. If you have a need for gas at a particular time with your two-block gas tank and there is only one gas station there, that gas station needs to be operating when you need it, where you need it or you will simply have to pay a thousand dollars or whatever they choose to charge you per gallon.
That is market power. We have seen a number of issues of locational and time based or temporal market power that are temporary in nature but can be very expensive to consumers that can develop. We have effectively addressed that by having a market analysis and surveillance function within the Independent System Operator, but I would assert that close to the ground market power analysis will be a continuing essential feature of deregulation.
Page 179 PREV PAGE TOP OF DOC The last point I guess I wish to make is the institution of an independent system operator or its equivalent, however structured, I believe is an appropriate institution to accomplish the goals of restructuring, which are lower prices to consumers, efficient markets, competition, and maintenance of public reliability for this essential commodity that affects all of our lives.
Thank you for the opportunity.
[The prepared statement of Mr. Fluckiger follows:]
PREPARED STATEMENT OF KELLAN FLUCKIGER, VICE PRESIDENT FOR OPERATIONS, CALIFORNIA INDEPENDENT SYSTEM OPERATOR
The California Independent System Operator (ISO) is a not-for-profit public benefit corporation created by California's landmark restructuring legislation, and run by a multi-stakeholder board of directors. It operates the high voltage power lines that deliver electricity throughout California. The mission of the ISO is to ensure a reliable, open and nondiscriminatory transmission system, and to facilitate efficient electricity markets. The ISO operates the world's first competitive markets for ''ancillary services,'' which allows the maintenance of reserve and replacement energy, and for ''congestion mitigation,'' which allows the ISO to prevent system overloading. Together, these markets help lower the cost of electricity, and maintain reliability of the transmission grid when the unexpected happens.
Page 180 PREV PAGE TOP OF DOC Traditional antitrust review can address some market power issues related to transmission facilities, but efficient electric power markets will require a dynamic and ongoing effort to monitor and address market power issues. Structural reform, such as the creation of regional transmission organizations such as ISO, will be a major step in enhancing the efficiency of transmission markets. However, even with open transmission lines under the independent control of an ISO, generation firms can still exercise market power in transmission. Even players with small market shares of generation can have power and be able to affect significantly energy prices by ''gaming'' the transmission system. We see significant opportunities for the continued exercise of market power in the ancillary services markets and in congestion mitigation. The ancillary services markets are much ''thinner'' than are overall energy markets, and the demand for ancillary services is ''inelastic'' in that the ISO cannot act to reduce consumption in response to high prices or market power.
The ISO's Department of Market Analysis monitors the California markets, develops indicators of market performance, and reviews violations of market rules. Once the Department determines that corrective action is necessary, market rules can be changed to promote market efficiency. Under the appropriate circumstances, violations may be referred to FERC and other agencies for further action.
We believe that ISOs are an excellent framework to institutionally address antitrust issues with respect to market power in the generation and transmission of electricity. First, ISOs are a disinterested player in the market. Second, ISOs function to facilitate efficient markets. In addition, ISOs are in the best position to monitor and ensure compliance with the rules, and to seek corrective action when necessary. The self-policing function is most appropriately done by ISOs because the rules of the road are highly technical and proper monitoring is extremely data intensive. It would be difficult to have the monitoring function outside the ISO since any entity responsible for policing the markets needs operational access to the transmission system. We believe that any federal legislation governing RTOs should be based on the principle of self-policing.
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Finally, ISOs should be the main facilitator for planning for future needs. The ISO can ensure that planning is done in the best possible manner, is open, fair and considers all non-transmission alternatives. In conjunction with this planning role, the ISOs should play a central role in coordination with state siting and permitting agencies.
The California Independent System Operator (ISO) is a not-for-profit public benefit corporation that operates the high voltage power lines that deliver electricity throughout California, and between neighboring states, Mexico and parts of British Columbia. The ISO appreciates the opportunity to present its views on competitive issues in electricity deregulation to the House Judiciary Committee.
Background on the California ISO
The California ISO was created by landmark restructuring legislation, AB 1890, which was passed unanimously by both houses of the California legislature and signed into law on September 26, 1996. AB 1890 changed California's electricity industry by ''unbundling'' the traditional services of utilities into functional components, and creating a new structure and new institutions to facilitate competition at the wholesale and retail levels.
The legislation transferred the transmission function to the control of a new corporation, the ISO, while leaving the distribution function to the incumbent utilities. In addition, large-scale generation divestiture was undertaken by each of the three formerly vertically integrated investor owned utilities. California was the first state to offer large-scale retail choice and a competitive electricity generation market to consumers.
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The ISO is governed by a stakeholder board, with representatives from groups who have a stake in the electric power systemutilities, independent power generators, marketers, industrial, commercial and residential consumers, agriculture, public power, municipalities, and public interest groups. The mission of the ISO is to ensure a reliable transmission system, to ensure open and nondiscriminatory transmission access to all suppliers of commodity electricity, and to facilitate efficient electricity markets. On March 31, 1998, the ISO assumed computerized control of 85 percent of California's power grid124,000 square milesassuming operational control over the transmission systems formerly operated by the three investor-owned utilities in the state: Pacific Gas & Electric, Southern California Edison and San Diego Gas and Electric. While the utilities no longer control the operation of the transmission system, they continue to own the system and receive a fee for its usage. Today, the ISO delivers 204 billion kilowatt-hours of electricity each year, enough to serve the annual energy needs of 27 million Californians.
In the new deregulated structure, the generators compete to sell electric energy and generating capacity in several separate but inter-related markets. They may sell into the forward energy markets operated by the California Power Exchange, a second new corporation created by AB 1890. Generators may also sell into the real-time energy, or ''spot'' market, operated by the ISO. In addition, the ISO operates two innovative markets for other energy products: ''ancillary services'' and ''congestion mitigation.''
Ancillary services are products that must be available to ensure the reliable operation of the transmission grid, such as reserves. The ISO operates the world's first competitive market for ancillary services which allows the maintenance of real-time balance in the system by competitive procurement of reserve and replacement energy. Generators may also enter into bilateral contracts for forward energy and ancillary services, with specific consumers directly or with new intermediaries called Scheduling Coordinators, who interact with the ISO to schedule transmission. The ISO also operates the first competitive market for congestion mitigation. This market allows the ISO to manage the flow of electrons on the transmission lines to prevent overloading by buying the right to adjust the flow of electricity at congestion points in times of peak demand.
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Together, these markets not only help to lower the cost of providing electricity, but most importantly, through the use of tools acquired in the competitive marketplace, the ISO is able to maintain the safety and reliability of the transmission grid by fine-tuning the flow of electricity when the unexpected happens, such as a power plant failure or a sharp increase in the demand for power.
As a consequence of direct access and the opening of retail competition, AB 1890 has stimulated numerous new businesses, including retail marketing and customer service, load and supply aggregation, metering, data management, and retail revenue cycle services. Providers of these business services, plus the providers of generation, transmission and distribution services, collectively comprise the new California electric marketplace.
The new California market structure is innovative and complex, and the ISO recognizes the need to review and evaluate the performance of the various markets and to identify ways to improve market efficiency. To sustain healthy competition, we think it is essential that no market participant be able to take unfair advantage of the market rules or procedures or to concentrate market power and impede competitive market forces. This is particularly true during the years in which the markets will be forming and maturing. As noted by the Committee, electric power transmission lines in many areas constitute an ''essential facility'' for purposes of antitrust analysis. Traditional antitrust review can address some market power issues related to these facilities, but efficient electric power markets will require a dynamic, ongoing effort to monitor and address market power issues. Because it is often the highly complex interaction between electricity generation, transmission and congestion that can give rise to market power, we believe that ISOs such as the California ISO are in the best position to address market power issues and ensure a fully competitive electric power market.
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Addressing Market Power
The traditional antitrust reviews of mergers and acquisitions conducted by the Department of Justice, the Federal Trade Commission and the Federal Energy Regulatory Commission (FERC) are the first step in addressing market power issues in the transmission of electric energy. These merger analyses use measures which are based on assumptions about the correlation between market structure and competition. While these assumptions may be valid in the electricity markets, they are only a snapshot of the potential for the exercise of market power, not an ongoing or dynamic assessment of the behavior of market participants, and may not disclose market power in different product markets and time periods.
We believe a dynamic, ongoing assessment is necessary for the efficient functioning of the electricity markets because specific market rules, design features, and barriers may allow the exercise of market power even if overall market concentration suggests the markets should be competitive. For instance, due to the link between transmission congestion and energy prices in both zonal and nodal pricing systems, even players with small market shares of generation can have power and be able to affect significantly energy prices in different zones or nodes by ''gaming'' the transmission and congestion management system. In the ancillary services markets, relatively small players often are in a position to use unique temporal or physical situations to exploit market power for limited periods of time which, although limited, can cause considerable market harm.
Page 185 PREV PAGE TOP OF DOC In 1996, FERC issued its Order 888 which was aimed at promoting competition in the bulk electric power markets. In issuing Order 888, FERC recognized that ''Transmitting utilities own the transportation system over which bulk power competition occurs and transmission service continues to be a natural monopoly.''(see footnote 39) As FERC explained:
It is in the economic self-interest of transmission monopolists, particularly those with high-cost generation assets, to deny transmission or to offer transmission on a basis that is inferior to that which they provide themselves. The inherent characteristics of monopolists make it inevitable that they will act in their own self-interest to the detriment of others by refusing transmission and/or providing inferior transmission to competitors in the bulk power markets to favor their own generation, and it is our duty to eradicate unduly discriminatory practices.(see footnote 40)
The goal of Order 888 was, ''to remedy undue discrimination in access to the monopoly owned transmission wires that control whether and to whom electricity can be transported in interstate commerce.''(see footnote 41) FERC examined several policy tools to achieve this goal, and chose ''functional unbundling'' as the cornerstone of the Order. Functional unbundling required utilities to separate their transmission systems and staff from their wholesale generation marketing functions and staff; abide by a standard of conduct to define impermissible contact between generation and transmission personnel; take transmission services under the same open access tariff of general applicability as do others; state separate rates for wholesale generation, transmission, and ancillary services; and rely on the same Open Access Same-Time Information System (OASIS) that its transmission customers rely on to obtain information about its transmission system when buying or selling power. Functional unbundling did not change the incentives of vertically-integrated utilities to use their transmission assets to favor their own generation, but instead attempted to reduce the ability of utilities to act on those incentives.
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Functional unbundling was assumed to be sufficient to address anti-competitive behavior and promote competition. In Order 888, FERC chose not to require the more invasive regulatory option of ''corporate unbundling'' which would require utilities to divest generation assets from transmission ownership. However, FERC has now recognized that more is needed to ensure a competitive marketplace in electricity.
FERC's recent Notice Of Proposed Rulemaking (NOPR) on Regional Transmission Organizations (RTOs) revisits the issue of whether functional unbundling alone is sufficient to prevent the exercise of market power and to ensure efficient electricity markets. As explained in the NOPR, ''there are indications that continued discrimination in the provision of transmission services by vertically integrated utilities may also be impeding fully competitive electricity markets.''(see footnote 42)
In the NOPR, FERC has concluded that additional structural reform may be needed to mitigate these problems. ''We believe that further steps may need to be taken to address grid management if we are to achieve fully competitive power markets. We further believe that regional approaches to the numerous issues affecting the industry may be the best means to eliminate remaining impediments to properly functioning competitive markets.''(see footnote 43) To achieve the goals of fully competitive markets, the NOPR establishes an objective for all transmission owning entities to place their transmission facilities under the control of appropriate Regional Transmission Organizations (RTO) which would include properly structured ISOs.
Page 187 PREV PAGE TOP OF DOC FERC has proposed 11 minimum characteristics or functions of RTOs. Several of these minimum requirements address market power issues:
The RTO must be independent of market participants. Under this characteristic, the RTO, its employees and any non-stakeholder directors must not have a financial interest in electricity market participants. The NOPR would also require that an RTO have a decision-making process that is independent of control by any market participant or class of market participants.
The RTO must have exclusive authority for maintaining the short-term reliability of the grid it operates. Under the proposed regulations, an RTO must have exclusive authority to receive, confirm and implement all interchange schedules. To satisfy this requirement, an RTO must have the right to order re-dispatch of any generator connected to RTO-operated transmission facilities if necessary for the reliable operation of those facilities.
The RTO must administer its own transmission tariff and employ a transmission pricing system that will promote efficient use and expansion of transmission and generation facilities. To fulfill this function, an RTO must be the only provider of transmission service over the facilities under its control and must be the sole administrator of its own tariff.
The RTO must ensure the development and operation of market mechanisms to manage transmission congestion. The Commission would require that RTOs establish market mechanisms for congestion management which are designed to accommodate broad participation by all market participants and to provide efficient price signals regarding the consequences of transmission usage decisions.
Page 188 PREV PAGE TOP OF DOC The RTO must monitor markets for transmission services, ancillary services and bulk power to identify design flaws and market power and to propose appropriate remedial actions. Under this requirement, an RTO must monitor the behavior of various market participants, including transmission owners, to determine if their actions hinder the RTO in providing reliable, efficient and nondiscriminatory transmission service. An RTO would be required to monitor any markets for ancillary services and bulk power that it operates. In addition, an RTO would have an obligation to assess periodically how markets operated by other entities, such as bilateral power sales markets and unaffiliated power exchange markets, affect RTO operations (and how RTO operations affect such other markets).(see footnote 44)
The California ISO is structured to address these requirements. FERC has found its governance to be independent of market participants, via a balanced stakeholder board with heavy end-user representation. The ISO has exclusive authority to receive, confirm and implement interchange schedules, may order re-dispatch of generators if necessary for reliable grid operations, has authority to approve or disapprove requests for scheduled outages of transmission facilities, and sets reliability standards within those established by national and regional bodies. The ISO is the provider of transmission service and the administrator of the open access tariff within the ISO Controlled Grid. The ISO administers ancillary services markets, determines the amounts and locations of ancillary services, allows market participants to self supply services, and serves as the supplier of last resort. Using the ancillary services markets, the ISO administers a real time balancing market. The California ISO reviews and monitors the operation of the markets its administers.
Ongoing Need to Address Market Power
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Structural reform such as the creation of RTOs will be a major step in enhancing the efficiency of transmission markets. However, the mere existence of an RTO is not sufficient in itself to assure open competition in the electric power markets. Even with open transmission lines under independent control, generation firms can still exercise market power in transmission. In fact, in some instances, divestiture of transmission assets will exacerbate the opportunities to exercise market power.
Currently, the players with major market share in the transmission markets are investor owned utilities (IOUs) which historically have been required to serve demand at fixed prices. As ''net buyers,'' these entities have so far had incentive to exercise market power ''defensively'' to keep prices low. All this will change as more and more divestiture occurs, stranded assets are paid off, and rate freezes or caps placed on IOU's during transition periods are removed. In the future, market power is more likely to be exercised ''offensively'' to increase prices.
To understand fully the basis for ongoing opportunities to exercise market power, it is very important to understand that transmission is much more that just a set of wires in the air. All wires have limited capacity, and demands for electricity must be met essentially on a second-by second basis. In addition, electricity in the bulk power markets cannot be stored in any meaningful way. These facts create the opportunity for gaming the markets at the intersection of the generation of electricity and congestion on the transmission wires and in markets for ancillary services.
One of the principle functions of the ISO is to ensure the reliability of the transmission system. The ISO must balance the supply and demand for electricity in real time. When there is an unexpected increase in demand, the ISO must have at its disposal adequate reserve capacity to meet that increase with a sufficient operating margin. To meet these demands, the ISO operates a real-time imbalance market, the so-called spot market, to balance the available supply to meet system demands. In addition, the ISO operates an ancillary services market where it can purchase the reserve power necessary to maintain the reliability of the system.
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Another of the principle functions of the California ISO is to ensure the safety of the transmission system by preventing the shipment of electricity in excess of the capacity of the transmission wires. When too many generators wish to ship too much power the result is congestion. The ISO must act to mitigate the congestion on the wires or risk the safety of the system. Instead of resorting to command and control approaches, the ISO also uses market forces to address congestion. Unique in California, the ISO operates a congestion mitigation market where participants can agree voluntarily to curtail their loads, or to generate additional power to meet demand.
We see significant opportunities for the continued exercise of market power in the ancillary services market and in congestion mitigation. First, the ancillary services markets are much ''thinner'' than are overall energy markets since not all units that can provide energy can provide ancillary services. In addition, the demand for ancillary services is ''inelastic'' in that the ISO must procure ancillary services to meet reliability requirements as they occur, and cannot act to reduce consumption in response to high prices or market power. In sequential markets such as California, where ancillary services are purchased after the bulk of the energy market is scheduled, the available supply of ancillary services is even thinner.
Traditional market power tests can only partially deal with these issues. Moreover, it is critical that they appreciate the need to address the correct transmission ''product,'' whether it be the spot market, the ancillary services market or the congestion mitigation market. To do this, traditional tests must be augmented with more real-time indications of bid-sufficiency, peculiar bidding behavior and anomalous market situations. As the ''provider of last resort,'' the ISO needs to have the ability to manage the transmission markets.
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California ISO Department of Market Analysis
As noted above, for the market to operate in an open and competitive manner, no participant should be able to take unfair advantage of the rules or procedures or to be in a position where it is able to concentrate market power and inhibit competition. The exercise of market power and the gaming of market rules distort market prices and render them less fair and efficient. Any circumstances that impede fair and open competition must be identified and corrected if consumers are to benefit fully. In order to address issues of market power, the California ISO has established a Department of Market Analysis, formerly called the Market Surveillance Unit. The Department is the organization within the ISO that keeps a close watch on the efficiency and effectiveness of the ancillary services, congestion management and real-time spot markets.
The Department of Market Analysis monitors the markets and develops indicators of market performance, and reviews deliberate or inadvertent violations of market rules or contracts that affect the efficiency of the market, and under appropriate circumstances, violations may be referred to FERC and other agencies. The Department determines the existence of market power abuse and recommends structural changes where needed to address particular situations by reviewing ISO rules and protocols from a market performance perspective and asking the question, ''Do these rules support efficient market operation?'' The Department has developed catalogs of indices that it monitors and data it collects from market participants. The indices and data are used by the Department to detect abuses that have an impact on the fairness and efficiency of the ISO markets' operations.
Page 192 PREV PAGE TOP OF DOC Once the Department of Market Analysis determines that corrective action is necessary, there are a number of mechanisms that can be used to ensure that the market continues to function in a fair and efficient manner. For example, with the approval of FERC and the adoption of authorizing tariff provisions, penalties and sanctions can be meted out to market participants whose behavior violates established rules and protocols. In addition, where they have jurisdiction, other regulatory agencies can be informed. In other cases, the problem may stem from the inadequacy of a rule as opposed to its violation. In that circumstance, the promotion of efficiency and fairness may require that the tariff be changed. In only its first year of operation, the California ISO, through the surveillance efforts of its internal market monitors, has identified several such instances and applied to FERC for appropriate tariff modifications. Because it is integrated within the ISO, the Department of Market Analysis is well positioned with the data and technical know how to detect market imperfections and to recommend corrective action be it enforcement referrals or structural changes.
ISOs Offer an Excellent Framework to Address Market Power
We believe that ISOs are an excellent framework to institutionally address antitrust issues with respect to market power in generation and transmission of electricity. First, ISOs are a disinterested player in the market. The California ISO is a non-profit public benefit corporation unaffiliated with the buyers and sellers in the market. The ISO's mission is to ensure the safety and reliability of the transmission system.
Second, ISOs function to facilitate robust and efficient markets, allowing generators to do what they do bestfocus on the efficient production of power. To do this, the ISO establishes a clear and unbiased set of rules of the road to govern the market. Finally, ISOs are in the best position to monitor and ensure compliance with the rules, and to seek corrective action when necessary.
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We believe that any federal legislation governing RTOs should be based on the principle of self-policing. In the new and complex markets being developed to allow for deregulation of the electric utility industry, such as the transmission and energy imbalance (or spot) markets, market monitoring and analysis must be ''on the ground'' so to speak, with its finger on the pulse of market activity so that it can address what is going on in real time. That is the most effective first-line of defense against market power and inefficiency, as well as against potentially ineffective or misguided regulation by outside agencies. In the context of a deregulated electrical transmission system, with its technically complex rules and data intensive monitoring needs, the self policing function is most appropriately done by the ISO. It would also be both difficult and inefficient to locate the monitoring or policing functions outside the ISO since the entity responsible for that function must have access to and a profound understanding of the operations of the interconnection system.
Finally, ISOs should be the main facilitator for planning for future needs. The ISO can ensure that planning is done in the best possible manner, is open, fair and considers all non-transmission alternatives. In conjunction with this planning role, the ISOs should play a central role in coordination with state siting and permitting agencies.
After more than a year of experience operating the transmission system in a deregulated environment, we believe that the ''Swiss cheese'' approach to deregulation is not effective. However, that is what we will have if only FERC-regulated facilities are required to have open access to their transmission facilities. The remaining facilities outside of FERC jurisdiction, such as Municipal utilities and Public Power Systems are ''holes'' in the competitive marketplace. Since they retain their monopoly powers, these ''holes'' are replete with the potential for the exercise of market power. Not only does this create difficulties at the border between the competitive and monopoly worlds, but if you have enough holes, their collective power hinders or prevents development of competitive markets, even in fully deregulated areas. We believe it is essential to bring all providers of transmission service under the same rules of access to ensure the accomplishment of the goals of true open access and efficient markets.
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Finally, we urge you to respect regional differences in any restructuring legislation. The Western Interconnection, which operates over the entire inter-mountain and West Coast region has unique electrical features not found in interconnections in the East. As a result, no single approach to operating the transmission system will work nation-wide, and no single model for addressing market power should be forced on all areas of the country. Instead, Congress may wish to adopt the ''open architecture'' approach proposed by FERC in its NOPR. A single set of principles is certainly appropriate, but the implementation should be accomplished with deference to required needs and solutions.
Mr. HYDE. Thank you very much.
STATEMENT OF JIM SULLIVAN, PRESIDENT, ALABAMA PUBLIC SERVICE COMMISSION, ON BEHALF OF THE NATIONAL ASSOCIATION OF REGULATORY UTILITY COMMISSIONERS
Mr. SULLIVAN. Good morning, Mr. Chairman, and members of the committee. My name is Jim Sullivan, and I am president of the Alabama Public Service Commission and I serve as the current president of the National Association of Regulatory Utility Commissioners, also known as NARUC. I am here today on behalf of NARUC.
NARUC is a quasigovernmental nonprofit corporation which was founded in 1889, consisting of governmental agencies engaged in the regulation of utilities and carriers. The chief objective of NARUC is to serve the consumer interests by seeking to improve the quality and the effectiveness of public regulation in America.
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In view of NARUC's members, it is critically important to understand how antitrust legal concepts apply to the utility industry before restructuring reaches an advanced stage. Antitrust law operates far better as a preventive and educational tool than as a means of securing remedies after abuses.
The ongoing transition taking place in the electric power industry presents a paradox. On one hand legislators and regulators are in the process of relaxing traditional forms of oversight and placing increased reliance on the discipline of a marketplace. On the other hand, companies within the industry are pursuing significant mergers and consolidations which could frustrate the very forces we are counting on to discipline market behavior in the future.
Many States have elected to restructure retail electric markets and are putting in place elements that are essential to ensure vibrant, safe, and sustainable markets. In fact to date, 23 States have adopted retail electric restructuring programs, and those States represent more than one-half of the Nation's population. I believe States will continue to pursue restructuring programs that are in the public interest of their respective economies and citizens. NARUC supports the prerogative of each individual State to restructure its retail electric industry at its own pace.
Notwithstanding the pace of restructuring, the electric industry is currently undertaking mergers and consolidations of significant scope and scale. Indeed, in many circumstances, some degree of consolidation can clearly result in significant efficiencies that benefit utilities. Yet consolidation can also reduce the number of competitors in newly emerging markets with the risk of limiting consumers' choices in various ways. Horizontal mergers can limit choice by concentrating ownership in the chain of energy production and delivery. Vertical combinations may present a company with the opportunity to leverage its control of regulated facilities and thereby gain an advantage in another unregulated business segment. Mergers across industry lines based on theories of convergence between the electric power and natural gas industries or electricity and telecommunications have also been proposed, and such combinations could conceivably undermine the benefits of competition between alternative service delivery systems.
