[Senate Hearing 110-509]
[From the U.S. Government Publishing Office]
S. Hrg. 110-509
REGULATION OF THE ELECTRIC
UTILITY INDUSTRY
=======================================================================
HEARING
before the
COMMITTEE ON
ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
TO
EXAMINE THE ADEQUACY OF STATE AND FEDERAL REGULATORY STRUCTURES FOR
GOVERNING ELECTRIC UTILITY HOLDING COMPANIES IN LIGHT OF THE REPEAL OF
THE PUBLIC UTILITY HOLDING COMPANY ACT IN THE ENERGY POLICY ACT OF
2005, WITH PARTICULAR ATTENTION TO THE REPORT ISSUED BY THE GOVERNMENT
ACCOUNTABILITY OFFICE--GAO-08-289, UTILITY OVERSIGHT: RECENT CHANGES IN
LAW CALL FOR IMPROVED VIGILANCE BY FERC
__________
MAY 1, 2008
Printed for the use of the
Committee on Energy and Natural Resources
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44-545 PDF WASHINGTON DC: 2008
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COMMITTEE ON ENERGY AND NATURAL RESOURCES
JEFF BINGAMAN, New Mexico, Chairman
DANIEL K. AKAKA, Hawaii PETE V. DOMENICI, New Mexico
BYRON L. DORGAN, North Dakota LARRY E. CRAIG, Idaho
RON WYDEN, Oregon LISA MURKOWSKI, Alaska
TIM JOHNSON, South Dakota RICHARD BURR, North Carolina
MARY L. LANDRIEU, Louisiana JIM DeMINT, South Carolina
MARIA CANTWELL, Washington BOB CORKER, Tennessee
KEN SALAZAR, Colorado JOHN BARRASSO, Wyoming
ROBERT MENENDEZ, New Jersey JEFF SESSIONS, Alabama
BLANCHE L. LINCOLN, Arkansas GORDON H. SMITH, Oregon
BERNARD SANDERS, Vermont JIM BUNNING, Kentucky
JON TESTER, Montana MEL MARTINEZ, Florida
Robert M. Simon, Staff Director
Sam E. Fowler, Chief Counsel
Frank Macchiarola, Republican Staff Director
Judith K. Pensabene, Republican Chief Counsel
C O N T E N T S
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STATEMENTS
Page
Bingaman, Hon. Jeff, U.S. Senator From New Mexico................
Boyd, Michael E., President, CARE, Sunnyvale, CA.................
Domenici, Hon. Pete V., U.S. Senator From New Mexico.............
Feingold, Hon. Russell D., U.S. Senator From Wisconsin...........
Gaffigan, Mark, Director, Natural Resources and Environment,
Government Accountability Office...............................
Hempling, Scott, Executive Director, National Regulatory Research
Institute......................................................
Kelliher, Joseph T., Chairman, Federal Energy Regulatory
Commission.....................................................
Kelly, Suedeen G., Commissioner, Federal Energy Regulatory
Commission.....................................................
Kerr II, James Y., Commissioner, North Carolina Utilities
Commission Representing National Association of Regulatory
Utility Commissioners..........................................
Moeller, Philip D., Commissioner, Federal Energy Regulatory
Commission.....................................................
Owens, David K., Executive Vice President, Business Operations,
Edison Electric Institute......................................
Spitzer, Marc, Commissioner, Federal Energy Regulatory Commission
Wellinghoff, Jon, Commissioner, Federal Energy Regulatory
Commission.....................................................
APPENDIX
Responses to additional questions................................
REGULATION OF THE ELECTRIC
UTILITY INDUSTRY
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THURSDAY, MAY 1, 2008
U.S. Senate,
Committee on Energy and Natural Resources,
Washington, DC.
The committee met, pursuant to notice, at 9:30 a.m. in room
SD-366, Dirksen Senate Office Building, Hon. Jeff Bingaman,
chairman, presiding.
OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR FROM NEW
MEXICO
The Chairman. Alright. Good morning. Thanks to all of you
for coming. I have a short statement to give. I know Senator
Domenici does as well.
But, Senator Feingold is our first witness today and is a
Senator who is largely responsible for us having this hearing.
He was very focused on this issue back when we were enacting
the 2005 Energy bill. We appreciate him being here.
So why don't we just go right to him and hear his testimony
at this point. After that, I'll give my statement and Senator
Domenici will give his.
Senator Domenici. Welcome.
STATEMENT OF HON. RUSSELL D. FEINGOLD, U.S. SENATOR FROM
WISCONSIN
Senator Feingold. Thank you so much, Mr. Chairman. I thank
Senator Domenici, the Ranking Member. It's tremendously
courteous of you to allow me to go at all and certainly to go
at the beginning.
Thank you very, very much. Thank you for holding this
hearing. I'm here today to express my strong concerns about the
lack of consumer and small business protections against harmful
transactions or cross subsidization between companies and their
affiliate companies.
The Energy Policy Act of 2005 significantly altered the
Federal regulation of utilities by repealing the Public Utility
Holding Company Act or PUHCA of 1935. In response Chairman
Bingaman, Senator Brownback and I requested a report from the
General Accounting Office to examine the effect of PUHCA's
repeal on the oversight of electric utility holding companies
and the ability to prevent harmful cross subsidization. I'm
pleased that the committee is examining the GAO's recent
findings and recommendations that are identified in the report
entitled, Utility Oversight: Recent Changes in Law Call for
Improved Vigilance by FERC.*
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* Report has been retained in committee files
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The report is disturbing. It reveals that ``the Federal
Energy Regulatory Commission has made few substantive changes
to either its merger review process or its post merger
oversight since the EPA Act and as a result does not have a
strong basis for ensuring the harmful cross subsidization does
not occur.'' Chairman, harmful cross subsidization results in
very real and serious impacts on consumers, small businesses
and our economy as a whole.
Unfair practices between utility companies and their
affiliates force electricity and natural gas consumers to foot
the bill for another company's expenses and allows the
utilities to unfairly compete against small businesses. Now
previously, PUHCA, as you well know, had stood as a barrier to
harmful cross subsidization and other abusive affiliate
transactions for decades. Given its repeal it is essential that
Congress ensure their effective authorities for oversight and
regulation of electric utility holding companies.
Under the current law established in 2005 to encourage
investment in the utility sector there is little doubt that
utilities will become larger, more complex and located in
geographically diverse areas. The size and complexity of these
companies also will make it more difficult to identify abuses.
Unfortunately all too often utilities have succumb to
temptation and have relied on the more stable regulated
utilities within the company to shore up balance sheets and
offset risky non-utility investments while customers,
ratepayers and investors pay the bill.
To ensure adequate protections, Senator Brownback and I
have championed efforts to require FERC to establish ring
fencing rules to help ensure that the financial integrity of
public utilities is not harmed by the repeal of PUHCA. Ring
fencing is the legal walling off or encircling of a regulated
utility from its unregulated affiliates. Insulating utilities
in this way is intended to protect regulating the utility
itself and its investors, the electricity and natural gas
consumers as well as to prevent unfair, illegally subsidized
competition with small businesses.
Our legislative proposal has the support of trade
associations, unions, small business representatives, public
interest groups and utility associations, such as the American
Public Power Association, the American Sub Contractors
Association, Associated Builders and Contractors, Association
of Financial Guarantee Insurers, International Brotherhood of
Electrical Workers, National Electrical Contractors
Association, Plumbing, Heating, Cooling Contractors, public
citizens, public interest research groups, Small Business
Legislative Council and the Sheet Metal and Air Conditioning
Contractors National Association.
So, Mr. Chairman, I look forward to continue to work with
you, this committee, Senator Brownback and our colleagues to
ensure that there are strong safeguards against harmful cross
subsidization. Thanks so much to both of you.
The Chairman. Thank you very much for your testimony and
your interest in this issue and continued focus on it. I think
it's useful to us. We are going to try at today's hearing to
get good testimony about what, if any, additional action we
should consider here in the Congress. But thank you very much.
Senator Domenici. Thank you, Senator.
The Chairman. Let me go ahead and make a statement, and
then Senator Domenici. Then we'll call the first panel forward.
I believe this is an important hearing. I look forward to
hearing from the witnesses, and appreciate the thoughtful
testimony we've already received in written form.
In 2005 when we passed the Energy Policy Act, we did a
number of things related to the electric utility industry.
Among the most important, Senator Feingold mentioned was the
repeal of PUHCA. PUHCA had stood as an important consumer
protection statutes since 1935. In the 1930s when PUHCA was
passed, the country had just been through a great deal of
turmoil in the electric utility industry.
In the 1920s the industry had expanded rapidly. The
financing of that expansion was through some highly
questionable corporate practices. Large complicated holding
company structures were developed and sprawled across the
country.
Regulation by the States was almost impossible, and there
was no Federal regulation at that point. Many observers credit
the Pondsey schemes developed to finance electricity expansion
with being one of the main causes of the stock market crash in
1929.
Congress and the Roosevelt Administration passed PUHCA to
get control of the corporate structure of the electricity
industry. It did that in two ways. First, ownership of
utilities by other kinds of businesses or ownership of other
businesses by utilities was discouraged or outright banned.
Second, large multi-State holding companies were required
to file all affiliate transactions. All transactions with
utility affiliates had to be at cost. The intent was to keep
our corporate structure simple enough that State regulators
could keep track of it or to subject multi-State systems to
stringent regulation of inter-affiliate relationships at the
Federal level.
So as we began to move toward a more competitive industry
many viewed PUHCA as being outmoded. Its strict ownership
requirements discourage potential investors. Its geographic and
structural requirements discourage new interest into markets.
I agreed with that point of view. I still do. However, I
also felt that the consumer protections of the Holding Company
Act should not be entirely lost. We insisted that part of the
legislation we would enact would strengthen FERC's merger
authority to require clearer protection against cross
subsidization and pledges of debt by a utility for the benefit
of its affiliate companies.
Many in Congress believe that this was not enough. The
consumers would not be protected without broader consumer
safeguards. We had just been through another era when utilities
were getting into financial trouble because of their
relationships with corporate affiliates and Members of Congress
were concerned.
Some of these protections were accepted, such as the merger
authority language. Senator Cantwell proposed market
manipulation provisions that were included. Other proposals
were not accepted. Specifically, Senator Feingold and Senator
Brownback's proposal for affiliate transactions was not
accepted.
At that time, they asked for a report to be done by the GAO
and that we have a hearing. I supported that request and this
hearing is the result of that request.
GAO has issued its report. GAO is here today to testify on
its conclusions. They were highly critical, as Senator Feingold
pointed out, of FERC's application of its new authority, its
new merger authority and of its cross subsidization regime in
general. FERC is here, primarily to argue that the rules they
have put in place are sufficiently protective in their view.
If GAO is correct and FERC's rules are insufficient, that's
a serious issue that we need to try to correct. If Chairman
Kelliher is correct and FERC is adequately protecting consumers
than obviously we have nothing to worry about. So we're here
today to look at that exact question. I very much appreciate
all the witnesses being here.
Senator Domenici.
STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR FROM NEW
MEXICO
Senator Domenici. Thank you very much, Mr. Chairman. Thanks
to all of the Commissioners for joining us here today. I was
one of those who for years thought PUHCA, years before its
repeal, thought that it should be repealed. I remember that
you, Mr. Chairman, went along with that as you've indicated in
your statement. We did provide some safeguards that you wanted
in the energy legislation that included that PUHCA repeal.
I want to, here and now, complement the Commission under
the leadership of its chairman. I believe from everything I
have ascertained that the disagreement of Chairman Kelliher
with the GAO findings is quite appropriate. I believe the
chairman is correct. I believe GAO is not correct. Maybe they
can convince me today.
But from what I see all the ominous predictions, when we
passed the repeal about merger mania would occur. We would see
all kinds of the things happening that were protected against.
None of those have happened.
There's been no merger mania. Just been about average
merger effectiveness as the years prior to the repeal. I want
to, by day's end, hope that I can say to the Commission that
they should continue with what they're doing and do it in a
very strong and forceful way.
I'm willing to listen to what those who are here to say
that you ought to do more. But I frankly do not believe any
harm to anyone has occurred during the time that we've had the
repeal, during which the Commission has exercised its authority
and has brought in the States where they can be helpers and
make the thing work better. All in all, I think, in a very
admirable job. Thank you very much, Mr. Chairman. I look
forward to the witnesses.
[The prepared statement of Senator Domenici follows:]
Prepared Statement of Hon. Pete V. Domenici, U.S. Senator From
New Mexico
Welcome. Thank you all for being here this morning. I very much
appreciate the witnesses taking time out of their busy schedules--
particularly all five FERC Commissioners--to appear before us today as
we examine the repeal of ``PUHCA,'' the Public Utility Holding Company
Act of 1935.
After years of debate, Congress repealed this 70-year-old law in
the Energy Policy Act of 2005. The rigid geographic and ownership
limitations--while important protections in the wake of the 1929 stock
market crash--became outdated. PUHCA's restrictions served as a barrier
to much needed investment in the utility industry and denied customers
potential merger-related benefits.
Those opposed to PUHCA repeal argued that consumers would not be
protected because affordable and reliable utility services could not be
ensured. But everyone shared the common goal of consumer protection.
In order to close any regulatory gaps left from PUHCA's repeal,
Congress moved to protect consumers from affiliate abuse by:
strengthening the merger review authority of both FERC and
the state commissions;
enacting ``PUHCA 2005''--a provision granting federal and
state regulators access to holding company books and records
for audit and oversight purposes; and
amending the Federal Power Act to require FERC, in its
merger review process, to protect consumers from improper
cross-subsidizations.
Additionally, to address any remaining concerns of our colleagues
who supported federal ``ring-fencing'' measures, the Energy Committee
agreed to ask GAO to study the implications of PUHCA repeal and
committed to conduct a hearing on the results. Of course that completed
GAO report is now before this Committee--it's why we're all here today.
Despite some of the doomsday predictions we heard during the energy
debate, there has not been an explosion of merger proposals in the
industry. FERC has reviewed only 17 merger proposals since passage of
EPAct. Importantly, GAO has not found any instances of cross-
subsidization since PUHCA repeal.
However, GAO does find fault with the oversight provided by both
FERC and the states and concludes that the Commission lacks a strong
basis for ensuring that harmful cross-subsidization does not occur.
Mr. Chairman, I appreciate you holding this hearing today. I know
FERC has worked very hard to implement its new Energy Policy Act
responsibilities and that Chairman Kelliher disagrees strongly with the
GAO's findings. While PUHCA may no longer be the front-burner issue it
was back during the energy bill debate in 2005, it is important that we
understand the implications of that repeal and its impact on consumers.
I also want to thank GAO for undertaking this review and thank the
other witnesses before us--representing state, consumer, and utility
interests--in assessing today's post-PUHCA regulatory scheme.
The Chairman. Thank you very much. Why don't we go ahead
and call the first panel forward. Chairman Kelliher,
Commissioner Moeller, Commissioner Wellinghoff, Commissioner
Kelly and Commissioner Spitzer, please. Thank you all for being
here. We very much appreciate it.
Why don't we start with you, Chairman Kelliher? Why don't
you go ahead with your statement? We'll include all the
statements, of course, in the record as if read. But any points
you would like to make to us orally, we're glad to hear those
as well. So, go right ahead.
STATEMENT OF JOSEPH T. KELLIHER, CHAIRMAN, FEDERAL ENERGY
REGULATORY COMMISSION
Mr. Kelliher. Thank you, Mr. Chairman. Let me begin first
of all by thanking you for your efforts on the Farm bill. There
were provisions in the Farm bill that could have fractured FERC
jurisdiction over wholesale power markets, could have impaired
our ability to assure just and reasonable wholesale power
prices and actually invited manipulation. I want to thank you
for your leadership in working on those provisions and the hard
work of your staff. So I'm grateful for that.
My written statement does emphasize what FERC has done
since Congress expanded our merger authority in 2005. But what
I'd like to do in my oral remarks is really answer, emphasize,
a slightly different point. Why we have taken the course that
we have and why we have not pursued certain alternatives. So
really answer the why question rather than the what question.
Now let me begin first of all by thanking Chairman
Bingaman, Senator Domenici and other members of the committee
for the strong merger provisions of the Energy Policy Act of
2005. The expanded scope of that provision included generation
facilities and holding company review and those changes I
personally believe were necessary. I personally advocated in
favor of those for close to 10 years.
But Congress, in the expanded merger provisions, the
expanded 203 provisions of the Energy Policy Act did largely
ratify the merger test that FERC had used for a number of
years. FERC--the Congress also added the cross subsidization
provisions in section 203. I really think that's the core of
the question here today is have we properly exercised, have we
properly utilized the provisions regarding cross subsidies the
Congress added to our merger and corporate review authority.
I want to emphasize though that cross subsidization, by no
means, is a new duty for the Commission. It's something that
we've been doing since the 1930s. It's really at the heart of
ratemaking, preventing improper cross subsidization.
So addressing it in the context of merger review is not
new. It's different. We have normally policed cross subsidies
when we set rates rather than review a merger. But it's not
altogether a new proposition for us.
Now the Commission has been very active in implementing the
expanded section 203 provisions. As detailed in my written
testimony, we began within weeks of enactment of the new law.
We continued through February of this year, so altogether the
Commission has spent about two and a half years on the expanded
section 203 provisions. But I welcome the interest of the
committee in this area. I think we have acted in a manner
consistent with the statutory language and congressional
intent.
But really to understand how the Commission has preceded,
it's important to understand the nature of section 203. This is
a very highly complex area. It is frequently short handed as
our merger provision. But it actually goes far beyond mergers.
It also applies to more than traditional utilities.
I think there might be a perception that section 203 is a
merger provision, only affects utilities. It does not. The
range of entities that are subject to 203 is very broad.
It includes independent power producers who have no cost
based rates. It includes marketers and traders who own no
generation, but own contracts. It includes utilities that truly
are not vertically integrated. They don't own generation. They
don't make wholesale power sales.
It also applies to a very wide range of transactions.
Securities transactions, utility purchases of power plants,
internal transfers where there actually is no sale, merger or
acquisition, the sale of power plants between two unaffiliated
power producers. So it applies to a very wide range of
transactions. Some of which actually do not entail a risk of
cross subsidization.
Now another factor that governed our review is what should
the proper relationship of FERC be to State regulators as we
address cross subsidization. To me that's governed our
decisions. Given there's a broad range of transactions.
Another complexity is that there's more than one way to
guard against cross subsidization. Even ring fencing, which is
a popular and a proven means. It is a category. There's
actually a variety of ring fencing measures. So some
transactions raise risk of cross subsidization, some do not.
There are a range of equally effective ways to guard against
cross subsidization.
So then that led us to a threshold question of how should
we use this in a new authority given our relationship with the
States. The way electricity is governed in this country, we
have a very Federalist scheme. FERC has strong authority.
States have strong authorities.
The kinds of transactions that do entail some risk of cross
subsidization typically involve a vertically integrated
utility. Vertically integrated utilities are typically governed
by both FERC and State regulation. The kind of transactions
that arguably raise the greatest risk of cross subsidization
are typically subject to both FERC and State merger review.
Now we had two paths that we could go down as we use our
new 203 authority. One is a preemptive approach where we would
establish a single Federal rule to guard against cross
subsidization at the point of a merger or we could take a
cooperative approach. To me the rationale for the preemption
approach would be a view, a prediction or actually almost an
assumption of comprehensive failure by the part of State
regulators to guard against cross subsidies. I'm not prepared
to make that assumption. I don't think the Commission is
either.
The rationale for cooperation is a view that Federal and
State regulators actually have a concert of interest. We both
want to avoid cross subsidies. We both have a duty to prevent
cross subsidies. We're charged with protecting different
consumers, retail consumers or wholesale consumers.
But we actually have a concert of interest. We believe that
we recognize there's more than one equally effective way to
guard against cross subsidies. There's actually no need to
preempt the States. To me, need alone should dictate whether we
preempt the States. I think it's actually unnecessary to
preempt the States in this area.
So FERC has taken a cooperative approach with the States.
The approach that we've taken, we will review. We allow States
to address cross subsidies. We will review the conditions they
establish. If we find them inadequate we will add to them. But
we will have a cooperative approach.
That is reflected in the recent order the Commission
approved with regard to Puget Sound in Washington State.
Washington State has very strong ring fencing protections. We
will look to the provisions, the protections that the State
ultimately decides on. If necessary, we'll add to them.
With that I just wanted to emphasize the kind of approach
that we took and the considerations that we bore in mind as we
developed our policy toward implementing section 203. I thank
you for inviting the Commission today.
[The prepared statement of Mr. Kelliher follows:]
Prepared Statement of Joseph T. Kelliher, Chairman, Federal Energy
Regulatory Commission
INTRODUCTION AND SUMMARY
Mr. Chairman and members of the Committee, thank you for the
opportunity to speak here today. My testimony addresses the efforts of
the Federal Energy Regulatory Commission (FERC or the Commission) to
implement the aspects of the Energy Policy Act of 2005 (EPAct 2005)
concerning electric utility holding companies in the context of mergers
and elsewhere. Supplies and prices of energy play a critical role in
our economy and in the welfare of our Nation's citizens. EPAct 2005
sought, in various ways, to allow and encourage greater investment in
the energy industry while at the same time protecting customers from
cross-subsidization and other improper activities. I welcome the
Committee's review of these important issues.
At heart, the Commission is a consumer protection agency. Our
primary task since the 1930s has been to guard the consumer from
exploitation. The Commission has extensive ratemaking authority under
the Federal Power Act (1935) and the Natural Gas Act (1938), and the
Commission has used that authority vigorously to prevent cross-
subsidization. Our most powerful tool for preventing cross-
subsidization is the disallowance of recovery in rates of costs found
unjust and unreasonable as improper cross-subsidies. The states have
similar tools to prevent rate recovery of unjust and unreasonable
costs. And, these tools apply to all utilities, not just the few
involved in a merger at any given time.
EPAct 2005 expanded FERC's merger and corporate review authority
under section 203 of the Federal Power Act (FPA). Specifically, EPAct
2005 clarified our jurisdiction over public utility holding company
mergers, and granted FERC authority over acquisitions of generation
facilities used for wholesale sales and certain holding company
securities acquisitions. With respect to these changes, I thank
Chairman Bingaman in particular for his leadership in filling statutory
gaps regarding holding company mergers and generation facility
acquisitions. EPAct 2005 also largely codified the merger test used by
FERC for some years but, significantly, added to the public interest
determination a required finding that a transaction will not result in
cross subsidization of a non-utility associate company or the pledge or
encumbrance of utility assets for the benefit of an associate company,
unless such cross-subsidization, pledge or encumbrance is in the public
interest. Finally, EPAct 2005 amended FPA section 203 to hold that a
merger or other corporate transaction requiring section 203 approval
will be deemed granted if the Commission does not act within 180 days
of filing, with the opportunity for the Commission to grant itself one
180-day extension for good cause. This time limitation signaled
Congressional intent that the Commission act expeditiously in making
its public interest determinations for corporate transactions.
EPAct 2005 also repealed the Public Utility Holding Company Act of
1935 (PUHCA 1935) and enacted PUHCA 2005. Under PUHCA 1935, the
Securities and Exchange Commission (SEC) regulated certain utility
holding companies extensively. In the decades after PUHCA 1935's
enactment, federal and state regulation of utilities increased
significantly enough that PUHCA 1935 was thought to be an unnecessary
impediment to investment in the energy industry. Therefore, PUHCA 2005
does not require or allow the Commission to regulate holding companies
in the same way as the SEC did under PUHCA 1935. This is because the
Commission and states have very powerful regulatory tools to protect
customers against holding company abuses, particularly their corporate
and ratemaking authorities. To assist them in using their ratemaking
tools, PUHCA 2005 authorizes the Commission and state regulators to
obtain the books and records of holding companies and their members if
relevant to jurisdictional rates. State regulators have independent
authority under PUHCA 2005, and do not need FERC's approval to obtain
information. The only provision of PUHCA 2005 that touches on the
Commission's substantive authority is a procedural provision that
allows multi-state holding companies and state commissions to obtain a
determination regarding centralized service company cost allocations
for such multi-state holding companies, although the Commission already
has substantive authority to do this under the FPA now that PUHCA 1935
has been repealed.
The Commission implemented its responsibilities under EPAct 2005
within the tight deadlines set by Congress, and has subsequently issued
additional rules to improve its implementation of PUHCA 2005, its new
corporate authorities under FPA section 203 and its rate oversight with
respect to potential cross-subsidies. The Commission's new rules
address, e.g., accounting for centralized service companies in holding
companies, pricing for affiliate trades of non-power goods and
services, and cross-subsidy filing requirements for applicants in FPA
section 203 cases. On the latter issue, our policy is to accept state
cross-subsidization protections absent evidence that additional
measures are needed to protect wholesale customers or where states lack
authority in this area.
In addition, the Commission staff conducts targeted audits to
detect and protect against cross-subsidization. The Commission
considers a range of factors in selecting companies for audits,
including a variety of methods for assessing risk. The Commission has
never relied on self-reports as its primary enforcement mechanism to
prevent inappropriate cross-subsidization. While the Government
Accountability Office (GAO) has criticized our efforts, I do not
believe its report reflects a full understanding of the factors
considered by the Commission in selecting companies for audits or in
conducting the audits, as discussed in more detail below.
IMPLEMENTATION OF EPACT 2005'S MERGER AND PUHCA PROVISIONS
Upon enactment of EPAct 2005, the Commission took a series of
actions addressing FPA section 203 and PUHCA 2005, all within the
statutory deadlines:
(1) adopted regulations to implement PUHCA 2005, including
detailed reporting and record retention requirements for
utility holding companies and their service companies, and
accounting requirements for centralized service companies,
codified at 18 C.F.R. Part 366 (December 2005);
(2) revised the accounting requirements for centralized
service companies, to provide greater accounting transparency
(proposed rule, April 2006; final rule, October 2006);
(3) amended the Commission's regulations for FPA section 203
to require explicit consideration of whether a proposed merger
or other corporate transaction ``will result in cross-
subsidization''; required applicants to provide the Commission
with a record that would allow it to address cross-
subsidization; and required applicants to demonstrate that
proposed mergers would not result in cross-subsidization or the
pledge or encumbrance of utility assets, or explain how the
cross-subsidization or pledge or encumbrance would be in the
public interest (December 2005); and
(4) amended the Commission's regulations under FPA section
203 to grant ``blanket authorizations'' (a regulatory pre-
approval) for certain transactions that would accommodate
greater investment in utilities, including certain holding
company acquisitions of utility securities under new FPA
section 203(a)(2), where there was no adverse impact on
competition or harm to captive customers (December 2005).
