April 9, 2008
A government watchdog agency is attacking federal energy regulators, saying that that they are not properly monitoring the convergence among electric and gas utilities -- something that the Federal Energy Regulatory Commission says is "inaccurate" and reflects a "misunderstanding" of the issues.
The debate centers on whether repeal of the Public Utility Holding Co. Act of 1935 (PUHCA) has worked. By rescinding the law in 2005, both Congress and the administration reasoned it would attract much-needed investment to the utility world by allowing companies to combine operations more easily. But others have feared it might make oversight of the united companies more problematic.
Under any set of circumstances, there remains a myriad of regulatory hoops enterprises face if they want to merge. The Securities and Exchange Commission may play less of a role but FERC will continue to play an integral part in these decisions. And, the states will not lose their say in the matter. Major mergers and asset acquisitions are still subject to scrutiny by all relevant regulatory bodies.
"The commission responded promptly with a series of actions all within the short time frames required by the new laws," says Joseph Kelliher, chairman of FERC, adding that he has focused much of the agency's attention on preventing "cross-subsidization."
Conversely, the Government Accountability Office says that FERC is not up to the task, fearing that the regulated affiliates now have a greater opportunity to allocate resources to their unregulated businesses -- costs that may drive up electricity prices and subsequently get tucked away in the rate base. FERC has made "few substantive changes to its merger review process or its post-merger oversight," GAO says.
GAO supports its premise by saying that FERC relies on existing enforcement mechanisms that include self-certification and a limited number of compliance audits, which are ad hoc and not risk-based. At its planned 2008 audit rate of three companies per year, each company under FERC's helm would get audited every 12 years.
Since the repeal of PUHCA in 2005, FERC has either reviewed or is in the process of examining at least 15 different mergers. GAO says that it has not rejected any of those combinations and has allowed nine of them to go through without any conditions. In three of those cases, FERC attached conditions that required the companies to show that ratepayers would be adequately protected.
"By reassessing its audit approach, how it shares the results of its audits, and its resources, FERC could take important steps to demonstrate its commitment to ensure that companies are not engaged in cross-subsidization at the expense of consumers," says the recently released GAO report. "Absent such a reassessment, the potential exists for FERC to approve the formation of companies that are difficult and costly for it and states to oversee and potentially risky for consumers and the broader market."
Proactive Oversight
Two general dynamics are at play here. One is simply that the GAO has a reputation of being fair but also extremely critical of any government agency it scrutinizes. The second is that FERC is still trying to shed its corporate lapdog image that it earned during the California energy crisis. Onlookers had accused it of sitting on the sidelines while some unscrupulous power and gas traders manipulated markets.
The energy agency has responded to new market conditions. Over the years, it has become far less reactive and much more proactive in that it tries to oversee day-to-day activities. Toward that end, it created the Office of Market Oversight in 2002 to actively monitor markets to ensure that they are operating openly and fairly. One of its roles is to look for improper cross-subsidization.
The agencies with oversight responsibilities are also providing intelligence to one another. The effort has proved helpful whether the SEC is going after companies for insider trading or whether FERC is examining specific suppliers and their possible roles in manipulating markets during the California energy crisis of 2000-2001. The days of inert leadership seem to have disappeared, and companies are aware of it.
GAO is certainly correct to warn of the potential for cross-subsidization. But the hangover from the 2001 energy bust still lingers and it would be foolhardy of any utility to try and dupe regulators. If the increased civil and criminal penalties would not be a deterrent then the unwanted public attention would. As such, FERC says that sound mechanisms are in place to allow it to guard against the potential for flow-through of any inappropriate costs to consumers of regulated utilities.
FERC also emphasizes that it does not rely on self-reporting to determine if cross-subsidization occurs and that the assertion is wrong that it will take 12 years to audit every company under its umbrella. It says that it is also already using a risk-based audit system to determine how to spend the agency's finite resources, noting that it normally polices cross subsidies when it reviews rates, rather than at the point of a merger.
The report "suffers from a fundamental misunderstanding of important issues, is based on incomplete information, contains many errors, and demonstrates flawed analysis," says Chairman Kelliher.
The agency, in fact, has been incorporating its new responsibilities assigned it in 2005. Among its principal jobs is to make certain that the repeal of PUHCA goes smoothly -- to, in effect, improve the viability of electricity markets and ensure that the benefits of all merger activity are shared throughout the value chain. That incorporates the prevention of cross-subsidization of utility affiliates. The hope is that the changes will attract the investment necessary to increase reliability and improve services and to do so without sacrificing good regulatory oversight.
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