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Accordingly, we continue to believe that State and Federal policymakers should develop a more thorough understanding of the consequences that could arise of industry consolidation. The Nation's consumers should not be placed at risk of forfeiting the traditional benefits of regulation without receiving the benefits of effective competition. Certainly while it has been argued that the regulatory industry structure may not always yield optimal results in terms of efficiency and innovation, it is far preferable to a market dominated by unregulated monopolies.
The number of antitrust concepts that are likely to be implicated by restructuring were discussed in an April 1996 publication prepared by the National Regulatory Research Institute, which is NARUC's research arm. As the NRRI report explains, the following issues can be expected to arise as a transition to greater competition continues: Predatory pricing, territorial division, tying arrangements, pricing discrimination, formulation of joint ventures, and other agreements among competitors that can be a means of undermining competition.
NARUC and its members have worked extensively with FERC in conferences and meetings on RTO policy and we look forward to the development of a workable policy which protects competition and restructured utility markets while respecting important regional differences. We believe that regional flexibility is a critical factor in ensuring the cooperation and coordination between utility systems that is essential to assure the safe and reliable operation of the Nation's grid.
Mergers and acquisitions are perhaps the most significant concern among NARUC members in the area of antitrust policy. The possible reduction of competition amidst a wave of mergers and acquisitions can limit the benefits that restructured markets can provide.
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To best protect emerging markets, State and Federal regulators must be able to anticipate and address competition related concerns while mergers are still pending. If mergers proceed without adequate review, it is possible that the only future remedy would be to apply the antitrust laws through the courts and impose remedies retrospectively. Such a course would be expensive, disruptive, and extremely time consuming. We urge Congress to keep in mind the role FERC and the State commissions play in addressing competition policy, particularly in the area of mergers.
In conclusion, NARUC commits to work with you to ensure that the Congress and the States discharge our common obligations and secure our common interest in assuring adequate consumer protections in any restructuring legislation that Congress may enact.
[The prepared statement of Mr. Sullivan follows:]
PREPARED STATEMENT OF JIM SULLIVAN, PRESIDENT, ALABAMA PUBLIC SERVICE COMMISSION, ON BEHALF OF THE NATIONAL ASSOCIATION OF REGULATORY UTILITY COMMISSIONERS
States are leading the way to restructure retail electric markets and putting in place elements that are essential to ensure vibrant, safe and sustainable markets.
Page 198 PREV PAGE TOP OF DOC The electric industry is undertaking mergers and consolidation of significant scope and scale. However, consolidation can also reduce the number of competitors in newly emerging markets with the risk of limiting consumers' choices.
A regulated market is preferable to a market dominated by unregulated monopolies.
The following issues can be expected to arise as the transition to greater competition continues:
Predatory Pricing where a firm prices below its cost to drive out competitors and permit the firm, subsequently, to raise its price and reap monopoly benefits.
Territorial division where agreements among competitors divide or ''carve up'' territories.
Tying arrangements where the offering for sale of one product or service is contingent upon the condition that another product or service be taken.
Price discrimination where the sale of the identical commodity is made to two or more different buyers at different prices.
Formation of joint ventures and other agreements among competitors can be a means of undermining competition.
Mergers and acquisitions are perhaps the most significant concern among NARUC members in the area of antitrust policy.
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State and Federal regulators must be able to anticipate and address competition-related concerns while the merger is pending otherwise it is possible that the only remedy would be to apply antitrust laws through the courtsan expensive, disruptive and time-consuming proposition.
NARUC urges Congress to keep in mind the role of FERC and the State Commissions play in addressing competition policy, particularly in the area of mergers.
Congress may wish to consider whether it is appropriate to reinforce FERC's authority to provide a range of remedies for the reduction in competition that accompanies a merger.
Congress should consider filling possible jurisdictional gaps in the merger area by exploring mechanisms to ensure competition-related issues are evaluated by an appropriate entity which might be FERC, the Federal Trade Commission, the Department of Justice, individual State commissions, or some combination of these through a Joint Board.
Mr. Chairman and Members of the Committee:
Good morning. My name is Jim Sullivan. I am President of the Alabama Public Service Commission. I am also President of the National Association of Regulatory Utility Commissioners (''NARUC'') on whose behalf I appear here today. NARUC is a quasi-governmental nonprofit corporation, founded in 1889, consisting of governmental agencies engaged in the regulation of utilities and carriers. The chief objective of NARUC is to serve the consumer interest by seeking to improve the quality and effectiveness of public regulation in America.
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NARUC congratulates the Judiciary Committee for once again convening timely hearings on the relevance of antitrust issues to current legislative initiatives aimed at restructuring the nation's electric power industry. NARUC was pleased to testify before the Judiciary Committee in the last Congress on these issues. We continue to believe that the issues under your committee's jurisdiction are vitally important to the restructuring debate. In the view of NARUC's members, it is critically important to understand how antitrust legal concepts apply to the utility industry before restructuring reaches an advanced stage. Antitrust law operates far better as a preventive and educational toolaimed at assuring that conditions that might allow firms to engage in abusive activities do not arisethan as a means of securing remedies from such abuses. In actual application, antitrust proceedings have proven to be slow, expensive and contentious. The nation, therefore, will benefit from a proactive analysis that understands the nature of market conditions that could give rise to antitrust concerns.
As we noted in our previous appearance, the ongoing transition taking place in the electric power industry presents a paradox. On the one hand, legislators and regulators are in the process of relaxing traditional forms of oversight, and placing increased reliance on the discipline of a marketplace. On the other hand, companies within the industry are pursuing significant mergers and consolidations. NARUC's members that are in the process of implementing restructured markets are concerned that, if this consolidation proceeds without adequate understanding of its long-term competitive implications, it could frustrate the very forces that we are counting on to discipline market behavior in the future.
Regulators' movement toward competitive market structures.
Page 201 PREV PAGE TOP OF DOC States are leading the charge to restructure retail electric markets. In each case, the States are putting in place elements that are essential to ensure vibrant, safe and sustainable markets.
Twenty-three States have adopted retail electric restructuring programs to enable customers to choose among energy suppliers while ensuring the safety, reliability and quality of electric services. Still others are working through their State commissions and/or legislatures to provide open access to retail electricity markets.
While some argue that this level of activity is insufficient, the States that have adopted retail open-access electricity programs are home to more than one-half of the nation's population. All this activity has taken place within the last four years alone, and I believe States will continue to pursue restructuring programs that are in the public interest.
The States pursuing retail open-access are acting with great care and precision to ensure the continued reliability of electric services and universal access to retail services and public benefits previously provided by a vertically integrated electric industry. Careful review of these activities discloses that State restructuring initiatives contain many common elements: customer choice, functional unbundling, pricing reform, stranded cost recovery, protection of public benefits, sensitivity to the exercise of market power, and mechanisms to support emerging regional markets. It should also come as no surprise that the timing and implementation of such initiatives differ from State to State in ways that reflect local customer needs and other market realities including such factors as climate, demographics, indigenous resources, environmental impacts, past choices of technology, current resource preferences, system capacity, geography, and form of utility ownershipto name a few.
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As legislators and regulators authorize competitive entry into electricity markets, the industry is undertaking mergers and consolidation of significant scope and scale. Industry leaders support proposed mergers and consolidations on the need for size, sophisticated capabilities and access to capital as companies compete more and more on a global scale. Indeed, in many circumstances, some degree of consolidation can clearly result in significant efficiencies that benefit utility consumers.
However, consolidation can also reduce the number of competitors in newly emerging markets with the risk of limiting consumers' choices in various ways. As we noted in our last appearance before the Committee, horizontal mergers could limit choice by concentrating ownership in the chain of energy production and delivery (for example, generation within a given geographic region). Or vertical combinations may present a company with the opportunity to leverage its control of certain regulated essential facilities and thereby gain an advantage in another, unregulated business segment. Mergers across industry lines, based on theories of ''convergence'' between the electric power and natural gas industries (or electricity and telecommunications), have also been proposed. Such combinations could conceivably undermine the benefits of competition between alternative service delivery systems.
Accordingly, we continue to believe that State and Federal policymakers should develop a more thorough understanding of the consequences that could arise from industry consolidation. Only if such consequences are anticipated may measures be taken to avert or mitigate them. The nation's consumers should not be placed at risk of forfeiting the traditional benefits of regulation, without receiving the benefits of effective competition. Certainly, while it has been argued that the regulated industry structure may not always yield optimal results in terms of efficiency and innovation, it is far preferable to a market dominated by unregulated monopolies.
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NARUC is not in a position to present the Committee with detailed recommendations as to how restructuring legislation should relate to antitrust concerns. As we previously described, a number of antitrust concepts that are likely to be implicated by restructuring were discussed in greater detail in a study prepared by the National Regulatory Research Institute (''NRRI''), the research arm of NARUC, that was published in April 1996. We have provided a copy of the report for the Committee's staff.
As the NRRI report explains, the following issues can be expected to arise as the transition to greater competition continues:
Predatory pricing where a firm prices below its cost so as to drive out competitors and permit the firm, subsequently, to raise its price and reap monopoly profits. Emerging utility structures, in which some operations operate competitively while other parts remain regulated, may give rise to unique opportunities for predatory pricing behavior when companies can subsidize competitive operations with revenues from regulated services. To address this problem, last week at its Summer Committee Meetings, the NARUC adopted ''Guidelines for Cost Allocations and Affiliate Transactions'' (attached hereto) to provide guidance to regulators on ways to limit cross subsidies between regulated and competitive lines of business.
Territorial division relates to agreements among competitors to divide or ''carve up'' territories. Because utilities will continue to have geographically exclusive service territories for their transmission and distribution services, regulators and other policymakers will need to ensure that such territories are not used to leverage competitive lines of business such as electric power supply and related energy services.
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Tying arrangements involve the practice of offering for sale one product or service only on the condition that another product or service be taken. Regulatory mechanisms such as open access and affiliated transaction codes of conduct are intended to police against such abuses. State regulators are developing such codes of conduct as one element of their restructuring activities.
Price discrimination occurs when the sale of the identical commodity is made to two or more different buyers at different prices. Retail sales of power occur under State commission-approved tariffs that guard rigorously against undue discrimination. However, competitive pressures can provide utilities with incentives to offer power sales through contracts rather than tarriffed service. Utilities are beginning to recruit customers far beyond their service territories. Accordingly, regulatory and competition policies must monitor and provide appropriate safeguards to ensure that the benefits of competition are distributed fairly to all customer classes.
Formation of joint ventures and other agreements among competitors can be a means of undermining competition. Accordingly, under antitrust law, such agreements are permitted to the extent they go no further than necessary to achieve their legitimate purpose. Utilities have long engaged in collaboration through power pools, reliability councils and similar institutions. The Federal Energy Regulatory Commission (FERC) has issued a Notice of Proposed Rulemaking on Regional Transmission Organizations (RTOs) intended to ensure that the important benefits provided by regional cooperation and control of transmission facilities do not harm competition. NARUC and its members have worked extensively with FERC in conferences and meetings on RTO policy and look forward to the development of a workable policy which protects competition in restructured utility markets while respecting important regional differences. We believe that regional flexibility is a critical factor in ensuring the cooperation and coordination between utility systems that is essential to ensure the safe and reliable operation of the nation's grid.
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Mergers and acquisitions are perhaps the most significant concern among NARUC members in the area of antitrust policy. As I mentioned at the opening of this statement, the possible reduction of competition amidst a wave of mergers and acquisitions could limit the benefits that restructured markets can provide. Prospective partners to many of these mergers have expressed frustration at the lengthy delays that they have faced in obtaining regulatory and other approvals at both the Federal and State levels. While these concerns are understandable, we believe that they should not limit the ability of decisionmakers to evaluate the public interest aspects of pending mergers. Because the potential consequences of electric industry consolidation can be so great, State and Federal regulators must be able to anticipate and address competition-related concerns while the merger is pending. As NARUC stated in its last appearance before this Committee, if mergers proceed without adequate review, it is possible that the only future remedy would be to apply the antitrust laws through the courts, and impose remedies retrospectively. Such a course would be expensive, disruptive and extremely time-consuming.
NARUC's purpose in offering this testimony is not to propose detailed and specific actions for Congress to take in restructuring legislation. Rather, we have sought to highlight the various areas that will need attention. However, in considering electric restructuring legislation, Congress should focus on both the regulatory and antitrust impacts of its handiwork. Moreover, we urge Congress to keep in mind the role FERC and the State commissions play in addressing competition policy, particularly in the area of mergers. As we stated in our previous testimony, Congress may wish to consider whether it is appropriate to reinforce FERC's authority to provide a range of remedies for the reduction in competition that accompanies a merger. Moreover, Congress should consider filling possible jurisdictional gaps in the merger area. Large-scale mergers raise regional competitive implications that may extend across state borders into adjacent states where there may be no direct opportunity to review the merger and give explicit consideration to its extraterritorial, retail market implications. Mechanisms could be explored to ensure that competition-related issues are evaluated by an appropriate entity which might be the FERC, the Federal Trade Commission, the Department of Justice, individual State commissions, or some combination of these entities operating through the mechanism of a Joint Board.
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In conclusion, on behalf of NARUC, I sincerely appreciate the opportunity to appear here today. While there is no clear answer to many of the questions raised herein, it is important that the Committee understand the antitrust issues that restructuring raises. This Committee should ensure that these issues are adequately addressed in any federal legislation on the topic of electric industry restructuring. NARUC commits to work with you to ensure that the Congress and the states discharge our common obligation, and secure our common interest, in assuring adequate consumer protections in any restructuring legislation that Congress may enact.
GUIDELINES FOR COST ALLOCATIONS AND AFFILIATE TRANSACTIONS
The following Guidelines for Cost Allocations and Affiliate Transactions (Guidelines) are intended to provide guidance to jurisdictional regulatory authorities and regulated utilities and their affiliates in the development of procedures and recording of transactions for services and products between a regulated entity and affiliates. The prevailing premise of these Guidelines is that allocation methods should not result in subsidization of non-regulated services or products by regulated entities unless authorized by the jurisdictional regulatory authority. These Guidelines are not intended to be rules or regulations prescribing how cost allocations and affiliate transactions are to be handled. They are intended to provide a framework for regulated entities and regulatory authorities in the development of their own policies and procedures for cost allocations and affiliated transactions. Variation in regulatory environment may justify different cost allocation methods than those embodied in the Guidelines.
The Guidelines acknowledge and reference the use of several different practices and methods. It is intended that there be latitude in the application of these guidelines, subject to regulatory oversight. The implementation and compliance with these cost allocations and affiliate transaction guidelines, by regulated utilities under the authority of jurisdictional regulatory commissions, is subject to Federal and state law. Each state or Federal regulatory commission may have unique situations and circumstances that govern affiliate transactions, cost allocations, and/or service or product pricing standards. For example, The Public Utility Holding Company Act of 1935 requires registered holding company systems to price ''at cost'' the sale of goods and services and the undertaking of construction contracts between affiliate companies.
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The Guidelines were developed by the NARUC Staff Subcommittee on Accounts in compliance with the Resolution passed on March 3, 1998 entitled ''Resolution Regarding Cost Allocation for the Energy Industry'' which directed the Staff Subcommittee on Accounts together with the Staff Subcommittees on Strategic Issues and Gas to prepare for NARUC's consideration, ''Guidelines for Energy Cost Allocations.'' In addition, input was requested from other industry parties. Various levels of input were obtained in the development of the Guidelines from the Edison Electric Institute, American Gas Association, Securities and Exchange Commission, the Federal Energy Regulatory Commission, Rural Utilities Service and the National Rural Electric Cooperatives Association as well as staff of various state public utility commissions.
In some instances, non-structural safeguards as contained in these guidelines may not be sufficient to prevent market power problems in strategic markets such as the generation market. Problems arise when a firm has the ability to raise prices above market for a sustained period and/or impede output of a product or service. Such concerns have led some states to develop codes of conduct to govern relationships between the regulated utility and its non-regulated affiliates. Consideration should be given to any ''unique'' advantages an incumbent utility would have over competitors in an emerging market such as the retail energy market. A code of conduct should be used in conjunction with guidelines on cost allocations and affiliate transactions.
1. Affiliatescompanies that are related to each other due to common ownership or control.
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2. Attestation Engagementone in which a certified public accountant who is in the practice of public accounting is contracted to issue a written communication that expresses a conclusion about the reliability of a written assertion that is the responsibility of another party.
3. Cost Allocation Manual (CAM)an indexed compilation and documentation of a company's cost allocation policies and related procedures.
4. Cost Allocationsthe methods or ratios used to apportion costs. A cost allocator can be based on the origin of costs, as in the case of cost drivers; cost-causative linkage of an indirect nature; or one or more overall factors (also known as general allocators).
5. Common Costscosts associated with services or products that are of joint benefit between regulated and non-regulated business units.
6. Cost Drivera measurable event or quantity which influences the level of costs incurred and which can be directly traced to the origin of the costs themselves.
7. Direct Costscosts which can be specifically identified with a particular service or product.
8. Fully Allocated coststhe sum of the direct costs plus an appropriate share of indirect costs.
Page 209 PREV PAGE TOP OF DOC 9. Incremental pricingpricing services or products on a basis of only the additional costs added by their operations while one or more pre-existing services or products support the fixed costs.
10. Indirect Costscosts that cannot be identified with a particular service or product. This includes but not limited to overhead costs, administrative and general, and taxes.
11. Non-regulatedthat which is not subject to regulation by regulatory authorities.
12. Prevailing Market Pricinga generally accepted market value that can be substantiated by clearly comparable transactions, auction or appraisal.
13. Regulatedthat which is subject to regulation by regulatory authorities.
14. Subsidizationthe recovery of costs from one class of customers or business unit that are attributable to another.
B. Cost Allocation Principles
The following allocation principles should be used whenever products or services are provided between a regulated utility and its non-regulated affiliate or division.
1. To the maximum extent practicable, in consideration of administrative costs, costs should be collected and classified on a direct basis for each asset, service or product provided.
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2. The general method for charging indirect costs should be on a fully allocated cost basis. Under appropriate circumstances, regulatory authorities may consider incremental cost, prevailing market pricing or other methods for allocating costs and pricing transactions among affiliates.
3. To the extent possible, all direct and allocated costs between regulated and non-regulated services and products should be traceable on the books of the applicable regulated utility to the applicable Uniform System of Accounts. Documentation should be made available to the appropriate regulatory authority upon request regarding transactions between the regulated utility and its affiliates.
4. The allocation methods should apply to the regulated entity's affiliates in order to prevent subsidization from, and ensure equitable cost sharing among the regulated entity and its affiliates, and vice versa.
5. All costs should be classified to services or products which, by their very nature, are either regulated, non-regulated, or common to both.
6. The primary cost driver of common costs, or a relevant proxy in the absence of a primary cost driver, should be identified and used to allocate the cost between regulated and non-regulated services or products.
7. The indirect costs of each business unit, including the allocated costs of shared services, should be spread to the services or products to which they relate using relevant cost allocators.
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C. Cost Allocation Manual (Not Tariffed)
Each entity that provides both regulated and non-regulated services or products should maintain a cost allocation manual (CAM) or its equivalent and notify the jurisdictional regulatory authorities of the CAM's existence. The determination of what, if any, information should be held confidential should be based on the statutes and rules of the regulatory agency that requires the information. Any entity required to provide notification of a CAM(s) should make arrangements as necessary and appropriate to ensure competitively sensitive information derived therefrom be kept confidential by the regulator. At a minimum, the CAM should contain the following:
1. An organization chart of the holding company, depicting all affiliates, and regulated entities.
2. A description of all assets, services and products provided to and from the regulated entity and each of its affiliates.
3. A description of all assets, services and products provided by the regulated entity to non-affiliates.
4. A description of the cost allocators and methods used by the regulated entity and the cost allocators and methods used by its affiliates related to the regulated services and products provided to the regulated entity.
Page 212 PREV PAGE TOP OF DOCD. Affiliate Transactions (Not Tariffed)
The affiliate transactions pricing guidelines are based on two assumptions. First, affiliate transactions raise the concern of self-dealing where market forces do not necessarily drive prices. Second, utilities have a natural business incentive to shift costs from non-regulated competitive operations to regulated monopoly operations since recovery is more certain with captive ratepayers. Too much flexibility will lead to subsidization. However, if the affiliate transaction pricing guidelines are too rigid, economic transactions may be discouraged.
The objective of the affiliate transactions' guidelines is to lessen the possibility of subsidization in order to protect monopoly ratepayers and to help establish and preserve competition in the electric generation and the electric and gas supply markets. It provides ample flexibility to accommodate exceptions where the outcome is in the best interest of the utility, its ratepayers and competition. As with any transactions, the burden of proof for any exception from the general rule rests with the proponent of the exception.
1. Generally, the price for services, products and the use of assets provided by a regulated entity to its non-regulated affiliates should be at the higher of fully allocated costs or prevailing market prices. Under appropriate circumstances, prices could be based on incremental cost, or other pricing mechanisms as determined by the regulator.
2. Generally, the price for services, products and the use of assets provided by a non-regulated affiliate to a regulated affiliate should be at the lower of fully allocated cost or prevailing market prices. Under appropriate circumstances, prices could be based on incremental cost, or other pricing mechanisms as determined by the regulator.
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3. Generally, transfer of a capital asset from the utility to its non-regulated affiliate should be at the greater of prevailing market price or net book value, except as otherwise required by law or regulation. Generally, transfer of assets from an affiliate to the utility should be at the lower of prevailing market price or net book value, except as otherwise required by law or regulation. To determine prevailing market value, an appraisal should be required at certain value thresholds as determined by regulators.
4. Entities should maintain all information underlying affiliate transactions with the affiliated utility for a minimum of three years, or as required by law or regulation.
E. Audit Requirements
1. An audit trail should exist with respect to all transactions between the regulated entity and its affiliates that relate to regulated services and products. The regulator should have complete access to all affiliate records necessary to ensure that cost allocations and affiliate transactions are conducted in accordance with the guidelines. Regulators should have complete access to affiliate records, consistent with state statutes, to ensure that the regulator has access to all relevant information necessary to evaluate whether subsidization exists. The auditors, not the audited utilities, should determine what information is relevant for a particular audit objective. Limitations on access would compromise the audit process and impair audit independence.
2. Each regulated entity's cost allocation documentation should be made available to the company's internal auditors for periodic review of the allocation policy and process and to any jurisdictional regulatory authority when appropriate and upon request.
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3. Any jurisdictional regulatory authority may request an independent attestation engagement of the CAM. The cost of any independent attestation engagement associated with the CAM, should be shared between regulated and non-regulated operations consistent with the allocation of similar common costs.
4. Any audit of the CAM should not otherwise limit or restrict the authority of state regulatory authorities to have access to the books and records of and audit the operations of jurisdictional utilities.
5. Any entity required to provide access to its books and records should make arrangements as necessary and appropriate to ensure that competitively sensitive information derived therefrom be kept confidential by the regulator.
F. Reporting Requirements
1. The regulated entity should report annually the dollar amount of non-tariffed transactions associated with the provision of each service or product and the use or sale of each asset for the following:
a. Those provided to each non-regulated affiliate.
b. Those received from each non-regulated affiliate.
c. Those provided to non-affiliated entities.
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2. Any additional information needed to assure compliance with these Guidelines, such as cost of service data necessary to evaluate subsidization issues, should be provided.