As a foundation for a second round of initiatives, the Commission
held public conferences on December 7, 2006, and March 8, 2007.
Industry participants and state commissioners provided input on key
issues including the protection of utility customers from cross-
subsidization. In particular, the Commission sought input on overlaps
in state-federal jurisdiction with respect to mergers and various
cross-subsidization protections such as ``ring-fencing'' and other
techniques to protect the assets of regulated utilities. One important
purpose of these conferences was to solicit the views of state
regulators on the best way to prevent cross-subsidization, and how to
coordinate federal and state merger review to that end.
In response to the input received in those conferences and written
comments following the conferences, the Commission took the following
actions in July 2007:
(1) The Commission issued a Supplemental Merger Policy
Statement, which provided clarification and guidance on the
types of commitments applicants could make and the ring-fencing
measures applicants could offer to address cross-subsidization
concerns. In response to recommendations by the states, the
Commission said that it would accept state ring-fencing
measures absent evidence that additional measures were needed
to protect wholesale customers or where there was a regulatory
gap because states lacked such authority. The Commission also
adopted certain ``safe harbors,'' for example, for transactions
not involving a franchised public utility with captive
customers, since these are unlikely to present cross-
subsidization concerns.
(2) The Commission proposed rules to codify restrictions on
the pricing of power and non-power goods and services in
affiliate transactions between franchised public utilities with
captive customers, on the one hand, and their market-regulated
power sales affiliates and their non-utility affiliates, on the
other hand.
(3) The Commission proposed rules to grant additional limited
``blanket authorizations'' for certain jurisdictional corporate
transactions that would not harm either competition or captive
customers.
In February of this year, the Commission adopted final rules on the
pricing of non-power goods and services. The rules require that any
such sales to a franchised public utility with captive customers by a
market-regulated power sales affiliate or non-utility affiliate will
not be at a price above market price, and any such sales by a
franchised utility with captive customers to a market-regulated power
sales affiliate or non-utility affiliate will be at the higher of cost
or market price, unless otherwise authorized by the Commission. The
Commission also codified a requirement it had previously imposed case-
by-case, requiring its prior approval under FPA section 205 of any
power sales between a franchised public utility with captive customers
and any market-regulated power sales affiliates. These restrictions
apply to all public utilities, not just those proposing a merger. These
rules strengthen FERC's ability to protect customers against affiliate
abuse.
Also in February, the Commission adopted final rules allowing
additional limited blanket authorizations to facilitate investment in
the electric utility industry and, at the same time, ensure that public
utility customers are adequately protected from any adverse effects of
such transactions.
All of the above rules and the Commission's Supplemental Merger
Policy Statement have focused first and foremost on ensuring customer
protection (including protection against inappropriate cross-
subsidization) and precluding harm to competition, but also on removing
unnecessary transaction burdens and limitations on much-needed
investment in the utility industry. Also, consistent with Congress'
specific directive in the section 203 amendments, the Commission in its
rules has identified classes of transactions that meet the statutory
standards for approval and thus can be expeditiously considered for
approval.
CROSS-SUBSIDIZATION ISSUES UNDER FPA SECTION 203
In exercising our new responsibility to police cross subsidies in
evaluating merger applications, we could have imposed a uniform and
preemptive federal rule on ring-fencing provisions. That approach,
however, could have preempted state merger conditions even if those
conditions guarded against improper cross subsidization just as
effectively as the federal rule. Given the common interest of FERC and
state regulators in policing improper cross subsidization, that
approach would have produced unnecessary conflict between federal and
state regulators.
Under FERC's more flexible approach, we will review merger
conditions imposed by a state commission to protect consumers from
improper cross subsidization or encumbrance, such as ring fencing or
other measures. If these conditions are sufficient to guard against
improper cross subsidization, FERC will not impose additional
conditions. If we determine state safeguards are inadequate, we will
impose additional conditions. If states have no authority to act, we
likewise will step in to ensure that adequate protections are in place.
Our approach reflects the reality that a wide variety of
transactions are subject to FPA section 203, many of which are not
mergers of regulated utilities. Some of these transactions entail some
risk of improper cross-subsidization, but others do not. Our approach
also reflects the reality that there is more than one mechanism to
effectively guard against improper cross-subsidization. Ring fencing is
only one such means.
In most cases, a transaction subject to section 203 that entails
some risk of cross-subsidization would also be subject to review by
state commissions. A preemptive federal approach would limit the
ability of state commissions to craft cross-subsidization safeguards,
and force state commissions to accept the federal rule. A preemptive
approach could be warranted in circumstances such as when uniform
regulation would provide a particular benefit or when widespread
evidence suggests a regulatory failure on the part of state
commissions. I do not believe that protecting against improper cross-
subsidization presents such a situation. I believe my state colleagues
have been vigilant in guarding against cross-subsidization in the
course of state merger review. Under our approach, FERC properly
exercises its new duty to guard against improper cross-subsidization,
and we can and will take action where state protections are inadequate.
But we view preemption as a last resort, not a first resort.
Earlier this month, the Commission applied this approach in
conditionally approving the merger of Puget Energy, the holding company
that owns Puget Sound Energy and other public utilities, and a number
of investor firms, led by Macquarie Group. We found the transaction
will not harm competition or rates, adversely affect regulation or
result in improper cross subsidization. The Washington Utilities and
Transportation Commission has strong ring fencing requirements, and the
applicants' filing with the state commission proposed ring fencing
commitments and other measures to insulate Puget Sound from any risk
related to the financial activities of its affiliates as a result of
the transaction. Consistent with our Supplemental Merger Policy
Statement, we stated that we would accept the cross-subsidization
conditions ultimately adopted by the Washington commission unless they
are inadequate to police improper cross subsidization. We reserved our
authority to issue supplemental orders as appropriate after the ring
fencing provisions adopted by the Washington commission are filed with
the Commission.
In every case under FPA section 203, the Commission bases its
decision on the record developed in that case--a record created not
only by the applicant but also by others, including customers and state
consumer advocates, competitors, state commissions and attorneys
general. If this record is not adequate, the Commission can find that
the applicant's filing is ``deficient'' and direct the applicant to
submit additional record evidence. Other parties can review and
challenge any of the evidence. The Commission also can institute so-
called ``paper hearing'' procedures or even trial-type evidentiary
hearing procedures. Once there is sufficient record evidence, the
Commission's decision must be based on this record evidence. A
Commission decision based on non-record evidence will be overturned by
a reviewing court.
The Commission carefully analyzes the record evidence submitted by
a section 203 applicant. However, the Commission is not bound to follow
the analysis of the applicants, and it often does not. Rather, the
Commission analyzes the entire record, determines the appropriate
result based on the entire record, and provides its analysis of the
record in its public order.
While the Commission in some cases relies on commitments by merger
applicants, and these commitments are important tools, they are far
from the only tools used by the Commission. The Commission has many
means by which it can prevent cross-subsidization, including its
traditional ratemaking authority. However, applicant commitments
usually reflect a careful review of Commission policy by the
applicants, and applicants often anticipate merger conditions that
would otherwise be imposed by the Commission to prevent cross-
subsidization. Further, adherence to those commitments is a condition
of the Commission's approval and if public utilities do not adhere to
the commitments they are subject to sanctions, including possible civil
penalties. For every transaction approved under section 203, the
Commission also retains authority under section 203(b) to issue such
supplemental orders as it may find necessary or appropriate with
respect to the transaction.
CROSS-SUBSIDIZATION ISSUES IN OTHER CONTEXTS
The Commission's rules implementing PUHCA 2005 will enhance the
ability of the Commission and others to police cross-subsidization. As
noted above, the Commission adopted new accounting regulations in
October 2006, adding a new Uniform System of Accounts for centralized
service companies, in order to provide greater transparency to protect
ratepayers from paying improper service company costs. In addition, the
Commission's December 2005 rules required holding companies and service
companies to retain records consistent with the retention periods for
public utilities and natural gas companies, and required centralized
service companies to file on an annual basis financial information and
information related to non-power goods and services provided to
affiliates. Information collected in that form is available
electronically to market participants and the public for use in
detecting cross-subsidization, affiliate abuse, or other improper
activities.
As further protection, the Commission staff conducts targeted
audits as proactive measures to detect and protect against cross-
subsidization. Even before PUHCA 1935 was repealed, the Commission had
a longstanding practice dating back at least to the 1970s of auditing
affiliated transactions as part of its financial audit program. More
recently, in November 2003, the Commission began auditing affiliated
transactions as part of its multi-scope audits covering its market-
based rate program. See, e.g., Progress Energy, 111 FERC 61,243
(2005); Public Service Company of Colorado, Docket No. PA05-1-000
(November 28, 2005).
In anticipation of the repeal of PUHCA 1935, the Commission
developed and implemented a comprehensive audit program to conduct
audits of affiliated transactions to detect and deter cross-
subsidization. The audit program reflects the detailed auditing
procedures and techniques used to guide the audit team in conducting
the audits.
The Commission considers a number of factors including the size and
complexity of holding companies in determining how many holding company
audits the Commission will conduct in a given year. PUHCA 2005 did not
go in effect until February 2006. Until the Commission obtains
sufficient experience conducting holding company audits pursuant to
PUHCA 2005, the Commission cannot estimate precisely how many of these
audits will be needed in the future. Three PUHCA 2005 audits are
scheduled for FY08 and these are the initial audits focused on
compliance with these requirements. These three audits include some of
the largest utility holding companies. These audits are not definitive
indicators of the number of audits that the Commission will perform in
subsequent years.
The Commission uses a variety of methods to assess risk in
selecting audit candidates. These methods include internally developed
screens and models, past compliance history, information gleaned from
on-going and completed audits, investigations, complaints, Commission
financial forms, SEC filings, websites, and rate information gathered
from Commission and state rate filings. Further, unlike other agencies
that do not have ratemaking responsibilities, the Commission has
available a variety of legal and technical experts very familiar with
the details of public utilities and the holding companies of which they
are a part, and the particular regulatory and other issues facing those
public utilities. We therefore bring all our expertise to bear in
determining which companies should be audited.
Contrary to the implications in the recent GAO Report,\1\ the
Commission has never relied on self-reports as its primary enforcement
mechanism to prevent inappropriate cross-subsidization. Cross-
subsidization, by its very nature, does not lend itself to being self-
reported. Ratemaking is a complicated process which relies on the
development of an extensive record on costs and revenues, and
determination of the proper allocation of costs between jurisdictional
and non-jurisdictional operations, the appropriate distribution of
costs between and among the various jurisdictional services, and the
selection of an appropriate rate of return. Under these circumstances,
self-reports would not be an effective method to monitor cross-
subsidization. In any event, prior to passing through costs in cost-
based rates, a public utility must request authority to do so and
therefore the Commission, at the time of such a request, can determine
whether the proposed rate or rate formula permits inappropriate cross-
subsidization to occur and, if so, to disallow rate recovery. Further,
as described above, the Commission has adopted specific, prophylactic
restrictions regarding the pricing standard that will be applied in
determining whether transactions will be considered to have resulted in
inappropriate cross-subsidization (in shorthand, whether an ``at cost''
or a ``market'' standard will be applied).
---------------------------------------------------------------------------
\1\ GAO Report, Recent Changes in Law Call for Improved Vigilance
by FERC, GAO-08-289(February 2008) at 8,10 and 14-15.
---------------------------------------------------------------------------
In its report, the GAO makes four recommendations that purportedly
would enhance the Commission's ability to detect and prevent harmful
cross-subsidization involving public utilities. These recommendations
focus primarily on post-merger oversight, in particular with respect to
the audit process. While I appreciate the GAO's concern that audit
candidates be chosen appropriately and that the Commission should take
into account the financial risks facing a company, and I have asked
Commission staff to look into the recommendations made by GAO, I do not
believe the report reflects a full understanding of the factors
considered by the Commission in selecting companies to be audited, or
all of the factors in addition to risk that should be considered in
selecting such companies.
The GAO Report's first recommendation is that the Commission
``[d]evelop a comprehensive, risk-based approach to planning audits of
affiliate transactions in holding companies and other corporations that
it oversees to more efficiently target its resources to highest
priority needs and to address the risk that affiliate transactions pose
for utility customers, shareholders, bondholders, and other
stakeholders.'' Contrary to the premise of this recommendation, the
Commission followed a risk-based approach in selecting the FY08 PUHCA
audit candidates and will continue to follow a similar approach in the
future. The risk-based approach entailed a comprehensive review of
audit materials obtained from the SEC; discussions with the SEC;
examination of financial information contained in FERC Form No. 60,
FERC Form No. 1, and SEC filings; rate information gathered from
Commission filings; and discussions with the Commission's legal and
technical experts. In addition to the above methods, the Commission
audit staff searched through 155 boxes of audit materials received from
the SEC covering 28 holding companies, participated in several
conference calls with the SEC staff responsible for the implementation
of PUHCA 1935 and discussed audit practices, processes and procedures,
as well as outstanding issues for certain holding companies. Finally,
shortly after the audits started, the Commission held discussions with
state commission officials in the states of Georgia, Alabama,
Mississippi, Florida, Maryland, Virginia, West Virginia, and
Pennsylvania.
The second recommendation suggests that the Commission should
develop a better understanding of the risks posed by each company, by
monitoring the financial condition of utilities and developing a better
means of collaborating with state regulators. Contrary to the GAO
Report's assumptions, the Commission audit staff frequently interacts
with state regulators during an audit. For example, the Commission's
audit staff recently either met or had telephone conversations with
eight state regulators regarding the three current FY08 PUHCA 2005
audits. These actions demonstrate the Commission's recognition that
maintaining contact with state regulators is mutually beneficial to the
states and the Commission.
However, the suggestion that the Commission should monitor the
financial condition of utilities fails to appreciate that a company's
stock price and bond ratings are typically driven by the company's
overall business risks and prospects. Thus, the fact that a company's
stocks or bonds are doing well or poorly says little or nothing,
standing alone, about whether cross-subsidization is occurring. That is
why the Commission's existing method of assessing risk is comprehensive
and takes into account both financial and non-financial information
rather than solely relying on a utility's stock prices and bond ratings
as indicators of potential cross-subsidization.
The third recommendation is that the Commission ``[d]evelop an
audit reporting approach to clearly identify the objectives, scope and
methodology, and the specific findings of the audit, irrespective of
whether FERC takes an enforcement action, in order to improve public
confidence in FERC's enforcement functions and the usefulness of audit
reports on affiliate transactions for FERC, state regulators, affected
utilities, and others.'' The Commission has always strived to clearly
identify its objectives and methodologies for all areas of its
jurisdictional responsibilities. The Commission is currently
implementing this recommendation in the audit context. For example, in
November 2007, the Commission's audit staff began the process of
including an enhanced audit methodology section in all of its public
audit reports. See, e.g., Kansas City Power & Light Co., Docket No.
PA06-6-000 (Nov. 27, 2007). Also, the Commission's public audit reports
have always included audit objectives and scope, as well as audit
findings, where applicable. In contrast, the SEC previously issued non-
public audit reports at the completion of its holding company audits.
Thus, the Commission's enhanced audit methodology and practice of
publicly publishing audit reports have increased the transparency of
the process.
Finally, the GAO Report recommends that the Commission, ``[a]fter
developing a more formal risk-based approach, reassess whether it has
sufficient audit resources to perform these audits'' and request
additional funds, if necessary. The Commission continuously reassesses
its audit and other resources to achieve its strategic goals. To that
end, for each audit cycle, the Commission prepares an annual audit plan
that is vetted with senior Commission officials, and reviewed and
approved by me as Chairman. Needless to say, the Commission will
continue to seek additional funds from Congress if it believes it needs
more resources to carry out its auditing responsibilities, including
PUHCA 2005 and cross-subsidization audits, just as the Commission
recently did when requesting additional funds for transmission system
reliability audits. To summarize, the Commission's auditors already
follow a risk-based approach for selecting holding company audit
candidates for examination of their affiliated transactions, and the
Commission constantly assesses and reassesses its audit resources to
carry out the audit priorities in the annual audit plan. Similarly, the
Commission continues to collaborate with state regulators to capitalize
on their unique knowledge. Interacting with state regulators during the
course of an audit is a practice the Commission auditors have followed
for a long time. Finally, the Commission continually strives to
maintain and improve existing staff practices to ensure that the audit
reports include clear audit objectives, scope, and methodologies.
CONCLUSION
In conclusion, let me emphasize that, just as the Commission has
done since 1935, it will continue to be vigilant to protect customers
from inappropriate cross-subsidization through its ratemaking and other
authorities, and to also protect them against mergers or other
jurisdictional corporate transactions that are not consistent with the
public interest. The rules and policies the Commission has adopted
since enactment of EPAct 2005, and the strengthening of its enforcement
function, have given the Commission an even stronger foundation to
protect against inappropriate cross-subsidization on an ongoing basis
irrespective of whether a merger is involved. Our existing cross-office
approach to regulating utilities allows us to bring to bear all agency
expertise necessary to detect potential problems and protect customers.
Further, with respect to protecting customers against inappropriate
cross-subsidization or realignment at the time of a request for merger
or other corporate approval under section 203 of the FPA, the
Commission has in place a sound program for ensuring such protection--
an approach that provides appropriate deference to state regulatory
protections and that fills any regulatory gaps.
I note that it has now been two years since the repeal of PUHCA
1935, the enactment of the PUHCA 2005 books and records provisions, and
the amendments to our FPA section 203 corporate authority took effect
(February 2006). Since that time, the predicted ``rush'' of major
utility mergers and realignments has not occurred, and in fact the
annual number of merger applications filed with the Commission has not
increased compared to the prior period. Whatever the future may hold
with respect to increased utility merger or investment activity, I
believe the Commission has laid a solid foundation to adequately
protect customers and we will continue to adapt our policies and our
auditing approach as necessary to meet our core customer protection
mission.
I would be happy to answer any questions the Committee members may
have, after my colleagues have had an opportunity to express their
views.
The Chairman. Thank you very much for your testimony.
Commissioner Kelly, go right ahead.
STATEMENT OF SUEDEEN G. KELLY, COMMISSIONER, FEDERAL ENERGY
REGULATORY COMMISSION
Ms. Kelly. Thank you, Mr. Chairman. Thank you, Chairman
Bingaman, Ranking Member Domenici and members of the committee
for your leadership and for the opportunity today to update you
on the status of the Energy Policy Act of 2005 and PUHCA of
2005 and their implementation.
As Chairman Kelliher noted in his written testimony, at
heart, the Commission is a consumer protection agency. The
Commission must continue to work closely with this committee,
and more broadly, the Senate and the House to make certain that
FERC is protecting the American consumer. This has never been
more the case than today.
With the repeal of PUHCA 1935, EPACT has correctly taken
the SEC out of the enforcement business and given the role to
FERC. That has expanded FERC's role considerably. I'm very
proud of the work that this Commission has done and notably our
tremendous staff to breathe life into our new and evolving
role.
Today I'd like to discuss four issues:
First, the impact of this legislation on investment in the
energy market.
Second the need to build more process into FERC's
enforcement authority.
Third, the issues of cross subsidization and encumbrances
of utility assets.
Fourth, the case for compliance.
To understand the States and the Commission's regulatory
and enforcement roles under this relatively new legislation,
it's essential to discuss the very positive impact that EPACT
has had on the energy market itself. EPACT has helped the
American consumer and the economy by broadening the field of
investors in the energy market, which of course, is one of the
best ways to spur the improvements and innovations in the
market that we are eager to see. The proponents of this
legislation saw new opportunities for new investors with new
money and new ideas to enter the energy market giving the
impetus to push ahead into the 21st century.
As noted in the GAO report, this objective has been met.
New investors have entered the energy marketplace since EPACT
was enacted and specifically because it was enacted. This is
good news for the American consumer.
What this also means is that the energy market has welcomed
a host of new members and investors who may be and in some
cases are, unfamiliar with regulation. It would be
irresponsible for all of us to purposefully attract new
investors to the energy market and not educate them about the
rules that govern it. Therefore the Commission must at a
minimum develop an enforcement strategy and be transparent in
communicating that strategy to market participants.
There's a distinct difference between including objectives
and scope in an individual audit and setting forth the
Commission's objective, scope, vision and strategy for
enforcement more broadly. The GAO's paper raises issues that
this committee and my fellow Commissioners have taken seriously
and must take seriously. Whether we build risk based
assessments into the Commission's enforcement mandate as the
GAO recommends or some other methodology that is clear,
predictable, fair and sufficiently straight forward that market
participants can understand it and know what rules to follow.
It's imperative that the Commission adopt and communicate a
clear vision for its enforcement strategy.
A risk based assessment has considerable merit on the micro
level for individual companies.
First, risk is a metric readily identifiable in the
business community. Market participants and holding companies
make decisions everyday on the basis of their own risk
calculations in a variety of circumstances.
Second, risk assessments can lay down clear metrics that
will give market participants sufficient predictability
concerning what is expected of them.
Third, risk also provides the flexibility to not be so
prescriptive, that the metrics rule out unforeseen or variable
circumstances. One size does not fit all. Risk assessments take
that reality into account.
The key in all of this is to continue to foster Congress'
successful intent behind EPACT and the repeal of PUHCA 1935,
bringing new investment and new investors into the marketplace
while avoiding another ENRON from occurring. With the clearly
thought out and communicated enforcement strategy that
marketplace predictability and enhanced certainty will attract
even greater investment and further protect the American
consumer from any exploitation.
It's no mystery that the provisions on cross subsidization
were central to the passage and enactment of EPACT 2005 and the
repeal of PUHCA of 1935. Cross subsidization is to be avoided
at all costs. Through cross subsidization a utility could
increase rates to the American consumer, not to benefit the
consumer, but to benefit some business entity held by the
consumer or its holding company. Or through cross subsidization
a utility could allow some unregulated entity held by it or its
holding company to use the utilities assets to provide it an
unfair competitive advantage. Or it could also be used to harm
the financial integrity of the utility itself.
That is why the Commission took the steps that it has as
laid out in the chairman's written testimony. However, we can
and we must do more. The chairman cautions against adopting a
uniform and preemptive Federal rule on cross subsidization in
the absence of widespread evidence of State regulatory failure.
I agree with him that many State Regulatory Commissions
have succeeded. But they have not succeeded across the board.
Not all States have comprehensive corporate structuring
statutes in place.
PUHCA provided that protection for the American consumer.
PUHCA did it in a very blunt and, as we came to see, a very
inefficient way. So, Congress has rightfully repealed that Act.
But in its absence it requires us to be vigilant that corporate
structures not be adopted which provide the possibility of
harmful cross subsidization or inappropriate encumbrances of
utility investment of utility assets to the detriment of
utility investors and consumers.
I agree that there is no one silver bullet for preventing
cross subsidization. Some States have found ring fencing to be
very successful. Other States find that it presents problems
and have chosen not to accept it. That does not mean the
Federal Government cannot provide more leadership in the area
of cross subsidization.
We could, for example, insist that at least one of the
suite of mechanisms to prevent cross subsidization be adopted.
Not every one of the 50 States needs to adopt ring fencing. But
they should all be looking at some proven mechanism to ensure
that where cross subsidization is a possibility the corporate
structure will be done in such a way as to prevent that from
occurring. FERC could and should help States pilot a course for
the adoption of productive corporate structure policies.
I would also like to talk about the future--what I hope to
see the role----
The Chairman. Could you sort of summarize because we're
going to run out of time?
Ms. Kelly. Thank you, Mr. Chairman.
The Chairman. Thanks.
Ms. Kelly. I just wanted to say briefly that as the
enforcement role of the Commission and the States continue to
evolve, regulators should be working with market participants
to ensure that they understand how to comply with the rules. I
would like to see the Commission embark on a serious program of
compliance and not just enforcement. Thank you.
[The prepared statement of Ms. Kelly follows:]
Prepared Statement of Suedeen G. Kelly, Commissioner, Federal Energy
Regulatory Commission
INTRODUCTION
Thank you, Chairman Bingaman, Ranking Member Domenici, and members
of the Committee for your leadership and for the opportunity to update
you on the status of the Energy Policy Act of 2005 (EPAct 2005) and the
Public Utility Holding Company Act of 2005 (PUHCA 2005) and their
implementation.
I also want to extend my gratitude to Senators Feingold and
Brownback who, along with Chairman Bingaman, asked the Government
Accountability Office (GAO) to look into the progress made on the
implementation of EPAct 2005. More specifically, I applaud them all for
demanding a close look at what the Commission is doing to prevent
cross-subsidization. Cross-subsidization was central to this
legislation's enactment, and we--as a Commission--can and must go
farther than we have on this most serious issue. As Federal Energy
Regulatory Commission (FERC) Chairman Kelliher noted in his testimony,
``At heart, the Commission is a consumer protection agency,'' and the
Commission must continue to work closely with this Committee and, more
broadly, the Senate and the House to make sure that FERC is protecting
the American consumer.
This has never been more the case than today. With the repeal of
PUHCA 1935, EPAct 2005 has correctly taken the Securities and Exchange
Commission (SEC) out of the enforcement-picture and has expanded FERC's
role considerably. I am proud of the work that the Commission and--
notably--our tremendous staff have done to breathe life into this new
and evolving role.
Congress was correct to repeal PUHCA 1935, entrusting the
regulatory and enforcement roles to the states and to FERC, when it
comes to the holding companies that have acquired or seek to acquire
public utilities. FERC is equipped to regulate and take enforcement
action to enforce that regulation. Under PUHCA 2005, FERC and the
states have access to the holding companies' books and records, so that
regulators can make fully informed decisions. Congress has also
correctly given the Commission the authority it needs to ``blow the
whistle'', as necessary, and assess appropriate penalties.
Permit me to discuss four issues: first, the impact of this new
legislation on investment in the energy market; second, the need to
build more process into FERC's enforcement authority; third, cross-
subsidization; and fourth, the case for compliance.
IMPACT OF EPACT 2005 ON THE ENERGY MARKET--NEW INVESTORS
To understand the states' and the Commission's regulatory and
enforcement roles under this relatively new legislation, it is
essential to discuss the very positive impact EPAct 2005 has on the
energy market itself.