RESOLUTION REGARDING COST ALLOCATION GUIDELINES FOR THE ENERGY INDUSTRY
WHEREAS, There is ongoing concern regarding potential cross-subsidization between the regulated monopoly operations and the non-regulated businesses of electric and gas utilities; and
WHEREAS, Utilities are adopting various business strategies to adjust to the changing retail markets, including forming alliances and creating subsidiaries, divisions and partnerships to participate in non-regulated, competitive markets; and
WHEREAS, State utility commissions are examining and adopting various policies to monitor the competitive activities of regulated energy utilities; and
WHEREAS, State utility commissions are examining and adopting policies and rules concerning potential cross-subsidies between regulated utilities and non-regulated affiliates including pricing of assets, products and services; and
WHEREAS, The National Association of Regulatory Utility Commissioners (NARUC) requested the Staff Subcommittee on Accounts together with the Staff Subcommittees on Strategic Issues and Gas to prepare for NARUC's consideration, ''Guidelines for Energy Cost Allocations''; and
WHEREAS, The Staff Subcommittee on Accounts together with the Subcommittee on Gas and Strategic Issues have prepared for NARUC's consideration ''Guidelines for Cost Allocations and Affiliate Transactions''; and
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WHEREAS, Each State or Federal Regulatory commission may have unique situations and circumstances that govern affiliate transactions, cost allocations, and/or service or product pricing; and
WHEREAS, The ''Guidelines for Cost Allocations and Affiliate Transactions'' are to provide guidance to the states and are not intended to be rules or regulations prescribing how cost allocations and affiliate transactions are to be handled; and
WHEREAS, The Staff Subcommittees on Accounts, Strategic Issues and Gas should periodically review the Guidelines for Cost Allocations and Affiliate Transactions, taking into consideration the progression of competition in the electric and gas industries nationally, and report their findings, including proposed changes to the guidelines, if necessary, that promote efficiency in competitive energy markets while guarding against cross-subsidization by monopoly ratepayers; now therefore be it
RESOLVED, The Board of Directors of the of the National Association of Regulatory Utility Commissioners (NARUC), convened in its 1999 Summer Meeting in San Francisco, California, adopts the attached ''Guidelines for Cost Allocations and Affiliate Transactions''; and be it further
RESOLVED, The NARUC directs the Staff Subcommittees on Accounts, Strategic Issues and Gas, to review the Guidelines for Cost Allocation and Affiliate Transactions, taking into consideration the progression of competition in the electric and gas industries nationally and report their findings to NARUC, including proposed changes to the guidelines, if necessary, on or before January 1, 2001, and annually thereafter, and be it further
Page 217 PREV PAGE TOP OF DOCRESOLVED, The NARUC applauds and thanks the Staff Subcommittees on Accounts, Gas, and Strategic Issues for their excellent work in developing the guidelines.
Sponsored by the Committees on Electricity and Finance and Technology
Adopted by the NARUC Board of Directors July 23, 1999
Mr. HYDE. Thank you, Mr. Sullivan.
STATEMENT OF JIM McGLYNN, PRESIDENT, McWILLIAMS ELECTRIC COMPANY, INC., ON BEHALF OF THE NATIONAL ELECTRIC CONTRACTORS ASSOCIATION AND THE NATIONAL ALLIANCE FOR FAIR COMPETITION
Mr. MCGLYNN. Good morning, Mr. Chairman and members of the committee. My name is Mr. Jim McGlynn. I am an electrical contractor from the northeast area of Illinois. Thank you for the opportunity to come before you today to discuss the issue of increasing concern to myself and thousands of small businesses across the country.
My appearance today is on behalf of the National Alliance for Fair Competition, NAFC, a coalition of 10 national trade associations and a national electrical contractors association, which is a member of NAFC. Collectively the members of NAFC represent approximately 35,000 businesses, the vast majority of them which are small businesses. Most of these firms operate in the contracting industry. Some are electrical contractors like myself. Others are mechanical, air conditioning, plumbing, heating and cooling or sheet metal contractors and some supply energy, fuel, and equipment.
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My firm along with others within NAFC share a single overriding concern: We are suffering from the effects of unfair utility competition. We have seen our markets eroded, our customers lost, our revenues shrink because regulated public utilities and their unregulated affiliates have taken the opportunity to engage in subsidized competition against us. Deregulation in the electrical power industry has created pressures for utilities to diversify into other lines of work, typically those which are related to the energy business, such as electrical or mechanical work.
Typically the regulated utility will establish an unregulated affiliate to conduct such work. This results in an arrangement where the utility and its affiliate operate in a mixed economic environment which is particularly regulated and is a monopoly and particularly competitive and unregulated. This allows the unregulated affiliate to offer its services at prices below, in some cases below cost, and to outbid firms such as ours for work in the marketplace. Such action also harms rate payers since they must bear the burden of paying higher rates to cover these costs.
The ability of the utility and its affiliate to get away with such a scheme is entirely dependent upon the vigilance of the State utility regulatory authority to detect and police such activities. Unfortunately such methods of unfair competition are notoriously difficult to detect at best and many State commissions lack the resources or the authority to pursue complex cross subsidization investigations, such as my home State of Illinois. The sad and discouraging fact is that many small businesses find nowhere to turn for relief or help. It seems that we fall into a gap between the antitrust laws and agencies that enforce these laws and the public utility commissions and their regulatory jurisdiction and authority.
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I would like to explain this problem and suggest some possible remedies for the committee's consideration. State public utility commissions protect aggrieved rate payers and are not much concerned with the problems of aggrieved competitors. PUCs also lack the authority to provide any compensation to a business which might be harmed as a result of unfair competition caused by impermissible subsidy.
Further, the ability to raise the issue may be contingent upon the institution of a rate case by a utility so any relief would be after the fact. However, if the subsidy is found to exist, the PUC can stop it and take measures to reduce the potential for future occurrences.
Agencies such as the Federal Trade Commission which enforce the antitrust laws are not a particularly good forum for dealing with this problem. It has been said that antitrust laws protect competition, not competitors. While it is true that compensation damages are available and initial action may be more timely than at the PUC level, proving the existence of the impermissible subsidy is only the beginning. This is because the antitrust laws may require further analysis into the existence of market power and establishing the relevant market. Satisfying such requirements may be impossible for a firm which operates in a market served by thousands of competitors. Thus, despite the fact the impermissible and unfair methods of the competition between regulated public utilities and their unregulated affiliates may exist, and despite the fact that firms are being harmed does not appear to be any single appropriate forum in which timely and effective remedies can be sought.
I would like to note that our industry has approached the FTC on several occasions concerning this problem only to find they have either no interest or believe there are no harm occurring since we operate in an industry in which there are many competitors and little present potential for any unregulated utility affiliate to dominate the market.
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This is in direct contrast to the FTC's oft stated position with respect to the need to protect the emerging competitive market power industry from the anti-competitive effects of utility cross subsidization. Here we have the same fact situation, the same harm, the same impermissible subsidies but only one industry is deemed worthy of protection. This needs to change. If not, the FTC might well find that subsidized competition in the related energy services industry has reduced the thousands of small competitors down to a far fewer number of large utility affiliated firms.
To address the concerns of the small business competitors, NAFC and NECA suggest that any comprehensive Federal deregulation legislation contain measures which serve to provide appropriate remedies for unfair competition.
First, competitors need a forum, as well as ratepayers and consumers, in which they can present their complaints as competitors and obtain a timely response. Federal legislation, at a minimum, should provide authority and direction for State utility regulatory bodies to entertain complaints of unfair competitive conduct from competitors which may have been harmed.
Second, any comprehensive Federal legislation should clearly prohibit cross-subsidization and cost shifting. In addition, there needs to be a better definition of cross-subsidization which is in keeping with the more typical fact patterns encountered in today's deregulated markets. Specifically, intangibles as well as tangibles need to be covered and it should be made clear that regulated monopolies have a duty to ratepayers to maximize the value of utility assets in any transfers to their unregulated affiliates.
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Third, any Federal restructuring legislation should require States which deregulate to establish both structural and behavioral rules to protect competition in existing energy-related services markets; that is, contractor markets, as well as competition in the emerging energy commodities markets. Applications of State codes of conduct should be extended to all utility affiliates regardless of the type of activity in which they are engaged.
Fourth, it should be as easy for an aggrieved competitor to obtain relief as an aggrieved ratepayer. Proof of the existence of an impermissible subsidy or shifting of costs should, in and of itself, be enough to make a case for relief, whether the complaint is before a State utility regulatory authority or before the FTC. Cross-subsidization and cost shifting in the context of a mixed regulated and unregulated environment clearly should be regarded as a per se form of unfair competition under the law. Inquiries into market power only should be relevant for determining the extent of damages.
On behalf of NAFC and NECA, I thank Chairman Hyde and the other members of the Judiciary Committee for initiating these inquiries into the antitrust aspects of utility deregulation and the opportunity to appear here today. We encourage the committee to continue its inquiries and to provide the thousands of small business owners faced with this anticompetitive conduct a means to address such problems.
NAFC and NECA believe that this committee is the proper forum in which to discuss the potential solutions to anticompetitive conduct and to fashion rules for ensuring free, fair, and open competition. The House Judiciary Committee contributed substantially to the final language adopted by Congress in connection with the Telecommunications Act. It needs to again assert the jurisdiction over deregulation of energy utilities, especially in connection with any comprehensive deregulation and restructuring legislation. Without such jurisdiction, the interests of thousands of small businesses will be substantially damaged.
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Thank you. I will answer any questions anyone might have. Thank you.
Mr. HYDE. Thank you, Mr. McGlynn.
[The prepared statement of Mr. McGlynn follows:]
PREPARED STATEMENT OF JIM MCGLYNN, PRESIDENT, MCWILLIAMS ELECTRIC COMPANY, INC., ON BEHALF OF THE NATIONAL ELECTRIC CONTRACTORS ASSOCIATION AND THE NATIONAL ALLIANCE FOR FAIR COMPETITION
Thank you, Mr. Chairman, Mr. Conyers and members of the committee. It is a pleasure to be here to speak on this important subject today.
The McWilliams Electric Company, of which I am President and CEO, is located in the Chicago area and was first established in 1922. Since then, it has grown to become a substantial company employing over 200 people.
I am here today to testify on behalf of the National Electrical Contractors Association (NECA) which, along with nine other national trade associations, is a member of the National Alliance for Fair Competition (NAFC). NAFC was formed specifically to draw attention to the problems small businesses face with respect to unfair competition from public utilities and their unregulated affiliates.
The organizations which comprise NAFC consist, overwhelmingly, of small, private sector businesses engaged in the design, supply, rental, sale, design, installation and servicing of electrical and mechanical products, equipment, and systems, as well as providing energy fuels. These firms operate in residential, commercial and industrial markets. While a few larger firms are included within this group, the majority of business are small by any standard of measurement and many are family owned and operated.
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The electric power industry is in the process of transition from a predominantly monopolistic, regulated environment to one characterized by increased competition and decreased regulation. Portions of the industry, e.g., distribution and transmission, will continue to be regulated while generation and other aspects will be unbundled and enter the competitive marketplace. The climate of deregulation, if not its actual occurrence, has prompted utilities to form unregulated affiliates and subsidiaries seeking to capture markets which have not traditionally been served by utilities and which lie, generally, outside the cope of their core functions. Increasingly, utilities have settled on entry into the energy services and related markets as a means of holding on to customers and establishing profit centers. Thus, utilities now seek to dominate the related energy services markets, such as those for electrical, HVAC, and air conditioning markets.
This diversification by utilities into areas outside of their publicly regulated role as producers and suppliers of energy has occasioned significant and continuing harm to small, private sector firms engaged in the related energy service fields. Utilities (typically through unregulated affiliates or subsidiaries) now routinely sell appliances, provide plumbing, heating, and cooling equipment and service contracts, engage in insulation work and sales of storm windows and doors, provide outdoor lighting and interior lighting fixtures. With the advent of deregulation, such activities substantially accelerated. Utilities have also begun to enter into security and alarm monitoring markets, telecommunications, and related energy markets such as energy management and energy monitoring. This competition engenders considerable friction between small private sector firms which have traditionally supplied such services and the utilities, which can call on the considerable marketing advantages associated with monopoly power. Further, and most importantly, utilities are unfairly subsidizing their market entry from their utility rate base. There is also considerable potential for small businesses to be denied access to newly emerging markets which are the key to future expansion, job growth, and profitability as deregulation progresses.
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Private sector businesses small and large welcome competition, as a rule. The deregulation of the utility industry in this country can be accorded a similar response if it is accompanied by steps designed to ensure that resulting competition is in fact free, fair, and open. Absent this, deregulation will be imperfect, unbalanced, and generally unfair, discriminatory and, ultimately, anti-competitive.
The primary obstacle to free, fair and open competition in existing markets, as well as emerging ones, is the ability of the utility to leverage its entry into, and penetration of, traditional private sector markets (typically through its non-utility subsidiaries or affiliates) by means unavailable to business entities that do not enjoy a status as a state-sanctioned monopoly.
It must be emphasized that the ''unfairness'' of such competition does not arise due to the utility's (or its subsidiary's or affiliate's) size, or due to any inherent advantage associated with corporate management, or with expertise in the field or relevant markets. Rather, the ''unfairness'' arises from two basic facts. First, the utility and its affiliated companies inhabit a mixed economic environment where certain operations are regulated and others exist in a competitive market. This, despite regulatory oversight, produces opportunities for cross-subsidization, cost shifting, and discriminatory conduct.
Second, the state has conferred upon a particular business entity, the utility, to the exclusion of all others, a monopoly franchise complete with a captive customer base in the tens, if not hundreds, of thousands of customer sites. This exclusive monopoly franchise provides a mechanism by which costs can be dispersed over this rate base and imparts an enormous reservoir of name recognition to the utility and its affiliates due to monopoly status. This franchise also imparts an ability and a legal right to gather customer site information regarding energy use (and future energy marketing leads) including a complete profile of each customer with respect to billing and credit history.
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None of these advantages is available to a private sector competitor, large or small.
The mixed environment of regulatory and competitive operations at the retail level which exists between remaining distribution utilities and their unregulated affiliates which may offer energy marketing and related customer energy services (e.g., electrical contracting, HVAC sales and service, appliance repair, engineering and design for electrical, mechanical, and air systems, etc.) is a cause of great concern to small business competitors. This increased dichotomy between regulated and unregulated operations of utilities and their affiliates has created a need for state regulators to examine and reassess the efficacy of existing rules and to devise more appropriate remedies and controls to meet the present circumstances.
Both state and federal regulators should be concerned about the effects on consumers and competition arising from potential discrimination and cross-subsidization in transactions between regulated distribution utilities and their unregulated affiliates providing retail electric and gas services. The Public Utility Commission of Texas has noted that:
[T]here is a strong likelihood that a utility will favor its affiliates where these affiliates are providing services in competition with other, non-affiliated entities. . . . [In addition,] there is a strong incentive for regulated utilities or their holding companies to subsidize their competitive activity with revenues or intangible benefits derived from their regulated monopoly businesses. . . . Finally, . . . current regulations . . . are not adequate to prevent or discourage [this] anticompetitive behavior . . .(see footnote 45)
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The inherent danger of cross-subsidization in mixed regulated and competitive markets has been frequently noted. Professor Alfred Kahn has observed:
''As long as the regulated prices continue to be set, directly or indirectly, on the basis of total company costs and revenues, or on the basis of some continuing process of allocation of costs between regulated and unregulated operations, there will always be the danger, in principle, of subsidization of the latter by the former.''(see footnote 46)
One of the most pernicious forms of cross-subsidization which occurs is that of misallocation of costs between the regulated and unregulated entities, or cost-shifting.(see footnote 47) It is rare that a naked subsidy from the regulated entity to the affiliated entity would be found absent some cost justification for the transfer. Because regulated entities receive a return based on their costs, there is a well recognized tendency for such entities to over-purchase and hold assets which can be used for both regulated and unregulated operations.(see footnote 48) Since the regulation of the regulated entity (e.g., the local utility) is tied to reported costs, increasing, or shifting, such costs to the regulated market operations need not negatively impact the utility. If the shifted costs are capital expenditures, the regulated entity gets an added revenue increase since the rate of return regulation is tied to capital investment.(see footnote 49)
The Department of Energy issued a report in 1993 which noted some of the problems associated with cross-subsidization and small business competitors.(see footnote 50)
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''A regulated firm's advantage in unregulated markets might arise, not from economies of scale or scope, but from evading regulation. By evading regulation, utilities could compete with independent firms by cross-subsidizing their unregulated service. Two means of evading regulation (and disadvantaging ratepayers) are self-dealing and cost shifting. A utility could use self-dealing and cost shifting strategies if:
1) its rates are based on costs, and
2) its expenditures cannot be monitored adequately.''(see footnote 51)
The Report then concludes that ''eliminating unfair competition may require preventing cost shifting and self-dealing.
The problems associated with such cost shifting create a significant detriment for electricity consumers, as well as competition, since such action makes for higher electricity prices. First, discrimination and cross-subsidization may artificially increase the costs of the regulated utility service as costs incurred for the benefit of the affiliate are shifted to the regulated firm. Under a rate-of-return regulatory regime, higher costs will result in increased prices in the regulated market. Second, such conduct may increase costs in unregulated markets by displacing innovative, lower-cost suppliers and entrants with a higher-cost affiliate of the local regulated distribution utility. Third, this displacement also may eliminate or reduce the process and product innovations that the displaced firms would have provided to consumers.
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Cost shifting and cross-subsidization can result in predatory-type pricing by utilities and their unregulated affiliates. There has been a tendency to dismiss claims of competitors concerning this possibility because, in the private sector, such a strategy can be expensive and carries a high risk of failure, . However, the utilities' particular hybrid structure, in which parts of their operations operate competitively while other parts remain regulated, can give rise to opportunities for predatory pricing behavior that simply do not exist in more purely competitive settings. A significant portion of utilities' cost structure is subject to a regulatory scheme that provides for assured recovery. The existence of this scheme may afford opportunities to cut prices in one segment of their business and enforce the collection of foregone revenues from monopoly ratepayers in another segment.
Further, detection of the occurrence of such shifting is exceedingly difficult and appropriate remedies to correct such abuses may be lacking. Even if ultimately detected, present enforcement procedures are invariably slow and competitors feel that the system cannot move expeditiously enough to protect against the risk of unfair competition or discriminatory treatment.
LACK OF APPROPRIATE REMEDIES
Competitors which are not affiliated with a regulated utility, whether small businesses or not, lack meaningful and appropriate remedies to address such unfair competitive conduct. In some cases, it has become difficult to even find a forum in which complaints may be presented. The reason appears to stem from several factors, including:
Page 229 PREV PAGE TOP OF DOC A division of authority between state utility regulatory authorities, which act to protect ratepayers, and antitrust enforcement agencies, which act to protect competition.
The lack of compensation for competitors harmed by unfair competition by utilities and their unregulated affiliates.
The challenge of the antitrust laws to adequately address new situations and fact patterns beyond the traditional scope and analysis of unfair and anticompetitive conduct.
I would like to discuss each of these points in turn.
To competitors who see their customers and markets being eroded by what appears to be unfair competition, it often seems as if there is a gap between what regulation can control and what the antitrust laws prohibit. As electrical contractors and other competitors have discovered, state utility regulatory bodies are not receptive to complaints by competitors concerning unfair competition despite the fact that the foundation of the complaint may be that impermissible cost shifting or cross-subsidization is occurring.
However, they are receptive to complaints by ratepayers even where the very same facts concerning cross-subsidies or cost shifting may exist. This is because the primary duty of such regulatory bodies is to protect ratepayers, not competitors. Thus, if a firm is harmed by unfair competitive conduct from a utility or it's unregulated affiliate, it must appear before the state utility regulators as a ratepayer and not as business competitor.
While such an approach, as an aggrieved ratepayer rather than an aggrieved competitor, may ultimately precipitate some action on the part of the regulators, it not result in any meaningful remedy to a business which has suffered harm occasioned by subsidized competition. Again, this is because utility authorities, when exercising their traditional authority to protect ratepayers from abuses, are limited to remedies which are appropriate for such situations. Thus, where an impermissible subsidy or cost shifting might be found, a state regulatory body might deny a rate increase by a utility or, in an extreme case, require that rates be lowered or impose a fine. However, having rates lowered does nothing to compensate a business which has lost jobs, customers and revenues as a result of impermissible conduct nor will it give back the jobs lost to employees of such a business.
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On the other hand, the antitrust laws do provide compensation, even to the extent of treble damages, where such anticompetitive or unfair conduct can be established. However, it may be difficult to establish that a violation of the law has occurred, even if a cross-subsidy if found to exist. This is because the present fact patterns do not necessarily conform to traditional antitrust analyses of market power or because an essential element of the crime is lacking.
As an example, it dies not appear that competitors harmed by cost shifting schemes would be able to sustain a predatory pricing complaint under the antitrust laws. One of the essential elements of a predatory pricing complaint is that, having driven off the competitors, the firm engaging in the predatory scheme raises its prices to reap the benefits of having become the market dominant provider. However, there may be no incentive for a utility affiliate to raise prices in a mixed market environment since, taken together, the utility and its unregulated affiliate are already reaping substantial profits. Thus, the last element of a traditional predatory pricing scheme is lacking and the complaint will fail.
Finally, in this regard it should be noted that an aggrieved ratepayer need only prove the existence of the cross-subsidy to obtain relief from a state regulatory authority. An aggrieved competitor seeking relief under the antitrust laws who has similarly proved the existence of a such a subsidy has only begum to make a case for relief. Additional inquiries would then need to be made concerning relevant markets, market power, and other factors.
MARKET POWER AND ECONOMIES OF SCOPE.
Page 231 PREV PAGE TOP OF DOC Other issues which arise, both with respect to obtaining regulatory oversight and invoking the antitrust laws, are the traditional analysis of market power and the arguments concerning economies of scope.
State utility regulators have, in some instances, refused to accord private sector firms engaged in energy related service markets equal coverage with those firms engaged in energy marketing under codes of conduct. Firms which seek to provide electric power or natural gas in competition with utility affiliates are frequently accorded protections which are denied electrical or mechanical contracting firms which are also engaged in competition with utility affiliates. For example, in Massachusetts, a utility may share employees and overhead expenses, or engage in joint advertising with a affiliate engaged in competition with electrical or mechanical contractors but not with an affiliate competing with energy marketing firms.(see footnote 52) Thus, despite the fact that the potential for cross-subsidization or cost shifting is equally possible regardless of which unregulated affiliate may be involved, contractors are accorded less protection than energy marketers.
This appears to be based on the fact that competition in such energy ''commodities'' is new and that there are fewer competitors in such markets than there are in the more mature energy related services markets for electrical and mechanical work. Under traditional antitrust theories, a market that is divided evenly among many participantsand this has been the case in the electrical contracting businesswill rarely have the potential for abuse of market power. Even if this were true for the moment, it will not be so for very long.
Indeed, we are no longer dealing with potentialities but realities with respect to emerging market dominance. As an example, FirstEnergyan Ohio based public utility holding companyrecently created an unregulated competitive electrical/mechanical contracting affiliate and, within the space of just over a year acquired ten large contracting firms located in several adjacent states. This operation, FirstEnergy Essential Facilities Services, now has over 1200 employees and an annual revenue base of over $400 million. While it is unclear whether this operation might meet antitrust criteria for market power purposes, it has clearly become one of the largest provider of electrical and HVAC/R services in the country and in very short time.
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This is not the only example. The growth of utility-owned affiliates operating in what has, until now, been a market characterized by thousands of small businesses, has been explosive. Unfortunately, there are as yet no statistics on such growth (a partial list is appended to this testimony) and it is unclear if those responsible for conducting antitrust compliance reviews make any effort to ascertain the extent of such growth or its impact on the markets served by our industry.
The consequences of this traditional approach to defining market power for businesses which must compete against utility affiliates are not only that they might be accorded fewer protections by state regulators than other firms competing in energy commodity markets, but that they may also be foreclosed from a remedy under the antitrust laws despite the unfairness of the competition.
Again, this illustrates the gap between state utility regulation and the antitrust laws. As an aggrieved ratepayer, proof of the existence of an impermissible cross-subsidy or cost shifting in and of itself might be enough to obtain action by the state utility regulatory body to cause such conduct to cease. However, the compensatory remedies under the antitrust laws available to an aggrieved competitor would be lacking. In contrast, proof of such cross-subsidization or cost shifting, standing alone, would be inadequate to obtain recovery for damages under the antitrust statutes. In either event, those harmed by unfair competitive conduct in such instances have nowhere to turn for an adequate remedy.