Born in this Committee, EPAct 2005 has helped the American consumer
and the economy by broadening the field of investors in the energy
market, which is one of the best ways to spur the improvements and
innovations in the market that we are all so eager to see. The
proponents of this legislation saw new opportunities for new investors
with new money and new ideas to enter the energy market, giving the
impetus to push ahead through the beginning of the 21st century. As
noted in the GAO report, this objective has been met: new investors
have entered the energy marketplace since EPAct 2005 was enacted and
specifically because it was enacted. That is good news for the American
consumer.
BUILDING A BETTER ENFORCEMENT PROCESS
What this also means is that the energy market has welcomed a host
of new members and investors who may be, and--in some cases--are,
unfamiliar with regulation. It would be irresponsible for all of us to
purposefully attract new investors to the energy market and not educate
them about the rules that govern it. Therefore, the Commission must--at
a minimum--develop an enforcement strategy and be transparent in
communicating that strategy to market participants. There is a distinct
difference between including objectives and scope in an individual
audit and setting forth the Commission's objectives, scope, vision, and
strategy for enforcement more broadly.
The GAO's thoughtful paper raises issues that this Committee and my
fellow Commissioners have and must take seriously. Whether we build
strategy risk-based assessments into the Commission's enforcement
mandate, as the GAO recommends, or some other methodology that is
clear, predictable, fair, and sufficiently straightforward such that
market participants can understand it and know what rules they must
follow, it is imperative that the Commission adopt and communicate a
clear vision for its enforcement strategy.
A risk-based assessment has considerable merit on the micro-level
for individual companies. First, risk is a metric readily identifiable
in the business community; market participants and holding companies
make decisions each day on the basis of their own risk calculations in
a variety of circumstances. Second, risk assessments can lay down clear
metrics that will give market participants sufficient predictability
concerning what is expected of them. Third, risk also provides the
flexibility to not be so prescriptive that the metrics rule out
unforeseen or variable circumstances. One size does not fit all, and
risk assessments take that reality into account.
For nearly all of the same reasons, a risk-based approach to
enforcement also has merit, on the macro-level, of assessing which
companies, regions, or problems should cause the Commission the
greatest concern, as it develops its enforcement strategy.
The key in all of this is to continue to foster Congress'
successful intent behind EPAct 2005 and PUHCA 2005: bringing new
investment and new investors into the marketplace, while avoiding
another Enron from occurring. With a clearly thought out and
communicated enforcement strategy, that marketplace predictability and
enhanced certainty will attract even greater investment and further
protect the American consumer from exploitation.
CROSS-SUBSIDIZATION
It is no mystery that the provisions on cross-subsidization were
central to the passage and enactment of EPAct 2005. Nor was it a
mystery in 2005. Cross-subsidization is to be avoided at all costs.
Through cross-subsidization, a utility could increase rates to the
American consumer not to benefit the consumer but to benefit some
business entity held by the utility or its holding company. Or, through
cross-subsidization, a utility could allow some unregulated entity held
by it or its holding company to use the utility's assets to provide it
an unfair competitive advantage and, possibly, harm the utility's
financial integrity. That is why the Commission took the steps it did,
as laid out in testimony by Chairman Kelliher. However, we can and must
do more.
Chairman Kelliher cautions against adopting a uniform and
preemptive federal rule on cross-subsidization in the absence of
widespread evidence of state regulatory failure. I agree with him that
many state regulatory commissions have succeeded, but they have not
succeeded across the board. I also agree that there is no one silver
bullet for preventing cross-subsidization, and that--to use the example
Chairman Kelliher invoked--some states have found ring-fencing to be
very successful, even though it can cause problems for other states
which have chosen not to accept it. That does not mean the federal
government cannot insist that at least one of a suite of mechanisms to
prevent cross-subsidization be adopted. Not every one of the 50 states
needs to adopt ring-fencing specifically, but they should all adopt
some proven mechanism to help them better regulate these holding
companies and guard the American consumer from cross-subsidization.
As a practical matter, the Commission currently relies primarily on
self-reported assurances from the market participants it regulates to
learn about their cross-subsidization practices and the likelihood of
those practices occurring. No amount of conferences, rules, or policy
statements will help the Commission obtain better information about
cross-subsidization until the Commission's auditing and enforcement
arms are given more resources and a clearer mandate to obtain the same
information on their own--independent of the information provided
directly by the market participants. Enhanced resources would also
permit the Commission to obtain better information from state
regulators and to meet more frequently with them. Finally, enhanced
audit and enforcement resources would build the Commission's capacity
to analyze this information so that it can better fulfill its mission
to protect the public interest.
Now is not the time to rule out options, but to explore them and
adopt one or more of them soon, whether it is through independent risk-
based assessments, as GAO recommends; ring-fencing; or some other
method. We must make sure we are doing all we can to guard the American
consumer from cross-subsidization and other forms of exploitation.
THE CASE FOR COMPLIANCE
As the enforcement role of the Commission and the states continues
to evolve, regulators must work with market participants to ensure that
they understand how to comply with the rules--especially insofar as new
investors who are unfamiliar with FERC, state regulators, and the
regulated energy marketplace generally are concerned. The Commission
has not used its authority to play ``gotcha'' with holding companies
and other market participants. That was not the intent of Congress and
this Committee. Still, we must make that abundantly clear to all market
participants and, in particular, to the new investors that EPAct 2005
was intended to attract.
With the 2005 enactment, the Commission has entered the enforcement
business and has room to grow in this endeavor. The Commission may want
to examine the enforcement practices of other government agencies
entrusted with similar authority, such as the Federal Trade Commission.
There are always ways to improve, and so why not look down the street
to agencies that have experience in this business? What are their
practices? What are their strategies? How are they staffed? What do
their budgets look like?
We may learn from these other agencies that it would be prudent for
the Commission to enter the ``compliance'' business as well. By
assisting regulated companies with their compliance on a more
consistent basis, they will gain a much better sense of what the rules
are, how to comply with them, and what the Commission values. The
Commission, in turn, will learn from its regulated companies which
rules are clear and effective and which are not. A strong compliance
program presumably would provide market participants with greater
assurance that the Commission is not out to play ``gotcha.'' To the
contrary, a more productive relationship should emerge. At the end of
the day, the American consumer would benefit from a Commission working
regularly with market participants to make sure they understand the
rules and are playing by them.
CONCLUSION
This Committee's efforts, under the leadership of Chairman Bingaman
and Ranking Member Domenici, cannot go for naught. These new laws can
be a boon not only to the energy market and the American economy, but
also to the American consumer. This legislation has sent FERC into a
new world of enforcement with the authority to impose million dollar
per day penalties. With that great power comes great responsibility. We
not only need to know where to look, but also what we are looking for.
To that end, we must develop a comprehensive enforcement strategy and
be clear about it. We must also enlist market participants and the
states as allies to protect the American consumer from exploitation.
The heavy stick of enforcement cannot--by itself--get the job done. We
must require that public utilities have the necessary structures in
place to prevent cross-subsidization, and we must work together to make
sure everyone plays by the rules. Thank you.
The Chairman. Thank you very much.
Commissioner Moeller.
STATEMENT OF PHILIP D. MOELLER, COMMISSIONER, FEDERAL ENERGY
REGULATORY COMMISSION
Mr. Moeller. Thank you, Mr. Chairman, Senator Domenici,
Senator Craig, Senator Cantwell. It's my pleasure to be here
before you today. My statement largely supports the written
testimony submitted by Chairman Kelliher concerning our ability
to detect and prevent any improper cross subsidization between
regulated utilities and their affiliates.
The Commission has had a long standing responsibility to
prevent utility consumers from paying rates that reflect
inappropriate cross subsidies. In my opinion the best
opportunity for the Commission to discover cross subsidization
is in the rate making process. That is before any cost can be
recovered from wholesale customers served under cost based
rates.
The Commission reviews those costs to determine if their
recovery would be just and reasonable. Costs that result from
inappropriate cross subsidies are not recoverable in rates.
While our auditing enforcement and merger authority is
significant these measures complement rather than substitute
for the rate review that FERC conducts. In addition the States
have responsibility over retail rates providing them with
authority to deny the recovery of amounts representing
inappropriate cost for subsidies and other unjust and
unreasonable costs.
As far as I have seen the repeal of PUHCA 1935 has not led
to an increase in cross subsidization. Not withstanding, our
Commission must exercise and is exercising vigilance in our
rate making, our merger review, our enforcement processes and
our auditing functions. I also believe that as competitive
energy markets mature, cross subsidization will become less of
an issue.
In purely competitive markets where there are no captive
customers and energy is sold at market based rates, utilities
will not have an incentive to add costs that result in non-
competitive prices. However the markets regulated by the
Commission are not purely competitive at this time and thus,
not immune from inappropriate cross subsidization between
affiliates. As such the Commission is and must exercise its
authority to guard against inappropriate cross subsidization.
With regard to the report issued by the Government
Accountability Office, I appreciate their efforts to examine
this issue. As explained in the chairman's statement, to some
extent we are considering or have already implemented or
adopted their recommendations. But in our efforts to
continually improve our oversight responsibilities and to
provide a more transparent enforcement process, I encourage any
comments, suggestions or criticisms as full compliance with our
rules and regulations is my policy goal.
Our job is to protect the consumers. One of the major
enforcement powers we have are the new authorities that you
gave us as a Commission in the 2005 Act. I've, at times over
the last year felt like a little bit of a lone voice asking
that our enforcement process be more open and transparent and
give more context to those who regulate so that it is fair.
Again, ultimately, consumers are protected through that. So
I'm quite heartened by the fact that I think that our
Commission has a growing recognition that that process needs to
be more open, particularly heartened by Commissioner Kelly's
comments to that effect. At the appropriate time I'd be happy
to answer any questions.
[The prepared statement of Mr. Moeller follows:]
Prepared Statement of Philip D. Moeller, Commissioner, Federal Energy
Regulatory Commission
Mr. Chairman and members of the Committee, I appreciate the
opportunity to appear before you today. My statement largely supports
the written testimony submitted by Chairman Kelliher concerning our
ability to detect and prevent any improper cross-subsidization between
regulated utilities and their affiliates.
The Commission has had a long-standing responsibility to prevent
utility consumers from paying rates that reflect inappropriate cross-
subsidies. In my opinion, the best opportunity for the Commission to
discover cross-subsidization is in the ratemaking process. That is,
before any costs can be recovered from wholesale customers served under
cost-based rates, the Commission reviews those costs to determine if
their recovery would be just and reasonable. Costs that result from
inappropriate cross-subsidies are not recoverable in rates. While our
auditing, enforcement, and merger authority is significant, these
measures complement rather than substitute for the rate review that
FERC conducts. In addition, the states have responsibility over retail
rates, providing them with authority to deny the recovery of amounts
representing inappropriate cross-subsidies and other unjust and
unreasonable costs.
As far as I have seen, the repeal of PUHCA 1935 has not led to an
increase in cross-subsidization. Notwithstanding, our Commission must
exercise and is exercising vigilance in our ratemaking, our merger
review, our enforcement processes, and our auditing functions. I also
believe that as competitive energy markets mature, cross-subsidization
will become less of an issue. In purely competitive markets where there
are no captive customers and energy is sold at market-based rates,
utilities will not have an incentive to add costs that result in non-
competitive prices. However, the markets regulated by the Commission
are not purely competitive at this time and thus, not immune from
inappropriate cross-subsidization between affiliates. As such, the
Commission is, and must, exercise its authority to guard against
inappropriate cross-subsidization.
Finally, with regard to the report issued by the Government
Accountability Office, I appreciate their efforts to examine this
issue. As explained in the Chairman's statement, to some extent we are
considering or have already adopted their recommendations. However, in
our efforts to continually improve our oversight responsibilities and
to provide a more transparent enforcement process, I encourage any
comments, suggestions, or criticisms as full compliance with our rules
and regulations is my policy goal.
I would be happy to respond to any questions.
The Chairman. Thank you very much.
Commissioner Spitzer.
STATEMENT OF MARC SPITZER, COMMISSIONER, FEDERAL ENERGY
REGULATORY COMMISSION
Mr. Spitzer. Thank you, Mr. Chairman, members. We've got
very learned colleagues here and sort of feel an old statement
by an Arizona hero, Morris Udall, is relevant. Everything's
been said, but not by everybody.
So I'll try to expedite my comments and particularly refer
to my having spent about 9 months of my life on a ring fencing
case in Arizona involving an acquisition in 2004 that informs
me as to the----
The Chairman. Which side of the case were you on?
[Laughter.]
Mr. Spitzer. I was representing the State of Arizona as the
commissioner at the time.
The Chairman. Ok.
Mr. Spitzer. Mr. Chairman, and I believe the FERC policies
that have arisen from the regulatory environment from EPACT
2005 correctly balance the competing considerations,
specifically fulfilling the congressional mandate to protect
rate payers with respectful consideration of State commissions
and their orders. Ensuring that an applicant demonstrate a
proposed transaction will not result in inappropriate cross
subsidization. FERC has deferred and I believe should defer to
State Utility Commission's findings regarding ring fencing.
FERC will impose protections regarding cross subsidization
or asset impairment if prophylactic authority does not exist
under State law or if specific State Regulatory protections are
insufficient to protect customers. FERC's imposition of
additional ring fencing measures is best exercised as a
backstop authority rather than a mechanism to preempt State
action. State Utility Commissions have long employed tools to
protect their retail customers from asset impairment and cross
subsidization in various contexts, including proceedings
regarding mergers and acquisitions. Thus, where States are
willing and able to address cross subsidization, FERC should
generally defer to lawful and effective State Utility
Commission orders.
As chair of the Arizona Corporation Commission I presided
over an application to acquire Unisource Energy Corporation,
the parent corporation of Tucson Electric Power Company. In
that case the Arizona Commission borrowed liberally from the
1997 decision of the Public Utility Commission of Oregon
approving the acquisition of Portland General Electric Company
by ENRON Corporation. In approving the 1997 acquisition the
Oregon Commission adopted several ring fencing provisions that
have been described as the gold standard for the protection of
retail ratepayers from asset impairment and cross subsidization
in the context of utility merger.
The proof in the pudding, so to speak is that due to ten
ring fencing conditions that the Oregon Commission imposed on
that merger transaction, the bankruptcy of ENRON Corporation
resulted in no negative impacts upon the regulated Oregon
utility. I cite to you the testimony in our technical
conference on this matter of Commissioner Ray Baum from the
Public Utility Commission of Oregon. The Arizona case also
raised potential asset impairment and cross subsidization
concerns.
Consequently the Arizona Commission examined at great
length all of the potential adverse ratepayer impacts of the
acquisition of an Arizona utility by out of State interests.
This review resulted in the parties to the proceeding,
including the Arizona Commission staff, to stipulate to the
Oregon Commission's ring fencing language with modest revisions
arising from and consistent with Arizona law. FERC should not
presume States are unwilling to protect their retail ratepayers
from asset impairment or from cross subsidization.
The cases decided by State Utility Commissions, including
my own experience on the Arizona Commission, suggest the
contrary is true. Therefore, FERC has properly adopted a
backstop for those circumstances where the States are without
statutory authority, unwilling or unable to impose cross
subsidization protections. In fact, since the passage of EPACT
2005, FERC has not preempted a State Utility Commission's ring
fencing determination, nor has it imposed views potentially
inconsistent with State rules.
It is incorrect, however, to contend that FERC has failed
to fulfill its statutory obligations. For example, in the Puget
Energy case, FERC recently approved a Federal Power Act,
section 203 acquisition conditioned on the Washington Utilities
and Transportation Commission's approval of proposed ring
fencing provisions. If the Washington Commission's cross
subsidization requirements are not adequate to protect
customers, the Commission will consider requiring additional
ring fencing provisions. But I must note, being familiar with
the Washington Commission, I think it would be incorrect for
FERC to presume that the Washington Commission's protections
will be inadequate.
State Utility Commissions are generally best suited to
craft effective ring fencing conditions to protect utility
assets and more importantly, their own ratepayers. Therefore,
where State Utility Commissions are willing and able to impose
adequate ring fencing rules that protect customers, the FERC
should not preempt or require additional and potentially
conflicting measures. Mr. Chairman, thank you very much.
[The prepared statement of Mr. Spitzer follows:]
Prepared Statement of Marc Spitzer, Commissioner, Federal Energy
Regulatory Commission
The first and noblest mission of utility regulation is the
protection of the ratepaying public. The Federal Energy Regulatory
Commission (FERC) and state utility commissions share this important
mission through a matrix of federal and state rules. The primary
obligation of FERC is to ensure reliable wholesale energy supplies at
just and reasonable rates. As described in Chairman Kelliher's
testimony, FERC has adopted a number of mechanisms to fulfill its
statutory obligations.
In the Energy Policy Act of 2005 (EPAct 2005), Congress expanded
those obligations by amending Section 203 of the Federal Power Act
(FPA) to require FERC to consider, among other things, whether a
proposed merger or other corporate transaction will result in the
improper impairment of utility assets or subsidization of non-utility
affiliates. EPAct 2005, section 1289.
In response to EPAct 2005, FERC undertook several rulemaking
proceedings to establish regulations and policies governing cross-
subsidization and asset impairment attendant to review of transactions
under FPA Section 203. A primary objective of these proceedings,
particularly in light of the repeal of the Public Utility Holding
Company Act of 1935 (PUHCA 1935), was to address potential harm to
captive ratepayers.
Among the interests balanced in the FERC rulemakings were how to
faithfully discharge the Congressionally-mandated obligation without
unnecessarily or counter-productively interfering in the long-standing
tradition of ``ring-fencing'' decisions by state utility commissions. I
believe the FERC's policies achieve the correct balance. In ensuring
compliance with the requirement that an applicant demonstrate that a
proposed transaction will not result in inappropriate cross-
subsidization, FERC has deferred, and I believe should defer, to state
utility commissions' findings regarding ring-fencing. FERC will impose
protections regarding cross-subsidization or asset impairment only if
prophylactic authority does not exist under state law or if specific
state regulatory protections are insufficient to protect captive
customers.
FERC's imposition of additional ring-fencing measures is best
exercised as a ``backstop'' authority rather than as a mechanism to
preempt state action. State utility commissions have long employed
tools to protect their retail customers from asset impairment and
cross-subsidization in various contexts, including proceedings
regarding mergers and acquisitions. Thus, where states are willing and
able to address crosssubsidization, FERC generally should defer to
lawful and effective state utility commission orders.
As Chair of the Arizona Corporation Commission (Arizona
Commission), I presided over an application to acquire UniSource Energy
Corporation, the parent corporation of Tucson Electric Power Company.
In the Matter of the Reorganization of UniSource Energy Corporation,
Decision No. 67454, ACC Docket No. E-04230A-03-0933 (Jan. 4, 2005). In
that case, the Arizona Commission borrowed liberally from the 1997
decision of the Public Utility Commission of Oregon (Oregon Commission)
approving the acquisition of Portland General Electric Company by Enron
Corp. In approving the 1997 acquisition, the Oregon Commission adopted
several ring-fencing provisions that have been described as the ``gold
standard'' for the protection of retail ratepayers from asset
impairment and cross-subsidization in the context of a utility merger.
The ``proof in the pudding,'' so to speak, is that, due to the ten
ring-fencing conditions that the Oregon Commission imposed on that
merger transaction, the bankruptcy of Enron Corp. resulted in no
negative impacts upon the regulated Oregon utility. Testimony of
Commissioner Ray Baum of the Public Utility Commission of Oregon,
Technical Conference on Public Utility Holding Company Act of 2005 and
Federal Power Act Section 203 Issues, FERC Docket No. AD07-2-000, at 24
(Dec. 7, 2006).
The Arizona case raised potential asset impairment and cross-
subsidization concerns. Consequently, the Arizona Commission examined,
at great length, all of the potential adverse ratepayer impacts of the
acquisition of an Arizona utility by out-of-state interests. This
review resulted in the parties to the proceeding, including the Arizona
Commission staff, stipulating to the Oregon Commission's ring-fencing
language with modest revisions arising from and consistent with Arizona
law.
FERC should not presume states are unwilling to protect their
retail ratepayers from asset impairment or cross-subsidization. The
cases decided by state utility commissions, including my own experience
on the Arizona Commission, suggest the contrary is true. Therefore,
FERC properly has adopted a ``backstop'' for those circumstances where
the states are without statutory authority, or are unwilling, to impose
cross-subsidization protections.
In fact, since the passage of EPAct 2005, FERC has not preempted a
state utility commission's ring-fencing determination nor has it
imposed views potentially inconsistent with state rules. It is
incorrect, however, to contend FERC has failed to fulfill its statutory
obligations. For example, in Puget Energy, Inc., 123 FERC 61,050
(2008), FERC recently approved an FPA Section 203 acquisition
conditioned on the Washington Utilities and Transportation Commission
(Washington Commission) approval of proposed ring-fencing provisions.
If, however, the Washington Commission's cross-subsidization
requirements are not adequate to protect customers, the Commission will
consider requiring additional ring-fencing protections.
State utility commissions are generally best situated to craft
effective ring-fencing conditions to protect utility assets, and most
importantly, their own ratepayers. Therefore, where state utility
commissions are willing and able to impose adequate ringfencing rules
that protect consumers, the FERC should not preempt or require
additional, potentially conflicting, measures.
The Chairman. Thank you very much.
Commissioner Wellinghoff.
STATEMENT OF JON WELLINGHOFF, COMMISSIONER, FEDERAL ENERGY
REGULATORY COMMISSION
Mr. Wellinghoff. Thank you, Chairman Bingaman, Ranking
Member Domenici and members of the committee. Thank you for the
opportunity to appear here today to discuss these issues with
you. I endorse Chairman Kelliher's testimony concerning the
role of the Federal Energy Regulatory Commission in protecting
consumers against improper cross subsidization from mergers
that involve an electric utility holding company.
I would like to highlight three related issues though.
First, I strongly support Chairman Kelliher's statement that
FERC is a consumer protection agency. I also agree that FERC
and State regulators have a common interest in policing cross
subsidization.
I believe that FERC's approach to that issue appropriately
reflects both these important principles. Specifically, FERC's
approach recognizes that States have an important role to play
in protecting consumers against improper cross subsidization in
the context of corporate transactions. As Chairman Kelliher
described in evaluating merger applications pursuant to section
203, the Federal Power Act, as amended, FERC reviews ring
fencing measures and other merger conditions that a State
commission imposes to safe guard customers against cross
subsidization. If that examination convinces FERC that such
state imposed conditions are sufficient we will not impose
additional conditions.
However, our approach also recognizes that Congress
assigned new authority to FERC in EPACT 2005. Where we
determined that state imposed conditions are inadequate or that
relevant State commissions lack authority to act, FERC can and
will use our new authority under the 2005 EPACT to protect
consumers against improper cross subsidization. I believe that
such initial deference to State regulatory review where
appropriate both promotes an efficient use of resources and
fosters greater State/Federal coordination.
By contrast, I am concerned that a less flexible preemptive
approach would unnecessarily undermine such coordination and
would limit the ability of State commissions to craft cross
subsidization safeguards. In this regard I agree with the
comments made at FERC's December 2006 Technical Conference on
these issues by Oregon Commissioner Ray Baum and former
Wisconsin Commissioner Robert Garvin, who observed that many
State commissions are effectively and independently carrying
out the statutory responsibilities to protect retail customers
from adverse effects of subsidization by public utility
affiliates within a holding company organization.
Second, it's worth emphasizing that in every case under
section 203 of the FPA the Commission bases its decision on the
record developed in that case by the applicant and other
parties. In addition to submissions from customers,
competitors, State Commissioners and Attorney Generals, I'd
like to highlight the contribution that FERC receives from
State consumer advocates. I was honored to serve as Nevada's
first State Consumer Advocate for customers of public utilities
and I believe that State Consumer Advocates can and do play an
important role of building the case records that supports
FERC's actions to protect customers against improper cross
subsidization.
Finally while it is essential to have well designed rules
in place at the Federal and State levels to protect against
improper cross subsidization, it is equally important to ensure
that those rules are being followed. This is a place for
auditing. Because FERC has great resources for auditing than
the States in many instances this is an area in which Federal/
State collaboration can be particularly instructive.
As Chairman Kelliher stated in his testimony FERC's audit
staff interacts frequently with State regulators during an
audit reflecting our recognition that maintaining contact with
State regulators is mutually beneficial to FERC and the States.
I would like to reiterate Chairman Kelliher's comments that
FERC will continue to seek additional funds from Congress if we
believe that more resources are necessary to carry out
essential auditing responsibilities including cross
subsidization audits just as FERC currently did when requesting
additional funds for transmission system reliability audits.
Thank you very much again, Mr. Chairman for inviting me.
[The prepared statement of Mr. Wellinghoff follows:]
Prepared Statement of Jon Wellinghoff, Commissioner, Federal Energy
Regulatory Commission
Chairman Bingaman, Ranking Member Domenici, and members of the
Committee, thank you for the opportunity to appear before you today.
I endorse Chairman Kelliher's testimony concerning the role of the
Federal Energy Regulatory Commission (FERC) in protecting consumers
against improper cross-subsidization from mergers that involve an
electric utility holding company. I would like to highlight three
related issues.
First, I strongly support Chairman Kelliher's statement that FERC
is a consumer protection agency. I also agree that FERC and state
regulators have a common interest in policing cross-subsidization. I
believe that FERC's approach to this issue appropriately reflects both
of those important principles.
Specifically, FERC's approach recognizes that states have an
important role to play in protecting customers against improper cross-
subsidization in the context of corporate transactions. As Chairman
Kelliher described, in evaluating a merger application pursuant to
section 203 of the Federal Power Act (FPA) as amended by the Energy
Policy Act of 2005 (EPAct 2005), FERC reviews ring fencing measures and
other merger conditions that a state commission imposes to safeguard
customers against cross-subsidization. If that examination convinces us
that such state-imposed conditions are sufficient, then we will not
impose additional conditions.
However, our approach also recognizes that the Congress assigned
new authority to FERC in EPAct 2005. Where we determine that state-
imposed conditions are inadequate, or that a relevant state commission
lacks the authority to act, FERC can and will use our new authority
under EPAct 2005 to protect customers and ultimate consumers against
improper cross-subsidization.