Another problem which unaffiliated firms face concerns arguments regarding so-called economies of scope or scale. This is an issue frequently raised by the Federal Trade Commission (FTC) in its testimony before state utility commissions. Economies of scope may result where there are costs common to the provision of two (or more) products or services. If the cost is incurred to provide the first product, then it need not be incurred again to produce the second. If the costs are truly common to both the regulated and unregulated operation then, for economic analysis purposes, they are not borne again by the regulated firm if it elects to provide the unregulated product. Thus, utilities invariably argue that they should be permitted to share employees, equipment, tools, and other assets, including good will, freely between regulated and unregulated operations and thereby capture these so-called economies of scope.
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While it is possible that there may exist some situations in which true economies of scope may exist, it is more likely that impermissible cost shifting and cross-subsidization will be the outcome where regulated assets are shared with unregulated operations.
Arguments regarding economies of scope frequently overlook certain facts. First, since the prices which can be charged in the unregulated market are subject to the forces of competition, there will be resistance to any attempt to charge more for the unregulated product or service. Thus, a utility will have every incentive to attribute all of any such common costs to the regulated monopoly operations where they can be borne by ratepayers. This will unnecessarily raise rates to captive customers.
By requiring ratepayers to pay more than they would have if costs were shared on an equitable basis, such action should be considered as violative of a regulated monopoly's obligation to maximize the value of their assets for the benefit of ratepayers. Inasmuch as ratepayer funds helped to build any value above cost that the regulated company's products, services or assets might have, such value should be returned to ratepayers whenever those assets, products or services are transferred to or used by the unregulated affiliate. This would serve to keep rates lower and simultaneously protect competition.
Unfortunately, the logic of such a position appears not to be relevant to the application of antitrust principles which are not concerned with protecting ratepayers of regulated monopolies.
Page 234 PREV PAGE TOP OF DOC A further problem with economies of scale concerns the implications of the validity of the claim that such economies truly exist. If such economies exist, then regulated firms and their affiliates would have advantages which could not be matched by private sector firms which are not affiliated with regulated public utilities. Such advantages would eventually drive out many competitors, probably smaller businesses which could not possibly match the lower market prices offered by affiliated competitors, as well as create a barrier to entry for other firms which might otherwise enter the market.
The predictable result would be that the present market, populated by thousands of small businesses and a few larger ones, would rapidly become one which contains far fewer firms overall, many more of which will be large with a commensurate, rapid decline in the number of small and medium sized firms. It is difficult to see how competition will be enhanced under such circumstances.
If such economies do exist, then they exist only for the benefit of unregulated firms affiliated with regulated utility monopolies. Unaffiliated competitors would not have access to these particular economies of scope and could become permanently disadvantaged. In such a situation, the optimal public policy response should require extending regulation to cover such unregulated affiliates and their relationships with the regulated entity.
Finally, because the only way in which economies of scope can be created is to permit the unregulated entity to have recourse to the assets of the regulated entity, the existence of true economies of scope may prove to be elusive. Because the greatest opportunity to create economies of scope will lie where the inputs of management, labor and equipment are most similar to the provision of both the regulated and unregulated products or services, it will, consequently, be more difficult for regulators to detect improper cost shifting and cross-subsidization. Thus, efforts to capture economies of scope will lead regulated utility monopolies to direct their entry into those very markets where the ability of regulators to determine that costs alleged to have been incurred in the provision of the regulated product or service were actually incurred to provide it. This difficulty in maintaining effective oversight will encourage not economies of scope, but anticompetitive and unfair cross-subsidization and cost shifting.
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Far from creating market efficiencies, the entry of unregulated utility affiliates into energy related markets poses the greatest probability of market inefficiencies. As observed by one commentator:
''By writing off the costs of its competitive services against the regulated sector, the regulated firm faces lower costs of supplying competitive markets. This may result in an increase in its share of the competitive market over what it would have been had the costs not been misallocated. At the margin, this may result in the displacement of more efficient capacity of unaffiliated firms by less efficient capacity of the regulated firm. In the extreme, more efficient suppliers of the competitive product may be excluded altogether. This ability arises not from the regulated firm's efficiencies, but because its costs may be borne by customers of its regulated product through cost misallocation. Moreover, the regulated firm may have a particular incentive to capture an inefficiently large share of the unregulated market, if doing so would add to the pool of costs that could be misallocated to its regulated sector.''(see footnote 53)
Furthermore, misallocation or cost shifting sends the wrong signals to investors who might mistakenly perceive the unregulated venture to be more profitable than it really is.
Finally, there is at least on situation where the potential for cross-subsidization is considerable and is particularly difficult for private sector firms to overcome. Utility affiliates frequently tout their ability to finance costs of a project out of savings in energy costs as a result of energy efficiency retrofits. Such ability requires very deep pockets and only the largest of unaffiliated competitors can hope to match this capability. The issue here is the ability of the unregulated utility affiliate to enjoy the benefit of preferential borrowing by the utility itself.
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Raising capital through borrowing may be a source of a cross-subsidy. Regulators may have a difficult time distinguishing whether the borrowing was done for the regulated product or service or another product or service. The regulated firms may be better able to raise funds for operations in unregulated markets by borrowing against the assets of the regulated business. Because the utility is an established firm while the unregulated affiliate is most likely a start-up and because of its status as a regulated utility with a guaranteed return, the risk inherent in a regulated market is lower than it would be for the unregulated market. This can result in subsidized lower-cost debt for the unregulated operation. The ''subsidy'' will be paid by increases in the risk of capital borrowed to pay for the regulated service because that capital now bears some of the same risk of the unregulated service.
To address the concerns of small businesses competitors, NAFC and NECA suggest that any comprehensive federal deregulation legislation contain measures which serve to provide appropriate remedies for unfair competition.
First, competitors need a forum in which they can present their complaints as competitors and obtain a timely response. Federal legislation, at a minimum, should provide authority and direction for state utility regulatory bodies to entertain complaints of unfair competitive conduct from competitors which may have been harmed. State utility regulatory authorities need to protection competition as well as ratepayers.
Second, the existing case law regarding cross-subsidization should be clarified and codified. Any comprehensive federal legislation should clearly prohibit cross-subsidization and cost shifting. In addition, there needs to be a better definition of cross-subsidization which is in keeping with the more typical fact patterns encountered in today's deregulated markets. Specifically, intangibles as well as tangibles need to be covered and it should be made clear that regulated monopolies have an duty to ratepayers to maximize the value of utility assets in any transfers to unregulated affiliates.
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Third, any federal restructuring legislation should require states which deregulate to establish both structural and behavioral rules to protect competition in existing energy related services markets as well as competition in emerging energy commodities markets. Application of state codes of conduct should be extended to all utility affiliates regardless of the type of activity in which they are engaged.
Forth, It should be as easy for an aggrieved competitor to obtain relief as an aggrieved ratepayer. Proof of the existence of an impermissible subsidy or shifting of costs should, in and of itself, be enough to make a case for relief whether the complaint is before a state utility regulatory authority or the FTC. Cross-subsidization and cost shifting in the context of a mixed regulated and unregulated environment should clearly be regarded as a per se form of unfair competition under the law. Inquiries into market power should only be relevant for determining the extent of damages.
Fortunately, Congress has already established a legislative precedent in rectifying a number of the potential anticompetitive aspects of deregulation faced by private sector businesses. An excellent point of departure for crafting pro-competitive law can be found in the 1995 Telecommunications Competition and Deregulation Act of 1995.
Title I, Subtitle 2, Part III, Sections 271275 spell out restrictions on Bell Operating Companies as they relate to competition with small business entities in the interLATA services (section 271), electronic publishing (section 274) and alarm monitoring (section 275). In addition, provisions dealing with operations of BOC affiliates (section 272) and manufacturing (section 273) were contained in the final bill.
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For example, section 272 establishes certain requirements which require BOCs to establish separate affiliates from which to provide activities which compete with certain small businesses (e.g., alarm monitoring, interLATA services, manufacturing), a BOC may jointly market certain services with its affiliate but only if competitors are treated equally and without discrimination.
Section 274 establishes restrictions on the use of name and trade marks by BOC affiliates when they compete against others in the electronic publishing business. In addition to the requirement of dealing out of a separate subsidiary, this section also requires that separate books, records and accounts be maintained. The affiliate is also prohibited from using the name or trademark of the BOC under specified circumstances; prohibited from incurring debt in a manner in which recourse may be had to the BOC; provide for the proper valuation of assets transferred from the BOC to the affiliate to prevent cross-subsidization. The BOC is also prohibited from performing a number of activities on behalf of its affiliate including hiring or training personnel, providing equipment, or engaging in research and development.
Section 275 prohibits discrimination by a telephone company in the provision of services, either by refusing to provide competitors the same services as it provides itself or by cross-subsidizing from local telephone service.
Thus, it can clearly be seen that Congress has already considered the problems of small businesses which compete with utilities and has developed meaningful remedies to the anti-competitive conduct anticipated in connection with overhauling the Nation's telecommunications laws.
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Now, similar treatment should be accorded to small businesses confronted by unfair competition from energy utilities.
JUDICIARY COMMITTEE JURISDICTION
The House Judiciary Committee contributed substantially to the final language adopted by Congress in connection with the Telecommunications Act. It needs to again assert jurisdiction over deregulation of energy utilities, especially in connection with any comprehensive deregulation and restructuring legislation. Without such jurisdiction, the interests of thousands of small businesses will be substantially damaged.
NAFC and NECA applaud Chairman Hyde and the other members of the Judiciary Committee for initiating this inquiry into the antitrust aspects of utility deregulation. We encourage the Committee to continue its inquiries and to provide the thousands of small business owners faced with anti-competitive conduct a means to address such problems.
NAFC and NECA believe that the proper forum in which to discuss the potential solutions to anti-competitive conduct and to fashion rules for ensuring free, fair, and open competition is this Committee.
We hope that the Committee will choose to explore legal remedies such as those indicated in this testimony as well as others, such as monopoly leveraging theories, when considering legislation in this area.
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Mr. HYDE. Mr. Travieso.
STATEMENT OF MICHAEL TRAVIESO, PEOPLE'S COUNSEL, STATE OF MARYLAND, ON BEHALF OF THE NATIONAL ASSOCIATION OF STATE UTILITY CONSUMER ADVOCATES
Mr. TRAVIESO. Yes. Thank you very much, Mr. Chairman and members. My name is Michael Travieso. I am the Maryland people's counsel, and under State law, Maryland law, it is my obligation to represent the residential consumers of utility services before State and Federal regulatory bodies and other agencies and courts. I am also a member of the Executive Committee of the National Association of State Utility Consumer Advocates, known as NASUCA, and it is on their behalf that I am testifying here today.
NASUCA is an organization that represents 39 State advocates plus the District of Columbia, and most of our focus is on small customers, residential and small business customers, the kind that Mr. English was talking about earlier. Over the past 5 years, NASUCA members have been actively involved in restructuring efforts in their States and also on the Federal level. In fact, just recently Greg Schmidt, who is the president of our organization, testified before the House Commerce Committee on the electricity restructuring bills that they are reviewing. In fact, I testified before your committee 2 years ago. So I appreciate the opportunity to come back on behalf of NASUCA.
As many people have said here today previously, virtually every State in the Union is looking at electric restructuring. More than 20 States to date, including my State, Maryland, have actually enacted electric restructuring bills, and I think it is very important for this committee to look at the competitive issues because those are going to be of enormous significance to small consumers, residential and small business consumers, which are the constituency that my organization deals with.
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NASUCA adopted a number of resolutions which specifically address the points that I am going to discuss in my testimony. But before I get to those specific points, I would like to take a moment to just talk about what the industry looks like today and where we are starting from, because I think that is of great significance.
We are not actually deregulating the electric industry. Even after competition is brought to the generation portion of this business, the distribution and transmission systems will still remain regulated. Right now, the largest participants in this industry are vertically integrated investor-owned utilities. They own the generation piece of the business that actually produces the electricity. They own the transmission wires over which the electricity is carried for long distances, and they own the distribution systems which actually supply the electricity to our homes and to our businesses.
As we go into a deregulated market, I think we need to realize that what we are doing is we are creating an entity that now will ownan investor-owned utilitythat now will own both regulated and unregulated facilities, that it will operate both in regulated and unregulated markets, at both regulated and unregulated prices. It will supply services at retail and also to its direct competitors, and it will do that both in the wholesale and the retail market.
Generally, these kinds of companies will start out with 100 percent of the retail market and with ownership and control over facilities over which their competitors will have to deliver their products. Utilities will have all the available data, they will have all the usage pattern, they will do all the billing and they will be in other businesses which are unregulated but related to their regulated businesses.
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The electricity markets themselves will be very complicated markets to examine. They could be as small as hourly markets. I think this was referred to earlier. So the market power question would be very difficult to ferret out when you are dealing with markets that can change rapidly over time.
Our positions basically are that effective competition in the wholesale and retail market will not develop if companies have market power, and without effective competition we will replace a regulatory system which perhaps might be inefficient but at least produce reasonable rates for small customers with an unregulated monopoly or oligopoly.
The first issue is vertical market power. There has been discussion here of the ISO, the independent system operator. NASUCA believes in that concept and would support Federal legislation that would give FERC the authority to institute a structure that would provide for the independent operation of a transmission system.
As far as affiliated use, which Mr. McGlynn has just discussed, we believe that legislation should provide FERC with the authority to monitor the development of competitive markets, to prevent abuses or preferential affiliate transactions, to remedy anticompetitive conduct in regional and wholesale markets and in situations where State commissions are not able to institute a proper remedy because of the regional nature of the company involved.
We are very concerned about horizontal market power in the context of the hourly markets and the ability of a competitor to raise prices to monopoly levels, because in that hourly market the competitor has market power. We believe that legislation should give FERC the authority to take appropriate corrective action to prevent horizontal market power, including divestiture and other structural remedies, if necessary.
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With respect to mergers, I did a little research before I came here today, and there have been 49 either proposed or approved mergers since the last time I testified here 2 years ago. That is a tremendous number in an industry that is consolidating very rapidly.
NASUCA believes that, I think in a way similar to APPA's testimony, that mergers should produce net benefits for consumers and that there ought to be a role, or in the statute it should say that a merger should not be approved unless it produces a net benefit for consumers. We also believe that FERC should have the authority to look at convergence mergers; that is, gas and electric, similar mergers as that, and also mergers involving holding companies that own electric utilities.
And finally, the issue of reliability is extremely important to us. Reliability is currently governed by voluntary organizations such as NERC. We believe that FERC should have the authority to review these voluntary organizations to make sure their rules are not discriminatory and anticompetitive, and to provide for continued reliability, which is something that every consumer, including especially small business and residential consumers require.
So in conclusion, Mr. Chairman, we would urge you to recognize that there is a difference in the electricity industry from typical industries that are unregulated now or even from the ones that have been restructured. We would urge the committee to always keep in the forefront of its policymaking that consumers, particularly residential and small business, rely on their elected officials to balance their needs against those of industry.
I thank you for this opportunity to testify here today and would welcome any questions.
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Mr. HYDE. Thank you, sir.
[The prepared statement of Mr. Travieso follows:]
PREPARED STATEMENT OF MICHAEL TRAVIESO, PEOPLE'S COUNSEL, STATE OF MARYLAND, ON BEHALF OF THE NATIONAL ASSOCIATION OF STATE UTILITY CONSUMER ADVOCATES
My name is Michael Travieso. I am the Maryland people's counsel. Under Maryland law, I am obligated to represent the residential consumers of utility services in Maryland before state and federal regulatory agencies and courts. I am also a member of the Executive Committee of the National Association of State Utility Consumer Advocates, (NASUCA), which is an organization of state utility consumer advocates from 39 states and the District of Columbia. I am testifying today on behalf of NASUCA and the Maryland Office of People's Counsel.
Over the past five years, NASUCA members have been extensively involved in both federal and state forums in the restructuring of the electric industry. More recently, Fred Schmidt, the Nevada consumer advocate and NASUCA's President, testified on July 22, 1999 before the House Commerce Committee. I testified for NASUCA before this Committee on June 4, 1997, and I thank Chairman Hyde, committee members and staff for inviting NASUCA back today.
Virtually every state in the union, as well as the District of Columbia, has examined the difficult policy questions relating to electric restructuring. More than twenty states to date, including my state, Maryland, have actually enacted electric restructuring legislation. Various federal legislative proposals have been introduced in Congress during each of the past several years. The members of NASUCA on the state level and NASUCA, the organization, on the federal level, have been actively advocating on behalf of consumers, most often residential and small business, in virtually all of these forums. NASUCA greatly appreciates this opportunity to discuss today's topic, one of the most important related to electric restructuring, ''Competitive Issues In Electric Deregulation.''
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NASUCA has adopted a number of resolutions which directly address these competitive issues. What I intend to do today is to summarize NASUCA's positions on the major issues which are contained in a number of NASUCA resolutions adopted over the past three years.
But first I would like to spend a moment discussing why we are not actually ''deregulating'' the electric industry and why the nature of that industry requires somewhat different treatment from businesses and industries which have never been highly regulated and even from those industries which have been ''deregulated'' over the last twenty years or so.
I. THE PAST AND THE PRESENT
The bulk of electric industry, until very recently, has been only a vertically integrated franchised monopoly. There are some independent power companies and some municipal and federal electric utilities, but for the most part customers have and for the time being still do buy their electricity from a single company at a regulated rate. Traditionally that company owns or controls the generation of electricity, its transmission over long distances at high voltages, and its delivery to our homes and businesses. What we are ''deregulating'' is only the generation portion. This means that an investor owned utility which does not divest its generation will automatically become a company selling both regulated and unregulated products at both market and regulated prices, to its direct competitors and to retail customers, in both wholesale and retail markets.
In addition, this vertically integrated utility will generally start out with 100% of the retail market and with ownership or control over facilities which its competitors must use in order to deliver products to their customers. This utility will have all of the available data on the usage patterns of all of the retail customers; all of the data on credit and payment histories; own virtually all of the meters; do all of the billing; and have wires which go into all of the homes and virtually all of the businesses in its former monopoly service territory. This utility will also, if it is not a regional holding company, have diversified into such free market businesses as gas marketing; appliance sales and service; energy conservation and demand services; plumbing heating and air conditioning contracting; local and long distance telephone service; security and alarm services and so on. It will be well capitalized; have substantial retained earnings; and will generally be given the right to collect a stream of revenue to pay off or down its non-competitive electric generation assets.
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This utility will also be operating transmission facilities that were not designed for a competitive marketplace. It will own valuable sites for the construction of new plants. It will already have secured rights of way for its transmission and distribution lines. It will own many miles of valuable fiber optic cable paid for from revenues generated by its regulated monopoly electric business.
The electricity markets it will compete in will be numerous and difficult to analyze from a competitive standpoint. For example, there will be regional wholesale markets, but because of transmission constraints there will be very small markets within these regional markets at the peak hours or minutes during certain days when energy prices will rise to astounding levels. Each hour itself could be a separate market. Electricity cannot be stored, so that competing suppliers and most customers will not be able to substitute different products for the highest priced electricity. Some markets may change almost instantaneously. For other markets there could be lengthy delays to efficient market entry because of site acquisition, zoning, construction, financing and other problems.
It is also important to recognize that the industry is consolidating at a rapid rate. When I testified in 1997, I spoke of twenty mergers in this industry in the few years preceding. If you look at the web page of the American Public Power Association, you will see that there have been or are in the works 49 additional mergers involving electric utilities since June of 1997.
II. NASUCA'S POSITIONS
Page 247 PREV PAGE TOP OF DOC What does all of this mean to the prospect of a truly competitive market developing for the wholesale and retail sale of electricity? That question brings me to the NASUCA resolutions I mentioned earlier. Effective competition in the wholesale and retail electricity markets will not develop if companies have market power in a particular market. Without effective competition we will have dismantled a regulatory system, which while somewhat inefficient, at least provided safe and reliable service at reasonable rates for small customers, and replaced it with an unregulated monopoly or oligopoly.
For these reasons, NASUCA has endorsed the following principles to assure that the transition from a regulated market to a competitive one does not harm consumers and, at least for small consumers, establishes a market structure and regulatory framework designed to make it difficult for a competitor or group of competitors to raise prices above competitive levels for periods long enough to produce monopoly profits. These principles are also designed to limit the ability of electric companies to erect barriers to entry; to engage in abusive self-dealing or to cross subsidize competitive businesses through regulated ones.
A. Vertical Market-Power
The first issue I want to comment on concerns vertical market power. An electric utility which owns generation, transmission and distribution facilities has an opportunity and a profit motive to engage in conduct which favors its own generation assets and limits or impedes its competitors from accessing and using its facilities. Generally this discussion focuses on the ability of a transmission owning utility to foster artificial constraints on the system that prevent efficient non-affiliated generators from supplying power and allow higher cost affiliated generation to operate. Transmission operation and control can also materially affect the economic allocation of resources between transmission and generation.
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NASUCA believes that the solution lies in the use of Independent System Operators (ISO's) or other independent and competitively neutral regional transmission organizations. NASUCA supports legislation which would insure that the Federal Energy Regulatory Commission has the authority to require a structure which assures the fair, independent and disinterested operation of the transmission system. FERC should also be given the authority to rectify transmission policies, practices or prices which create a competitive advantage for services offered by the transmission provider or its affiliates. The entity which operates a regional transmission system must be truly independent from the control of or the financial interests of any particular generation or transmission owner or any other users of the transmission system. The system operator should have plenary authority over the operation of the system. There should be regulatory oversight by the FERC of the governance, practices, tariffs, rules, requirements and procedures employed or enacted by the transmission system operator. FERC oversight should be coordinated and balanced with the oversight exercised by state public utility commissions.
B. Affiliate Abuse
A related problem exacerbated by electric utility restructuring is the ability of an electric utility which has both regulated and unregulated businesses to favor its affiliates in purchasing decisions; to provide affiliates with preferential service; to cross-subsidize unregulated affiliates; and to provide affiliates with market data which is denied to competitors. Legislation should provide FERC with the authority to monitor the development of competitive markets; to prevent abusive or preferential affiliate transactions; and to remedy anti-competitive conduct, in regional and wholesale markets and in situations where the multistate nature of the utility makes it difficult for state commissions to protect consumers adequately. These kinds of provisions are particularly important now in light of efforts by utilities to obtain stand-alone repeal of the Public Utility Holding Company Act. Congress must give FERC and the states adequate access to books and records and adequate authority to protect consumers from anti-competitive and abusive practices.
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C. Horizontal Market Power
Horizontal market power in the wholesale markets remains a significant concern even if all of the regional transmission systems are independently operated and all utilities are required to join an ISO or RTO. As noted above, wholesale markets are constantly changing based on increased demand at peak hours; constraints on the transmission system and the existence of or development of permanent or transitory load pockets. Load pockets are geographic areas into which it is difficult or impossible to import power because of insufficient transmission capacity. Legislation should give FERC the authority to monitor the markets, and to investigate and take appropriate corrective action to ensure that a utility cannot exercise market power to raise prices and cause higher prices for consumers beyond competitive levels. FERC should have the authority to eliminate undue concentrations of market power in any relevant market. FERC should have the authority to order divestiture and other structural remedies when necessary.
However, NASUCA does not advocate federal preemption in these areas. Many states have strengthened the power of their regulatory commissions to deal with anti-competitive acts in the new electric markets. Federal legislation should recognize that state commissions have a prominent role to play in ferreting out and preventing anti-competitive conduct in these newly opened retail markets. NASUCA also recognizes the traditional role played by the anti-trust division of the Justice Department by the Federal Trade Commission and by state Attorneys General enforcing state anti-trust laws. Any new federal legislation should not prevent or impede the vigorous enforcement of federal and state anti-trust laws.
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As noted above, electric utilities are merging at an unprecedented rate. A significant percent of these mergers are what have been termed ''convergence mergers'', the merger of an electric company and a gas distribution company or the merger of an electric company with an energy marketing company, for example. Legislation should change the current standard used by FERC to review utility mergers. FERC understands its test to be a ''do no harm'' standard. NASUCA believes that legislation should be adopted which would require a net-benefit test. The Federal Power Act requires FERC to determine if a prospective merger is in the public interest. Mergers which truly promote the public interest should provide a net benefit to consumers. NASUCA also urges Congress to give FERC review authority over convergence mergers and mergers of holding companies with electric utility subsidiaries.
As we increase wholesale competition and move toward retail competition, the number of transactions on the electric grid will increase, the number of users of the transmission grid will increase and the function of central planning for new generation capacity will decrease and perhaps disappear. Consumers are, as a result, greatly concerned about reliability. Currently reliability is largely dependent upon the voluntary and cooperative efforts promoted by the North American Electric Reliability Council (NERC) and its member organizations. NERC and these organizations have themselves recognized the need to broaden their membership as a result of restructuring. The time has now come to assure that consumers will continue to receive reliable electric service as we transition from rate setting to market prices and from central planning to market based capital investment decisions. In order to assure continued reliability legislation should give FERC the jurisdiction to review the requirements imposed by NERC and other voluntary organizations in order to insure competitive neutrality; due process and consumer protections. However, the role of states in maintaining reliability, safety and adequacy of electric systems within each state should not be preempted.
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NASUCA has not opposed the development of competitive electricity markets. However, NASUCA believes that the substitution of a competitive market structure for a regulated rate/cost of service structure, does not mean that we are deregulating the electric industry. Transmission services and delivery services will remain regulated. Consumers will need to be protected even more than in a fully regulated monopoly market. Congress should recognize that there is a need for an appropriate federal and state regulatory role in the competitive electric industry so that consumers do not suffer from anti-competitive and abusive practices.
NASUCA urges this Committee to keep always in the forefront of its policymaking that consumers, particularly residential and small businesses, rely on their elected officials to balance their needs against those of industry.
I thank you for this opportunity to appear before you again today on behalf of NASUCA and I look forward to your questions.
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Page 253 PREV PAGE TOP OF DOC Mr. HYDE. And now last, but of course foremost, Dr. Anderson.
STATEMENT OF JOHN ANDERSON, EXECUTIVE DIRECTOR, ELECTRICITY CONSUMERS RESOURCE COUNCIL, ON BEHALF OF CONSUMERS FOR FAIR COMPETITION
Mr. ANDERSON. Thank you very much, Mr. Chairman and members of the committee. I am here today on behalf of the Consumers for Fair Competition, or CFC. It is a coalition of small business interests, power marketers, consumer and investor-owned utilities, and representatives of both small and large electric consumers, as well as some environmentalists. We are unified in the belief that consumers must be afforded protections against anticompetitive behavior, particularly during the transition to a competitive electricity marketplace. Moreover, it is clear that effective competition will not simply emerge and be sustainable if market power issues are not adequately addressed and addressed up front.
I would like to emphasize that ELCON represents large businesses that are generally no friends of Government regulation. The difference between my members and incumbent electric utilities is that the market positions of my members were not created or sanctioned by Government-mandated monopoly franchises.
Normally, a new business in a competitive market enters that market with a market share of zero. Any market share it gains, it must earn.
The utilities, on the other hand, will enter new competitive power markets in most cases with a market share of 100 percent. Incumbent utilities did not earn this market advantage through innovation, efficiency, or market savvy. It was given to them by Government, and the service that they provide today is aptly compared with the black, rotary dial telephone that we all know is obsolete. Sure it worked, but we can do better and consumers want it better.
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The Coalition believes that the intended benefits of competition will not reach consumers if steps are not taken to address this market anomaly. The Coalition commends you, Mr. Chairman, for recognizing the importance of this issue and scheduling today's committee hearing.
Some in the restructuring debate argue that any action to address market power concerns is unneeded and inappropriate, that you shouldn't reregulate in deregulation legislation. Such assertions are, at best, incomplete.
First, it should be emphasized that the wires part of the electric industry, transmission and distribution, will remain natural monopolies for many years. Thus, ongoing regulation of these essential services is absolutely necessary.
Second, the goal of restructuring legislation should not be deregulation, but, rather, effective competition in generation and other competitive services. Market forces cannot mitigate anticompetitive practices if a dominant player can block or discriminate against new market entrants.
Given today's structure and operations of the electric industry, the opportunities for market power abuse are pervasive and often very subtle.
As you have heard from other witnesses, in the electric generation market, market boundaries today are determined largely by the physical limitations of the transmission system, but these limitations are often under utility control. Within a relevant market, it is common for an incumbent utility to own 40 percent or more of the generating capacity, a concentration level at which economists assume an ability of a dominant firm to raise prices above what would occur in a truly competitive market.
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But even worse, statistics showing the proportionate ownership of existing capacity only demonstrate part of the potential market power. Because of the physical nature of system operations, some generation assets hold disproportionate strategic values. While a generating company may possess a small percentage of total generation in a given geographic market, it may dominate a particular product sub-market within the region.
Some argue that new, independent generators can mitigate market power. Unfortunately, this is simply not the case. First, despite a significant increase over the past few years in the construction of non-utility generation, such facilities still represent a comparatively small fraction of total generation. Moreover, potential developers of such facilities often face a diverse set of entry barriers. Frequently, incumbent utilities own the only land suitable for new power plant construction, and in addition, in some States, only utilities themselves can request and receive the necessary regulatory permits.
Despite the enactment of the Energy Policy Act in 1992 and subsequent issuance of Orders 888 and 889, incumbent utilities can still manipulate their ownership and control of transmission facilities to favor their own generation, block power sales, and other anticompetitive practices. This is particularly acute at the growing number of constrained transmission interfaces.
Incumbent utilities are also able to leverage their regulated operations to the advantage of their unregulated affiliates, as you have just heard. In our more detailed written comments, we document some of these particular examples.
Page 256 PREV PAGE TOP OF DOC Steps are needed to assure the transition to a competitive market. It is important to ask at this point can the problems be addressed by State regulators and State regulators alone. CFC believes that even a simple look at this issue concludes that State authority alone is not adequate to assure the development and continuation of competitive interstate markets.
While States can play an important role in addressing potential anticompetitive and anticonsumer behavior, States alone cannot prevent competitive abuses. Again, my written comments describe the many reasons for this inadequacy.
Concluding that State authorities are insufficient to address market power, it also points out that existing Federal authority is inadequate. Certain actions need to be taken involving mergers, antitrust enforcement, grid management, utility affiliate relations and reliability.
Regarding mergers, FERC can today deny merger requests or market-based rate applications if it fails to meet a just and reasonable test. However, FERC is under a lot of restrictions. The CFC believes that both the FTC and the Department of Justice, as well as FERC, should continue to review mergers. If a merger advances competition, either on its own or through FERC-imposed conditions, it should be approved. If it potentially frustrates competition, it should be rejected. Regulatory gaps should be closed, and mergers should be scrutinized to ensure that they will produce continuing net consumer benefits, once again, as you have heard from several witnesses.
Second, some have argued that continued application of the antitrust laws is sufficient. We disagree. While continued application of antitrust laws is appropriate, the shortcomings of this approach must be recognized. The CFC supports remedies taken in the last Congress by Representatives DeLay and Markey. In that legislation, FERC has given authority and direction to mitigate undue market power, and when FERC finds such anticompetitive concentration, it is authorized in clear terms to take action.
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Third, the CFC believes that the ownership and control of the Nation's transmission system must be transferred to truly independent, regional bodies with strong authority to operate, plan, maintain, and expand the transmission system. Again, you have heard from several witnesses on this point.
Fourth, the former monopoly status of utilities provides anticompetitive opportunities in the ways utilities and their unregulated affiliates interact. Congress recognized these concerns and adopted several provisions in the Telecommunications Act of 1996, and the CFC urges adoption of parallel provisions in any electricity restructuring.
And fifth, as long as parties with commercial commodity interest retain exclusive control of system reliability, opportunities will exist to manipulate legitimate reliability objectives for commercial advantages. In this regard, the CFC supports consensus legislative language that has been put forth by the North American Electric Reliability Council.
Finally, you will often hear assertions that the Public Utility Holding Company Act is no more than an outdated statute intended to protect investors from fraudulent securities practices. Don't be misled. Rather than ushering in competition, as repeal proponents would have you believe, stand-alone repeal of PUHCA would have substantial anticompetitive repercussions and retard the development of vibrant competitive markets.
In conclusion, effective and sustainable competition will not automatically emerge in the absence of regulation. Regulation can and should be relaxed for those markets and products that are subject to effective competition. However, given the historical operation and structure of the electric industry, competition in all sectors and regions will not occur simply by legislative declaration.
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To promote the transition to competitive electric markets, steps must be taken to remove the vestiges of the former regulatory system and its accumulated opportunities to exercise market power.
Thank you very much for the opportunity to be here.
Mr. HYDE. Thank you, Dr. Anderson.
[The prepared statement of Mr. Anderson follows:]
PREPARED STATEMENT OF JOHN ANDERSON, EXECUTIVE DIRECTOR, ELECTRICITY CONSUMERS RESOURCE COUNCIL, ON BEHALF OF CONSUMERS FOR FAIR COMPETITION
Consumers for Fair Competition (CFC) is a broad coalition formed to promote effective competition in federal restructuring efforts, and to assure that the intended consumer benefits of lower rates, increases in efficiencies and innovation, and diversity of supply options are not frustrated by anticompetitive behavior. In general, CFC is encouraged by the recognized need to address market power concerns. However, we believe the pending bills lack sufficient tools and guidance to fully combat the varied and multiple ways in which the exercise of market power can and will frustrate the development of competitive markets.
First, the continued vertical integration of the industry provides opportunities for utilities to manipulate the transmission system to advantage their own generation or power marketing activities. Second, many generation markets remain highly concentrated with high barriers to entry, resulting in above-market prices and inadequate market development. Third, many market participants will participate in both regulated markets (transmission and distribution) and competitive markets (generation, marketing, energy and non-utility services), which provides considerable opportunities for cross-subsidization and other anti-competitive practices.
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The potential for market power abuse cannot be adequately addressed by market forces, federal antitrust enforcement or state restructuring laws. Congress must include provisions in federal restructuring legislation to:
Ensure that the transmission grid operates independent of electricity market participants
Alleviate overly-concentrated generation markets that will sustain high prices, entry barriers and inefficient markets
Scrutinize the competitive implications of all utility mergers
Provide state regulators with access to utility books and records and provide model, enforceable standards to prevent utility cross-subsidization
Establish mandatory reliability standards that ensure system integrity and prevent unfair market manipulation
The Consumers for Fair Competition urge the adoption of the following in comprehensive federal legislation on electricity restructuring:
The regional transmission organizations (RTOs) provisions in H.R. 2050.
Page 260 PREV PAGE TOP OF DOC The market power provisions of the DeLay-Markey bill of last Congress. In the alternative, Section 104 of H.R. 2050 should be revised to correct the limitations of scope and authority outlined in my testimony.
The merger provisions of H.R. 1828, and also provide for FERC review of electric and gas ''convergence'' mergers.
Measures that parallel the affiliate transactions provisions contained in the 1996 Telecommunications Act.
The reliability provisions contained in H.R. 2050 or H.R. 1828.
CFC does not support adoption of H.R. 2363 on a stand-alone basis. In addition, we believe that PUHCA repeal should be delayed to provide adequate opportunity for replacement market power provisions and retail competition to take hold. For that reason, CFC prefers the conditional repeal of PUHCA provided in H.R. 2050 and prefers the 18 month effective date contained in H.R. 667, H.R. 1828, H.R. 2050 and H.R. 2363.
To promote the transition to competitive electric markets, steps must be taken to remove the vestiges of the former regulatory system and its accumulated opportunities to exercise market power. Once done, the transition to competition can occur and the need for active regulation will subside.
The members of the Consumers for Fair Competition include: American Public Power Association (APPA), the Electricity Consumers Resource Council (ELCON), Enron Corporation, Friends of the Earth, Madison Gas & Electric Company, Missouri River Energy Services, National Association of State Utility Consumer Advocates (NASUCA), Northern California Power Agency, Ohio Municipal Electric Association, Transmission Access Policy Study Group (TAPS), Wisconsin Public Power Inc., National Alliance for Fair Competition (members include: Air Conditioning Contractors of America, Air Conditioning & Refrigeration Wholesalers Association, American Supply Association, Associated Builders and Contractors, Independent Electrical Contractors, Petroleum Marketers Association of America, Plumbing, Heating and Cooling ContractorsNational Association, National Electrical Contractors Association, Sheet Metal and Air Conditioning Contractors National Association)
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The members of the Consumers for Fair Competition include:
American Public Power Association (APPA)
The Electricity Consumers Resource Council (ELCON)
Friends of the Earth
Madison Gas & Electric Company
Missouri River Energy Services
National Association of State Utility Consumer Advocates (NASUCA)
Northern California Power Agency
Ohio Municipal Electric Association
Transmission Access Policy Study Group (TAPS)
Wisconsin Public Power Inc.
National Alliance for Fair Competition (NAFC)
(NAFC members include:
Air Conditioning Contractors of America
Air Conditioning & Refrigeration Wholesalers Association
Associated Builders and Contractors
Independent Electrical Contractors
Petroleum Marketers Association of America
Page 262 PREV PAGE TOP OF DOCPlumbing, Heating and Cooling ContractorsNational Association
National Electrical Contractors Association
Sheet Metal and Air Conditioning Contractors National Association)
Mr. Chairman, members of the Subcommittee, I am John Anderson, Executive Director of the Electricity Consumers Resource Council (ELCON). I am testifying today on behalf of the Consumers for Fair Competition (CFC), a coalition of small business interests, power marketers, consumer and investor-owned utilities, representatives of small and large electric consumers, and environmentalists. While the interests of these organizations in the broader restructuring debate are diverse, we are unified in the belief that consumers must be afforded protections against anti-competitive behavior during the transition to a competitive electricity marketplace. Moreover, it is clear that effective competition will not emerge and be sustainable if market power issues are not adequately addressed.
CFC was formed to advance policies necessary to promote effective competition and to provide the intended consumer benefits of lower rates, increases in efficiencies and innovation, and diversity of supply options. The coalition believes that the intended benefits of competition will not reach consumers if steps are not taken to address the market dominance of incumbent utilities. The coalition commends you, Mr. Chairman, for recognizing the importance of these issues and scheduling today's committee hearing.
Since its inception, the coalition has focused only on market power issues. CFC developed a core set of market power principles by which the group would judge any restructuring proposal. In addition, CFC has mobilized support against stand-alone repeal of the Public Utility Holding Company Act (PUHCA), testified before the Senate on PUHCA repeal, and worked with members of Congress to craft solutions to potential market power abuse.
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Some in the restructuring debate argue that any action to address market power concerns is unneeded and inappropriatethat you shouldn't re-regulate in deregulation legislation. They assert that market power problems do not exist in the electric utility, or that market forces will resolve them if they do exist.
First, it should be remembered that, given the continued monopoly status of transmission and distribution, on-going regulation of those essential services is necessary. Second, I would urge you to remember that the goal of restructuring legislation is not deregulation, but rather effective competition. Market forces cannot mitigate anticompetitive practices if a dominant player can block or discriminate against new market entrants. Competition in the electric utility industry will not occur simply by declaration. As noted by Federal Energy Regulatory Commission (FERC) Chairman Hoecker: ''Good markets don't just happen, they are developed, structured, created.''
Incumbent utilities did not earn their market advantages through innovation, efficiency, or market savvy. Rather, these advantages are an outgrowth of the historic regulatory system in which the utilities were vested with almost unlimited market power. However, the quid pro quo for that market power, was stringent regulatory oversight.
As you know, historically the vertically integrated industry was considered a natural monopoly and regulated as such. Consequently, levels of market concentration and corporate behavior that would raise concerns in other industries were accepted as outgrowths of this ''natural monopoly.'' Utilities received exclusive retail monopoly franchises, and vertical integrationwith a single company serving as the sole provider of all three functions of the electric utility industry (generation, transmission and distribution)was accepted and encouraged.
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If this were an infant industry, market forces alone might be sufficient to discipline anti-competitive practices. However, the starting point is vitally important. The historic structure of the electric utility industry provides incumbent electric utilities with unearned advantages that are inconsistent with, and contrary to, the creation and continuation of an effectively competitive market. If competition is the objective of restructuring, then any restructuring legislation must address the significant potential for anticompetitive practices and consumer abuses in the transition to a fully competitive market.
As noted economist Alfred Kahn put it: ''what is the best possible mix of inevitably imperfect regulation and inevitably imperfect competition?''
Anticompetitive Impacts of Market Power
Given the structure and operations of the electric utility industry, the opportunities for market power abuse are pervasiveand often subtle.
In the electric generation market, market boundaries are determined largely by transmission constraints, i.e., physical limitations on transfer capabilities. Within these boundaries, it is common for an incumbent utility to own 40 percent or more of the generating capacitya concentration level at which economists assume an ability of a dominant firm to set and control prices above what would occur in a truly competitive market.
It is not simply total installed generation capacity that is important. Because of the physical nature of system operations, some generation assets hold disproportionate strategic valuetheir operation may increase the carrying capacity of a vital transmission link, provide peaking capacity that largely sets market prices, or provide ''high-value'' ancillary services. Ownership of these facilities provides opportunities for anticompetitive behavior in a sub-market of the industry. Thus, while a generating company may possess a small percentage of total generation in a given geographic market, it may dominate a particular product sub-market within the region.
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Despite a significant increase over the past few years in the construction of non-utility generation, such facilities still represent a comparatively small fraction of total generation. Moreover, potential developers of such facilities often face a diverse set of entry barriers. Frequently, incumbent utilities own the prime real estate for plant location (often adjacent to existing plants). In addition, in many states, only utilities themselves can request and receive the necessary regulatory permits.
The vertical integration of most utilities provides another set of opportunities for anti-competitive practices. Despite enactment of the Energy Policy Act of 1992, and subsequent issuance of FERC Orders 888 and 889, incumbent utilities can manipulate their ownership and control of transmission facilities to favor their own generation, block power sales by other entities, reduce total supply of generation (and thereby increase prices), and even block development of new generation. This becomes particularly acute at the growing number of constrained transmission interfaces.
Incumbent utilities are also able to leverage their regulated operations to advantage their unregulated affiliates. Proprietary information on customer load patterns and energy needs can be transferred exclusively to affiliate power suppliers. Similarly, utilities can refer customers to their affiliates for installation and maintenance of HVAC equipment and other demand-side measures. Finally, utilities can cross-subsidize their unregulated affiliates through the market value of using the utility's name, logo or personnel, or by misallocating overhead expenses from the affiliate to the regulated utility.
These are not hypothetical concerns. The problems are real and pervasive:
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Economists for California's investor-owned utilities determined that those companies would possess undue market power even after divesting 50 percent of their thermal generation within the state.
Last summer's price spikes in the Midwest were exacerbated by the lack of effective competition and the lack of tools available for immediate response to demonstrated anti-competitive behavior, according to a study done by the Public Utility Commission of Ohio.
Price spikes of 3500% in California's ancillary services market were caused by undue market power according to filings by two California investor-owned utilities.
Rules for the PJMISO on governing how power plants tie into the grid discriminate against new market entrants, include unreasonable delays and are seen as a significant barrier to entry.
ISO-New England's congestion management system was approved by a governance structure that the FERC has rejected as inequitable.
The independent governing board for the PJMISO complained to FERC that the utility-controlled operating committee was allowing the transmission system to be manipulated for anticompetitive purposes.
Utilities have been cited for disclosing critical market information to affiliatesin violation of ''Chinese walls'' required by FERC.
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Utility commissions, small businesses and new market entrants have uncovered instances in which utilities have unfairly cross-subsidized their affiliates.
Power marketers, new market entrants, utilities and others argue that transmission owners have gained competitive advantages by withholding transmission capacity for the stated purpose of native load service or reliability.
Some cite the public disclosure of such abuses as ''proof'' that the current regulatory system adequately policies the market. However, many market participants and observers believe these instances are simply the, albeit sizable, tip of the icebergwith multiple undetected anti-competitive practices occurring for each uncovered or acknowledged infraction.
States Cannot Adequately Address Market Power Issues
If it is accepted that steps are needed to assure the transition to a competitive market, it is important to ask: Can these problems be addressed by state regulators?
CFC believes that a thorough analysis of this question concludes that state action alone is not adequate to assure the development and continuation of competitive interstate markets.
While states can play an important role in addressing potential anticompetitive and anti-consumer behavior, states alone cannot prevent competitive abuses:
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Power markets are regional in scope. The party engaging in anti-competitive actions in state X, may be located in state Youtside the legal authority of state X's regulatory commission.
States that have adopted retail competition have generally relinquished regulatory control over generation within the state. If problems later emerge in the operation of in-state generation, the commission may have no authority to address the problem.
Many utility operations span multiple states. Often state regulators have limited access to the books and records of out-of-state operations of these utilities.
Control and operation of the nation's transmission network is largely outside the scope of state regulation. While states can mandate or encourage in-state utilities to join regional transmission organizations, states cannot approve or oversee such entitiesonly FERC can.
Several states have encouraged utility divestiture of generation, but such action is usually done as a means of valuing assets for stranded cost determinationsnot for market power mitigation. In fact, such divestitures have largely left intact the same level of generation market power. Once divested, the state has no control over the operation of the divested generation.
States can have a parochial interest in protecting an in-state companyeven if such action is contrary to the interests of a competitive regional market.
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Federal Action Needed to Facilitate Competitive Markets
Concluding that state authorities are insufficient to address market power abuses does not in itself justify new federal authorities. An affirmative answer to that question must be based on a rigorous assessment of existing federal statutes.
First, it must be remembered that the current federal regulatory structurelike state utility regulationwas established for the old regulated monopoly framework. Actions are needed to adapt that system to the desired competitive end-state.
Today, FERC can deny a merger request or market-based rate application, or find that a utility fails to meet the ''just and reasonable'' test. However, the conditions that FERC can impose are not expressly delineated. Moreover, the Commission does not have clear policy guidanceother than vague ''public interest'' languagein determining what outcomes and objectives should be promoted.
Consumers for Fair Competition has identified several areas where FERC's regulatory mission and authorities must be altered to promote effective competition.
As you know, utilities are merging at an unprecedented rate. Since the mid-1990's, 24 utility mergers have been completed, and 12 additional mergers are pending at FERC. While mergers can bring efficiencies of size and scope, improved efficiencies and reduced rates are frequently not the result. According to a recent report by Anderson Consulting, less than half of the energy utility mergers over a 10 year period were profitable for shareholders. More troubling for the future of the competitive market, these mergers are often a mechanism for further consolidation of resources that potentially increases anticompetitive opportunities.
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Under the Federal Power Act, FERC has clear authority to review and condition proposed utility mergers. In addition, the Department of Justice and Federal Trade Commission can review utility mergers under the antitrust statutes. However, these agencies have largely deferred to the FERC in reviewing mergers.
CFC does not believe that FERC merger review authority should be eliminated, with utility mergers left exclusively to Justice and FTC. All else equal, the complexities of the electric utility industry argue for merger review by a regulatory organization intimately familiar with the industry. If FERC review were eliminated, that expertise (and staffing) would need to be added to the antitrust agencies. Second, mergers often include conditions that require on-going regulatory oversight. The antitrust agencies are not regulators capable of such on-going review.
For these reasons, CFC believes that, along with FTC and Department of Justice authorities left intact, continued FERC merger review is essential. Moreover, CFC believes that FERC's merger authority should be revised in several ways. First, the FERC standard for reviewing mergers should be expressly expanded to make competitive impacts the primary ''screen.'' If a merger advances competitioneither on its own or through FERC-imposed conditionsit should be approved; if it potentially frustrates competition, it should be rejected. Second, certain types of utility mergers and acquisitions''convergence'' mergers between electric and gas utilities and mergers between utility holding companiescan be structured to escape FERC review. These regulatory gaps should be closed. Third, mergers should be scrutinized to ensure that they will produce continuing net consumer benefits, not simply advance company empires and egos.
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CFC recommends coupling provisions from the Bumpers-Gorton and Administration bills to accomplish these objectives.