I believe that such initial deference to state regulatory review,
where appropriate, both promotes an efficient use of resources and
fosters greater federal-state coordination. By contrast, I am concerned
that a less flexible, pre-emptive approach would unnecessarily
undermine such coordination and would limit the ability of state
commissions to craft cross-subsidization safeguards. In this regard, I
agree with comments made at FERC's December 2006 technical conference
on these issues by Oregon Commissioner Ray Baum and former Wisconsin
Commissioner Robert Garvin, who observed that many state commissions
are effectively and independently carrying out their statutory
responsibilities to protect retail customers from the adverse effects
of subsidization by public utility affiliates within a holding company
organization.
Second, it is worth emphasizing that in every case under section
203 of the FPA, the Commission bases its decision on the record
developed in that case by the applicant and other parties. In addition
to submissions from customers, competitors, state commissioners, and
attorneys general, I would like to highlight the contributions that
FERC receives from state consumer advocates. I was honored to serve as
Nevada's first consumer advocate for customers of public utilities, and
I believe that state consumer advocates can and do play an important
role in building the case records that support FERC's actions to
protect customers against improper cross-subsidization.
Finally, while it is essential to have well-designed rules in place
at the federal and state levels to protect against improper cross-
subsidization, it is equally important to ensure that those rules are
being followed. This is the place for auditing. Because FERC has
greater resources for auditing than the states in many instances, this
is an area in which federal-state collaboration can be particularly
constructive. As Chairman Kelliher stated in his testimony, FERC's
audit staff interacts frequently with state regulators during an audit,
reflecting our recognition that maintaining contact with state
regulators is mutually beneficial to FERC and the states. I would like
to reiterate Chairman Kelliher's commitment that FERC will continue to
seek additional funds from the Congress if we believe that more
resources are needed to carry out our essential auditing
responsibilities, including cross-subsidization audits, just as FERC
recently did when requesting additional funds for transmission system
reliability audits.
Thank you again for inviting me to speak here today.
The Chairman. Thank you very much. Thank you all for your
excellent testimony. Let me ask a few questions and then defer
to Senator Domenici for his questions.
It seems like just hearing your various statements, I
think, at least from my perspective, we're all in agreement on
some basic things. FERC should not be preempting the States. I
agree with that. I think everybody has said that.
It's best for FERC to exercise backstop authority. That's
what I think we intended with the law. I guess my concern is
that I don't know that there, I believe Commissioner Kelly, you
said that I think the words you used were that FERC needs to
have a clearly thought out and communicated enforcement
strategy. I'm not sure that that is currently in place.
I guess I'm not sure that State regulators or corporations
that may consider mergers have a clear idea of when FERC will
step in and exercise backstop authority. That's a concern that
occurs to me. Let me also just refer, I believe your testimony,
Commissioner Spitzer, of where you talk about here at the end
of your statement, where State Utility Commissions are willing
and able to impose adequate ring fencing rules that protect
consumers, FERC should not preempt or require additional,
potentially conflicting measures. I agree with that.
The obvious question though is what are adequate ring
fencing rules at the State level? What has FERC told States and
told potential companies, with the idea of entering into
mergers, about what adequate ring fencing rules are. I guess
that's my concern.
Chairman Kelliher, do you have some reaction to that?
Mr. Kelliher. Yes, sir. First of all, I agree that section
203, a point I tried to make in my oral testimony, that section
203 the Federal Power Act is highly complex and the
transactions are complex. I would not be surprised if there's
some level of uncertainty in the regulated community as well as
in the public as to how does FERC go about these reviews.
But also the reviews are very fact intensive because look
at two different scenarios. Look at two companies, utilities,
that are distribution only companies. They own no generation.
They own no transmission. They engage in no sales at market
based rates. All they do is provide distribution service at a
rate set by State regulators. Let's say they merge.
Then look at another scenario of two independent power
producers merge. They make no cost based sales. Everything is a
market based rate sale. Let's say they're arguably in two
totally different regions of the country.
The kind of conditions that FERC might impose, I would
expect would vary in those two circumstances. In the second
there might be an argument that there's actually no risk of
cross subsidization. If there's no rate set by government.
There's no cost base rate. There's no regulated rate. You can
argue there's actually no risk of cross subsidization. So we
don't impose any protections on cross subsidization. In the
first, you might also argue there's not a risk of cross
subsidization because there's no non-regulated--there's no sale
of a service or a product that's not regulated.
But the third scenario would be a complicated merger, a
holding company, two holding companies that engage in market
based rate sales, cost based rate sales. Let's argue they're
even adjacent. In that case we might see a significant risk of
cross subsidization, the need to guard against it. We would
look at how the State, in this case, there might be multiple
States. What conditions are imposed by the States in their
review of those mergers and then what conditions do we need to
perhaps add to that.
That's part of the difficulty is that some mergers involve
multiple States. Some involve one State. The recent action we
took on Puget. It involved an acquisition of a utility in a
single State. Washington State has very strong ring fencing
provisions. They have some of the best regulators in the State
including North Carolina.
North Carolina and Washington have excellent regulators.
[Laughter.]
Mr. Kelliher. We are not going to blindly trust them. But
we're going to rely on the commitments the applicant made and
the State regulators. Then we'll look at those commitments. We
might add to them.
The Chairman. Ok. Let me just ask Commissioner Kelly if you
have a thought about this. I gather, as I understand the
chairman's position is that there are so many varieties of
mergers involved here, so many circumstances, it's really not
possible to give more specific direction as to what the
Commission would expect States to do by way of dealing with
this problem.
Do you have a point of view?
Ms. Kelly. Mr. Chairman, I believe that we can exercise
more leadership in this area of ensuring sensible and
appropriate corporate structures. Many of the States are
sophisticated in this area, but others are not. We have mostly
deferred to the States.
We could do more without preempting the States than we have
done. For example, we could take a more active role in
explaining for the States, where the problems lie in explaining
the importance of preventing the possibility of cross
subsidization instead of just taking care of it through the
rate making process after it has occurred. Considering the
productive verses the non-productive or any productive
corporate structures that are possible and keeping an eye out
for interstate conflicts because when you defer to States that
have different rules, there is the potential of interstate
conflicts and of putting undue burdens on entities that do
business in multiple States.
It's possible that we could come up with principles to
guide States without preempting. I think we should also
consider the possibility of adopting the State's structural
requirements as our own because currently if we defer to the
States, it's just a State requirement. If we adopted them as
our own, it would give us the ability to use our enforcement
assets and resources in the event that the States don't have
adequate ones, should some transgression occur.
The Chairman. Thank you very much.
Senator Domenici.
Senator Domenici. Thank you, Mr. Chairman. Commissioner
Kelly, let me ask this--first make an observation. It seems to
me that I was listening to each Commissioner and it seems like
that they all agree that basically with Chairman Kelliher's
statement, with the exception of you, Commissioner Kelly. I'm
not sure how much you're differing.
First I would like to ask, so that I would understand that,
have you raised with the Commission or the chairman the facts
that you are raising here today? Ask that the Commission do
something that's preparatory that they aren't currently doing?
Ms. Kelly. Senator Domenici, our role in implementing this
provision of EPACT has evolved. It's evolved since the law was
passed in 2005. When we initially----
Senator Domenici. That has nothing to do with my question.
My question is have you recommended to the Commission that they
do something they're not doing with reference to implementation
of the provisions that we've put in the law?
Ms. Kelly. As we have gone along, I have worked with the
chairman and the other Commissioners to evolve our thinking on
this issue.
Senator Domenici. Right.
Ms. Kelly. Initially we didn't, when we implemented rules,
when we proposed rules and adopted rules to implement PUHCA
2005, we did not deal with the issue of looking in advance at
corporate structures and that was acceptable to me because we
didn't have the knowledge. However, the chairman agreed to have
a technical conference on the subject, which we did in 2006.
A result of that technical conference we accumulated more
knowledge on the issue. Then at the end of 2006, we issued a
policy statement which evolved our thinking on this issue and
showed that we did have a concern about pre-merger review of
corporate statements. In that policy statement we have we
talked about ring fencing and other structures. We announced
our policy of looking at the States. Then in subsequent
decisions we have continued to evolve our thinking.
So I feel that the relationship that I've had with the
chairman and the other Commissioners has been very productive
and has resulted in an evolution of thinking about the
importance of this. I anticipate that it will continue.
Senator Domenici. That was a very long answer to a very
easy question. It's not difficult. I mean I really think I was
asking you whether you shared these views with the Commission
or did you come share them with us today for the first time?
Ms. Kelly. Oh, thank you, Senator.
Senator Domenici. I asked the question like that. You
didn't answer it. But that's alright. I guess you don't want
to.
Chairman Kelliher, would you tell me with reference to the
GAO report, they find that FERC does not have a strong basis
for ensuring that cross subsidization does not occur. Do you
agree with the report? How is the Commission protecting
consumers in that regard?
Mr. Kelliher. I would have to say I strongly disagree with
the report and continue to disagree respectfully. But I think
our primary means--I think in part it's just a disagreement on
how--what is the best means for FERC to guard against improper
cross subsidization? FERC, we have done that historically
through rate making.
When we set a rate, we prevent cross subsidy from being
recovered when we set a rate, when we set a regulated rate. We
did that in the 1930s. We do that today.
To me, rate making is the principal means at FERC to guard
against improper cross subsidization. Our rate making authority
was not affected by any extent by the 2005 Act. It wasn't
decreased and i.e., rate making is our principal means of
guarding against cross subsidies.
The 203 merger provisions are a supplement to that because
in part they only apply under certain kinds of transactions and
by certain kinds of entities. Whereas rate making has a broader
reach and a continuous reach. A merger view is a single point
in time. Whereas rate making is, well, I don't want to say that
rate making is forever. It sounds obnoxious. It's suggests that
there will always be a FERC. But rate making is more permanent,
let's say.
Senator Domenici. Ok. I just want to know, I'm sure that
all the Commissioners are aware of the GAO study and the GAO
report. First let me start with you, Commissioner Moeller, do
you agree or disagree with the GAO report? Are you all doing
your job right or do they make suggestions that indicate you
should change your ways?
Mr. Moeller. Senator Domenici, I think what the GAO report
respectfully may have missed is the point that the chairman
made and I tried to make in my testimony, the role of rate
making in protecting consumers from inappropriate cross
subsidies. That said, I thought the recommendations were,
really several of them, reasonable. I think we've actually
worked at implementing some of them, particularly being a
little more open in terms of how our auditing process goes.
So in that sense, I think maybe they missed the larger
point. But I appreciated their recommendations.
Senator Domenici. What about you, Mr. Spitzer?
Mr. Spitzer. Thank you, Mr. Chairman, Senator. Certainly
the FERC and all of us are wiling to consider anything to
further protect the interest of the ratepayers of this country.
With regard to the specifics, I think I'd associate my views
with those of Commissioner Moeller.
In terms of information sharing, I think we maybe could do
a better job and that could be very valuable to State
regulators, particularly with new types of corporate
structures. Just as an example, in Arizona we had to modify the
Oregon ring fencing provisions because Oregon involved an
acquisition by a SEC corporation of the operating utility. In
Arizona you had a leveraged buy out transaction which was
structured as a general partnership.
So the ring fencing rules had to be different to
accommodate different structures. Now we have infrastructure
funds that are structured even differently than leveraged
partnerships. They're not based on debt. They're based on
equity. To the degree to which FERC will share information and
share audit reports with our State colleagues, I think would be
very valuable.
That being said, my experience in transactions prior to
PUHCA and then since I came to FERC in 2006, I don't see any
harm that's occurred by virtue of the FERC rulemaking. So I
don't believe our rulemaking is inadequate. But certainly
anything we can do in terms of further sharing information and
audits might be very beneficial.
Senator Domenici. Commissioner.
Mr. Wellinghoff. Mr. Chairman, Senator Domenici, I disagree
with the fundamental premise of the GAO report. That is, that
it indicates that we're not protecting the interests of
consumers. However I think I certainly would agree with
Commissioner Moeller and I think some of the points that
Commissioner Kelly made that there's always room for
improvement.
I think there are suggestions in the GAO report that
certainly are worth considering and worth incorporating into
our practices. I would have no problem with considering that.
Senator Domenici. Thank you very much. Ms. Kelly?
Ms. Kelly. Senator Domenici, I agree that the GAO provides
us with some good ideas for improving our enforcement process.
Senator Domenici. I thank you all very much. Thank you, Mr.
Chairman.
The Chairman. Senator Cantwell.
Senator Cantwell. Thank you, Mr. Chairman. Commissioner
Kelliher, when you have cross subsidization it results in
utilities paying either inflated or above cost for goods and
services provided by that non-utility, right?
Mr. Kelliher. It could work two ways. A utility could sell
something below cost to an affiliate that makes sales or a
utility could buy something from an affiliate at above cost. So
it could work both. The utility customer loses either way, I
think.
Senator Cantwell. Right.
Mr. Kelliher. Yes.
Senator Cantwell. Exactly. To know if a utility paid above
market prices for an affiliate you would have to look and
review the cost and do a comparative, right, to really
understand that?
Mr. Kelliher. Yes, when there's an attempt to recover those
costs through a rate because if a utility seeks to change a
rate or set a rate, they would need FERC approval for
jurisdictional transactions. They would need State approval for
other transactions.
Senator Cantwell. But I mean, you would have to review all
those costs to really understand that. FERC, you know, under
their market based rates, doesn't look at individual cost
components.
Mr. Kelliher. We're----
Senator Cantwell. For a utility rate. You don't look at
that.
Mr. Kelliher. Typically cross subsidy can occur when you
have a vertically integrated utility. This is a general rule.
Vertically integrated utility engages in both cost based
transactions as well as market based transactions.
Some company, corporate systems have affiliates and you
have the mix of both cost based and market based transactions.
Senator Cantwell. But I'm saying under FERC what you look
at. You look at market based rates and so the Commission
doesn't review those individual component costs in looking at
the utility rate.
Mr. Kelliher. We set both market based rates and cost based
rates. We set cost based rates for transmission. For wholesale
power sales we set cost based rates as well as market based
rates.
Market based rates are a privilege, not a right. To get
market based rates the company has to demonstrate the absence
of market power or mitigate any market power. We have been
revoking market based rates where we find that a company cannot
demonstrate the absence of market power.
Senator Cantwell. I feel like we're tiptoeing around this
issue as it relates to ring fencing and that is that somehow
it's this State should have the first attempt. I mean I look at
the GAO report and it says that FERC has made few substantive
changes to either its merger review process or its post merger
review oversight since EPACT. As a result does not have a
strong basis for ensuring that harmful cross subsidization does
not occur.
Maybe Commissioner Kelly is in a different position than
the rest of you on the panel. But it seems to me that FERC
should implement a ring fencing provision to have more
effective tools in looking at these mergers. It should be part
of the process. Because I think where you are with your market
based rate authority it creates an enormous opportunity for
utilities and these decisions to move away, basically, from
protecting the consumers.
You're the cop on the beat. You can't leave it up to the
great State of Washington, ok. Yes, they have a great utility.
That utility commission did its job, but what about the other
States? What about these issues that are across States?
So you're basically saying, yes, it really worked
effectively in Washington State because they did their job. But
the bottom line is you don't have effective tools unless you
adopt something, like ring fencing, to really say that
consumers are going to be protected. I think the bottom line
here is that the public needs to understand because I don't
know of anybody out there who really is following the cross
subsidization, ring fencing, all of that dialog.
I mean the bottom line here is on mergers. Is the cop on
the beat going to do their job and protect consumers when a
merger happens from allowing a partnership, profit margin
sharing to basically drive up the rates, eventually, from
consumers? Because if you would have had a savings and instead
they are used. If you would have had profits and they were used
instead to subsidize this other company instead of helping to
protect the consumers on their rates. Eventually the consumer's
rates are going to go up.
So, I'm, Mr. Chairman, a fan of having a stronger statute
at the Federal level. We can't just leave it up to whether some
States want to do this job in policing the markets. That's what
FERC's job is, policing the markets.
I thank the Chair.
Mr. Kelliher. Could I respond, Mr. Chairman or I'm sorry.
The Chairman. If you'd like to respond, go ahead. If not,
we'll go to the next questioner. Go ahead.
Mr. Kelliher. At your discretion, sir.
The Chairman. You go ahead.
Mr. Kelliher. Ok, thank you. I would like to say, emphasize
that we do not blindly trust the States. Look at the
hypothetical--look at Washington State. Washington State has
strong ring fencing provisions. We approved the Puget Sound
acquisition, but we retained the authority to impose--issue
additional orders, impose additional conditions.
Look at a hypothetical. Let's assume failure by the
Washington State regulators, I don't think it's likely, but I
suppose it's not a zero percent scenario. Let's assume they
just set aside the requirements and say, we're not going to
ring fence. We're not going to do anything. We'll impose no
cross subsidization provisions.
In that scenario I think there's a good chance the
Commission would issue a future order imposing its own cross
subsidization provisions. It might be ring fencing. It might be
something else. But there is a possibility of preemption as we
use of cross subsidization authority in section 203. But it is
a last resort, not a first resort. I think that's the
distinction.
Should it be a first resort? Should it be reflexive? Should
we have something on the shelf that we impose in every 203
transaction? I don't think that would be wise given the nature
of the transactions.
The Commission recently had to approve the acquisition of
Bear Sterns by J.P. Morgan. Ring fencing frequently improves
cash management. If we had a uniform Federal approach on cross
subsidization I suppose we would have taken it and imposed it
in the J.P. Morgan acquisition of Bear Sterns. FERC would be
policing the cash activities of that entity. That doesn't seem
to be--we decided that really wasn't the right approach.
So there is a scenario of preemption if we're convinced
there's failure by the States. So that seemed to be your
concern. I just wanted to reassure you that we will act in the
event that a State fails, does not have to prevent cross
subsidies. We will attach our own provisions.
Senator Cantwell. If I could, Mr. Chairman, for 15 seconds.
The Chairman. Sure.
Senator Cantwell. I would just say with all that's happened
in the marketplace, having a very bright line on something like
ring fencing. That it's in your tool box would help in stopping
these problems. I certainly, you know, Bear Sterns owning, you
know, 10 percent of a utility.
I would hate to see what would happen to Bear Stern to own
10 percent of all utilities. We'd all be in a lot of trouble.
So, thank you.
The Chairman. Senator Craig.
Senator Craig. Thank you very much, Mr. Chairman. I say to
all of you I helped lead the repeal of PUHCA. I'm glad it's
gone. So, I'm always curious when those who opposed it ask the
GAO to examine because in repealing it we saw multiple roles.
We saw the role of the State as it related to cross
subsidization. I think you've all spoken to that. It sounds
like whether some agree or disagree that there's a variance of
ability or desire out there. But where it appears to be
necessary there seems to be action. It also appears to me that
at least, Mr. Chairman, you're telling us that where there is
inaction, the FERC is very willing to take action.
I've always felt in the marketplace in your role of
protecting consumers that rates went a lot further in
protecting the consumer than bureaucracies, often times or
systems. Now systems can lead to rates. I understand that.
But at the same time I'm glad you see a State role. I think
that's extremely important in all of this. As our markets
change, obviously the oversight and the responsibility of FERC
is critically important. I would much prefer that this
committee and the GAO focus on other things that I think are
tremendously more important today to consumers than this
business.
How about market manipulation, reliability, competitive
markets, I mean, to me, today, in the changing face of where we
are, those become extremely more valuable as roles for FERC to
play. I would hope that the business that you're in as it
relates to this particular activity and transitioning out of
PUHCA is not overpowering your ability to do all of these other
things. Because I think there are considerably more important
to the consumer in the marketplace.
I also want to thank you for, you know, implementing hydro
re-licensing. Those are the kinds of things that we have to get
done out there in the market that is important. You deserve
kudos for that. I'm willing to offer those up because I think
it's important.
So I guess if there is a question in my comment it would be
are you spending the right amount of time and the right amount
of energy and the right amount of resource in reliability,
market manipulation, competitive markets? Mr. Chairman?
Mr. Kelliher. I think those are exactly the top priorities
in the areas of enforcement. These are new responsibilities
Congress gave us just two and a half years ago and to me the
top priorities in the area of enforcement are preventing market
manipulation, preventing market power exercise and upholding
reliability standards. That's where we have to dedicate our
resources.
If they're top priorities they should get top priority of
our resources. So we are conducting audits. We are conduction
PUHCA audits. We conduct other financial audits. But I think we
have to focus on the high priorities.
Senator Craig. Anyone else wish to respond?
Ms. Kelly. Senator, I would just like to take this
opportunity to say how much I've appreciated Chairman
Kelliher's leadership in the implementation of EPACT 2005. As
this committee well knows, we were given many new tasks and
many new responsibilities. I believe that, if I recall
correctly, the initial list was 35 new efforts we were to
undertake within a year and a half and we did all of those.
I think that with our newest responsibilities the way we
are approaching them is continuing to evolve and continuing to
improve which is not surprising that it works that way as we
get more familiar with our responsibilities. If I could make
one more pitch that I put in my written testimony for more
resources for enforcement. Thank you.
Senator Craig. Thank you, Commissioner Kelly. It's
certainly in those priorities that we've laid out in EPACT
2005, we want to make sure you have the resources to do that. I
think the American consumer, more today than ever before, is
focused on the price of their energy. They want to know that
it's being reasonably priced in relation to its costs of
production. Thank you. Thank you all.
The Chairman. Senator Salazar.
Senator Salazar. Thank you.
Senator Domenici. Senator Salazar, would you yield for one,
30 seconds?
Senator Salazar. Absolutely, Senator.
Senator Domenici. I wanted to make an observation, Senator
Bingaman. I have to leave for a while. I just wanted to
congratulate the Commission. I think that you have properly,
Commissioner Kelly, summarized the great task that we gave you.
I don't think there's a better Commission than this one, nor do
I think looking at the law which had abundant new provisions
for a lot of agencies. A great law, I think.
You all were given about as many changes to administer as
any and you did it admirably. So I commend you. I hope that we
can get you the right resources. You're not the only one that
tells us they need them, but I'm glad you reminded us. As you
should be adequately--you should have adequate resources for
powerful people that are smart, that know their business,
helping you. So thank you very much. Thank you, Mr. Chairman.
The Chairman. Thank you. Senator Salazar.
Senator Salazar. Thank you, Chairman Bingaman. Thank you
for the Commissioners and your testimony here this morning. You
know, I looked at the GAO report last night and as I was
reading it, it seems to be simply in many ways a suggestion for
how we improve regulation.
I mean, if you look at the title of the report itself. It
says Utility Regulation opportunities exist to improve
oversight. Looking at the summary of what the GAO has found
here. It says that all the comprehensive risk based approach to
planning audits. It says monitor financial conditions of
utilities and has other recommendations there.
Yet I sense from the testimony presented both in written
form as well as here this morning that the Commission is being
very defensive of these GAO findings. If you recall in the 2005
bill which we were all involved in getting through. The
legislation that was proposed or the amendment I think on the
floor by Senator Brownback and Senator Feingold resulted in our
agreeing that what we would do is to have GAO conduct a review
after we had the chance to implement the law for a couple of
years.
So my question to each of you starting with you, Chairman
Kelliher, is whether there are things in this GAO report that
you find useful in terms of the ultimate objective here which
is making sure that we are protecting consumers in this new day
of post PUHCA which had been in place for what, 70 years before
we got to the 2005 EPACT Act. Are there things within the
recommendations that the GAO has provided to this committee
that you would find helpful. What would be the top two or three
if, or maybe you don't find any helpful? Give me a response to
that.
Mr. Kelliher. I would say that I would disagree with some
of the assertions and conclusions in the report. I just think
they're simply incorrect. But I don't reject the
recommendations out of hand. I think it is something we should
bear in mind whether we should conduct more audits. I think
that's, you know, in a perfect world we would do more across
the board in the area of enforcement. Perhaps we would do more
audits.
I think in some cases it's just a difference in
interpretation. I think we actually do risk based audits
currently. But we just view risk in a different manner than
GAO. But I think, as my colleagues have said, we are taking
therecommendations in the spirit in which they are offered.
I would have preferred that the report say that FERC is
doing a good job and it could do an even better job if it
considered these recommendations. But we're considering the
recommendations nonetheless.
Senator Salazar. Is the ability to do a better job
dependent on the resources currently that FERC has? For
example, doing additional audits or what are the barriers for
the Commission of being able to implement an improvement
strategy along the lines that GAO has indicated?
Mr. Kelliher. Resources are certainly an issue because we
have asked Congress for additional enforcement resources and
Congress has been supportive. But whatever we have is finite.
Then we have to allocate it.
To me the highest priority areas are preventing market
manipulation, preventing market power exercise, upholding
reliability standards. Then the other enforcement priorities
have to, to some extent, fight for the remainder of our
enforcement budget. This, I don't think, I think the financial
audits, the PUHCA audits simply aren't the same priority as
preventing market manipulation.
So if we do get more enforcement resources we might be able
to conduct more audits.
Senator Salazar. Let me ask the other Commissioners if
you'd comment quickly on this.
Commissioner Kelly.
Ms. Kelly. Senator Salazar, I agree with the GAO's
recommendation that we engage in some sort of open,
transparent, comprehensive risk based or some other similar
approach to undertake our enforcement activities. I think that
would be helpful to us. I think it would be helpful to the
regulated community.
So I think they have a lot to offer there. I do believe
that we need more resources in our enforcement area.
Senator Salazar. Commissioner Moeller.
Mr. Moeller. Senator Salazar, a little context, having been
a Senate staffer for several years when PUHCA repeal was being
considered, I think there was a big concern that there would be
merger mania after it was repealed. I think the perspective is
that there hasn't been, that we have been vigilant, but we need
to continue to be vigilant in examining inappropriate cross
subsidization in the case of a merger.
In talking to our audit folks, I think they feel that they
could be a little more open. But they also focus on things
where they see improvements. They don't go through the litany
of where they think a company is doing something well.
So that could be just a basic disagreement as to an
approach as to how we do audits. But again, I'm amenable to any
recommendations on how we can be more open and more transparent
in every part of our enforcement program.
Senator Salazar. Commissioner Spitzer.
Mr. Spitzer. Thank you, Senator. There were a number of
mergers arising prior to 2005 repeal of 1935 PUHCA. A number of
them turned out very badly including the Kansas transaction
that I know concerned Senator Brownback and 1935 PUHCA did not
serve ratepayers well. My judgment is that, due to the efforts
of this Congress, in 2005 ratepayer protections were actually
enhanced over the status quo ante.
The second observation would be that had FERC promulgated a
rule of a one size fits all preemptive ring fencing, for
example, Oregon, that would not have worked in the Arizona
transaction and might not have worked in other transactions
involving different types of investment vehicles.
That would segue into my third observation which would be
perhaps more outreach by FERC to State commissions. Making the
States aware, which have limited resources, that FERC has
perhaps certain observations or views regarding some of the new
investment vehicles in the utility space might assist the
States. That is the information and collaborative outreach that
I look forward to working with my State colleagues in the
future.
Senator Salazar. If I could ask one more question of you?
Is there a great variance in terms of the State capacity from
PUC to PUC? I would imagine that you have some States that have
significant resources and can provide the oversight function
that allows for them to play the backstop function. But do you
have? I would imagine the Commission has a good sense that some
States are, you might give them a ten in an eight plus rating
in terms of their oversight. Other States probably don't have
the resources really to provide that kind of oversight.
Mr. Spitzer. Senator in the second panel you're going to
hear from NARUC and Mr. Kerr, Commission Kerr, could certainly
discuss some of the efforts that the States have done in
collaborating amongst themselves. I would agree absolutely that
the States have different levels of resources and both within
the NARUC as well with FERC, there is collaboration with the
States. One of our missions should be to assist those States
where resource constraints cause them to ask for additional
advice.
Senator Salazar. Thank you.
Commissioner Wellinghoff.
Mr. Wellinghoff. Thank you, Mr. Chairman, Senator Salazar.
I believe that there are a number of things in the GAO report
that we do need to consider. We look at the issue of risk
ranking of audits, for example.
I would agree with the chairman that I think in some degree
we do that already. Certainly with risk ranking, looking at
market manipulation is the highest risk. The highest potential
harm to consumers I think we have to really put our audit
enforcement forces in that area first.
However, with respect to within analysis of potential cross
subsidization, perhaps there is some room for more structured
ranking of those audits as GAO suggests. But perhaps GAO also
needs to investigate more detail exactly how we are currently
structuring those audits. As the chairman indicates we do have
some measure of a risk ranking that we already use, although it
may not be something that's published and transparently
available.
If we did provide that information I think it could help
clarify that. In addition to the chairman's point on making it
more transparent as to what our backstop really is. Let's make
it clear. There certainly is a backstop to the extent that the
States are not providing for a vigorous and effective ring
fencing.
It certainly would be my policy and my position that FERC
would and should step in. But there is an issue of what is
actually that line. I think Senator Cantwell was concerned
about what is that line as well. Perhaps we could have a
workshop with the States and with the industry to explore that
line a little more.
I think we're defining the line as we get more cases.
Certainly I think the Puget case gives us one point on that
line. But perhaps we need to get more points on that line.
Thank you.
Senator Salazar. Thank you, Commissioner. Thank you, Mr.
Chairman.
The Chairman. Thank you very much. Let me thank all the
Commissioners. You've been very generous with your time and
very excellent testimony. We appreciate it.
Why don't we go ahead with the second panel? We have four
additional witnesses on the second panel.
Mark Gaffigan, who's the Director with the Energy Project
Division of Natural Resources and Environment with the GAO.
David Owens, Executive Vice President with Edison Electric
Institute.
The Honorable James Kerr who is the Commissioner with the
North Carolina Utilities Commission and representing NARUC here
today.
Scott Hempling is Executive Director with the National
Regulatory Research Institute.
Thank you all for being here.
Commissioner Kerr, I mispronounced your name. I apologize.
Let me just alert folks that about 11 o'clock, I'm going to
have to go to a meeting that Senator Reid has called. Senator
Salazar has agreed to remain and preside at that point. So, why
don't we go ahead with testimony? Then after each of you has
summarized your testimony I'm sure there will be questions.
Mr. Gaffigan, why don't you go right ahead?
STATEMENT OF MARK GAFFIGAN, DIRECTOR, NATURAL RESOURCES AND
ENVIRONMENT, GOVERNMENT ACCOUNTABILITY OFFICE
Mr. Gaffigan. Thank you, Mr. Chairman. Mr. Chairman,
Senator Salazar, members of the committee, Good morning. I'm
pleased to be here to discuss Federal and State oversight of
electric utility holding companies in light of the 2005 repeal
of PUHCA.
Since the repeal of PUHCA there has been considerable
interest about harmful cross subsidization--that is the passing
of inappropriate costs to utility consumers from transactions
between utilities and affiliated companies that are part of
larger utility holding companies. Regarding Federal oversight
of cross subsidization PUHCA's repeal impacted the Federal
Energy Regulatory Commission in two ways.
First, FERC's merger review responsibilities were expanded
to ensure at the time of merger that mergers between companies
would not result in cross subsidization.
Second, it made FERC the principle Federal agency
responsible for post merger oversight of utility holding
companies, eliminating the role of the Securities and Exchange
Commission.
States continue to share in utility oversight and are very
much interested in and impacted by Federal efforts. My
testimony today will be based on GAO's February 2008 report
that addressed the extent to which FERC has changed its merger
and post merger oversight processes to protect against cross
subsidization and second, the views of States about their
oversight capacity.
Regarding FERC, as has been stated, we found that FERC had
made few substantive changes to either its merger review
process or its post merger oversight and thus did not have a
strong basis for ensuring that harmful cross subsidization does
not occur. In the merger review process, FERC will rely on its
existing policy that requires merging companies to disclose
existing or planned cross subsidization. To certify in writing
that they will not engage in cross subsidization.
After mergers take place, FERC will rely on its existing
enforcement mechanisms, which include company self reporting of
violations. Two, a limited number of compliance audits. Our
primary concern and the focus of our report recommendations is
our view that FERC is over reliant on self reporting and under
reliant on cost and compliance audits.
Specifically FERC believes that the threat of large fines
will encourage companies to investigate and self report any
cross subsidization. However, to date, no companies have self
reported any such violations. Some key stakeholders who we
spoke to have raised concerns about this approach.
For example, could large fines chill a company's
willingness to self report? Others were concerned that
companies may not be fully aware of the broad cross
subsidization rules. Given the concerns about self reporting
and its inherent limitations, FERC's other primary enforcement
mechanism, compliance audits, is an important tool.
However, since the repeal of PUHCA, FERC has not completed
any holding company audits for cross subsidization. In 2008,
FERC plans to audit three of the 36 holding companies it has
determined are subject to its oversight. While this rate of
review and the number of holding companies may change, at this
pace, it would take 12 years for FERC to review each company.
Most important, while FERC's audit plans for 2008 reflects
insights of key staff. We did not find that FERC had a risk
based approach that formally considers the risk posed by
individual companies in determining where to focus its audit
resources. For example, the use of company financial
information and input from knowledgeable people in the
financial community and States could be used to help plan
FERC's audits.
Without a risk based approach, FERC may not be effectively
allocating its limited audit resources. Currently FERC's
division of audits has 34 full time staff. With a magnitude of
companies it oversees and a range of rules it enforces that go
well beyond holding company cross subsidization.
Making the most of limited resources is a theme that is not
exclusive to the Federal role. It is an excellent segue to the
State's views on their oversight capacity. While State views
vary, a common theme that we identified in our survey of the
States was the need for additional resources to respond to
changes in oversight after repeal of PUHCA.
For example, the majority of States reported auditing 1
percent or less of transactions between affiliated companies
over the last 5 years. States expressed their concerns about
Federal over reliance on self reporting and the need for
regular audits in light of their limited resources. Since
oversight is a shared mission, and there is a common resource
limitation, it makes even more sense for FERC to consider our
recommendations to develop a risk based audit approach that
includes collaboration with the States, consideration of
company's financial status and clear audit reporting. After
development of such an approach, FERC would also be in the best
position to assess the need for its resources to perform its
audits.
This concludes my opening statement. I have submitted a
written statement for the record. I welcome any questions you
might have. Thank you.
[The prepared statement of Mr. Gaffigan follows:]
Prepared Statement of Mark Gaffigan, Director, Natural Resources and
Environment, Government Accountability Office
Utility Regulation: Opportunities Exist to Improve Oversight
WHY GAO DID THIS STUDY
Under the Public Utility Holding Company Act of 1935 (PUHCA 1935)
and other laws, federal agencies and state commissions have
traditionally regulated utilities to protect consumers from supply
disruptions and unfair pricing. The Energy Policy Act of 2005 (EPAct)
repealed PUHCA 1935, removing some limitations on the companies that
could merge with or invest in utilities, and leaving the Federal Energy
Regulatory Commission (FERC), which already regulated utilities, with
primary federal responsibility for regulating them. Because of the
potential for new mergers or acquisitions between utilities and
companies previously restricted from investing in utilities, there has
been considerable interest in whether cross-subsidization--unfairly
passing on to consumers the cost of transactions between utility
companies and their ``affiliates''--could occur.
GAO was asked to testify on its February 2008 report, Utility
Oversight: Recent Changes in Law Call for Improved Vigilance by FERC
(GAO-08-289), which (1) examined the extent to which FERC changed its
merger review and post merger oversight since EPAct to protect against
cross-subsidization and (2) surveyed state utility commissions about
their oversight. In this report, GAO recommended that FERC adopt a
risk-based approach to auditing and improve its audit reports, among
other things. The FERC Chairman disagreed with the need for our
recommendations, but GAO maintains that implementing them would improve
oversight.
WHAT GAO FOUND
In its February 2008 report, GAO reported that FERC had made few
substantive changes to either its merger review process or its post
merger oversight since EPAct and, as a result, does not have a strong
basis for ensuring that harmful cross-subsidization does not occur.
FERC officials told GAO that they plan to require merging companies to
disclose any cross-subsidization and to certify in writing that they
will not engage in unapproved cross-subsidization. After mergers have
taken place, FERC intends to rely on its existing enforcement
mechanisms--primarily companies' self-reporting noncompliance and a
limited number of compliance audits--to detect potential cross-
subsidization. FERC officials told us that they believe the threat of
the large fines allowed under EPAct will encourage companies to
investigate and self-report noncompliance. To augment self-reporting,
FERC officials told us that, in 2008, they are using an informal plan
to reallocate their limited audit staff to audit the affiliate
transactions of 3 of the 36 holding companies it regulates. In planning
these compliance audits, FERC officials told us that they do not
formally consider companies' risk for noncompliance --a factor that
financial auditors and other experts told us is an important
consideration in allocating audit resources. Rather, they rely on
informal discussions between senior FERC managers and staff. Moreover,
we found that FERC's audit reporting approach results in audit reports
that often lack a clear description of the audit objectives, scope,
methodology, and findings--inhibiting their use to stakeholders.
GAO's survey of state utility commissions found that states' views
varied on their current regulatory capacities to review utility mergers
and acquisitions and oversee affiliate transactions; however many
states reported a need for additional resources, such as staff and
funding, to respond to changes in oversight after the repeal of PUHCA
1935. All but a few states have the authority to approve mergers, but
many states expressed concern about their ability to regulate the
resulting companies. In recent years, two state commissions denied
mergers, in part because of these concerns. Most states also have some
type of authority to approve, review, and audit affiliate transactions,
but many states review or audit only a small percentage of the
transactions; 28 of the 49 states that responded to our survey question
about auditing said they audited 1 percent or fewer transactions over
the last five years. In addition, although almost all states reported
that they had access to financial books and records from utilities to
review affiliate transactions, many states reported they do not have
such direct access to the books and records of holding companies or
their affiliated companies. While EPAct provides state regulators the
ability to obtain such information, some states expressed concern that
this access could require them to be extremely specific in identifying
needed information, thus potentially limiting their audit access.
Finally, 22 of the 50 states that responded to our survey question
about resources said that they need additional staffing or funding, or
both, to respond to changes that resulted from EPAct, and 8 states have
proposed or actually increased staffing since EPAct was enacted.
Mr. Chairman and Members of the Committee: Thank you for the
opportunity to discuss our work on federal and state efforts to protect
against potential cross-subsidization in the utility industry after the
repeal of the Public Utility Holding Company Act of 1935 (PUHCA 1935).
Public utilities sell about $325 billion worth of electricity and
natural gas to more than 140 million customers in U.S. homes and
businesses each year. These utilities may face the need to invest
potentially hundreds of billions of dollars to expand and upgrade the
utility infrastructure over the next 10 years. Oversight of utilities
is carried out by the federal government and state commissions--with
the federal role focused on regulation of interstate transmission and
wholesale markets and the states' role focused on regulating retail
markets. These federal and state regulators seek to balance efforts to
protect utility consumers from potential supply disruptions and unfair
pricing practices while ensuring that utilities are profitable enough
to attract private investment. Traditionally, this regulation took
place within the framework of PUHCA 1935 and other federal laws. In
2005, the Energy Policy Act (EPAct) repealed PUHCA 1935, removing some
limitations on the companies that could merge with or invest in
utilities and opening the sector to new investment. The repeal of PUHCA
1935 has raised concerns about whether the remaining laws and
regulations strike an appropriate balance between encouraging
investment in the utility sector and protecting consumers.
PUHCA 1935 was a response to the rapid expansion, consolidation,
and subsequent bankruptcies in the utility sector during the early part
of the 20th century. Prior to its enactment, utilities were regulated
by state commissions. As utilities grew, they began to span across
multiple states that often had different rules and jurisdictional
authority, making it difficult for state utility commissions to
effectively regulate them. By the 1920s, as a result of mergers and
acquisitions, utilities were largely controlled by a handful of complex
corporations--called holding companies--many of which owned several
utilities as well as other companies. In many cases, the companies
within these holding companies--called affiliates--sold a wide range of
goods and services to utilities, such as fuel for power plants. Since
the rates utility customers pay generally include the cost of all the
goods and services bought to serve them, some transactions between
these affiliates allowed the utilities to take advantage of economies
of scale to the benefit of utility customers, such as when utilities
effectively shared the cost of legal and other administrative services
with affiliates instead of each company maintaining staff and other
resources to provide these services separately.
However, affiliate transactions that were priced unfairly could
inflate customers' rates to subsidize operations outside the utility--
called cross-subsidization. Compounding this complex web of corporate
ownership and affiliate transactions, poor disclosure of financial
information and limited access to financial records made it difficult
for investors to accurately assess the utilities' financial health.
Many of these holding companies were involved in risky business
ventures outside the utility industry and had pledged utility assets to
support those investments. Partly as a result of the poor financial
disclosure and the complex web of corporate ownership and affiliate
transactions, many utilities went into bankruptcy during the financial
collapse followed by the Great Depression.
To restore public confidence after the Depression, the federal
government undertook three efforts that influenced the regulation of
utilities. First, to protect investors, including utility investors,
the federal government created the Securities and Exchange Commission
(SEC) in 1934. SEC established rules--including improved financial
reporting--for the financial markets and publicly traded companies
participating in those markets, as well as a means to regulate them.
Second, to protect utility customers, the federal government enacted
the Federal Power Act of 1935 which served, and continues to serve
today, as the foundation of federal regulatory authority related to
regulation of public utilities, and empowered the Federal Energy
Regulatory Commission (FERC) to serve as the primary federal regulator
of utilities.\1\ As such, FERC became responsible for overseeing
interstate transmission of electricity, wholesale sales of electricity
to resellers (e.g., sales by utilities to other utilities), and
reviewing proposed mergers or acquisitions involving companies it
regulates. In its role of regulating interstate transmission and
wholesale sales, FERC has been responsible for approving prices (i.e.,
rates) for the use of transmission lines and the sales of electricity
in wholesale markets--also commonly called ``rate setting.'' As part of
that process, FERC has determined which costs, including affiliate
transaction costs, may be lawfully included in rates. Third, the
federal government enacted PUHCA 1935 to regulate investment in the
utility industry and protect investors and consumers from potential
abuses such as cross-subsidization by holding companies. SEC was
responsible for administering PUHCA, including reviewing mergers or
acquisitions involving holding companies. To that end, SEC was given
primary responsibility for examining and determining how to allocate
affiliate transaction costs for holding companies it regulates. Among
other things, PUHCA limited the formation of new holding companies that
were not physically connected by electric power lines, and prohibited
existing holding companies from acquiring more than one utility, unless
the utilities were physically connected by power lines. Over time,
other statutory and regulatory changes reduced some of the strict
limitations PUHCA 1935 initially imposed.
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\1\ The Federal Power Act of 1935 empowered the Federal Power
Commission, the predecessor to FERC.
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Over the past two decades, some interested parties in the utility
industry sought repeal of PUHCA 1935, arguing that it was a roadblock
to the private investment that could reduce the cost of improvements to
the utility infrastructure, and noting that several federal antitrust
laws that apply to utility companies have been passed since PUHCA was
enacted. Opponents of PUHCA 1935's repeal, including some business and
consumer representatives, expressed concern that its repeal would
encourage utilities to return to the kinds of risky business ventures
that spawned it, and that utilities would again become too complex to
effectively regulate, potentially raising prices for consumers.
Business groups outside the utility industry were also concerned that
utilities could use their monopolies to cross-subsidize investments
into other kinds of businesses and harm competition in those
industries.
In 2005, EPAct repealed PUHCA 1935--thereby opening the sector to
new investment--and replaced it with PUHCA 2005. The repeal of EPAct
1935 eliminated SEC's oversight role in regulating utility holding
companies or preventing cross-subsidies, giving FERC new authorities to
regulate corporate structures and transactions.\2\ FERC's expanded
authorities fall into two broad areas: 1) FERC was required to ensure
at the point of the merger review that the proposed merger would not
result in harmful cross-subsidization, and 2) FERC became the principal
federal agency responsible for determining how costs for affiliate
transactions should be allocated for all utility holding companies. To
help FERC better oversee these transactions, EPAct provided FERC
specific postmerger access to the books, accounts, memos, and financial
records of utility owners and their affiliates and subsidiaries, and
granted state utility commissions similar access. Furthermore, EPAct
expanded FERC's civil penalty authority to help it enforce its new
requirements, providing the commission the ability to levy penalties of
up to $1 million per day per violation. After EPAct, states continue to
play key roles overseeing utilities and reviewing mergers, including
conducting some audits of affiliate transactions.
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\2\ The SEC will continue enforcing laws and regulations governing
the issuance of securities and regular financial reporting by public
companies. The Department of Justice and the Federal Trade Commission
will continue their long-standing enforcement of antitrust laws. These
include the premerger provisions of the Hart-Scott-Rodino Antitrust
Improvements Act of 1976 and Section 7 of the Clayton Act.
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My testimony today will focus on our February 2008 report, Utility
Oversight: Recent Changes in Law Call for Improved Vigilance by FERC
(GAO-08-289), which examined: (1) the extent to which FERC, since
EPAct's enactment, has changed its merger or acquisition review process
and postmerger or acquisition oversight to ensure that potential
harmful cross-subsidization by utilities does not occur; and (2) the
views of state utility commissions regarding their current capacity, in
terms of regulations and resources, to oversee utilities. For that
report, we reviewed relevant reports and data, interviewed key
officials, visited four states--California, New Jersey, Oregon, and
Wisconsin--that had or were considering implementing strong protections
for overseeing holding and related affiliate companies, and surveyed
state utility regulators in all 50 states and the District of Columbia.
We performed our review from May 2006 through February 2008 in
accordance with generally accepted government auditing standards. Those
standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives.
In summary, we found:
FERC has made few substantive changes to either its merger
review process or its postmerger oversight since EPAct and, as
a result, does not have a strong basis for ensuring that
harmful cross-subsidization does not occur. FERC officials told
us that they plan to require merging companies to disclose
existing or planned cross-subsidization and to certify in
writing that they will not engage in unapproved cross-
subsidization. Once mergers have taken place, FERC intends to
rely on its existing enforcement mechanisms--primarily
companies' self-reporting noncompliance and a limited number of
compliance audits--to detect potential cross-subsidization.
FERC officials told us that they believe the threat of large
fines, as allowed by EPAct, will encourage companies to
investigate and self-report noncompliance. To augment self-
reporting, FERC officials told us that they are using an
informal plan to reallocate their limited audit staff to
conduct affiliate transaction audits of 3 of the 36 holding
companies it regulates in 2008. In planning these compliance
audits, FERC officials told us that they do not formally
consider companies' risk for noncompliance--a factor that
financial auditors and other experts told us is an important
consideration in allocating audit resources--relying instead on
informal discussions between senior FERC managers and staff.
Moreover, we found that FERC's audit reporting approach results
in audit reports that often lack a clear description of the
audit objectives, scope, methodology, and findings--inhibiting
their use to stakeholders.
Although states' views varied on their current regulatory
capacities to review utility mergers and acquisitions and
oversee affiliate transactions, many states reported a need for
additional resources, such as staff and funding, to respond to
changes in oversight after the repeal of PUHCA 1935. All but a
few states have merger approval authority, but many states
expressed concern about their ability to regulate the resulting
companies after merger approval. In recent years, two state
commissions denied mergers, in part because of these concerns.
Most states also have some type of authority to approve,
review, and audit affiliate transactions, but many states
review or audit only a small percentage of the transactions,
with 28 of the 49 reporting states auditing 1 percent or less
over the last five years. In addition, although almost all
states reported that they had access to financial books and
records from utilities to review affiliate transactions, many
states reported they do not have such direct access to the
books and records of holding companies or their affiliated
companies. While EPAct provides state regulators the ability to
obtain such information, some states expressed concern that
this access could require them to be extremely specific in
identifying needed information, thus potentially limiting their
audit access. Finally, 22 of the 50 states that responded to
our survey question about resources said that they need
additional staffing or funding, or both, to respond to changes
that resulted from EPAct, and 8 states have proposed or
actually increased staffing since EPAct was enacted.
FERC'S MERGER AND ACQUISITION REVIEW AND POSTMERGER OVERSIGHT TO
PREVENT CROSS-SUBSIDIZATION IN UTILITY HOLDING COMPANY SYSTEMS ARE
LIMITED
In February 2008, we reported that FERC had made few substantive
changes to either its merger and acquisition review process or its
postmerger oversight as a consequence of its new responsibilities and,
as a result, does not have a strong basis for ensuring that harmful
cross-subsidization does not occur. Specifically:
Reviewing mergers and acquisitions.--FERC's merger and acquisition
review relies primarily on company disclosures and commitments not to
cross-subsidize. FERC-regulated companies that are proposing to merge
with or acquire a regulated company must submit a public application
for FERC to review and approve. If cross-subsidies already exist or are
planned, companies are required to describe how these are in the public
interest by, for example identifying how the planned cross-subsidy
benefits utility ratepayers and does not harm others. FERC also
requires company officials to attest that they will not engage in
unapproved cross-subsidies in the future. This information becomes part
of a public record that stakeholders or other interested parties, such
as state regulators, consumer advocates, or others may review and
comment on, and FERC may hold a public hearing on the merger. FERC
officials told us that they evaluate the information in the public
record for the application and do not collect evidence or conduct
separate analyses of a proposed merger. On the basis of this
information, FERC officials told us that they determine which, if any,
existing or planned cross-subsidies to allow, then include this
information in detail in the final merger or acquisition order. Between
the time EPAct was enacted in 2005 and July 10, 2007--when FERC
provided detailed information to us--FERC had reviewed or was in the
process of reviewing 15 mergers, acquisitions, or sales of assets. FERC
had approved 12 mergers, although it approved three of these with
conditions--for example, requiring the merging parties to provide
further evidence of provisions to protect customers. Of the remaining
three applications, one application was withdrawn by the merging
parties prior to FERC's decision and the other two were still pending.
Postmerger oversight.--FERC's postmerger oversight relies on its
existing enforcement mechanisms--primarily self-reporting and a limited
number of compliance audits.\3\ FERC indicates that it places great
importance on self-reporting because it believes companies can actively
police their own behavior through internal and external audits, and
that the companies are in the best position to detect and correct both
inadvertent and intentional noncompliance. FERC officials told us that
they expect companies to become more vigilant in monitoring their
behavior because FERC can now levy much larger fines--up to $1 million
per day per violation--and that a violating company's actions in
following this self-reporting policy, along with the seriousness of a
potential violation, help inform FERC's decision on the appropriate
penalty.\4\ Key stakeholders have raised concerns that internal company
audits tend to focus on areas of highest risk to the company profits
and, as a result, may not focus specifically on affiliate transactions.
One company official noted that the threat of large fines may ``chill''
companies' willingness to self-report violations. Between the enactment
of EPAct--when Congress formally highlighted its concern about cross-
subsidization--and our February 2008 report, no companies had self-
reported any of these types of violations. To augment self-reporting,
FERC plans to conduct a limited number of compliance audits of holding
companies each year, although at the time of our February 2008 report,
it had not completed any audits to detect whether cross-subsidization
is occurring. In 2008, FERC's plans to audit 3 of the 36 companies it
regulates--Exelon Corporation, Allegheny, Inc., and the Southern
Company. If this rate continues, it would take FERC 12 years to audit
each of these companies once, although FERC officials noted that they
plan audits one year at a time and that the number of audits may change
in future years.
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\3\ FERC officials also told us that in addition to self-reporting
and audits of some companies, they also may initiate investigations
based on internal and external reports of potential violations.
Officials told us that they are able to initiate internal
investigations based on referrals from FERC staff such as those
monitoring natural gas and electricity trading and markets in the
market monitoring center. In addition, FERC officials noted that
companies and individuals may report potential violators. Such reports
may be made, they said, through their ``hotline'' reporting system,
which allows individuals to anonymously report suspected violations of
FERC rules. In addition, individuals knowledgeable of FERC's processes
and rules may also report violations as formal or informal complaints
that companies are violating the terms and conditions of the detailed
FERC-approved tariffs or rates. FERC officials did not tell us how many
such reports have been made related to cross-subsidies or how many of
such reports resulted in cross-subsidy violations. However, officials
noted that all complaints are investigated to determine whether they
have merit.
\4\ FERC generally plans to retain its flexibility and discretion
to decide remedies on a caseby-case basis rather than to prescribe
penalties or develop formulas for different violations.
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We found that FERC does not use a formal risk-based approach to
plan its compliance audits--a factor that financial auditors and other
experts told us is an important consideration in allocating audit
resources. Instead, FERC officials plan audits based on informal
discussions between FERC's Office of Enforcement, including its
Division of Audits, and relevant FERC offices with related expertise.