2. Market Concentration
As noted above, as a result of the regulatory structure of the past, some incumbent utilities unduly dominate their regional energy market. But this problem goes beyond ''incumbent'' utilities. As a result of some utility asset divestiture plans, some non-utilities have acquired the market dominance once held by the utilities. In New England, a non-utility acquired all the generation assets of the largest regional utility. The price spikes in California cited above were due to market power exerted by the new owners of the incumbent utilities' divested assets. While the general energy market in California may not be unduly concentrated, many of these sub-marketswhich in turn set the price for the general energy marketare overly concentrated.
If the market is unduly concentrated, market discipline cannot check anticompetitive behavior, the dominant market player can exact excessive profits, and consumers will suffer.
Economists have long established that regulation is needed as a substitute where competition does not or cannot exist. The question is what form of regulation is most appropriate to redress undue market concentration and restore competitive equilibrium?
Some have argued that continued application of the antitrust laws is sufficient. Consumers for Fair Competition disagrees. While continued application of the antitrust laws is appropriate, the short-comings of this approach must be recognized:
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Antitrust laws address explicit anticompetitive behavior; not existing structures that are inconsistent with competition,
Antitrust actions occur after competitive harm has occurred, and
Actions under the antitrust laws are time-consuming and costly. For new market entrants, the delay of relief can be a prescription for business failure.
We cannot wait for market failure to take the steps needed to foster competition.
Various policy options exist to address undue market concentration. Consumers for Fair Competition supports the approach taken last Congress by Representatives DeLay and Markey. In that legislation, FERC is given the authority and direction to mitigate undue market power. When FERC finds such anticompetitive concentration, it is authorized in clear terms to reimpose rate regulation and deny the dominant market player the use of market-based rates. FERC is also authorized to require the entity to participate in a regional transmission organization that will eliminate vertical market power. Only if these tools are inadequate to combat the market dominance is FERC authorized to order asset divestiture. As a practical matter, we do not believe that FERC will likely need to exercise its divestiture authority, but having this ultimate sanctionthe club in the closetensures that the less intrusive steps proposed in the DeLay-Markey bill function properly.
The denial of market rates is the central feature of this provision. First, it is proper economic practice. Market-based rates can only produce efficiencies and competitive pressure to lower costs if there is, in fact, a competitive market. In the absence of such competitionwhen one entity or group of entities dominant a marketthen market rates will simply produce monopoly profits. Second, the denial of market-based rates will compel utilities to submit their own market power mitigation plans in order to regain market-based rates. It should be noted that this same doctrine was used in deregulating the rail industry under the Staggers Act, where rate regulation is imposed on any shipper that dominates a market.
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3. Transmission Operation
The vertical control of the electric utility industry is largely incompatible with the needs of the competitive market. Despite the progress that has been made as a result of the Energy Policy Act and FERC Orders 888 and 889, the nation's transmission grid fails to operate on a non-discriminatory and comparatively neutral basis and fails to fully promote or support a competitive generation market.
Today, each utility's transmission network, despite a certain amount of reliability coordination, is operated largely as if it were an isolated island. This unnecessarily constrains and contracts markets. By acting in its own self-interest, owners can:
Reserve the majority of transmission capacity for its own use (which use is not effectively subject to FERC comparability standards),
Operate the system to favor its own (or affiliates') generation or retail marketing operation,
Utilize reliability objectivessuch as congestion management and emergency curtailment proceduresin a discriminatory and anticompetitive manner, and
Fail to make transmission investments that would alleviate congestion and promote the competitive market.
Page 274 PREV PAGE TOP OF DOC CFC believes that ownership and control of the nation's transmission system must be transferred to truly independent regional bodies with strong authority to operate, plan, maintain and expand the transmission system. Such action will:
Ensure all market participants have equal and nondiscriminatory access to transmission services;
Facilitate competition by eliminating rate pancaking and expanding the physical scope of markets;
Eliminate opportunities for the exercise of vertical market power,
Reduce horizontal market power in generation by expanding the size of the power market (and thereby reducing the comparative generation ownership of each regional participant), and
Ensure that transmission additions occur to eliminate bottlenecks, improve reliability, and facilitate construction of new generation.
CFC believes that the language contained in the DeLay-Markey bill can be refined to achieve these aims.
4. Utility Affiliate Transactions
The former monopoly status of utilities (and continued monopoly operation of distribution systems) provides anticompetitive opportunities in the ways that utilities and their unregulated affiliates interact. Utilities can:
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provide affiliates with preferential and discriminatory access to important information on power and non-power sales opportunities;
purchase goods or services from affiliates at above-market rates;
provide affiliates with goods or services at below-market rates;
perform various administrative services for the affiliate that are charged to the parent company or regulated utility; and
provide the affiliate, at no cost, with the considerable market value associated with the company name and logo.
Such actions harm consumers by having captive distribution system ratepayers cross-subsidize the utilities unregulated affiliate venture. Such actions also harm competitors by providing utility affiliates with an unearned and anticompetitive advantage.
Congress recognized these concerns and adopted several provisions in the Telecommunications Act of 1996 to ensure proper affiliate relations. These provisions establish ground rules for inter-affiliate relations and establish an enforcement mechanism. CFC urges adoption of parallel provisions in any electric utility restructuring bill.
Page 276 PREV PAGE TOP OF DOC As long as parties with a commercial commodity interest retain exclusive control of system reliability, opportunities will exist to manipulate legitimate reliability objectives for commercial advantage.
Establishment of FERC oversight of mandatory reliability requirements (and the security coordinators that do the implementation) will both promote a reliable electric system and competitively neutral reliability standards. The members of CFC support the consensus proposal developed by the North American Electric Reliability Council (NERC) and urge its adoption.
Stand-Alone PUHCA Repeal
You will hear assertions that the Public Utility Holding Company Act (PUHCA) is no more than an out-dated statute intended to protect investors from fraudulent securities practices. Don't be misled. Congress enacted PUHCA as a sister statute to the Federal Power Act. PUHCA establishes passive restraints on the structure of the electric utility industry in order to mitigate the formation and exercise of market power, preclude practices abusive to captive consumers and competitors, and facilitate effective regulation.
Rather than ushering in competition as repeal proponents would have you believe, stand-alone repeal will have substantial anticompetitive repercussions and retard the development of a vibrantly competitive market.
The members of CFC recognize that the current administration of PUHCA has clear limitations. However, its underlying purposesthe mitigation of market power and prevention of anti-competitive and anti-consumer utility diversificationsremain relevant today. CFC believes that PUHCA could and should only be repealed as part of a broad electric restructuring bill that contains the market power provisions outlined above.
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Summary of Legislative Recommendations
The Consumers for Fair Competition urge the adoption of the following provisions in comprehensive federal legislation on electricity restructuring:
The provisions of H.R. 2050 on regional transmission organizations (RTOs).
The market power provisions of the DeLay-Markey bill of last Congress. In the alternative, Section 104 of H.R. 2050 should be revised to correct the limitations of scope and authority outlined in my testimony.
The merger provisions of H.R. 1828, and also provide for FERC review of electric and gas ''convergence'' mergers.
Measures that parallel the affiliate transactions provisions contained in the 1996 Telecommunications Act.
The reliability provisions contained in H.R. 2050 or H.R. 1828.
CFC does not support adoption of H.R. 2363 on a stand-alone basis. In addition, we believe that PUHCA repeal should be delayed to provide adequate opportunity for replacement market power provisions and retail competition to take hold. For that reason, CFC prefers the conditional repeal of PUHCA provided in H.R. 2050 and prefers the 18 month effective date contained in H.R. 667, H.R. 1828, H.R. 2050 and H.R. 2363.
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Effective, sustainable competition will not automatically emerge in the absence of regulation. Regulation canand shouldbe relaxed for those markets and products that are subject to effective competition. However, given the historical operation and structure of the electric utility industry, competition in all sectors and regions will not occur simply by legislative declaration.
To promote the transition to competitive electric markets, steps must be taken to remove the vestiges of the former regulatory system and its accumulated opportunities to exercise market power. Once done, the transition to competition can occur and the need for active regulation will subside.
Mr. HYDE. Without objection, the opening statement of Mr. Conyers will be admitted into the record following my opening statement at the beginning of this hearing, and we will hand it up to you.
Well, thank you. Mr. Watt is recognized for 5 minutes.
Mr. WATT. Thank you, Mr. Chairman, and I am going to surprise the chairman by starting by heaping tremendous praise on him for having this very important hearing and very interesting hearing, especially given the subject matter. It is kind of hard to make electricity interesting, but too often I think we try to legislate in areas that we simply don't understand the range of considerations about, and legislation is so much more effective if you understand the various perspectives of the different interest groups.
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I think this hearing has really helped to try to bring all of those interest groups together. I don't know who put together the panels, but they were representative, I think, of most of the interest groups.
I was fascinated to hear Mr. Bryant say that he had the luxury of having, as his high priority, just the TVA and kind of looking out for their interest. My congressional district is substantially different than that, and I have heard all of these arguments and bits and pieces, but this is the first time, Mr. Chairman, that I have heard them kind of coalesced together on one panel and seen the difficulty we are going to have as we proceed in this area.
I have perhaps one of the largest and most successful investor-owned utilities in my congressional district: Duke Energy. I have municipal-owned or municipalities that have invested in utilities and would love to get out but want to be assured that their stranded costs that they have invested are repaid to them and that their customers continue to be provided the kind of electrical services that they got into the business to provide to them. I have rural cooperatives that serve a significant portion of my congressional district. I have heard the complaints of the small business competitors who wonder how Duke Energy can be in the business of selling electric stoves and have them expect to be competing down on the corner at the store and provide competitive prices, and I certainly have the consumers who this is supposed to be all about protecting their interests, and trying to balance all of those interests really is going to be an extraordinarily difficult task.
I heard the gentleman, whose name I won't be able to pronounce, from California say that allowing customers to purchase power from suppliers of their choicethat is an alien concept, I think, in North Carolina. I don't know of any consumer in North Carolina that now has the luxury that you describe, and maybe I am missing something, but we have light years to go before we get to a point where we are going to have consumers, customers, making choices between Duke Energy and Charlotte and private marketers. I don't even know what private marketers do, but I have never had one of them come to my door and offer to sell me any power in competition with Duke Energy, and I have never and I don't think my customers who are served by rural electrical cooperatives or these municipal-owned facilities have the luxury of shopping around currently for their energy needs.
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So as we make our way from where we are right now to, I suppose, where we are headed, is where California iswe are always behind California, everybody is always behind California, it seemswe have a number of very, very serious tasks ahead of us, and the first step in that, from a legislative perspective, is understanding each of these interests. And I think this hearing today has been inordinately enlightening toward that objective.
I have run out of time making my opening statement. I was going to ask the gentleman from California whether I could reasonably expect to see this kind of choice supplier system in North Carolina at any point in the next 10, 15, 20 years, but I thought it was more important to kind of flesh out all the different interests and praise my chairman for having this hearing. Maybe he will give me 1 minute to, since I have praised him so much, to let the gentleman tell me whether we are going to get to this Utopia that California has.
Mr. HYDE. The gentleman from North Carolina has ascertained the appropriate way to extract additional time. The gentleman, without objection, is given an additional minute.
Mr. WATT. Maybe the cooperatives and the gentleman from California can help enlighten me. Are we going to get that?
Mr. FLUCKIGER. Two brief comments. One, to commend your political astuteness in the approach to get the extra time. Second, there are undoubtedly rocks on the road to competition. First of all, the law that was passed in California did open the consumer choice to all customers. It is about 80 percent or 85 percent.
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Mr. WATT. Are they residential?
Mr. FLUCKIGER. All residential but only 85 percent of the utility load is participating. The holes that I referred to in our Swiss cheese are a number of municipalities and others who don't yet participate in that scheme, and that was one of the reasons I believe any comprehensive legislation adopted needs to be comprehensive in nature in giving authority presumably to FERC to require participation by all transmission providers as this process moves forward.
Mr. WATT. Now, is that providingI am sorry, Mr. Chairman, I am just fascinated by thisis that providing services to customers where they can go to 3 or 4 different providers and get their electrical needs like I can now do with my long distance telephone service?
Mr. FLUCKIGER. That is correct. Today, for the 85 percent that are participating under California's law, they can and do choose their electric supplier among a number of choices. There are a number of marketers and other utility affiliates and others in California, entities, energy service providers or scheduling coordinators that provide competitive electric services in California.
Mr. WATT. That is fascinating. Are we going to get there? The cooperative gentleman is going to tell me whether we can get there in North Carolina.
Mr. ENGLISH. First of all, let me just say that depends on your State legislature. Unless the Congress decides differently, it is up to each individual State to make its own decisions as to when it wants to make changes and what changes it may bring about.
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Second, electric cooperatives are the only ones right now that you have a choice with. So, if electric cooperatives are owned by the consumer and anytime those consumers want to get rid of that electric cooperative, all they have got to do is sell it. So you have got customer choice with every electric cooperative in the country as it stands now because it is the only one that is owned by the consumers themselves.
Mr. WATT. But if I gave up that electric service from the cooperative, would I be able to go and buy it from somewhere else in North Carolina now?
Mr. ENGLISH. Unless the laws in North Carolina have changed, you would have to sell the electric cooperative. Obviously, that would be a majority or whatever the by-laws provide for of the membership of that electric cooperative, but it would be up to them. They could sell it to anyone they wished.
Mr. WATT. Thank you, Mr. Chairman. Again, I wasn't just patting you on the back for the fun of it. This is a very, very difficult issue and one that we clearly are going to have to face as we go down the road, and it is just wonderful to have the competing considerations presented to us in this fashion because we won't have the luxury, like Mr. Bryant has alluded to, of just kind of looking out for our home interest. And if we do even, as I have indicated, my own home interest, I have identified at least five different interests in my home base that I am going to have to look out for.
Mr. HYDE. Thank you very much. The gentleman from Georgia, Mr. Barr.
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Mr. BARR. Thank you, Mr. Chairman. I too appreciate, Mr. Chairman, your convening this hearing today. It has been very interesting. There are very few of us in this room that were around back in 1935, I think it was, when the current Federal regulatory scheme, although it has been modified over the last couple of decades, went into effect.
So, similarly to what the Congress has done in the last few years to bring the financial services laws forward six or seven decades, I think it is very important that we do the same thing here, and I think the results will be better for consumers as well as local governments and ultimately for the energy companies, cooperative or otherwise.
The hearing today has been very interesting and I would also like to commend you, Mr. Chairman, for the memorandum that you sent around to the committee members. It provides a very, very succinct and easily understandable exposition which lays the ground work for this very complex series of laws that we are going to be looking at. It provides very good background, not only in the antitrust area, which is the area of direct concern to this committee, but provides a very solid basis for us to really get into and understand these issues.
So, Mr. Chairman, I appreciate the hearing, I appreciate the witnesses today, representing a broad cross-section of businesses and other entities interested in ensuring that as we move forward through this deregulatory process, that we do keep both the best interests of consumers, as well as of the shareholders and investors in mind, and look forward to continuing our work in this regard. Mr. Chairman, thank you.
Mr. HYDE. Thank you, Mr. Barr. The gentleman from Indiana, Mr. Pease.
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Mr. PEASE. Thank you, Mr. Chairman. I wish to express my regrets to members of this panel and those from the other panel that are still here about my absence during part of the hearing. As the chairman advised, there are a number of simultaneous hearings, and I regret that I missed some of your presentations, but I do appreciate the material that you have provided.
Dr. Anderson, in your remarks I think you said that a stand-alone repeal of PUHCA would be anticompetitive. I believe you made the statement.
Mr. ANDERSON. That is correct.
Mr. PEASE. But then you didn't explain why you think that is the case. Could you explain why?
Mr. ANDERSON. We believe that the act provides vital consumer protections today. Without that act, we could go back to conditions that were in existence before the 1935 act. Simply repealing PUHCA today would allow the incumbent utilities to merge and become bigger, without adequate regulatory protections and without giving consumers the right to try to protect themselves by being able to shop.
Mr. PEASE. You don't think the States are capable of doing that?
Mr. ANDERSON. No, I don't. I think that most of the electricity markets we face today are interstate in nature. It is not a criticism of the States. It is just the electrons, as was said by an earlier witness, don't respect State boundaries. The flow of electricity moves throughout the United States in a way that doesn't stop at any State boundaries. States have a very difficult time in regulating any commodity that flows in interstate commerce, and that is why we need a strong Federal protection.
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Mr. PEASE. Do others have thoughts on this point? Let me go to Mr. Naeve, then I will come back to you, Mr. Travieso.
Mr. NAEVE. I think it is a misnomer to characterize PUHCA as a consumer protection statute. PUHCA regulates the financial and corporate structure of regulated holding companies. Only a small fraction of all utility holding companies are regulated by PUHCA. It regulates the corporate structure, how many subsidiaries do you have and so forth, but it really is not a consumer protection statute.
Dr. Anderson suggested PUHCA is useful to protect against competitive harm in mergers. I find that interesting. Some utility mergers do have to be presented to the SEC for review under PUHCA, but certainly not all; only if mergers that are structured a particular way, if they have something called a two bite problem. These are mergers that result in utility assets being held in two or more separate subsidiaries. Then and only then do you go to the SEC for review of a merger.
Secondly, if a merger goes to the SEC for review under PUHCA, the SEC looks at a variety of factors. Such as whether the utility facilities operations of the merging companies are interconnected. The 1935 act tends to favor mergers of parties that are very close together, which tends to increase concentration of generation ownership, as opposed to the FERC policy which tends to favor mergers of more remotely located utilities where generation ownership is more spread out.
Also, as a practical matter, the SEC does not review competition issues. Although the factors included in the SEC merger review checklist, the effects of a transaction on concentration of control, the SEC has adopted a policy of deferring to other Federal agencies that also review exactly the same mergers for competitive effects. Because other Federal agencies have more anti-trust expertise and because the Public Utility Holding Company Act staff is very small, they don't themselves examine that issue.
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Mr. PEASE. Thank you, Mr. Naeve. Mr. Travieso, I do want to get another question in, so if you could be as succinct as you canif you wanted to respond to that.
Mr. TRAVIESO. I do have a response on the PUHCA issue, but you can determine
Mr. PEASE. Go quickly.
Mr. TRAVIESO. NASUCA believes that PUHCA is a consumer protection act, and I think all you have to do is read it. It is full of references to protecting consumers. It arose out of abuse that holding companies were involved in in the thirties. Those abuses were against consumers. So we also don't believe in the stand-alone repeal of PUHCA. The concept, I think, is that if there is effective competition, then certain aspects of PUHCA could be eliminated and certain responsibilities could be given to the FERC. But PUHCA exists because State regulators were not able to regulate the abuses that were occurring, particularly affiliated abuses among interstate public utility companies. That is why it was enacted in the first place.
Mr. PEASE. Mr. Chairman, could I ask unanimous consent for just a minute?
Mr. HYDE. Without objection, an additional minute.
Mr. PEASE. Thank you. Mr. English, I saw you wanting to respond to that, too, but before you do, I was intrigued by the general tenor of your presentation. Most of the other, and generalizations aren't fair I understand, but most of the other presentations seemed to say the way to ensure consumer protection or a free market is through Government regulation. I am not quite sure how that works. You seemed to be moving more into a pure free market where consumers make their own choices. Now, if I have unfairly characterized that, please correct me, but if it is at least close, can you explain a little further what you mean by that?
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Mr. ENGLISH. You are close, and that comes from my experience as a Member of Congress. I have had too many bills and too many amendments in which the intent of the bill or the amendment doesn't seem to get carried out. And as has been pointed out here, I think we already have a number of laws that are already on the books. The question is whether you go beyond what is already on the books.
You may want to adjust the laws that are on the books to meet the situations you anticipate, but in reality, we have got two problems. One is will the intent in this hair-cutting attempt to try to address specific problems that the Congress may see, be actually carried out, not only with this administration or future administrations, but then we have also got the whole question of turf; and the turf issue is one within Federal agencies we found to be very difficult.
Right now we have got a bit of a concern. We are regulated by the Rural Utility Service out of the Department of Agriculture for most of our membership, but by the same token now, we have the Federal Energy Regulatory Commission who says it has jurisdiction. Both are talking about small distribution cooperatives of 2,500 and 5,000 consumers who may have a mile or two of what could be under some provisions interpreted as a transmission line. Well, that is where I think we are really getting far afield.
What I am talking about here, and let me say very quickly before I get too much further down the road, I would agree that PUHCA is a consumer protection legislation, and the question as to whether it should be updated, and how, in addressing the problems of the next century, that is another issue, I think, as well.
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But bottom line, when it really comes down to it, I feel that if you are talking about a real alternative, if you are really talking about having competition, if you are talking about deregulation more than reregulation or adding more regulation and calling it deregulation, then I think really what you are down to at that particular point is this question of is there any other alternative to market power. And the bottom line is that the only real alternative is, as far as I can see, is empowering those consumers, and you have got to give them as much freedom as you possibly can, you have got to let them work together, you have got to let them come together, and if they get ticked off at their local electric utility, cooperate with somebody in some other part of the country to make sure they get electric power as cheaply as they possibly can.
That is the only way that I can see that you can get at it. And so I suppose that if I had not served in this body and had more faith in seeing this kind of fine-tuning done and seeing it carried out precisely in the manner it is intended, I would have more confidence in moving in that direction. But I would just suggest to you this may be an alternative that may allow some of this fine-tuning to be done by the consumers themselves.
Mr. PEASE. Thank you very much. Thank you, Mr. Chairman.
Mr. HYDE. Thank you, Mr. Pease. Mr. Bachus, the gentleman from Alabama.
Mr. BACHUS. Thank you, Mr. Chairman. I also commend you because I may need more time.
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Mr. HYDE. A little more vigorous compliment.
Mr. BACHUS. Thank you. Well, maybe I don't need a lot more time. Mr. Sullivan, since you are from my home State and we are friends, I do want to ask you something; and that is, our rates in the Southeast are about 16 to 20 percent below the national average. What do you see competition in the electric industry doing to those rates and, maybe in general to rates across the Nation? But I am particularly interested in the Southeast.
Mr. SULLIVAN. Thank you, Mr. Bachus. And I too am particularly interested in the Southeast when I am wearing my Alabama Public Service Commission hat. Today I happen to be wearing another hat, which is to represent our national organization, NARUC, which represents all the 50 States. But I think I can answer your question to give you the drift of where all the States are coming from and still let you know where we are in the Southeast.
Every State is different. Our economies are based in different industries, and every State must approach restructuring in its own way to benefit our economies. Some States like California had to do something to protect the economy. Their electric rates were too high. They had to figure out a way to get those rates down and so they had to act. And what they have done is not perfect but it is a lot better than what they had to work with originally.
Other States in the country, like the MidwestIndiana, Illinois, Ohioare trying to figure out a way to get their rates down, and so they are approaching restructuring differently.
Page 290 PREV PAGE TOP OF DOC In the Southeast where our rates are indeed 16 to 20 percent below the national average, we have the luxury of not having to act right now, but we can watch what is happening in California. We can watch what is happening in New England and we can watch what is happening in the Midwest, and we can take advantage of the successes that they have there and we can learn from their mistakes.
What I believe is that you are going to see as we move through this process of restructuringand indeed it is not deregulation, it will be reregulationand I think what we are going to see is that in some States rates will come down and in other States like Alabama and the Southeast, there is a propensity for those rates to go up and reach some sort of a median national average, and that is why we want to move more slowly. That is why we want to make sure of what we are doing.
One thing I can say, in light of this particular hearing today, it doesn't matter whether you are from a high-cost State trying to get rates down or from a low-cost State trying to keep rates down, I think all States would agree that we are against unregulated monopolies, and that is why we are so concerned about the contents of what this hearing is all about here today.
Mr. BACHUS. Thank you very much. Mr. Hegemann, I am particularly interested in some of your remarks. You support FERC's authority to have investor-owned utilities divest their assets or to order them to turn over control to their transmission lines. Is that correct?