To obtain a more complete picture of risk, FERC could more actively
monitor company-specific data--something it currently does not do. In
addition, we found that FERC's postmerger audit reports on affiliate
transactions often lack clear information--that they may not always
fully reflect key elements such as objectives, scope, methodology, and
the specific audit findings, and sometimes lacked key information, such
as the type, number, and value of affiliate transactions at the company
involved, the percentage of all affiliate transactions tested, and the
test results. Without this information, these audit reports are of
limited use in assessing the risk that affiliate transactions pose for
utility customers, shareholders, bondholders, and other stakeholders.
In our February 2008 report, we recommended that the Chairman of
the Federal Energy Regulatory Commission (FERC) develop a
comprehensive, risk-based approach to planning audits of affiliate
transactions to better target FERC's audit resources to highest
priority needs. Specifically, we recommended that FERC monitor the
financial condition of utilities, as some state regulators have found
useful, by leveraging analyses done by the financial market and
developing a standard set of performance indicators. In addition, we
recommended that FERC develop a better means of collaborating with
state regulators to leverage audit resources states have already
applied to enforcement efforts and to capitalize on state regulators'
unique knowledge. We also recommended that FERC develop an audit
reporting approach to clearly identify the objectives, scope and
methodology, and the specific findings of the audit to improve public
confidence in FERC's enforcement functions and the usefulness of its
audit reports. The Chairman strongly disagreed with our overall
findings and the need for our recommendations; nonetheless, we maintain
that implementing our recommendations would enhance the effectiveness
of FERC's oversight.
STATES VARY IN THEIR CAPACITIES TO OVERSEE UTILITIES
States utility commissions' views of their oversight capacities
vary, but many states foresee a need for additional resources to
respond to changes from EPAct. The survey we conducted for our February
2008 report highlighted the following concerns:
Almost all states have merger approval authority, but many
states expressed concern about their ability to regulate the
resulting companies. All but 3 states\5\ (out of 50 responses)
have authority to review and either approve or disapprove
mergers, but their authorities varied. For example, one state
could only disapprove a merger and, as such, allows a merger by
taking no action to disapprove it. State regulators reported
being mostly concerned about the impact of mergers on customer
rates, but 25 of 45 reporting states also noted concerns that
the resulting, potentially more complex company could be more
difficult to regulate. In recent years, the difficulty of
regulating merged companies has been cited by two state
commissions--one in Montana and one in Oregon--that denied
proposed mergers in their states. For example, a state
commission official in Montana told us the commission denied a
FERC-approved merger in July 2007 that involved a Montana
regulated utility, whose headquarters was in South Dakota,
which would have been bought by an Australian holding company.
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\5\ After completion of our survey, one state subsequently obtained
approval from its legislature to review and approve future electric
utility mergers.
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Most states have authorities over affiliate transactions,
but many states report auditing few transactions. Nationally,
49 states noted they have some type of affiliate transaction
authority, and while some states reported that they require
periodic, specialized audits of affiliate transactions, 28 of
the 49 reporting states reported auditing 1 percent or fewer
over the last five years. Audit authorities vary from
prohibitions against certain types of transactions to less
restrictive requirements such as allowance of a transaction
without prior review, but authority to disallow the transaction
at a later time if it was deemed inappropriate. Only 3 states
reported that affiliate transactions always needed prior
commission approval. One attorney in a state utility commission
noted that holding company and affiliate transactions can be
very complex and time-consuming to review, and had concerns
about having enough resources to do this.
Some states report not having access to holding company
books and records. Although almost all states report they have
access to financial books and records from utilities to review
affiliate transactions, many states reported they do not have
such direct access to the books and records of holding
companies or their affiliated companies. While EPAct provides
state regulators the ability to obtain such information, some
states expressed concern that this access could require them to
be extremely specific in identifying needed information, which
may be difficult. Lack of direct access, experts noted, may
limit the effectiveness of state commission oversight and
result in harmful cross-subsidization because the states cannot
link financial risks associated with affiliated companies to
their regulated utility customers. All of the 49 states that
responded to this survey question noted that they require
utilities to provide financial reports, and 8 of these states
require reports that also include the holding company or both
the holding company and the affiliated companies.
States foresee needing additional resources to respond to
the changes from EPAct. Specifically, 22 of the 50 states that
responded to our survey said that they need additional staffing
or funding, or both, to respond to the changes that resulted
from EPAct. Further, 6 out of 30 states raised staffing as a
key challenge in overseeing utilities since the passage of
EPAct, and 8 states have proposed or actually increased
staffing.
In conclusion, the repeal of PUHCA 1935 opened the door for needed
investment in the utility industry; however, it comes at the potential
cost of complicating regulation of the industry. Further, the
introduction of new types of investors and different corporate
combinations--including the ownership of utilities by complex
international companies, equity firms, or other investors with
different incentives than providing traditional utility company
services--could change the utility industry into something quite
different than the industry that FERC and the states have overseen for
decades. In light of these changes, we believe FERC should err on the
side of a ``vigilance first'' approach to preventing potential cross-
subsidization. As FERC and states approve mergers, the responsibility
for ensuring that cross-subsidization will not occur shifts to FERC's
Office of Enforcement and state commission staffs. Without a risk-based
approach to guide its audit planning--the active portion of its
postmerger oversight--FERC may be missing opportunities to demonstrate
its commitment to ensuring that companies are not engaged in cross-
subsidization at the expense of consumers and may not be using its
audit resources in the most efficient and effective manner. Without
reassessing its merger review and postmerger oversight, FERC may
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. In addition, the lack of clear information in audit
reports not only limits their value to stakeholders, but may undermine
regulated companies' efforts to understand the nature of FERC's
oversight concerns and to conduct internal audits to identify potential
violations that are consistent with those conducted by FERC--key
elements in improving their self-reporting. We continue to encourage
the FERC Chairman to consider our recommendations.
Mr. Chairman, this completes my prepared statement. I would be
happy to respond to any questions you or other Members of the Committee
may have at this time.
The Chairman. Thank you very much.
Commissioner Kerr.
STATEMENT OF JAMES Y. KERR II, COMMISSIONER, NORTH CAROLINA
UTILITIES COMMISSION REPRESENTING NATIONAL ASSOCIATION OF
REGULATORY UTILITY COMMISSIONERS
Mr. Kerr. Thank you, Mr. Chairman. On behalf of my
colleagues at NARUC I appreciate the opportunity to be here
today and thank you and the members of this committee. I
suspect I ought to also thank Chairman Kelliher for his
insightful assessment of the relative regulatory bodies across
the country. My colleagues in Washington State and I believe
he's absolutely correct in that regard.
I want to thank you, Mr. Chairman, Senator Brownback and
Senator Feingold for requesting this report and especially
thank GAO for the quality work product. NARUC had the
opportunity to work closely with GAO in conducting the survey
and producing the report. Since the report was issued GAO has
presented on the report to our staffs of committee on
accounting.
We believe the report provides both States and our Federal
colleagues at FERC a valuable tool to continue to do what
you've asked us to do with the adoption of EPACT 2005 which is
to work together to ensure that we effectively carry out our
shared responsibility to consumers. I believe that the report
reveals no actual regulatory failures. It reveals no actual
regulatory gaps.
It does however identify areas for potential improvements
for regulation at both the State and Federal level. Given the
awesome responsibility we share with our Federal colleagues to
protect consumers, I believe that the GAO report is both timely
and helpful.
I want to briefly summarize four points from the
perspective of State regulators.
First of all and this cannot be underestimated is the
capital needs facing these vital industries are tremendous and
they are growing everyday. The growing concern about various
environmental issues, interest in efficiency, demand response,
alternative generation as well as advanced technologies for
more traditional forms of generation are causing significant
increases in the capital demands in these industries and that
is coupled unfortunately at a time when both commodity and
construction costs are escalating.
We cannot perceptively and prescriptively determine how or
where the capital will or should come from to meet these needs.
We can and do care greatly about who owns and operates these
vital businesses. How they are owned and operated. But we
cannot afford to discriminate or foreclose the various
approaches the needs are simply too great.
These, as Chairman Kelliher said, and I agree are very fact
specific inquiries. To meet the challenges we will need the
opportunity to consider a variety of approaches, transactions
and sources of capital both internal and external. We need to
be able to benefit from the creativity and variety that the--
with the adoption of EPACT 2005 and the repeal of PUHCA 1935,
we now have a greater opportunity to take advantage of.
But you, as you are doing today, should ask yourselves do
we have an adequate and effective regulatory structure to
perform this inquiry and to protect consumers. You've heard a
lot from the first panel about the Federal approach. I won't
cover that again.
I will say that I think when you read the record in this
case including the GAO report the answer is yes, we do have an
effective regulatory structure. From the State level and I'll
anticipate the question of do we disagree with the GAO report
in any regard. I don't think this is a disagreement. But I
would say that I think the GAO report probably underestimates
the pervasive, positive role that rate making authority plays.
I don't mean to be trite. But I do believe that the old
expression that if you have them by the rates, their hearts and
minds will follow is in fact, an accurate assessment of the
importance of rate making authority as it affects the totality
of the relationship. We have the power, as demonstrated by the
record to approve mergers and acquisitions and other transfers.
But also importantly and I think this was slightly
underemphasized is the ability to condition merger approvals,
rate making orders to address areas where actual statutory
authority may not exist. I have attached to my testimony an
extensive appendix from our Duke Synergy merger review that I
think makes that point almost too clear with its length and the
detail. Then once you've done that. You have the ability to
regulate, verify and enforce the various relationships that
exist. I think that from a State perspective we believe that we
do.
So what are we doing since the repeal of PUHCA and where do
we find ourselves? My last point would be that we are working
cooperatively with our Federal colleagues. We are, as the GAO
suggests, we might want to, willing to do more in this regard.
Some States are expanding the regulatory tools where they
determine necessary. They are either getting statutory
authority or relying more on orders and conditions. We are
working through to leverage resources. To Senator Salazar, to
your earlier question, we are trying to leverage resources
across States and commissions through NARUC, through the
National Regulatory Research Institute, through our extensive
interaction with the financial community and if resources are a
problem we can work with our State legislatures on funding for
resources if additional resources are necessary.
I'd be happy to answer questions at the appropriate time.
Thank you.
[The prepared statement of Mr. Kerr follows:]
Prepared Statement of James Y. Kerr II, Commissioner, North Carolina
Utilities Commission Representing National Association of Regulatory
Utility Commissioners
Good morning Chairman Bingaman, Ranking Member Domenici, Members of
this Committee, and distinguished panelists.
My name is Jim Kerr. I am a member of the North Carolina Utilities
Commission (``NCUC''). I am also the immediate past President of the
National Association of Regulatory Utility Commissioners (``NARUC''),
and I am testifying today on behalf of that organization. In addition,
my testimony reflects the views of the NCUC and provides some detailed
information concerning our approach to issues raised in this hearing
and the GAO Report. On behalf of NARUC and the NCUC, I very much
appreciate the opportunity to appear before you this morning.
I ask that my testimony be made a part of the record and I will
summarize our views.
NARUC is a quasi-governmental, non-profit organization founded in
1889. Our membership includes the State public utility commissions
serving all States and territories. NARUC's mission is to serve the
public interest by improving the quality and effectiveness of public
utility regulation. Our members regulate the retail rates and services
of electric, gas, water, and telephone utilities. We are obligated
under the laws of our respective States to ensure the establishment and
maintenance of such utility services as may be required by the public
convenience and necessity and to ensure that such services are provided
under rates and subject to terms and conditions of service that are
just, reasonable, and non-discriminatory.
INTRODUCTION
The Energy Policy Act of 2005 (``EPAct 2005'') repealed the Public
Utility Holding Company Act of 1935 (``PUHCA 1935'') and enacted the
Public Utility Holding Company Act of 2005 (``PUHCA 2005''). EPAct 2005
also expanded the Federal Energy Regulatory Commission's (``FERC' or
the ``Commission'') merger and corporate review authority under Federal
Power Act (``FPA'') Section 203.
PUHCA 1935 repeal opened the door for new and different corporate
combinations, including the ownership of utilities by complex
international holding companies or private equity firms. At the same
time, the repeal did not fundamentally alter the manner in which State
commissions regulate.
State regulatory commissions have traditionally had jurisdiction
over the regulation of utilities in various areas, including mergers
and acquisitions, affiliate transactions, audits, and financial
reporting. The repeal of PUHCA 1935 did not change the States'
authority in these areas. In fact, EPAct 2005 explicitly gave State
Commissions authority to obtain the books and records of a public
utility in a holding company system, the holding company or any
associate company or affiliate.
State commissions have the obligation under State law to ensure the
establishment and maintenance of such energy utility services as may be
required by the public convenience and necessity. We have to ensure
that such services are provided at rates and conditions that are just,
reasonable and nondiscriminatory for all consumers.
State commissions have powerful regulatory tools to protect
customers. Each State has extensive ratemaking authority, and in the
exercise of the same, has the right to disallow recovery in rates of
inappropriate or improper costs, including those deemed to represent
cross-subsidies. The exercise of State merger review authority provides
a means to protect consumer interests by imposing conditions on any
proposed transaction. In fact, the broad statutory mandates to uphold
the public interest and ensure reliable service at just and reasonable
rates have allowed State commissions to establish specific consumer
protections not directly spelled out under their broad statutory
authority.
COORDINATION WITH FERC
The Report by the Government Accountability Office (``GAO''),
Recent Changes In Law Call for Improved Vigilance by FERC, GAO-08-289
(February 2008)(``GAO Report'' or Report'') concluded with a number of
recommendations to the FERC Chairman.\1\ One of the recommendations
stated that the Chairman should develop ``a better means of
collaborating with [S]tate regulators to leverage resources already
applied to enforcement efforts and to capitalize on [S]tate regulators'
unique knowledge. As part of this effort, FERC may want to consider
identifying a liaison, or liaisons, for [S]tate regulators to contact
and to serve as a focal point(s).''\2\
---------------------------------------------------------------------------
\1\ GAO Report, Recent Changes In Law Call for Improved Vigilance
by FERC, GAO-08-289 (February 2008) at 31-32.
\2\ Id.
---------------------------------------------------------------------------
NARUC has had an extensive and constructive working relationship
with FERC, and welcomes the recommendation of the GAO Report in this
regard. Currently, we have three State/FERC Collaboratives that cover
cross jurisdictional areas: demand response, competitive procurement
and smart grid. These initiatives have involved all members of the FERC
and Senior Staff and a broad cross-section of State Commissioners and
Staff. These efforts have been collegial, informative and productive.
In short, the relationship and precedent exists to explore to continue
working together in this particular case.
FERC's implementing regulations under EPAct 2005 have been
respectful of State authority. FERC has said that where there is State
authority in the area of merger review and cross-subsidization
protections, that authority should be recognized. For example, as to
reviews under FPA Section 203, the FERC policy is to accept State
cross-subsidization protections unless there is evidence that
additional measures are needed to protect wholesale customers or if
there is a regulatory gap because the State lacks authority in the
area. This approach properly coordinates federal and State merger
review to avoid unnecessary conflict and potential claim of federal
preemption.
RESPONSES TO THE GAO REPORT
The following sections will focus on responding to the issues
covered in the GAO Report's survey of State commissions. The issues
covered in the State survey are (1) State Review of Mergers, (2) State
Regulation of Affiliate Transactions and Cross-Subsidies, (3) Financial
Protections or Ring-Fencing (4) Audits, Access to Books and Records,
and Financial Reporting; and (5) Status of State Resources. The GAO
recognized that most of the State commissions have authority which they
exercise in these areas.
We note that the detail of the State responses to specific
questions depended on the respondent. Further research into State
Commission practices were conducted with GAO Staff's visits to four
States only.\3\ In addition, responses and observations were provided
from non-State commission entities, such as officials from the
financial community,\4\ an ``expert'' with ``extensive experience with
FERC and several [S]tate public utility commissions'',\5\ a
``consultant whose firm does numerous affiliate transaction audits in
many [S]tates'',\6\ ``utility experts'';\7\ a ``president of an audit
company'';\8\ and ``representatives from two consumer groups''.\9\
These points were not made to be critical of the GAO Report, but to
recognize the difficulty in responding with precision to the Survey
responses.
---------------------------------------------------------------------------
\3\ Id. at 26.
\4\ Id. at 24.
\5\ Id. at 26.
\6\ Id.
\7\ Id. at 28.
\8\ Id.
\9\ Id. at 27.
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(1) State Review of Mergers
Almost all States have specific authority to review mergers and
similar corporate transactions. The GAO Report recognized that even for
the two States that do not have direct merger review authority, these
States were able to use other State Commission authority to conduct
such reviews.\10\ Each State will apply its merger authority to the
facts and circumstances of the merger transaction at hand.
---------------------------------------------------------------------------
\10\ The GAO Report survey concluded that only 3 States (Florida,
Indiana, Texas) out of the responding 50 States lack authority to
review mergers. GAO Report, Recent Changes In Law Call for Improved
Vigilance by FERC, GAO-08-289 (February 2008) at 22. The Report notes
that after completion of the survey, one State (Texas) subsequently
obtained approval from its legislature to review and approve future
electric utility mergers.
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The merger statute in my home State of North Carolina is fairly
typical: It prohibits any transfer affecting a public utility without
approval from the NCUC.\11\ Such approval will be given ``if justified
by the public convenience and necessity''. The ``public convenience and
necessity'' standard has been described by the North Carolina courts as
``a relative or elastic theory rather than an abstract or absolute
rule''.\12\
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\11\ N.C. Gen. Stat. 62-111.
\12\ State ex. rel. North Carolina Utilities Commission v. Casey,
245 N.C. 297, 96 S.E.2d 8 (N.C. 1957).
---------------------------------------------------------------------------
According to the leading North Carolina case construing our
transfer statute, the NCUC is required to ``inquire into all aspects of
anticipated service and rates occasioned and engendered by the proposed
transfer'' in deciding the issues raised by a merger application.\13\
The ultimate decision must be made by analyzing ``the facts of each
case''. This amounts to a requirement that we utilize a ``totality of
the circumstances'' or an ad hoc balancing test in review merger
applications.
---------------------------------------------------------------------------
\13\ State ex. rel. Utilities Commission v. Village of Pinehurst,
115 P.U.R.4th 558, 393 S.E.2d 111 (N.C.App. 1996).
---------------------------------------------------------------------------
While the repeal of PUHCA 1935 has not fundamentally altered our
authority or ability to review merger applications, our merger analysis
has been affected in a limited number of ways:
(1) We have not had to impose conditions that attempted to
preclude PUHCA 1935-related preemption under the Ohio Power
decision;
(2) We have had to beef up our accounting-related conditions
to account for the absence of certain accounting practices that
would have otherwise been required by PUHCA 1935; and
(3) We have had to impose financial protection conditions to
account for the absence of various limitations and protections
that had been provided for by PUHCA 1935.
Other than the above and a widening scope of the types of
transactions that can be presented to the NCUC for review and approval,
PUHCA 1935 repeal has had little impact on the manner to which we
handle merger-related proceedings.
To be sure, the NCUC tries to provide applicants with some idea of
the nature of our concerns in preparation for filing an application for
a merger or similar business combination transaction. As a matter of
decisional law, we have attempted to put some further meat on the
statutory test in our decisions. Several of our prior orders provide
that a merger should be approved, whether as proposed or as
conditioned, as long as:
(1) The proposed transfer has no known adverse impact on the
rates and service of the utility;
(2) Customers are protected from potential harm as much as
possible; and
(3) Customers are provided with sufficient benefits as a
result of the transfer to offset any potential costs, risks and
harms.
We have required applicants to file cost/benefit and market power
studies. The obvious purpose of this request is to ensure that a
particular proposal will not have a harmful anticompetitive effect on
North Carolina retail ratepayers and to provide us some idea of the
extent of any cost savings from a particular merger.
As a general proposition, we have tended to ascertain if a proposed
transaction makes broad business sense. If it does, we determine what,
if anything, needs to be done through the adoption of conditions to
ensure that customers are not harmed and that the benefits are
commensurate with the potential costs, risks, and harms. Because of the
fact that the broad business justification for most of the transactions
before us is relatively apparent, most of our Orders tend to focus on
the development of appropriate conditions.
For your review and information I have attached an Appendix* which
illustrates in greater detail how the NCUC reviewed the Duke Energy
Corporation/Cinergy Corporation merger (``Duke/Cinergy merger'') after
the repeal of PUHCA 1935. For example, the NCUC adopted: (1) certain
conditions relating to accounting rules and affiliate transactions; (2)
conditions intended to preserve the utility's access to capital and to
ensure that the utility is not utilized solely as a source of funding
for unrelated holding company activities; and (3) certain rate-related
transactions intended to require the utility to share the cost savings
predicted to result from the transaction. All these conditions had the
simple purpose of preserving the ability of the NCUC to regulate the
utility in the same way that it always had.
---------------------------------------------------------------------------
* Document has been retained in committee files.
---------------------------------------------------------------------------
(2) State Regulation of Affiliate Transactions and Cross-Subsidies
With regard to affiliate transactions and authority to prevent
potential cross-subsidies, the GAO reported that almost all the State
commissions regulate affiliate transactions or regular reporting of
such transactions, or both.\14\ In fact, the Report said that 49 of the
reporting 50 States have some type of authority to approve, review and
audit transactions between utilities and their affiliated
companies.\15\
---------------------------------------------------------------------------
\14\ GAO Report, Recent Changes In Law Call for Improved Vigilance
by FERC, GAO-08-289 (February 2008) at 25.
\15\ Id. at 9, 25. The Report noted that 27 States reported that
under their authority, affiliate transactions did not require prior
State commission approval, but could be reviewed and disallowed later.
Id. at 25. The findings were that 41 States require utilities to report
affiliate transactions at least annually, or more frequently. Id.
---------------------------------------------------------------------------
In North Carolina, we have specific statutory authority to review
affiliate transactions. The majority of potential affiliate contracts
are subject to being reviewed and declared void if found to be unjust
or unreasonable and made for the purpose or with the effect of
concealing, transferring or dissipating the earnings of the utility. In
addition, prior to paying any kind of compensation to the listed types
of affiliated companies for services, the utility must obtain the
Commission's approval to pay the compensation. All affiliated costs and
expenses are subject to being audited and disallowed within the context
of a general rate case.
In our most recent merger proceeding we required that an
independent audit be conducted no less than every two years of the
affiliate transactions undertaken pursuant to the affiliate agreements
associated with the merger. The audit includes both the holding
company's and the utility's compliance with all conditions imposed by
the Commission concerning affiliate company transactions, including the
propriety of the transfer pricing of goods and services between and/or
among the utility and its affiliates.
In addition, a number of State Commissions--Arkansas,
California,\16\ Kansas,\17\ Maryland\18\ and New Jersey--have opened
proceedings to address measures for ratepayer protection post-PUHCA
1935 repeal.
---------------------------------------------------------------------------
\16\ Order Instituting Rulemaking Concerning Relationship Between
California Energy Utilities and Their Holding Companies and Non-
Regulated Affiliates, Docket No. R. 05-10-030, October 27, 2005. The
GAO Report cited to California's work to increase its authority to
oversee affiliate transactions. GAO Report, Recent Changes In Law Call
for Improved Vigilance by FERC, GAO-08-289 (February 2008) at 25.
\17\ In the Matter of the Investigation of Affiliate and Ring-
Fencing Rules Applicable to all Kansas Electric and Gas Public
Utilities, Docket No. 06-GMIX-181 -GIV, May 14, 2007.
\18\ Commission Staff Analysis of Ringfencing Measures for
Investor-Owned Electric and Gas Utilities, Maryland Public Service
Commission, February 18, 2005.
---------------------------------------------------------------------------
For example, the New Jersey Board of Public Utilities (``BPU'')
approved new regulations with the goal of providing additional
protection for the State's electric and natural gas customers.\19\ The
New Jersey BPU developed the regulations after analyzing what changes
should be made to offset the protections lost at the federal level with
the repeal of PUHCA 1935.\20\
---------------------------------------------------------------------------
\19\ Affiliate Relations, Fair Competition and Accounting
Standards, Public Utility Holding Company Standards and Related
Reporting Requirements, Docket Number AX05070641 (September 18, 2006).
\20\ Id.
---------------------------------------------------------------------------
As these examples show, each State commission must address for
itself how it wishes to balance allowing additional investment while
also ensuring consumer protections. Each State must be allowed to
structure the scope of ratepayer protections that will fulfill its
statutory duty and public interest charge.
(3) Financial Protections or Ring-Fencing
PUHCA 1935 provided protection to ratepayers against a variety of
financial risks caused by the creation of a holding company, such as
draining the utility of cash and using it for collateral and
diversification into non-core, risky businesses. With the repeal of
PUHCA 1935, none of these federal limitations and protections remains
in effect.
Even before the repeal of PUHCA 1935, many States sought to protect
ratepayers from risks associated with utilities being acquired by
holding companies, including diversification into non-utility
businesses. Although it has become common practice for electric
utilities to diversify into non-utility and foreign businesses, this
diversification carries an increased risk. NARUC believes that this
risk should not be borne or shifted to the customers of the regulated
utility, since the beneficiaries of these investments are the
shareholders.
States use a variety of mechanisms to effectively guard against
improper cross-subsidization. One approach is to craft ``ring-fencing''
protections. The goal of ring-fencing is to build structural and
financial protections around utility subsidiaries within a holding
company system in order to insulate these subsidiaries from potential
risks and negative impacts created by affiliates.\21\ Rating agencies
have looked favorably on ring-fencing provisions established through
State regulatory policies.
---------------------------------------------------------------------------
\21\ Some examples of ring-fencing provisions are: (1) requirement
that regulated utilities maintain a separate corporate entity; (2)
utility to have its own Board of Directors and management; (3)
utility's accounts and records kept separately from those of
affiliates; (4) independent cash management and debt for utilities; (5)
State commission approval before securities can be issued; (6) limits
on dividends (7) minimum equity requirements; (8) periodic ring-fencing
reports.
---------------------------------------------------------------------------
Perhaps the most well-known instance of a State using ring-fencing
to protect a utility from potential holding company risks occurred when
the Public Utility Commission of Oregon saved Portland General Electric
Company (``PGE'') from the adverse effects of the Enron bankruptcy.
Despite Enron's historic collapse, PGE was able to maintain its
financial integrity because of the actions taken by the State to
``ring-fence'' or protect the utility from Enron's other business
ventures.
Another State approach is a ``mini-PUHCA''--a tool that attempts to
recreate PUHCA 1935 at the State level. The Wisconsin Utilities Holding
Company Act (``WUHCA'')\22\ is a well-known example of statutory ring-
fencing. In implementing the State law, the Wisconsin Public Service
Commission (``PSCW'') has adopted a three-pronged approach to address
cross-subsidization: (1) imposing restrictions, (2) implementing
reporting requirements, and (3) conducting compliance audits of holding
company transactions and operations.
---------------------------------------------------------------------------
\22\ Wis. Stat. Sec. 196.795.
---------------------------------------------------------------------------
(4) Audits, Access to Books and Records, and Financial Reporting
As the GAO Report notes, each State Commission's audit process is
unique.\23\ The Report recognized that for the 4 States GAO Staff
visited, those States put ``special emphasis on auditing affiliate
transactions''.\24\
---------------------------------------------------------------------------
\23\ GAO Report, Recent Changes In Law Call for Improved Vigilance
by FERC, GAO-08-289 (February 2008) at 9, 25-26.
\24\ Id. at 27.
---------------------------------------------------------------------------
FERC and State regulators already collaborate on audit review. We
will continue to work with our federal colleagues on improving audits
of affiliated transactions and cross-subsidies.
The GAO concluded that all States regularly require financial
reports from utilities and are able to obtain access to the financial
books and records of these utilities.\25\ The Report said that all 49
responding States require utilities to at least provide financial
reports.\26\ GAO added that States have access to utility companies'
financial books and records in order to review affiliate
transactions.\27\
---------------------------------------------------------------------------
\25\ Id. 27
\26\ Id. at 9, 27.
\27\ Id. at 9.
---------------------------------------------------------------------------
NARUC advocated the explicit EPAct 2005 authority for State access
to needed books and records. Access to the books and records to verify
transactions directly affecting a company's regulated utility
operations is of vital importance to State commissions. Requests for
such access by a State commission, its staff, or its authorized agents
are presumably valid, material, and relevant, with the burden falling
to the company to prove otherwise.
The GAO concludes, however, that some States do not have such
direct access to books and records of holding companies or affiliated
nonutility companies.\28\ The reasons vary.\29\ State Commissions will
continue to work on ways to improve their access to this information.
FERC's detailed accounting and increased transparency in its record
retention policies for holding companies and centralized service
companies assists in improving States access to needed information from
utility companies and their affiliates.
---------------------------------------------------------------------------
\28\ Id. at 9, 27-28.
\29\ Id.
---------------------------------------------------------------------------
(5) Status of State Resources
GAO reported that some States reported that they needed additional
staffing and funding to respond to changes in their oversight
responsibility.\30\ At the same time, the Report recognized that States
have gained over 2 years of experience since EPAct 2005 was passed.\31\
---------------------------------------------------------------------------
\30\ Id. at 9, 29-30.
\31\ Id. at 29.
---------------------------------------------------------------------------
States have been and will continue to collaborate and expand on
their knowledge base. NARUC's Meetings, which occur three times a year,
have featured various PUHCA and utility merger panels. NARUC's Staff
Subcommittee on Accounting and Finance has also produced
publications\32\ and sponsored meeting panels on these topics. This
Staff Subcommittee collaborated with GAO Staff on the State survey. The
National Regulatory Research Institute (``NRRI'') has published various
briefing documents to educate State Commissioners on key issues arising
from PUHCA 1935 repeal and the changing utility merger landscape.\33\
---------------------------------------------------------------------------
\32\ See, e.g, Ring Fencing Mechanisms for Insulating a Utility in
a Holding Company System, NARUC Staff Subcommittee on Accounting and
Finance, July 27, 2003.
\33\ See e.g., Implications of EPAct 2005 for State Commissions,
The National Regulatory Research Institute, October 2005; Repeal of the
Public Utility Holding Company Act of 1935: Implications and Options
for State Commissions, The National Regulatory Research Institute,
August 2006; Private Equity Buyouts of Public Utilities: Preparation
for Regulators, The National Regulatory Research Institute, December
2007.
---------------------------------------------------------------------------
States can better coordinate with their State colleagues on a
regional basis, as well as with FERC, in regulating these increasingly
complex multi-State utility companies. State commissions can work with
their respective legislatures to improve the status of State resources.
CONCLUSION
In our view, NARUC's members have performed admirably in their
oversight responsibilities in the short time since passage of EPAct
2005. In light of the challenges identified by GAO, there will be more
work ahead to insure continued oversight of mergers in the utility
sector, particularly given the vastly different resources available to
the various States. We are confident that with FERC's continued
cooperation and collaboration, as well as the academic resources
NARUC's members have with NRRI the States will be ready for the
challenge.
Senator Salazar [presiding]. Thank you, Mr. Kerr.
Mr. Owens.
STATEMENT OF DAVID K. OWENS, EXECUTIVE VICE PRESIDENT, BUSINESS
OPERATIONS, EDISON ELECTRIC INSTITUTE
Mr. Owens. Thank you, Senator. I certainly do appreciate
this opportunity.
My name is David K. Owens. I'm the Executive Vice President
of the Business Operations at the Edison Electric Institute. As
you well know EEI is a trade association of U.S. shareholder
owned electric companies and has international affiliates and
associate members worldwide.
I certainly do appreciate the leadership that this
committee has provided with the implementation of EPACT 2005 to
encourage investment in electric utility infrastructure. We
believe that EPACT has been successful in encouraging
significant new investments. We applaud the leadership of this
committee.
We also believe that FERC has done a really good job of
implementing its new responsibilities under EPACT 2005. FERC
has undertaken a completed series of major rulemaking, as the
Chair mentioned earlier. Those have lead as an example to the
adoption of new requirements for holding companies and their
service companies. FERC has adopted new accounting standards as
an example for centralized service companies. They've developed
clear rules for pricing affiliate transactions. They've
developed new auditing and enforcement initiatives. So they've
done a whole set of major new initiatives in order to deal with
this evolving area.
They've done all of this while working very closely with
the States. As you all know our country needs significant new
investment in electric infrastructure in the coming years. To
provide the enormous investment which we estimate to be over a
trillion dollars by 2030, it requires us to employ a
flexibility and a variety of organizational structures and
organizational arrangements. This is in order to finance,
construct, to operate and maintain facilities needed to provide
our country with the electricity it demands. In addition some
of our companies need the option to merge in some instances or
consolidate with other companies with the appropriate
regulatory reviews in order to achieve additional efficiency
benefits which benefit our customers.
Now under existing Federal laws we believe that FERC is
well equipped to ensure that mergers and acquisitions are in
the public interest and that consumers are well protected. We
think that FERC has done a fairly adequate job in that area.
EPACT 2005, as we all know, Congress replaced a 70-year-old
PUHCA 1935 with updated PUHCA 2005. It also updated and
expanded section 203 of the Federal Power Act to give FERC new
authorities regarding mergers.
As a result FERC has strengthened its regulation of utility
mergers and acquisitions and has incorporated new oversight of
affiliate transactions in particular to prevent cross
subsidization, an encumbrance of utility assets except when in
the public interest. Contrary to projections or predictions by
many that EPACT would lead to this vast array of mergers, that
really has not happened. We've had a modest increase in
mergers.
In my written testimony I've outlined the many steps FERC
has taken to put in place advanced merger, acquisition,
accounting, financial and reporting regulations policies and
practices. The significant actions have involved a tremendous
commitment by FERC with substantial input from State regulators
and other key stakeholders. We believe the States play an
important role in regulating utilities, in approving mergers,
in protecting retail consumers and Federal laws should continue
to accommodate this role without duplicative or conflicting
requirements.
States clearly play a very active role as Commissioner Kerr
has just indicated. They oversee utility mergers. They oversee
retail rates. They look at the just and reasonable
transactions. They oversee a whole range of activities relating
to affiliate transactions. Most State commissions have
considerable authority to ensure the financial integrity of
utilities they regulate and to insulate and protect consumers
of public utilities from potential adverse consequences of non-
utility related investment or activities.
Congress and FERC have recognized that States play such a
vital role in regulating electric utility mergers and
activities and have sought to accommodate the State role in
Federal statutes and regulations. Thus the Federal Power Act
provides a clear sharing of responsibilities between States and
FERC and oversee utility activities and similarly FERC
regulation reflect the complementary Federal and State roles.
Now I realize I'm running out of time. Let me make a point.
That point is that I disagree substantially with some of the
recommendations of the GAO report. Specifically with regard
with whether FERC is doing a good job and whether there are
regulatory gaps.
We disagree, as I indicated, FERC has issued a broad range
of rulemakings. They have comprehensive authority over all
aspects of rate making. They've adopted new accounting rules.
They've adopted pricing rules for affiliates. So they've done
an awful lot. They have very broad based auditing
responsibility. So I don't believe that the comments or the
suggestions by GAO are well founded.
I do believe that there are some recommendations that the
Commission should look at carefully and that relates to
transparency and working more closely with the States. Thank
you.
[The prepared statement of Mr. Owens follows:]
Prepared Statement of David K. Owens, Executive Vice President,
Business Operations, Edison Electric Institute
My name is David K. Owens, and I am Executive Vice President in
charge of the Business Operations Group at the Edison Electric
Institute (EEI). EEI is the trade association of U.S. shareholder-owned
electric companies and has international affiliate and industry
associate members worldwide. Our U.S. members serve 95% of the ultimate
customers in the shareholder-owned segment of the industry and
represent about 70% of the U.S. electric power industry.
EEI appreciates the steps forward that Congress took in the Energy
Policy Act of 2005 (EPAct 2005) to encourage new investment in and by
the electric utility industry. Our country needs new investment in
electric infrastructure to ensure continued availability of reliable,
affordable electricity. The steps Congress took in EPAct 2005 to
modernize regulation of the industry, while ensuring that ample
consumer protections remain in place, were appropriate and are
producing positive results. Contrary to predictions that were made
before EPAct 2005 was enacted, merger activity since enactment has
actually been relatively modest. At the same time, the provisions of
EPAct 2005 have encouraged significant new investment in energy
infrastructure.
Moreover, the Federal Energy Regulatory Commission (FERC) has done
an exemplary job in implementing its new responsibilities under EPAct
2005. FERC has undertaken and completed a series of major rulemakings
and new auditing and enforcement initiatives in a very short time,
meeting tight deadlines set in EPAct 2005. In the process, FERC has
strengthened its regulation of utility mergers and acquisitions,
managed the complicated transition from the Public Utility Holding
Company Act of 1935 (PUHCA 1935) to its successor the Public Utility
Holding Company Act of 2005 (PUHCA 2005), and incorporated new
oversight of affiliate transactions, in particular to prevent cross-
subsidization and encumbrance of utility assets except when in the
public interest. And FERC has done all this while working closely with
and respecting the authority of the states that also regulate utilities
in these areas.
OUR COUNTRY NEEDS SIGNIFICANT NEW INVESTMENT IN ELECTRICITY
INFRASTRUCTURE IN COMING YEARS TO MEET INCREASING DEMAND AND TO ENSURE
CONTINUED RELIABILITY
As this Committee knows well, electricity is a vital service to our
nation. EEI and its member companies take pride in providing reliable,
affordable supplies of electricity, even as our country's population
and demand for electricity have grown dramatically in recent years and
continue to grow. Electricity is essential to powering our homes,
businesses, and industries with cooling, refrigeration, heating,
lighting, computers, telecommunications equipment, medical equipment,
and the host of other day-to-day necessities on which we all rely.
Because electricity is provided and used on an instantaneous basis and
cannot practicably be stored, the provision of affordable, reliable
electricity requires a careful balancing of generation, transmission,
and distribution facilities. In turn, constructing, operating, and
maintaining these facilities require an enormous investment.
In coming years, the United States will need significant additional
electricity generation and delivery resources. The Energy Information
Administration (EIA) is projecting that electricity demand will
increase by 30% by 2030. Already, as the North American Electric
Reliability Corporation (NERC) has indicated in its most recent 10-year
assessment of the nation's electricity system, many areas of the
country are operating on thin demand-supply and delivery-capacity
margins.\1\ This need for new facilities will only increase in future
years, as a result of continued population growth, increasing
electrification of our nation's homes and businesses, increasing demand
for renewable energy resources, and compliance with enhanced
environmental standards--even with a major commitment to energy
efficiency.
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\1\ NERC 2007 Long-Term Reliability Assessment 2007-2016 (October
2007), www.nerc.com.
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To put these issues in perspective, I would like to provide some
numbers:
Overall Capital Expenditures (Capex)
Capex for U.S. shareholder-owned electric utilities rose by
15.5% in 2007, from $59.9 billion in 2006 to $69.1 billion in
2007, and is projected to reach approximately $75 billion in
2008 and $75.5 billion in 2009.\2\
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\2\ The 2008 and 2009 projections and the 2007 category allocation
are based on EEI's spring 2007 study of industry capital spending based
on SEC Form 10-K data, company presentations, and discussions with
companies.
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Total capital spending in 2007 was projected to be allocated
as follows: Generation 31%; Distribution 30%; Environmental
14%; Transmission 12%; Natural Gas-related 6%; and General/
Other 7%.\3\
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\3\ Id. The ``General/ Other'' category includes investments that
do not fit into the other categories listed, such as construction,
materials, fuel processing, and mining activities.
---------------------------------------------------------------------------
Companies are boosting spending on environmental compliance
and transmission and distribution upgrades, and are beginning
to announce new generation projects in many power markets to
ensure adequate reserve margins over the long term. Already,
657 projects that would provide more than 130,000 MW of
capacity either have applications pending, have been approved,
or already are under construction.\4\
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\4\ These numbers are based on recent analyses byVentex, Inc., an
EEI consultant.
---------------------------------------------------------------------------
According to a recent study conducted by the Brattle Group,
dramatically increased raw materials prices (e.g., steel,
cement) have increased construction costs directly and
indirectly through the higher cost of manufactured components
common in utility infrastructure projects. These cost increases
have primarily been due to high global demand for commodities
and manufactured goods, higher production and transportation
costs (in part owing to high fuel prices), and a weakening U.S.
dollar.
Preliminary findings released by the Brattle Group estimate
that, without taking into account utility energy efficiency
programs, close to $1.5 trillion in investment in new
generation ($559 billion) and transmission and distribution
($900 billion) will be required by 2030 to meet electricity
demand. Brattle further estimates that required generation
investment can be reduced from $559 billion to $457 billion if
more aggressive utility energy efficiency programs are
implemented.
Transmission Capital Expenditures\5\
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\5\ These transmission and distribution investment data are
provided in real terms (2006$) and have been adjusted for inflation
using the Handy-Whitman Index. Planned transmission investment was
adjusted for inflation using the GDP Deflator.
---------------------------------------------------------------------------
In 2006, both shareholder-owned electric utilities and
stand-alone transmission companies invested an historic $6.9
billion in the nation's transmission grid. This represents a
51% increase over 2000 levels.
Since the beginning of 2000, the industry has invested more
than $37.8 billion in the nation's transmission system.
Over the 2007-2010 time period, the industry is planning to
invest $37 billion in the transmission system.
This amount represents a 55% increase over the amount
invested from the 2003-2006 period.
Distribution Capital Expenditures
In 2006, shareholder-owned electric utility investment in
the distribution system surpassed $17 billion for the first
time. This level of investment ($17.3 billion) represents a
6.5% increase over the inflation-adjusted $16.2 billion ($14.5
billion prior to inflation adjustment) invested in 2005.
2006 industry distribution investment represents an 18%
increase over 2000 levels.
Since the beginning of 2000, the industry has invested
almost $109 billion in the nation's distribution system.
to provide the investment resources for electricity infrastructure,
electric utilities need to be able to employ a variety of
organizational structures, merge, consolidate, form partnerships, and
acquire assets
EEI members include vertically integrated electric utilities that
provide electricity generation, transmission, distribution, and related
services to families and businesses throughout the country. Our members
also include generation-only and transmission-only ``stand alone''
companies. Many of these utilities and companies are owned by parent
companies that may also own other electric utilities, energy, and non-
energy businesses. Many of the energy companies are affiliated with
others, either through parent-subsidiary or partnership models.
Thus, there are a variety of organizational structures and
affiliations within the electric utility industry. This variety of
structures and affiliations has enabled the electricity industry to
finance, construct, operate, and maintain facilities needed to provide
our country with the electricity it needs. Indeed, the sheer cost of
electricity facilities, and the risks involved in siting, financing,
and earning a reasonable rate of return on them--especially in times of
increasing wholesale competition and fuel and materials charges--often
require the ability to use a variety of organizational structures and
affiliations to share costs and risks.
In addition, utilities need the option to merge or consolidate with
other companies. For electric utilities and their customers, mergers
and acquisitions offer many potential benefits including:
Potential cost efficiencies
Increased economies of scale
Greater optimization of generation, transmission, and
distribution assets
The ability of a larger utility to offer new and innovative
products and services to consumers
Acquisition of superior technology capability
Scale necessary for significant capex, to maintain credit
quality, to lower cost of capital, and to enhance access to
capital markets and new investors.
Indeed, severely limiting utilities' ability to take advantage of
economies of scale and experience in competitive markets could deny
electric customers the benefits of such economic efficiencies. These
efficiencies enable companies to supply products and services at lower
costs to consumers.
This said, the pace of mergers and acquisitions in recent years has
been relatively modest. In 2007, there were four announced deals, six
completed transactions, and one withdrawn deal. In 2006, there were
seven announced deals. This represents a small step up in overall
activity from the quiet three-year period from 2003 through 2005, when
most companies were implementing back-to-basics strategies by exiting
non-core businesses, investing in core utility and competitive
generation operations, and strengthening their balance sheets.
Nevertheless, the number of whole company merger and acquisition deals
in 2006 and in 2007 remained well below the higher pace that marked the
late 1990s, when 10 to 20 announcements per year were the norm. An
emerging trend of recent utility merger and acquisition activity has
been the increasing participation of private equity investors and
international buyers, including infrastructure funds and international
utilities.
UNDER EXISTING FEDERAL LAWS, FERC IS WELL EQUIPPED TO ENSURE THAT
MERGERS AND ACQUISITIONS ARE IN THE PUBLIC INTEREST, AND THAT CONSUMERS
ARE WELL PROTECTED--AND FERC IS FULLY ON THE JOB
Recognizing the need for new infrastructure, and the need to
accommodate new investment in and by the electricity industry, in the
past two decades, Congress has taken steps to update and modernize the
laws governing the structure and operation of the industry. These steps
have helped to ensure that companies have sufficient flexibility to
provide the resources needed to get the job done, while also ensuring
that consumers and markets are well protected. In particular, Congress,
states, and the FERC have taken steps to encourage competition in fuel
supply and electricity generation, while also ensuring open access to
electric and natural gas transmission facilities. In addition,
organized markets for electricity sales and delivery have evolved,
including regional transmission organizations (RTOs) and independent
system operators (ISOs), providing the ability to call on a wide array
of generation and transmission resources to serve load centers within
different regions of the country.
Recognizing that these legal and policy changes have spurred
changes in the electric utility industry, in EPAct 2005, Congress
replaced the 70-year old PUHCA 1935 with an updated PUHCA 2005. In
addition, Congress updated section 203 of the Federal Power Act (FPA)
to require FERC, in reviewing proposed mergers and financial
transactions, to ensure that these activities will not result in cross-
subsidization of non-utilities by utilities or encumbrance of utility
assets, unless in the public interest.
In making these changes, Congress recognized that the FPA and other
laws governing the electric utility industry have evolved substantially
since 1935. Furthermore, FERC, states, and Wall Street have developed
increasingly sophisticated regulations and other measures to ensure
that companies that provide electricity services make ample information
about their finances and activities available to regulators and the
public, and the companies do not engage in inappropriate behavior that
can harm customers.
In particular, FERC has put in place advanced merger, acquisition,
accounting, financial, and reporting regulations, policies, and
practices. Under its merger provisions, FERC examines a wide array of
factors, such as: the ability of companies in a proposed merger to
exercise market power; the relative concentration that would result
from the merger; benefits of the merger to wholesale and retail
consumers; and measures necessary to protect consumers. FERC also has
detailed accounting and financial disclosure requirements to ensure
that public utility, wholesale, and transmission activities are open to
regulators and the public. FERC actively oversees utility financial
transactions under section 203 of the Federal Power Act, and FERC
oversees rates to ensure that they remain just and reasonable under
sections 205 and 206 of the Act.
In addition, FERC has moved aggressively under its existing
authority to prevent abuse of financial relationships between regulated
utilities and their unregulated affiliates, issuing strict new rules
that prohibit utilities from using debt linked to utility assets for
non-utility businesses. FERC has imposed rules to regulate cash
management practices, including limits on the amount of funds that can
be transferred from a regulated subsidiary to a non-regulated parent
company. FERC also has adopted detailed standards of conduct to ensure
that transmission providers do not use their unique access to
information to provide unfair advantages to their wholesale merchant
functions and their marketing affiliates. FERC vigorously audits and
enforces compliance with these standards. FERC closely scrutinizes all
transactions where a utility seeks to purchase power from an affiliate
by contract or purchase a power plant owned by an affiliate, to ensure
that the price does not exceed the market price and the utility does
not unduly favor its affiliate over other competitors in the wholesale
market.
Since passage of EPAct 2005 alone, FERC has issued a number of
complex, stringent regulations aimed at implementing PUHCA 2005 and
revised FPA section 203. These regulations ensure that companies will
keep detailed records and make them available as needed to FERC and to
state regulators. They ensure that FERC approval is required for
mergers, acquisitions, and major financial transactions, subject to
strict guidelines and certain blanket authorizations to help streamline
the review process. They also protect against inappropriate cross-
subsidization of non-utilities by utilities, in particular when captive
customers could be harmed. To list just a few of the more significant
FERC developments in these areas since EPAct 2005:
PUHCA 2005 regulations
--December 8, 2005--Final rule and report to Congress
--April 24, 2006--Rehearing order
--July 20, 2006--Rehearing order
--December 7, 2006--Technical conference
--February 26, 2007--Rehearing order
PUHCA 2005 accounting and reporting regulations
--January 11, 2006--Guidelines for notification of holding company
status
--January 13, 2006--New dockets prefix notice
--February 9, 2006--Additional guidelines for filings under PUHCA
2005
--March 6, 2006--Filing guidelines for self certification notices
--April 7, 2006--Electronic filing guidelines
--July 18, 2006--Technical conference
--October 19, 2006--Final rule
--October 19, 2006--Form 60 electronic filing final rule
--December 14, 2006--Form 60 software notice
FPA section 203, merger, and cross-subsidy regulations
--December 23, 2005--Final rule
--January 10, 2006--Errata to the rule
--April 24, 2006--Rehearing order
--July 20, 2006--Rehearing order
--August 1, 2006--Errata to the rehearing order
--December 7, 2006--Technical conference
--March 8, 2007--Technical conference
--July 20, 2007--Policy statement
--February 21, 2008--Final rules and supplemental policy statement
These activities have involved thousands of hours of work by FERC,
with input by the public, to ensure that the Commission has developed
careful, protective measures. In each of the technical conferences,
FERC Commissioners and staff heard in person from representatives of
all stakeholders, particularly representatives of state commissions and
consumers addressing the respective role of FERC and the states. The
Commission has had to take a large array of factors into account,
balancing the need for information and to impose appropriate
constraints, against the cost and impacts on companies and markets. We
believe, on balance, the Commission has sought to implement its
statutory responsibilities fairly and effectively, in the public
interest.
STATES PLAY AN IMPORTANT ROLE IN REGULATING UTILITIES, APPROVING
UTILITY MERGERS, AND PROTECTING RETAIL CUSTOMERS. FEDERAL LAW SHOULD
CONTINUE TO ACCOMMODATE THIS ROLE WITHOUT DUPLICATIVE OR CONFLICTING
REQUIREMENTS
As the General Accounting Office (GAO) has recognized at page 9 of
its report to Congress on ``Utility Oversight'' in the wake of EPAct
2005, ``state regulators in all but a few states reported [that]
utilities must seek state approval'' for mergers, and ``most states
have some type of authority to approve, review, and audit affiliate
transactions.'' In fact, as the record before FERC and in its technical
conferences demonstrates, states play a prominent role in these areas.
States clearly play a very active role in reviewing proposed
mergers. State utility commissions look closely to ensure that mergers
will be in the public interest and will fully protect retail customers.
Often governors and even legislatures weigh in as well. States also are
not shy about denying approval of a proposed merger if they believe
that the proposal does not meet these tests or provide adequate
benefits to utility customers. In addition, states actively oversee
utility activities, including affiliate transactions, with a
substantial focus on protecting retail customers. States oversee retail
rates to ensure that the rates are reasonable given the costs needed to
provide electricity. States also ensure that rate-regulated utility
resources are not inappropriately used for non-utility activities, and
states ensure that utility affiliates fairly reimburse regulated
utilities for any shared resources. States ensure compliance with these
rules through their careful scrutiny of company books and records, to
which PUHCA 2005 assures access. A February 2004 Fitch Ratings report
highlights the ``increasingly proactive'' efforts of state commissions
in these areas, especially through their authority to approve rates:
[State regulatory commissions] generally have broad statutory
mandates to do whatever is necessary to uphold the public
interest and ensure that reliable service is provided at just
and reasonable rates. This broad authority can be used to
disallow from customer rates any financing, affiliate
transaction or other operating costs viewed as inconsistent
with the public interest.\6\
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\6\ ``Utility Regulatory Survey of State Public Service
Commissions,'' Fitch Ratings Ltd., February 25, 2004, p. 2.
Last year, EEI conducted a survey of existing state laws and
voluntary utility practices. We found that under their original
enabling state legislation, most state commissions have considerable
authority to assure the financial integrity of the utilities they
regulate and to insulate and protect customers of public utilities from
potential adverse consequences of non-utility related investments or
activities. These authorities allow state commissions to address
transactions involving affiliates of a public utility and to insulate
the jurisdictional utility and its consumers from the actions of other
affiliates when appropriate. While each state commission may implement
its authority in its own manner, most state commissions have the
---------------------------------------------------------------------------
authority:
To approve the issuance of securities by the jurisdictional
utility (or utility subsidiaries), including common stock,
preferred stock, long-term debt, short-term debt above a
certain ``materiality'' threshold, and guarantees of
obligations of others.