Mr. HEGEMANN. Yes. Basically we believe that if you are going to have open access that allows for the competition to take place, it is necessary that the transmission system, not just in one region but over areas larger than several States, be in the hands of an entity that is not compromised by also owning, say, generation.
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Mr. BACHUS. Also, actually selling their generation assets?
Mr. HEGEMANN. Well, you can accomplish it by divestiture.
Mr. BACHUS. Right. Let me ask you this in connection with that. Mr. Anderson also mentioned that as a club in the closet, I think, in his testimony, but do you support that for municipal-owned utilities, giving the same power to divest assets in municipals?
Mr. HEGEMANN. I think from the standpoint of making transmission capacity available, yes.
Mr. BACHUS. Do you apply the same rules to municipal-owned utilities? Don't you think they ought to have the same rules?
Mr. HEGEMANN. I think they should. To the extent that someone mentioned earlier that in California, the public sector, transmission was not part of the ISO, there is a good reason for that, and that is the private use restrictions in the tax-exempt financing, municipal financing laws that are on the books today. So if that were removed, that would allow the private use, say, of publicly-owned transmission facilities. Now, obviously that private use would be modified and changed by law, and therefore, it could be part of an ISO, and under those conditions, I think in order to make the system work, we do need to have all the transmission systems available to the customer.
Mr. BACHUS. In fact, I will say this. You have mentioned what the gentleman from California said and that is, you do have in California and the Pacific Northwest, even in Tennessee and around Alabama with TVA, you have parts of the transmission system that are not regulated by FERC. So you would advocate allowing
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Mr. HEGEMANN. Let me just give you a little background. I personally have been moving power at the wholesale level since about 1986, and I can tell you from experience that it is not who owns the transmission, whether they are public, private, or co-op, or some other consumer-owned arrangement. The question is, does the owner of that transmission system, think it is in their best interest to make it available to a third party? And if it isn't in their best interest and they are working for their stockholders, they are not going to make it available to you to allow you to do business in an area they traditionally have done business. So the end result is that if you want to break that and truly have open competition, you have to make all the transmission available and not leave out patches or blocks of it in particular areas.
Mr. BACHUS. Part of what is proposed before the Congress is to continue to exempt them sowhich I think, and I agree with you, I think, and the gentleman from California, we have to put them all in there, have the same regulation.
The last thing I want to ask you is, we talk about the need for more competition and everything. I would ask maybe you, Mr. Hegemann and others, there are 2000 municipal utilities today, 900 electric co-ops, 200 investor-owned utilities, 500 power marketers already in the electric market. Shell Oil, Amoco, BP are entering the electric markets as they become competitive. That is a lot of potential competition. How do we justify saying there aren't enough sellers or sufficient freedom of entry?
Mr. HEGEMANN. Well, I think it is a two-part question. To the extent is that enough, I think it could possibly be enough marketers or players in the industry. What we are seeing todayand I mentioned before that I have been in this business for a long time and been moving power at the wholesale level since the early eighties, mid-eightieswhat you see is a need to do something about the delivery system. It doesn't make any difference how many players you have in a marketplace as far as marketers. What you really need is the mechanism to get the power from, say, the generator, whether it be through a marketer or from the owner of a generator to the customer, and that has been our battle at the wholesale level for as long as I can remember, and that continues to be the real battle to open up competition to all the consumers of this country.
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Mr. BACHUS. And those rules ought to apply to municipal-owned utilities as well, the same rules that apply to investor-owned utilities to allow that?
Mr. HEGEMANN. I think if you are going to have true competition and have the consumer have the right to have choice, it doesn't make any difference who owns those transmission facilities today. They have to be made available to the public so all customers can use them.
Mr. BACHUS. Mr. Chairman, I am going to ask for an additional 30 seconds, unanimous consent, if I could for one final question.
Mr. HYDE. Without objection.
Mr. BACHUS. Mr. Anderson, Mr. Pease, the gentleman from Indiana, asked you about whether State action alone is adequate to address these power market concerns. I would ask you, can you give me any case where State government regulators have reached the same conclusion that State action alone was not sufficient and actually approached the Federal Government and asked them to step in to address some of these concerns?
Mr. ANDERSON. I can't right now, but I think I can provide some things for the record. I would defer to Commissioner Sullivan who is probably in a much better position to say whether State commissions have actually asked for action.
Mr. BACHUS. I just don't know of any instance where the States have said we don't have the ability to protect our consumers and we need Federal help. Do any of you know of any instances?
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Mr. SULLIVAN. I would say that on the recent RTO issue in which the States have been working with the Federal Energy Regulatory Commission, there has been some discussion, for instance in the State of Ohio, about trying to figure out a way to get pancake prices down where transmission issues were being discussed, but I can't think of any State that has really come out and said that we would like what is now State jurisdictional to become federally jurisdictional.
Mr. BACHUS. I would like to know of any of those instances, because then we would know how to fashion a remedy. And, Mr. McGlynn, I want to tell you that the concerns you expressed about the cross-subsidiesI have had electrical contractors in my area that have given me examples of thatand I think we have to struggle with fair competition, but also I think that is a legitimate concern.
Mr. HYDE. Mr. Jenkins.
Mr. JENKINS. Thank you, Mr. Chairman. And I am sorry I had to go to a meeting and miss the testimony of most of these distinguished gentlemen, and I don't know where to start because I am disadvantaged. I don't know what they said, but let me pick on Mr. English, because he and I in some ways are in at least one of the same categories. I consider myself to be rural, a country mouse, and Mr. English represents a lot of rural areas across this country.
Mr. English, how many folks do you represent here today in your capacity as the president of the Rural Electric Association?
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Mr. ENGLISH. Well, 32 million consumers in 46 States that own nearly 1,000 electric cooperatives across the country.
Mr. JENKINS. So I don't know any of the gentlemen on the panel with you who speak for as many people as you.
Mr. ENGLISH. They would probably disagree on that, but I will agree with you.
Mr. JENKINS. All right. Well, let me ask you this, and I don't know what you have said previously, but from any of the bills that have been thrust upon us or introduced in the Congress, do you see any of the bills that are going to be beneficial to rural America because of the provisions that they have within them relative to reregulation of the electric utility industry in this country?
Mr. ENGLISH. Well, Mr. Jenkins, I have got to say that there is no single bill that we have seen that we embrace and say that this would be great for rural America. By the same token, there are pieces and parts of each bill I think that could be helpful. I think Mr. Sullivan probably touched on it correctly, that each and every State is going to be a little bit different, and certainly within the States themselves it is going to be different. Most all of the studies that I have seen is, as is so often the case, rural America does not seem to be at the top of everyone's list as a chief beneficiary of the exchanges.
Mr. JENKINS. Well, if we are all going to have different needs and they are going to have to be addressed individually after any deregulation scheme, isn't that an argument for status quo, to stay where we are, to not really go to any elaborate deregulation scheme in this country?
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Mr. ENGLISH. I think a strong argument could be made there. However, California and New York, some of the higher priced States as far as electric services are concerned, they felt it was in their best interest to move and I can appreciate that.
If I could, Mr. Jenkins, very quickly, I would point out, though, we do have to recognize where we are in this country, and that is, there are only two other countries that come as close to having rates as low as we do here in the United States. There is none that is more reliable than we have here in the United States, and ours is the only country over the last 10 years where rates have been going down. So that puts a little different perspective.
Mr. HYDE. Mr. Jenkins, the Chair dislikes to intervene, but I have to go. I have asked Mr. Barr to take over so that you are not short-circuited, foreclosed, but I do want to thank the panel. You have been wonderful. This has been a very productive hearing, and we will lean on you some more, but thank you, and I am sorry to have to leave. You are almost through.
Mr. JENKINS. Well, Mr. English, you were in the room. You heard the questions that I put to some gentlemen who were on the previous panel with respect to new building capacity. Is there anything in this legislation that, in your opinion, will facilitate the construction of new capacity in this country?
Mr. ENGLISH. I know of nothing.
Mr. JENKINS. And is there not a pretty widely held point of view that this is probably going to be the greatest difficulty that faces the electric utility industry in this country is the lack of capacity for the future?
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Mr. ENGLISH. I think without question. And more particularly in the transmission area, there is no question that is of concern to all of us.
Mr. JENKINS. We talked about the cost of fuels and the cost of labor. We talked about environmental costs. It is my viewpoint that from what I have heard in all the meetings that I have been to, that the environmental cost to the electric utility industry will be increased under the provisions of these bills that have been put forth. Is that your opinion?
Mr. ENGLISH. Particularly under some of the provisions that have not yet been ratified by the Congress. I am talking about the Kyoto Accords. There is no question that will have an increase as far as cost to consumers in the electric utility industry.
Mr. JENKINS. And nobody has suggested to me in response to my questions that there is going to be any decrease in the price of nuclear fuels or in the price of coal or in the cost of generation at any hydrostation in this country.
Mr. ENGLISH. I can't disagree with a thing you are saying, Congressman.
Mr. JENKINS. Well, what was that old commercial, ''Where's the beef? So where are the benefits to the consumer, the American consumer, with respect to any of these reregulation schemes?
Page 298 PREV PAGE TOP OF DOC Mr. ENGLISH. Well, back in my home State of Oklahoma we call that betting on the come.
Mr. JENKINS. Well, but you say we have a system that produces the lowest cost electricity in the world.
Mr. ENGLISH. Close to the lowest. There are two other countries that come close.
Mr. JENKINS. We have a system that has the most reliable system without any question.
Mr. ENGLISH. Without any question.
Mr. JENKINS. And yet we are fixing to fix something that ain't broke.
Mr. ENGLISH. I think that is a very good description of the situation.
Mr. JENKINS. Thank you, sir.
Mr. BARR. I thank the gentleman from Tennessee. I would like to echo the chairman's parting remarks and thank you all for a very lucid explanation.
Page 299 PREV PAGE TOP OF DOC Mr. English.
Mr. ENGLISH. Mr. Chairman, I believe I heard the chairman at the beginning but I assume that all written statements will be made a part of the record.
Mr. BARR. All statements will be made a part of the record. If there is any additional material that any of you gentlemen would like to furnish the committee, please feel free to do so. It will also be incorporated. I thank you gentlemen very much and this hearing is concluded.
[Whereupon, at 1 p.m., the committee was adjourned.]
A P P E N D I X
Material Submitted for the Hearing Record
PREPARED STATEMENT OF BOB KEINGSTEIN, PRESIDENT, AIR CONDITIONING CONTRACTORS OF AMERICA
The Air Conditioning Contractors of America (''ACCA'') would like to commend the Members of the Judiciary Committee for their foresight in addressing the antitrust implications of electricity restructuring. ACCA is a nonprofit trade association that represents and serves firms who design, install, service and repair heating, ventilation, air conditioning and refrigeration (HVACR) equipment for residential, commercial and industrial customers. ACCA represents approximately 9000 mostly small businesses through national membership as well 68 state and local chapters across the country. As you may know, ACCA launched its ''Fair Competition Is Cool!'' Campaign over two years ago to address anti-competitive practices in the utility industry. Air conditioning contractors have worked with many other building trades professionals through the National Alliance for Fair Competition (''NAFC''), which includes plumbers, electrical contractors, petroleum marketers, mechanical contractors, and builders,in all some 35,000 open and union shops nationwide. We also wish to support the remarks made by James J. McGlynn in today's hearing on behalf of the NAFC and Consumers for Fair Competition, a broad-based coalition of which we are members.
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More than 50,000 HVACR and other specialty contractors do $67 billion worth of business each year in fulfilling the service needs of more than 100 million households and businesses throughout the nation. Each of these companiesand the nearly 600,000 people who work for themis endangered by unfair utility competition. As the U.S. Small Business Administration found, ''Many utilities, looking for new ways . . . to weather the shakeout that is expected to occur when their industry is deregulated, are getting into the heating, ventilation and air conditioning business.'' SBA's sobering conclusion: ''Competition with monopoly utilities in unregulated markets can result in the destruction of non-utility competitors . . .'' At this point in time, there can be no question that restructuring of the electric power industry is one of the most important and complex issues facing Congress. After all, restructuring affects every one from utilities and large industrial consumers to the individual homeowner and small businessperson.
Cross-subsidization and Other Anti-Competitive Conduct
To date, most of the debated has focused on the impact that electricity restructuring would have on utility service and its relative benefits to different classes of consumers. Our members are concerned, however, that an aspect of the debate has largely been ignored up to this point and that is anti-competitive conduct by utilities to gain an unfair competitive advantage in related service markets. They do this to defray the costs of making the transition to a competitive marketplace and the inability of current antitrust laws to prevent such behavior.
As restructuring approaches, we are increasingly concerned about utilities and their affiliates using benefits acquired under their pre-existing monopoly power. These assets were obtained through monopoly power, paid for by ratepayers, and were never intended to defray the costs of entering unrelated competitive markets. This practice, known as ''cross-subsidization,'' is manifested in the sharing of vehicles, service tools, employees, common logos and trade names, bill or statement stuffers, marketing information and mailing lists. Ratepayers paid for these assets, but not so the parent utility could gain a competitive advantage in unrelated markets. Obviously, small and medium-sized air conditioning contractors pay these costs of doing business out of our own pockets, not as a benefit received as a result of a state-conferred franchise. For example, bill stuffers, while appearing trivial, actually amount to free advertising for affiliates of utilities. Further, while private mailing pieces may be thrown away at high rates, advertising placed in utility bills is sure to be read because any customer that fails to read his or her bill is likely to have their electricity cut off!
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We have a collection of bill stuffers and advertising from throughout the nation to show the range of below-market offers utilities can make in these promotions.
The assets utilities deploy in cross-subsidization have significant value. Just as the Internal Revenue Service and the Securities and Exchange Commission require the evaluation of ''good will'' in commercial transactions, so too, do we derive enormous value from our customer lists and good names. For utilities to pretend these assets have minimal or little value, as they do, is simply to work from a false premise.
ACCA has made a careful analysis of the impact that cross-subsidies can have on the U.S. economy based upon the experience in our industry. Dr. Richard Carlson of Spectrum Economics in Palo Alto, California examined the impact of such market power abuse on our industry. As mentioned earlier, the industry has annual revenues of over $67 billion and employs over 530,000 people. About 70 percent of this workforce are employed in contracting firms with fewer than 50 people. Almost half work for companies with less than 10 employees. The industry pays high wages, averaging about $17 per hour, and provides a livelihood to over 53,000 small business owners and their families. The analysis shows that the HVACR sector is already quite competitive and that inappropriate use of market power can have far-ranging economic consequences. Cross-subsidies could cost as many as 60,000 jobs nationwide and result in consumer losses of over $2 billion as the market contracts because of utility practices.
At this point it is clear that utility behavior constituting apparent market abuse has been found nationwide, with particular examples in New Jersey, Maryland, Massachusetts, Michigan, Minnesota, Texas and Californiain residential, small business and commercial markets.
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Let me be clearACCA supports full and open competition. Indeed, competition among air conditioning contractors is vigorous as a quick glance at any telephone book reveals. But any legislation restructuring the market for electricity must contain an outright prohibition against unfair cross-subsidization backed by appropriate remedies in order to guarantee competition that is truly free and fair. To do otherwise is to allow the utilities to skew market realities in both the electric power industry and among affected unrelated businesses, and is not true competition in any sense of the word.
Limitations of Antitrust Law to Address Cross-subsidization and Other Anti-Competitive Conduct
Although federal antitrust laws are well suited to address some of the more grievous abuses of market power such as monopolization or attempted monopolization, the typical affiliate abuses of market power that most directly harm ACCA members and other small businesses are more subtle. Existing law inadequately addresses them. Indeed, Douglas Melamed, Principal Deputy Assistant Attorney General of the Antitrust Division at the United States Department of Justice in testimony before the Commerce Committee's Subcommittee on Energy & Power said:
The authority of the Department of Justice to enforce the antitrust laws with respect to electric power industry does not sufficiently address the ability of electric utilities to exercise market power that can thwart free competition within the industry. The antitrust laws do not outlaw the mere possession of monopoly power that is the result of skill, accident, or previous regulatory regime. Antitrust remedies are thus not well-suited to address problems of market power in the electric power industry that result from existing high levels of concentration in generation or vertical integration.(see footnote 54)
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Echoing this view, the staff of the FTC Bureau of Economics has commented in filings before state public utility commissions considering affiliate transactions that:
Antitrust enforcement is focused on anti-competitive mergers and unfair methods of competition. From an antitrust perspective, a firm that lawfully acquired market power does not commit an antitrust offense merely by exercising that power unless, for example, it engages in unfair methods of competition to protect that power. Consequently, antitrust enforcement may not be able to remedy such market power as a market moves from locally regulated monopolies to competition.(see footnote 55)
Indeed, Congress appears to have reached a similar conclusion in its consideration of the Telecommunications Act of 1996, enacting substantial provisions to prevent monopoly leveraging and other forms of market power abuse by the regional Bell operating companies (''RBOC's'').(see footnote 56) It is a simple fact that without proper controls affiliate transactions present fertile ground for vertical market power abuses,(see footnote 57) and that current antitrust law is not sufficient to address these problems.
The Need for Federal Legislation to Prevent Cross-Subsidization
The obvious anti-competitive impact of utility cross-subsidization is ultimately higher prices for utility consumers and anti-competitive harm to HVACR contractors forced to compete against utility subsidiaries whose prices are artificially low. However, Congress has the opportunity to prevent this from happening and promote competition that is truly fair and open by including language prohibiting cross-subsidization in any restructuring bill.
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Frankly, what is needed is an outright prohibition on cross-subsidization supported by appropriate sanctions similar to those in current federal antitrust laws. In taking such an approach, Congress would be sending an unmistakable and clear message that anti-competitive practices will not be tolerated under the guise of restructuring. Specifically, Congress should seek to clarify that all transactions between a utility and its affiliate, associate or subsidiary companies should be conducted at arms-length and the value of any sale, transfer, or use of utility assets, whether tangible or intangible, or personnel between a regulated utility and its unregulated affiliate, should be recovered to prevent cross-subsidization.
A direct prohibition on cross-subsidization will not present a problem for those utilities that refrain from anti-competitive practices during the transition to a competitive marketplace. Moreover, federal legislation is essential to address the problem of cross-subsidization. First, anti-competitive behavior lies at the heart of the antitrust law and policy in this nationa conclusion Congress has consistently supported for over a hundred years. Absent federal legislation, restrictions on cross-subsidization will fall between the cracks because of the limitations of current regulations and case law.
Second, for small businesses such as HVACR firms, it is far too costly to approach every state and every court to vindicate our interests, particularly when faced with the substantial resources available to electric utilities.
Finally, we believe that there is an important federal interest in uniformity on these issues. Once Congress acts to restructure electric utilities, the competitive practices of these companies will not stop at state borders. Since electrons and other services often crosses state lines, state solutions on their own will be insufficient to curb abuse of market power. Utility regulators in one state will not have authority over unregulated affiliates of out-of-state utilities. As a result, federal solutions must be crafted.
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Some have supported stand-alone repeal of the Public Utility Holding Company Act, or PUHCA. While we are not experts on the nuances of that law, it does strike me that in order to repeal it, Congress will have to once again consider appropriate limitations on the investment of monopoly assets. ACCA believes that consideration of changes to or repeal of PUHCA presents the perfect legislative opportunity to craft a solution to utility cross-subsidization, one of the major market power abuses in need of remedial action.
The continued drive of certain utilities to use their monopoly leverage to enter HVACR and other unrelated markets is literally a life-and-death struggle for many small- and medium-sized businesses in this nation. And the problem is growing geometrically. A report issued in July by the C Three Group, a research and strategic consulting group in Atlanta, showed that there has been a surge in non-traditional businesses by investor owned utilities in the past few years. They report that at year-end 1992, these utilities had $30 billion of assets in non-traditional businesses. By year-end 1998, that figure had soared fivefold to $150 billion.
Consequently, this hearing and the legislation that hopefully will result from it, presents an ideal opportunity to address the growing problem of cross-subsidization.
This Committee's jurisdiction over the nation's antitrust policy and enforcement leaves it uniquely positioned to see that electricity restructuring legislation effectively prevents anti-competitive conduct by utility monopolies as the transition is made to a competitive market. As the Committee is well aware, new concerns are already arising in other newly deregulated markets about the potential for market power abuses in the wake of increasing consolidations. ACCA urges the Committee to take action now to allay such concerns as the electricity market is restructured. Only by such action can fair and open competition be assured from the outset, and can the benefits of lower prices and consumer choice be guaranteed.
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Hon. MOZELLE THOMPSON, Commissioner,
|Committee on the Judiciary,|
|House of Representatives,|
|Washington, DC, November 17, 1999.|
Federal Trade Commission,
DEAR COMMISSIONER THOMPSON: I appreciate your appearing before the Committee on the Judiciary to testify at the oversight hearing on ''Competitive Issues in Electricity Deregulation'' on Wednesday, July 28, 1999.
A Member of the Committee has asked that you answer additional written questions for the record. I have attached a copy of the questions. I would appreciate your answering the questions in writing and returning your answers to the Committee for inclusion in the hearing record at your earliest convenience.
If the Committee can provide you with any additional information, please do not hesitate to have your staff contact Joseph Gibson by phone at (202) 2253951 or by fax at (202) 2257682. I appreciate your participation in our hearing.
cc: Hon. John Conyers, Jr.
QUESTIONS FROM CONGRESSMAN SMITH
1. What are the specific (not general or anecdotal) market power concerns of your agency with respect to electricity deregulation legislation?
2. Why doesn't current law address or prevent the specific concerns identified in your answer to question 1?
3. In the absence of transmission constraints (that prevent several competitors from getting electricity to a market), how can there be market power in the electricity distribution market?
4. Doesn't current law give the Federal Energy Regulatory Commission authority to order relief of transmission constraints so that any competitor can get his commodity (electricity) to any market or customer?
Hon. HENRY J. HYDE, Chairman,
|U.S. Federal Trade Commission,|
|Office of the Commissioner,|
|Washington, DC, January 11, 2000.|
Page 308 PREV PAGE TOP OF DOCCommittee on the Judiciary,
House of Representatives, Washington, DC.
DEAR CHAIRMAN HYDE: Thank you for your letter passing on several questions from Representative Smith, arising from my testimony on ''Competitive Issues in Electricity Deregulation.'' I appreciated the opportunity to testify before the Committee, and to answer follow-up questions in writing.
1. What are the specific (not general or anecdotal) market power concerns of your agency with respect to electricity deregulation legislation?
Market power concerns in the electric power industry stem from a variety of sources. Some are specific to the history and technology of this industry and some reflect conditions that exist in many industries as they emerge from long periods of regulation into competition.
The two principal types of market power concerns in a deregulating industry are (1) discriminatory access to transmission and (2) horizontal-market power.
Many owners of transmission assets are vertically integrated, that is, they also own generation and/or distribution assets. Vertical discrimination is a significant concern in the electric power industry because part of the industry retains characteristics of a natural monopoly. Most importantly, the transmission grid and the local distribution grid remain regulated monopolies under Federal and State regulation. Where a single firm controls both regulated transmission facilities and unregulated generation facilities serving the same customers, the firm has incentives to discriminate against other generation sources in the operations of its transmission lines. Favoring its own generation facilities can increase the profits of the firm
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Vertical transmission access discrimination is a manifestation of horizontal market power at the transmission level in the electric power industry. Because of large economies of scale in providing transmission services, parallel transmission lines are rare, and effective competition in transmission services is unlikely. Consequently, rate regulation has been used to constrain the exercise of market power in transmission. As long as competition was also untenable in generation and other services, wide-spread vertical integration in concert with regulation eliminated most incentives to discriminate in granting access to transmission services.(see footnote 58) With the advent of competition at the generation level, a vertically integrated transmission/generation owner is likely to discover that discriminating against competing suppliers of generation services (in providing transmission services) is a newly available means to exercise some of the transmission market power that it cannot exercise directly because of continued rate regulation of transmission services. In this case, the transmission market power results in higher prices (and profits) for the electricity generated by the vertically integrated firm because transmission discrimination reduces the degree of competition facing the firm's generation assets.(see footnote 59)
The problem of discrimination in access to the transmission grid is acute in the electric power industry because it is difficult to detect and document this discrimination. Transmission transactions are extremely time sensitive because electricity cannot be economically stored in large quantities. As a result, transmission transactions are highly vulnerable to subtle forms of discrimination. For example, an integrated transmission monopolist might afford other generation sources access to its transmission services on terms that raise others' costs and permit the monopolist to protect supracompetitive profits in the generation market.
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Horizontal market power concerns in the electric power industry focus on potential dominance of one or a few generating firms in areas of the country where transmission congestion creates restricted geographic markets of electric energy from time to time. In this context, it refers to the ability of one or more electric generating firms to raise prices above competitive levels for an extended period of time. Concentrations of generation are high in some geographic areas, in part, because antitrust laws were not utilized in examining the competitive effects of the mergers that have taken place between electric utilities over the past 70 years. The antitrust laws were not employed because federal and state regulators assumed that rate and service regulation would continue to restrain horizontal market power throughout the entire industry. As regulations are relaxed for generation and retail trade of electricity, existing market power in generation may prevent consumers from realizing the full benefits of competition.
An additional horizontal power concern is coordinated interaction between suppliers. Whenever an industry transitions from regulation to competition conditions, there is a greater than normal danger that incumbent firms jointly will attempt to increase the costs of entrants or delay the introduction of new technologies that threaten their market positions. It is precisely these entrants and new technologies that bring the benefits of competition to consumers.
2. Why doesn't current law address or prevent the specific concerns identified in your answer to question 1?
With respect to vertical discrimination, the concerns expressed in FTC staff comments to FERC about the behavioral remedies approach embodied in FERC orders 888 and 889 appear to be borne out by experience.(see footnote 60) The FERC Regional Transmission Organization NOPR is in large part based on the growing evidence that discriminatory access to transmission remains a substantial problem under Orders 888 and 889.
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With respect to horizontal market power concerns, the existing antitrust laws are not designed to address existing market power developed while an industry was regulated. Instead, the antitrust laws are designed to address increases in market power brought about by mergers or unfair methods of competition. Of course, unfair methods of competition may include abuse of legally obtained market power, but market power obtained in a regulated context might be legally exercised without ever having been subject to antitrust scrutiny. Although federal legislation may enable individual states to address these issues to some degree (and some have done so), the success of these efforts may be limited by the complexity of the analysis often required to identify existing market power and by the likely interstate nature of both the problems and the remedies.
3. In the absence of transmission constraints (that prevent several competitors from getting electricity to market), how can there be market power in the electricity distribution market?
If (1) electricity transmission was costless, (2) the transmission grid was designed for extensive trading between regions, and (3) discrimination in transmission was not at issue, existing horizontal market power in generation would be of much less concern. Unfortunately, none of these critical elements exist in the present transmission system. Further, because transmission services are not costless (and are unlikely to become so), even an economically efficient transmission grid would not be free of congestion. Rather, the benefits of relieving each transmission constraint modification would be balanced against the cost of the required additional transmission investments and operating costs. In such a system congestion would continue to occur from time to time in various locations. Thus, generation market power is likely to continue to be a concern if generation is highly concentrated.
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4. Doesn't current law give the Federal Energy Regulatory Commission authority to order relief of transmission constraints so that any competitor can get his commodity (electricity) to any market or customer?
FERC may approve new transmission facilities but expansion of the transmission network to alleviate load pockets is a notoriously difficult, time consuming, and uncertain process. Environmental, health, and aesthetic considerations are among the important issues raised in the localized siting approval process for transmission expansions and enhancement. FERC's authority to order expansion of the natural gas transmission network is substantially greater than its authority in the electric power industry.
I hope this response answers the questions of Representative Smith, and, as always, I am ready to provide additional information on request.
|Mozelle E. Thompson, Commissioner.|
Hon. DOUGLAS MELAMED, Deputy Assistant Attorney General,
|Committee on the Judiciary,|
|House of Representatives,|
|Washington, DC, November 17, 1999.|
U.S. Department of Justice, Washington, DC.
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DEAR MR. MELAMED: I appreciate your appearing before the Committee on the Judiciary to testify at the oversight hearing on ''Competitive Issues in Electricity Deregulation'' on Wednesday, July 28, 1999.
A Member of the Committee has asked that you answer additional written questions for the record. I have attached a copy of the questions. I would appreciate your answering the questions in writing and returning your answers to the Committee for inclusion in the hearing record at your earliest convenience.
If the Committee can provide you with any additional information, please do not hesitate to have your staff contact Joseph Gibson by phone at (202) 2253951 or by fax at (202) 2257682. I appreciate your participation in our hearing.
cc: Hon. John Conyers, Jr.
QUESTIONS FROM CONGRESSMAN SMITH
1. What are the specific (not general or anecdotal) market power concerns of your agency with respect to electricity deregulation legislation?
2. Why doesn't current law address or prevent the specific concerns identified in your answer to question 1?
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3. In the absence of transmission constraints (that prevent several competitors from getting electricity to a market), how can there be market power in the electricity distribution market?
4. Doesn't current law give the Federal Energy Regulatory Commission authority to order relief of transmission constraints so that any competitor can get his commodity (electricity) to any market or customer?
Hon. HENRY J. HYDE, Chairman,
|U.S. Department of Justice,|
|Office of Legislative Affairs,|
|Washington, DC, February 11, 2000.|
Committee on the Judiciary,
House of Representatives, Washington, DC.
DEAR MR. CHAIRMAN: This responds to your letter requesting the Department's response to written questions pertaining to the Committee on the Judiciary oversight hearing entitled ''Competitive Issues in Electricity Deregulation.''
We appreciate the opportunity to provide this additional information. Please let me know if the Department of Justice may be of further assistance.
Page 315 PREV PAGE TOP OF DOCSincerely,
|Robert Raben, Assistant Attorney General.|
The Honorable John Conyers, Jr.
Ranking Member, Committee on the Judiciary
FOLLOW-UP QUESTIONS AND ANSWERS TO ''COMPETITIVE ISSUES IN ELECTRICITY DEREGULATION'' HEARING
Q. What are the specific (not general or anecdotal) market power concerns of your agency with respect to electricity deregulation legislation?
Electric utilities have historically possessed market power in their service territories. States generally established territories within which a single certified supplier had the right to supply electric energy to consumers at rates fixed by a regulatory agency. The resulting ownership patterns, coupled with transmission constraints in a particular region, may result in consumers being denied access to an adequate number of generators. We are concerned that in those situations a dominant firm may be able to charge prices that exceed competitive levels.
We are also concerned that utilities that own transmission as well as generation will use their control over transmission to discriminate against competitors in the generation market. Incumbent utilities commonly own both transmission and generation. These utilities have the ability and incentive to favor their own generation by denying access to transmission or providing access on less favorable terms to competing generators.
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Q. Why doesn't current law address or prevent the specific concerns identified in your answer to question 1?
The antitrust laws do not outlaw the mere possession of monopoly power. Charging prices that exceed competitive levels is not an antitrust law violation. This is why we favor structural remedies, including divestiture, to address market power that is the result of transmission constraints and high concentrations of ownership of generation.
The Federal Energy Regulatory Commission's (FERC) Order 888 does require public utilities to provide nondiscriminatory access to transmission. We are concerned, however, that behavioral rules such as Order 888 cannot effectively address the problem of discriminatory access to transmission. Behavioral rules are complex and often can be difficult to enforce. Electric power transactions are often time-sensitive, and a generator that is denied transmission access in violation of Order 888 has no timely effective remedy. Structural remedies, such as mandatory participation in a regional transmission organization (RTO) that is independent of the interests of transmission owners, eliminate the incentive to discriminate.
Q. In the absence of transmission constraints (that prevent several competitors from getting electricity to a market), how can there be market power in the electricity distribution market?
Page 317 PREV PAGE TOP OF DOCEven when there is sufficient transmission capacity in an area, the cost of long-distance transmission may as a practical matter eliminate from a market potential lower-cost sellers of electricity. The inability of potential competitors economically to enter a market may leave consumers with few suppliers of electricity. Generators in a highly concentrated market may have the ability to exercise market power.
Q. Doesn't current law give the Federal Energy Regulatory Commission authority to order relief of transmission constraints so that any competitor can get his commodity (electricity) to any market or customer?
As indicated above, the cost of long-distance transmission may make it uneconomic for a potential competitor to enter a market. It is correct that FERC can order relief of transmission constraints. FERC in its Order 888 directed utilities to enlarge the capacity of their facilities when necessary to fulfill their obligations under Order 888. However, FERC does not have any authority to decide where new transmission lines may be placed. The states have exclusive jurisdiction over the siting of new transmission lines. As a result, FERC merely has the authority to order a utility to seek the necessary state approvals to site new transmission. Any state through which a proposed transmission line runs has the power to veto the proposed expansion of transmission capacity. Transmission lines necessary to relieve transmission constraints may be required to pass through several states, some of which may not perceive a direct benefit from the transmission expansion.
(Footnote 1 return)
This written statement represents the views of the Federal Trade Commission. My oral presentation and response to questions are my own, and do not necessarily represent the views of the Commission or any other Commissioner.
(Footnote 2 return)
See Comment of the Staff of the Bureau of Economics, Federal Trade Commission, ''Promoting Wholesale Competition Through Open Access Non-discriminatory Transmission Services by Public Utilities, Recovery of Stranded Costs by Public Utilities and Transmitting Utilities,'' Dkt. No. RM966000 9(Aug. 7, 1995) (''BE/FERC I'').
(Footnote 3 return)
See Comment of the Staff of the Bureau of Economics, Federal Trade Commission, ''Inquiry Concerning Commission's Merger Policy Under the Federal Power Act,'' Dkt. Nos. RM958000 and RM947001 (May 7, 1996) (''BE/FERC II''); ''Revised Filing Requirements,'' Dkt. No. RM984000 (Sept. 11, 1998).
(Footnote 4 return)
For the Commission's most recent state comment, see Comment of the Staff of the Bureau of Economics of the Federal Trade Commission Before the Alabama Public Service Commission, Dkt. No. 26427, Restructuring in the Electricity Utility Industry (Jan. 8, 1999). Other recent comments have been submitted to the Louisiana Public Service Commission, Dkt. No. U21453 (affiliate transactions) (Oct. 30, 1998); the Public Utility Commission of Nevada, PUCN Dkt. No. 975034 (affiliate transactions) (Sept. 22, 1998); the Mississippi Public Service Commission, Dkt. No. 96UA389 (Transco proposal) (Aug. 28, 1998).
(Footnote 5 return)
15 U.S.C. §4158.
(Footnote 6 return)
15 U.S.C. §1227.
(Footnote 7 return)
15 U.S.C. §18.
(Footnote 8 return)
See R. Crandall and J. Ellig, Economic Deregulation and Customer Choice: Lessons for the Electric Industry, Center for Market Processes at 23 (1996) (within 10 years of substantial deregulation, prices in the natural gas, long distance telecommunications, airlines, trucking, and railroad industries decreased between 25 and 50 percent while quality of service improved). Of course, these benefits were not spread evenly among all consumers, and some previously subsidized service may have been negatively affected.
(Footnote 9 return)
In the electric power and telephone industries, regulatory agencies require providers to offer basic, low-cost service that may be subsidized by consumers who purchase additional services.
(Footnote 10 return)
As previously noted, in addition to already-existing market power, market power can be accumulated through merger.
(Footnote 11 return)
Green, R. J. and Newbery, D., ''Competition in the British Electricity Spot Market,'' 100 J. Pol. Econ. 929 (1995). See also Alex Henney, ''The Mega-NOPR: A Brit Crosses the Pond to Explain What's Happening at FERC,'' Pub. Utils. Fort., July 1, 1995 at 29; ''U.K.'s National Power, Powergen Must Sell Off Up to 6000 MW, Lower Rates,'' Elec. Util. Wk., Feb. 21, 1994.
(Footnote 12 return)
The Market Monitoring Committee of the California Power Exchange, Second Report on Market Issues in the California Power Exchange Energy Markets, at 67 (March 9, 1999) (''there is evidence that some generators were successfully exercising their market power during high-demand hours'').
(Footnote 13 return)
See Brennan, T., ''Why Regulated Firms Should Be Kept Out of Unregulated Markets: Understanding the Divestiture in United States v. AT&T,'' 32 Antitrust Bull. 741 (1987), and ''Cross Subsidization and Cost Misallocation by Regulated Monopolists,'' 2 J. Reg. Econ. 37 (1990).
(Footnote 14 return)
Open access refers to the principle that a monopoly owner of transmission or distribution assets must make them available to independent generators at price and service levels equal to those provided to its owned generators. FERC has focused on behavioral rules for open access and on developing mandatory common information sources concerning supply and transmission conditions. See BE/FERC I at 1516.
(Footnote 15 return)
More than 34 utilities have followed, or are following, a path of voluntary divestiture in order to compete more effectively in the deregulated climate. See FERC Notice of Proposed Rulemaking, ''Regional Transmission Organizations,'' RM992000, Slip Op. at 19 (May 13, 1999) (''FERC NOPR'').
(Footnote 16 return)
See FERC Order 888, Dkt. RM958000.
(Footnote 17 return)
FERC NOPR, slip op. at 6.
(Footnote 18 return)
See, e.g., ''Petition for a Rulemaking on Electric Power Industry Structure and Commercial Practices and Motion to Clarify and Reconsider Certain Open-Access Commercial Practices,'' filed with FERC by Altra Energy Technologies, Inc. and others on March 25, 1998. Aside from the question of compliance with FERC Order 888, there is a question about the breadth of its application. While FERC orders generally apply broadly to all energy sales involving interstate commerce, Order 888 does not apply to transmission by traditional vertically integrated utilities to accommodate ''native'' load. Transmission to accommodate native load accounts for a large portion of total transmission. Order No. 888, 61 Fed. Reg. at 21552.
(Footnote 19 return)
See BE/FERC I at 3.
(Footnote 20 return)
Operation of a transmission system by an independent system operator should assist investors in distinguishing between high transmission prices caused by physical bottlenecks at peak demand periods and high prices caused by the exercise of transmission market power. A potential downside to ISO operation is that ISOs, because they are non-profit entitites, may lack the incentive to perform efficiently and responsively unless methods to provide such incentives are specifically incorporated into the ISO structure.
(Footnote 21 return)
Because supply and demand for electricity are so time-sensitive, even the slightest delay in transmission can have serious impact on the reliability of any generator. A regulatory agency might find it very difficult to implement functional unbundling because of the difficulty of monitoring the numerous individual transactions nationwide to prevent degradations of contracts between independent generators and wholesale purchasers. See BE/FERC I at 59.
(Footnote 22 return)
A third possibility considered by some states that avoids the problem of lack of profit incentive in ISOs is to create a ''Transco,'' a for-profit, independent transmission company that would operate the transmission grid, and would be subject to nondiscrimination rules. In comments to the state of Mississippi, supra n.4, staff noted that Transcos may present particularly difficult governance questions, are likely to be biased against remedies to transmission congestion that involve new generation, and may not provide greater operating efficiencies than ISOs.
(Footnote 23 return)
U.S. Department of Justice and Federal Trade Commission, Horizontal Merger Guidelines, 4 Trade Reg. Rep. (CCH) 13,104 (Apr. 2, 1992), as amended, April 8, 1997. FERC announced that it would follow the principles in the Guidelines in its own analysis of utility consolidations. See Inquiry Concerning the Commission's Merger Policy under the Federal Power Act, RM966000, 61 Fed. Reg. 68,595 (Dec. 18, 1996).
(Footnote 24 return)
Specifically, the markets are defined by asking whether a hypothetical monopolist could raise prices by a ''small but significant and nontransitory'' amount, such that not enough buyers would switch to alternatives to make the price increases unprofitable. If the price increases would not be profitable, the relevant market is too narrowly defined. See Merger Guidelines §1.11.
(Footnote 25 return)
Electricity cannot be stored in any measurable quantities; it must be generated as it is consumed. Also, demand varies substantially not only seasonally but by time of day. Thus, the substitute sellers of electricity to any given consumer may be a number of firms offering subtly different products. Some consumers may want guaranteed reliability, while others may opt for interruptible power at lower prices. Some consumers may choose to defer power consumption to off-peak hours in return for lower prices. Each of these consumer decisions affects the definition of the relevant product market and may affect the number of potential suppliers in that market.
(Footnote 26 return)
Other things being equal, an acquiring firm will find it more difficult to engage in anticompetitive conduct, either unilaterally or in conjunction with others, in an unconcentrated than in a concentrated market. See Merger Guidelines §2.0.
(Footnote 27 return)
Department of Justice and Federal Trade Commission, Revised Section 4 of the Horizontal Merger Guidelines (Apr. 8, 1997).
(Footnote 28 return)
For instance, independent generators that have acted as maverick firms may be able to acquire additional capacity quickly, thus enhancing their ability and incentive to lower prices. Firms with an inefficient mix of generating plants for their markets (e. g., more low cost coal fired plants and fewer flexible natural gas fired plants in a market with highly volatile time of day demand peaks) may be able to adjust their capacity to the demand.
(Footnote 29 return)
See CMS Energy Corp., C3877 (consent order) (June 2, 1999); PacifiCorp, FTC File No. 971 0091 (consent agreement accepted for public comment, Feb. 17, 1998). The proposed consent order in PacifiCorp was withdrawn when the acquisition was abandoned.
(Footnote 30 return)
An additional potential anticompetitive effect of a convergence merger could occur if a regulated firm acquired market power over an unregulated input. If this occurred, a vertically integrated utility might be able to evade rate regulation at the retail distribution level. The retail rate may still be controlled through cost of service regulation, but the input costs at the generating level could be inflated and passed on to consumers at the retail level. For instance, a vertically integrated utility might attempt to increase its return at the regulated retail level by inflating its payments for its owned, but unregulated, electricity.
(Footnote 31 return)
While some refer to the transition to competition in the electric utility industry as ''deregulation,'' the more appropriate term is restructuring. Although generators and other power suppliers will be subject to significantly less regulation, the transmission and local distribution of electricity are expected to continue as monopoly services requiring continued regulatory oversight.
(Footnote 32 return)
The Administration transmitted CECA to Congress in two separate parts. The first part, which was introduced by Congressmen Bliley and Dingell (upon request) as H.R. 1828 on May 17, includes all of the non-tax-related provisions in the Administration's proposal. The portion of the legislation which would amend the tax code has not yet been introduced in the House of Representatives. Both parts of the bill were introduced in the Senate by Senators Murkowski and Bingaman (upon request)S. 1047 and S. 1048on May 13.
(Footnote 33 return)
The Department of Energy's Office of Policy recently released its Supporting Analysis for the Administration's proposed legislation. This analysis estimated the economic and environmental benefits associated with retail competition and the Administration's legislation and concluded that (1) annual savings of at least $20 billion per year, by 2010, would be achieved; (2) residential consumers in all states would benefit from retail competition and (3) greenhouse gas emissions would be reduced by an estimated 40 to 60 million metric tons annually by 2010.
(Footnote 34 return)
Investor-owned utilities and some cooperative utilities are subject to FERC jurisdiction pursuant to the Federal Power Act. Federal utilities, municipal utilities, and most cooperatively-owned utilities are non-jurisdictional.
(Footnote 35 return)
The Southeastern Power Administration (SEPA) does not own transmission facilities and, therefore, is not subject to the transmission provisions of CECA.
(Footnote 36 return)
''Slamming'' is the practice of changing a customer's service provider without that customer's knowledge. ''Cramming'' is the practice of billing a customer for unauthorized or fictitious service.
(Footnote 37 return)
By way of example, it is far more economical (and environmentally benign) to transmit power over a single high-voltage line than over a series of lower voltage lines owned by competing transmission companies.
(Footnote 38 return)
The SEC reviews certain mergers involving holding companies under the Public Utility Holding Company Act (''PUHCA''). Repeal of PUHCA, which is under consideration as part of electric utility restructuring legislation, would not significantly weaken federal review of mergers. The SEC does not have antitrust expertise, but instead employs a policy of ''watchful deference'' in which it relies on the reviews conducted by FERC, DOJ, FTC and the affected state utility commissions.
(Footnote 39 return)
FERC Order No. 888, 61 FR 21450, 21550 (May 20, 1996); also, 75 FERC 6160 (April 24, 1996); http://www.ferc.fed.us/news1/rules/data/rm95800w.txt.
(Footnote 40 return)
Id., at 21567
(Footnote 41 return)
Id., at 21541
(Footnote 42 return)
FERC Notice of Proposed Rulemaking on Regional Transmission Organizations, 64, FR 31390, 31391 (June 10, 1999); also, 87 FERC 61173 (May 13, 1999); http://www.ferc.fed.us/news1/rules/pages/RM992.pdf
(Footnote 43 return)
(Footnote 44 return)
See, Id. at 3141331429
(Footnote 45 return)
Promulgation of New Rules Governing Activities Between Affiliates, Public Utility Commission of Texas, Project No. 17459, 23 Tex. Reg. 5294 (May 22, 1998).
(Footnote 46 return)
A. Kahn, The Economics of Regulation, xxxvi, (Paper ed. 1988). Professor Kahn previously served as Chairman of the New York Public Service Commission.
(Footnote 47 return)
Some commentators view cross-subsidization and cost shifting as distinct. However, in a regulated environment, the two are so closely linked that, for the purposes of this submission, cost shifting will be considered as a form of cross-subsidization.
(Footnote 48 return)
This has been termed the ''AJ'' effect. See, Behavior of the Firm Under Regulatory Constraint, Averch & Johnson, 1962 and, generally, A. Kahn, The Economics of Regulation, supra, at pp 4959.
(Footnote 49 return)
See J. Abel, An Economic Analysis of Marketing Affiliates in a Deregulated Electric Power Industry, National Regulatory Research Institute, February 1998, pp 1819.
(Footnote 50 return)
Report To The President and Congress of the United States On the Current Status and Likely Impacts of Integrated Resource Planning, U.S. Dept. of Energy (1995). To be precise, the Report is a DOE study in which the FTC provided certain information in response to the framework devised by DOE. This framework did not include ''a broad investigation into the general issue of utility competition with small business''.
(Footnote 51 return)
(Footnote 52 return)
See generally, 220 CMR 12.00, et seq., Standards of Conduct for Distribution Companies and Their Affiliates.
(Footnote 53 return)
T. Brennan, Why Regulated Firms Should Be Kept Out of Unregulated Markets: Understanding Divestiture in United States v. AT&T., 32 Antitrust Bulletin 741, at 760.(1987).
(Footnote 54 return)
Concerning Electricity Competition: Market Power, Mergers and Public Utility Holding Company Act, 106th Cong. (May 6, 1999) (statement of A. Douglas Melamed, Principal Deputy Assistant Attorney General, Antitrust Division, United States Department of Justice).
(Footnote 55 return)
Comment of the Staff of the Bureau of Economics, Federal Trade Commission (October 8, 1998) (comments filed with the Commonwealth of Massachusetts Department of Telecommunication and Energy).
(Footnote 56 return)
Legislative action to prevent such unfair practices is not without precedent. To use a recent example, To use an example from recent history, section 272 of the Telecommunications Act of 1996 imposes a separate subsidiary requirement on former Bell System operating companies to prevent such unfair practices in the market for telecommunications services. Telecommunications Act of 1996, Pub. L. No. 104104, §272 (1996).
(Footnote 57 return)
See, e.g., Market Power Study, State of Maine, Public Utilities Commission (Docket No. 97877) at 1620 (documenting market power abuses).
(Footnote 58 return)
Not all incentives for transmission discrimination were eliminated, as per the Otter Tail Power case.
(Footnote 59 return)
In other industries, vertical discrimination is less likely to be a concern because the firm with market power at one level of the chain of production is more likely to exercise its market power at that level of production rather than to try to distort competition at other levels as well. In the electric power industry, regulation is likely to prevent full exercise of transmission market power. This gives vertically integrated firms incentives to seek ways to exercise transmission market power at other levels of production through discrimination.
(Footnote 60 return)
See Comments of the Staff of the Bureau of Economics of the Federal Trade Commission before FERC in Docket Nos. RM958000 and RM947001 (Aug. 7,1995).