To regulate the capital structure of the jurisdictional
utility (e.g. debt to equity ratios).
To assure that payment of dividends by a jurisdictional
utility is derived from retained earnings or does not lead to a
deviation from the utility's approved capital structure range.
To regulate or review intercompany loans involving a holding
company or utility affiliates.
To establish appropriate pricing for the sale of goods and
services between a jurisdictional utility and affiliated
companies.
To regulate services, transactions or contracts between a
jurisdictional utility and its holding company or other
affiliates companies above a material amount. Some states
exercise this oversight though an audit or prudence-review
process; others through a prior contract review.
To approve the sale or pledge of jurisdictional assets of
the public utility.
To approve the acquisition of utility assets (above a
material amount) by a public utility that would be put into
rate base within the commission's jurisdiction.
To approve a sale or merger of a jurisdictional utility,
including approval of the transfer of equity rights which
provide a controlling interest in a jurisdictional utility.
To obtain needed information from the jurisdictional utility
to ensure compliance with these other authorities through
annual or periodic reporting, certification of status, an audit
process, rate case filing or other methods.
Furthermore, states are continually refining and expanding the
authority of state public utility commissions over utility activities.
Congress and FERC have recognized that states play an important
role in regulating electric utility mergers and activities, and have
sought to accommodate the state role carefully in federal statutes and
regulations. Thus, the FPA provides a clear sharing of responsibilities
between states and FERC in overseeing utility activities. And
similarly, FERC regulations reflect the complementary federal and state
roles.
For example, in adopting new regulations for implementing FPA
section 203, FERC has been appropriately careful not to preempt
effective state regulations, but instead to review state-imposed
requirements to see if additional requirements are warranted under
federal law. Applying these regulations, FERC recently approved a
proposed merger involving Puget Energy, conditioned in part on the
Washington Utilities and Transportation Commission adopting conditions
that the merging companies proposed to have the state commission adopt
to protect against inappropriate cross-subsidization. FERC concluded
that, if adopted, those measures would fully protect against cross-
subsidization without the need for additional federal constraints. FERC
therefore approved the merger contingent on those conditions being
adopted at the state level. This is cooperative federalism in the
public interest in action.
FERC IS ACTIVELY AND APPROPRIATELY IMPLEMENTING ITS PUHCA 2005, FPA
SECTION 203, MERGER, AND CROSS SUBSIDY RESPONSIBILITIES, AND DOES NOT
NEED ADDITIONAL AUTHORITY THAT COULD CREATE UNNECESSARY BURDENS AND
UNCERTAINTY, THUS DISCOURAGING INVESTMENT
Taking all the developments just discussed into account, EEI
fundamentally disagrees with the GAO report's conclusion that FERC is
not doing an active enough job at overseeing utility mergers,
acquisitions, affiliate transaction, and cross-subsidy issues. FERC
actively oversees utility mergers and acquisitions, and the Commission
has instituted a very aggressive array of regulations, accounting and
reporting requirements, and auditing and enforcement measures to
protect captive customers, promote effective markets, ensure fair
competition, prevent inappropriate cross subsidies and encumbrance of
utility assets, and provide open access to transmission. Congress has
put an array of such statutory requirements in place, and we believe
these requirements are more than sufficient and are being effectively
implemented by FERC.
In addition, the Securities and Exchange Commission (SEC) oversees
company accounting, auditing, finances, and participation in financial
markets, including through implementation of the Sarbanes-Oxley Act of
2002. States oversee utility retail rates and activities, as discussed
above. And companies have voluntarily and as part of binding
commitments adopted an array of positive measures to protect customers.
Taken together, these measures provide robust assurances that the
electric utility industry operates for the public benefit, and these
measures amply protect consumers.
Requiring FERC to take additional steps toward rigid rules for
corporate and financial separation of shareholder-owned electric
utilities and their non-utility affiliate companies is unnecessary in
light of the fact that FERC and the states already have the authority
to protect, and do protect, regulated utilities and their customers
from any potential risks of affiliate businesses.
Increased federal oversight over non-utility corporate activities
and structure could create substantial barriers to investment and
competition in electricity markets, and could create unreasonable
restrictions and delays on the day-to-day business operations of
companies, contrary to what Congress intended when it modernized
utility regulation in EPAct 2005. It also could encroach upon authority
currently exercised by state utility commissions, and it would
unnecessarily duplicate, and possibly contradict, consumer protections
and corporate governance standards already in place at the federal and
state levels, including tough SEC corporate governance and accounting
standards imposed on all publicly-traded companies, not just utilities,
by the Sarbanes-Oxley Act. Furthermore, issues of affiliate
transactions and corporate financing are already addressed by state and
federal regulators, who have the flexibility to consider individual
circumstances and transactions.
Given the array of federal and state laws now in place, there is
abundant federal statutory and regulatory oversight of mergers and
acquisitions and protections against inappropriate cross subsidization
and encumbrance of utility assets. Congress does not need to add any
additional new requirements and constraints at this time.
Senator Salazar. Thank you, Mr. Owens.
Mr. Hempling.
STATEMENT OF SCOTT HEMPLING, EXECUTIVE DIRECTOR, NATIONAL
REGULATORY RESEARCH INSTITUTE
Mr. Hempling. Thank you, Senators for the opportunity to
appear. I'm Scott Hempling, Executive Director of the National
Regulatory Research Institute. I'm here as an expert, not as a
representative of any entity. My expertise derives from years
in private practice where I've been on the inside of dozens of
State commissions and know the facts associated with their
efforts.
Senators, over the past century our citizens have paid
trillions to support the infrastructure of our Nation's
electric utilities. We must ensure that the recipients of those
trillions remain accountable to the public. For 70 years the
Public Utility Holding Company Act of 1935 provided that
accountability.
Its central technique was corporate simplification. Each
utility holding company had to limit its assets and activities
to those necessary to vital electric service. The Act thus
aligned corporate form with public interest obligation.
The GAO/FERC dialog focuses on cross subsidies.
Specifically, to FERC's practices and policies protect
ratepayers from bearing the cost of business activities
unrelated to the provision of essential electric service. But
that question is only a subset of the much larger questions
forced upon regulators by Congress' repeal of the 1935 Act.
The larger question is what is our vision for corporate
structure? Is that vision consistent across States and between
States and FERC? If there is no such vision do we have a
process for creating one?
When it repealed the 1935 Act, Congress left these
questions unanswered. At the same time, repeal increased the
likelihood of structural complexity. Gone are the geographic
limits. Gone are the type of business limits on utility mergers
and acquisitions. Gone are the prohibitions on leverage
financing. Gone is the at cost requirement for all inter-
affiliate transactions. The corporate structure options are now
nearly unlimited.
State commissions and FERC thus face questions they have
not had to address, systematically at least, for 70 years.
Should they limit the types of companies and corporate
structures that furnish essential service? Should they welcome
new structural options without limit? Should they proceed ad
hoc? Are leveraged private equity firms when owned by investors
with short term interests an appropriate substitute for
traditional conservative buy and hold investors?
On these questions, Senators, there is no expert consensus,
no political consensus and no systematic process for arriving
at either. Some argue that protection against cross subsidies
and other structural risks lies in rate making. This view is
not fact based.
Ratemaking depends on auditing. Auditing is not like a trip
to the dentist who checks every tooth. Auditing is sampling. It
cannot promise 100 percent coverage, especially with limited or
what FERC calls, targeted regulatory resources allowing
structures that invite cross subsidies or complicate auditing
increases the probability of problems.
Ratemaking is also after the fact. But after the fact
regulation invites too big to fail results. In the business
world poor decisionmakers fail, but not always.
We all are familiar with situations, some very recent, in
which a company size or significance pressures regulators to
prop them up. State commissions dependent on the incumbent
utility will tend to save the company rather than revoke its
right to serve. Given the inherent uncertainty of back end rate
review, front end structure review makes more sense. The
regulatory community needs to address this reality.
The GAO study cited State commission concerns about
availability of resources to deal with cross subsidies. Those
concerns are the real, empirical world that I know about, that
I practiced law in, that I presently serve. In fact the
resource problem is larger. After several dozen mergers and
acquisitions in the electric and gas industries since 1985, no
one has systematically studied the economic, engineering,
finance and managerial implications of these transactions.
In conclusion my testimony today urges alertness and
anticipation. We need to identify the types of utility
corporate transactions that trigger regulatory concern and we
need to create policies to address them. Some say that to
articulate a vision for accountable corporate structures is to
``reconstruct'' the 1935 Act in violation of Congress' 2005
intent.
This argument is deficient in logic and law. Section 203,
the Power Act, requires the Commission to judge mergers by a
public interest standard. The public interest requires
accountability. The 2005 Congress did not dilute this language.
It subjected more transactions to it.
It remains regulators continuous obligation to align
corporate structures with the public interest. With the repeal
of the 1935 Act that obligation becomes more difficult to
fulfill. The acquisition of remote utility properties, the
mixing of utility and non-utility businesses, the use of
unconventional ownership structures and financing structures,
these all call for new resources and new expertise. The dialog
created here by GAO and FERC is a worthy beginning, but it is
only beginning.
Mr. Chairman, I hope during the questions we can address
the issue of preemption because I believe there's some
significant misunderstandings about the nature of that term and
how it should apply in this context. In the meantime, let me
thank you and the members of the committee for this opportunity
to testify. I look forward to your questions.
[The prepared statement of Mr. Hempling follows:]
Prepared Statement of Scott Hempling, Executive Director, National
Regulatory Research Institute
Mr. Chairman and Members of the Committee: My name is Scott
Hempling. I am the Executive Director of the National Regulatory
Research Institute (NRRI). NRRI is an independent, Section 501(c)(3)
corporation, funded largely by voluntary state commission payments. Its
mission is to carry out the research activities that enable utility
regulators to make public interest decisions of the highest possible
quality. My testimony today reflects my own views, and not those of
NRRI, any state commission or any past client of mine or of NRRI.
As an attorney in private practice, I advised public and private
sector clients involved in regulated industries, particularly state
regulatory commissions and organizations of consumers or consumer
representatives. I have represented clients in many cases under the
Public Utility Holding Company Act of 1935 (PUHCA), before the
Securities and Exchange Commission (SEC) and the U. S. Court of
Appeals. I have testified before this and other Congressional
committees many times on PUHCA and other electric industry matters.
The stated purpose of this hearing is to ``examine the adequacy of
state and federal regulatory structures for governing electric utility
holding company structures in light of the repeal of the Public Utility
Holding Company Act'' of 1935, and in particular to discuss the
concerns raised by the report of the United States Government
Accountability Office (GAO), Recent Changes in the Law Call for
Improved Vigilance by FERC, GAO 08-289 (February 2008). These ``recent
changes'' are the 2005 repeal of the Public Utility Holding Company Act
of 1935, and the new FERC authorities established by the Public Utility
Holding Company Act of 2005. The GAO report has produced some useful
dialogue between FERC and the GAO on FERC's regulatory policies. My
testimony seeks to extend this dialogue so that we address the gamut of
regulatory issues raised by the Committee and by the 2005 amendments.
My testimony has five parts.
Part I places the current debate between FERC and GAO in the larger
context of corporate structure regulation. Effective corporate
structure regulation should encourage transactions that serve the
public interest and discourage ones that do not.
Part II explains that the 2005 repeal of the Public Utility Holding
Company Act of 1935 created gaps in corporate structure regulation.
Part III argues that to restore public accountability in corporate
structure transactions we must (a) identify and promote sensible
corporate structures and (b) apply cost-benefit standards.
Part IV explains that regulatory preparedness for the new
structural transactions made possible by the repeal of PUHCA 1935
requires multidisciplinary expertise and a shared multijurisdictional
purpose.
Part V, the conclusion, argues for alertness on the part of all
regulators.
I. CROSS SUBSIDIES IN CONTEXT: EFFECTIVE CORPORATE STRUCTURE REGULATION
SHOULD ENCOURAGE TRANSACTIONS THAT SERVE THE PUBLIC INTEREST AND
DISCOURAGE INEFFICIENT ONES THAT DO NOT
Over a century, our citizens have paid trillions of dollars to
support the infrastructure of our nation's electric and gas industries.
Corporate structure regulation seeks to make the recipients of those
trillions--owners, financiers and operators of that infrastructure--
accountable to the public. To that end, legislators and regulators have
asked five questions:
1. Who can acquire and own electric and gas utilities?
2. What business activities may exist within the utility's
corporate family?
3. What corporate structures may these corporate families
have?
4. What financial structures may these corporate families
have?
5. What interactions may occur among the members of the
corporate family?
These five questions share a common purpose: to encourage
transactions in the public interest, and discourage transactions that
are not.
The detailed dialogue between the General Accounting Office and the
Federal Energy Regulatory Commission on cross subsidies addresses one
subset of these questions: Do FERC's practices and policies prevent
infrastructure owners from forcing ratepayers to bear, through
excessive electricity and gas rates, the cost of business activities
unrelated to the provision of essential electric and gas service?
The five major questions make clear that cross subsidy regulation
is only one part of a corporate structure accountability mechanism. The
GAO-FERC debate is part of a larger conversation: What is our vision
for corporate structure? Does anyone have one? If so, is that vision
consistent across states, and between states and FERC? If there is such
a vision, do the regulators work consistently toward that goal? If
there is no such vision, is there a process for creating one?
When Congress in 2005 repealed the Public Utility Holding Company
Act of 1935, it left these questions unanswered. The result is multiple
gaps in corporate structure regulation, in our ability to screen
inefficient from efficient transactions, and in the accountability of
infrastructure owners to consumers, investors and the public. Ensuring
accountability requires that regulators identify and promote sensible
corporate structures that satisfy rigorous cost-benefit standards. To
prepare for this task--to put standards in place before receiving
proposals for the many structural transactions made possible by the
2005 repeal--requires new multidisciplinary expertise and a common
purpose shared by the multiple regulatory jurisdictions.
II. THE REPEAL OF PUHCA 1935 CREATED GAPS IN CORPORATE STRUCTURE
REGULATION
A. PUHCA 1935 created accountability to investors, consumers and the
public through four types of regulation
For 70 years, the federal Public Utility Holding Company Act of
1935 (``PUHCA 1935'') defined and limited the structural options for
electric utilities.\1\ PUHCA 1935's central policy goal was utility
accountability--to customers, investors, regulators and legislators.
Its central technique was corporate simplification--the alignment of
corporate form with public service obligation.
---------------------------------------------------------------------------
\1\ I use the term ``PUHCA 1935'' to distinguish that statute from
the Public Utility Holding Company Act of 2005, which includes the
language repealing the PUHCA 1935, plus some provisions relating to
regulators' access to books and records, and procedures for allocating
certain costs among holding company affiliates. PUHCA 1935 was codified
at 15 U.S.C. sec. 79 et seq. Practitioners customarily referred to
PUHCA 1935 provisions by section number rather than by U.S. Code cite;
therefore Section 1 of PUHCA is 15 U.S.C. sec. 79a, Section 2 is 15
U.S.C. sec. 79b, etc.
---------------------------------------------------------------------------
The alignment mechanism was the ``integrated public-utility
system''. each utility holding company had to limit its assets and
activities to those necessary to provide electric or gas service to the
public. PUHCA 1935 applied this principle by running corporate
structure proposals through a series of tests, restrictions and reviews
in four major areas: mergers and acquisitions, mixing of utility and
non-utility businesses, issuances of debt or equity, and interaffiliate
transactions. An understanding of these tests assists the analysis of
how deeply the regulatory infrastructure has changed.
1. Mergers and acquisitions
Under Section 10 of PUHCA 1935, the acquisition of a public
utility, through the holding company form, had to satisfy six tests.
Specifically, the acquisition:
1. Must not ``tend towards interlocking relations or the
concentration of control of public-utility companies, of a kind
or to an extent detrimental to the public interest or the
interest of investors, or consumers,'' Section 10(b)(1);
2. Must bear a ``fair relation to the sums invested in or the
earning capacity of'' the property acquired, Section 10(b)(2);
3. Must not ``unduly complicate the capital structure of the
holding company system,'' Section 10(b)(3);
4. Must not be ``detrimental to the public interest or the
interest of investors or consumers or the proper functioning
of'' the holding company system, Section 10(b)(3);
5. Must not be ``detrimental to the carrying out of the
provisions of'' Section 11 (relating to simplification of
holding company systems, Section 10(c)(1); and
6. Must ``serve the public interest by tending towards the
economical and efficient development of an integrated public-
utility system,'' Section 10(c)(2).
2. Mixing of utility and non-utility businesses
For ``registered'' holding companies (usually the multi-state
systems), the Act limited operations to ``a single integrated public-
utility system.'' The only exception was for ``such other businesses
[i.e., other than the business of a public-utility company] as are
reasonably incidental, or economically necessary or appropriate to the
operations of such integrated public-utility system....'' Section 1
1(b)(1). Example: If a utility owned coal burning plants, its holding
company could own a coal mine to service those plants; but it could not
own hotels and restaurants to house and feed coal miners.
For all ``exempt'' holding companies (usually the intrastate
systems), the Act allowed ownership of nonutility businesses, but only
to the extent not ``detrimental to the public interest, or the interest
of investors or consumers.'' Section 3(a).
3. Issuances of debt or equity
For the registered holding companies, Section 7(d)(1) prohibited an
issuance of securities if the issuance triggered one or more of six
negative findings:
1.``The security is not reasonably adapted to the security
structure of the declarant and other companies in the same
holding-company system''.
2.``The security is not reasonably adapted to the earning
power of the declarant''.
3.``Financing by the issue and sale of the particular
security is not necessary or appropriate to the economical and
efficient operation of a business in which the applicant
lawfully is engaged or has an interest''.
4.``The fees, commissions, or other remuneration, to
whomsoever paid, directly or indirectly, in connection with the
issue, sale, or distribution of the security are not
reasonable''.
5.``In the case of a security that is a guaranty of, or
assumption of liability on, a security of another company, the
circumstances are such as to constitute the 6 making of such
guaranty or the assumption of such liability an improper risk
for the declarant''; or
6.``The terms and conditions of the issue or sale of the
security are detrimental to the public interest or the interest
of investors or consumers.''
4. Interaffiliate transactions
Sections 12 and 13 of PUHCA 1935 applied to registered holding
companies a set of prohibitions and conditions relating to
interaffiliate transactions in two major categories: financial
transactions (e.g., loans, guarantees of indebtedness, extension of
collateral), and sales of goods and services (other than electricity or
gas).
Prohibited transactions included any loaning of money, or
guaranteeing of indebtedness, by a utility subsidiary in favor of its
holding company or any affiliate. See Section 12(a). Other
interaffiliate transactions had to heed SEC rules, which generally
required interaffiliate pricing to be ``at cost,'' to prevent utility
subsidiaries from being forced to subsidize nonutility businesses. See,
e.g., Section 13(d).
B. The repeal of PUHCA 1935 eliminated key accountability measures,
increasing the likelihood of corporate complexity and abuse of
interaffiliate relations
By eliminating the 1935 Act's restrictions and reviews, the 2005
statute increased the likelihood of structural complexity, including
self-dealing between regulated and unregulated holding company
affiliates. Gone are the geographic and type-of-business limits on
utility mergers and acquisitions, along with reviews of and limits on
leveraged financing and interaffiliate transactions.
These changes make utility regulation more challenging. Because
PUHCA 1935 induced conservatism in corporate restructuring, states and
FERC had less need to create their own policies. Of the dozens of
mergers between 1985 and 2005, most involved the joining of adjacent
utilities. In these cases, the main challenges were to test the claims
of cost savings from the combination (claims based on the assumption
that the combination would produce greater economies of scale and
scope); then allocate the risks, costs and benefits associated with
those claims among customer groups and investors. Additional challenges
included identifying and protecting against horizontal and vertical
market power; and ensuring that the larger, post-merger entity devoted
sufficient attention to local quality of service. These mergers, for
the most part, did not involve the joining of remote electric
facilities, or the mixing of utility and nonutility businesses, or
leveraged private equity financing that increased debt while decreasing
public information.
By removing limits on geographical, type-of business or financial
arrangements, the repeal of PUHCA 1935 changed the market for corporate
restructuring. Regulators at state commissions and at FERC thus face
questions they had not had to address, systematically at least, for 70
years: Should they impose limits on the types of companies and
corporate structures that provide retail monopoly service to
electricity and gas customers? Or should they welcome new structural
options without limit? With respect to these questions, there is no
expert consensus, no political consensus, and no systematic process for
arriving at one.
III. TO ENSURE PUBLIC ACCOUNTABILITY IN CORPORATE STRUCTURE
TRANSACTIONS, WE MUST (A) IDENTIFY AND PROMOTE SENSIBLE CORPORATE
STRUCTURES AND (B) APPLY COST-BENEFIT STANDARDS
A. What types of corporate structures promote the public interest?
In repealing PUHCA 1935, the 2005 Congress expressed no particular
vision for corporate structures. There are no federal statutory limits
on geographic remoteness, the mixing of utility and nonutility
business, leveraging, private buyouts, interaffiliate transactions.
Anyone can try anything.
Regulators thus face corporate structure transactions not
permitted, or not permitted without review, for 70 years. This
circumstance requires us to revisit regulatory policy on corporate
structures. The purpose of such revisiting is not to replicate every
aspect of the prior federal regime, but to inquire systematically into
the nature of the new transactions and to determine the appropriate
regulatory response, if any.
The table on the following page, ``Corporate Restructuring by
Public Utilities: How Should Regulators Prepare and Respond?,''
displays the necessary analysis. Listed on the left are corporate
structure events which attempt to describe all major types of
transactions: 7 categories and 21 subcategories. Listed across the top
are the 3 categories of regulatory options--prohibition; permission
without review; and permission subject to reviews, limits and
conditions. By completing this table, the regulator determines,
systematically, the types of companies and corporate structures
permitted to provide utility service. For each of these 63 cells, PUHCA
1935 gave an answer. With PUHCA 1935's detail eliminated, the answers
now must come from state law, and state and federal regulatory
discretion.
This Part III of my testimony introduces the type of analysis
applicable to four of these subjects: expansion of utility business,
mixing of utility and nonutility businesses, interaffiliate
transactions and issuance of debt or equity. First, the regulator must
define the types of transactions that trigger regulatory concern. Then
the regulator must determine the response: prohibition, permission
without review, or permission subject to standards and review. The
concepts below are examples for consideration. Some overlap. There is
no intent that all should be promulgated. Rather, regulators and
legislators should consider the full array and select those that suit
their preferences.
Caution: Advocates of regulatory forbearance may misinterpret this
table as a recommendation for regulatory conditions in every cell. The
table does not prescribe a result; rather, it ensures alertness--to
those corporate structure actions that warrant regulatory attention,
and to the types of regulatory intervention (including no
intervention). The purpose is to alert regulators to a statutory fact:
the 1935 Act addressed every cell, in some way; the 2005 Act addresses
only some.
1. Utility acquisitions of more utility businesses
The regulatory concern here relates to diseconomies of scale,
management distraction and business risk: Will a utility become part of
a system so large that quality and efficiency of local service will
suffer, or local concerns be ignored, in setting terms and conditions
of service? These transactions warrant attention whether structured as
an acquisition, pooling of interests, transfer of assets or other form
of restructuring; or whether the certificate to serve is transferred or
remains in the original hands.
As with all the subject areas discussed here, the options for
regulatory action on utility requests for permission to acquire other
utility businesses include prohibitions, permission without review, and
permissions subject to conditions and reviews. In cases where the
statute or regulator does not prohibit the acquisition, regulators
should submit it to economic tests, such as requirements of new
efficiencies, non-recovery of any acquisition premium except to the
extent the premium is matched by demonstrated cost reductions, and
limits on the utility debt used for the acquisition. There also are
structural conditions, such as placing the in-state utility business in
a corporation separate from nonutility business, requiring that the
utility maintain its own bond ratings, and requiring that the in-state
utility obtain, file, maintain and update annually a third party's
nonconsolidation opinion, i.e., an opinion that regulatory provisions
are sufficient to prevent utility from being forced into bankruptcy
should the holding company or other affiliate fail. Operational
conditions include requirements that the merged entities be
operationally integrated, commit to specified operational cost
reductions (otherwise, there would not be cost justification for the
merger), use best practices in all areas, satisfy quality of service
standards, and bring no new cost or risk unless exceeded by measurable
benefits.
A risk associated with any of these conditions is that they may not
provide a level of protections comparable to what existed before the
transaction.
2. Mixing of utility and nonutility businesses
The mixing of utility and nonutility business, including the
control of a utility business by a nonutility owner, was long
prohibited or discouraged by PUHCA 1935. The concerns here are
management distractions, use of utility ratepayers to finance or
guarantee debt associated with the nonutility business, and unearned
competitive advantages for utilities entering nonutility markets.
Regulatory options, along with prohibition, and permission without
review, include: (a) limits on the percentage of total holding company
assets, revenues or net income that can be attributable to nonutility
businesses; (b) limits on holding company or utility financing of any
acquisition of nonutility businesses; (c) limits on the utility's
ability to file for bankruptcy based on affiliate difficulties; and (d)
forms of separation between utility and nonutility businesses, such as
separate affiliates, accounting, financing and financial statements.
3. Interaffiliate transactions
Affiliate transactions fall into four major categories: sales of
utility services, sales of nonutility goods and services, sales of
utility assets, and financial transactions (e.g., loans and guarantees
of indebtedness). Affiliate transactions move in both directions: to
and from the utility, from and to the holding company or other
affiliates. There are multiple risks. ``Cross subsidy'' is a term
frequently used in this context but infrequently defined. Where the
corporate family has both utility and nonutility businesses, a cross
subsidy occurs when a utility ratepayer bears costs caused by
nonutility activities; i.e., when the ratepayer pays a price for
utility service higher than she would have paid in the absence of the
nonutility activities. When a utility holding company buys a hotel and
shifts acquisition costs to the ratepayers, a cross subsidy occurs.
When a utility enters a risky nonutility business, and the utility
covers the higher cost of capital through utility rates, a cross
subsidy occurs.
Cross subsidies are only part of the adverse effects of
inappropriate interaffiliate relations. When utility customers have
historically borne the economic cost of an asset, they should receive
the full market value associated with that asset's use by others. But a
common practice is for the nonutility affiliate to obtain rights to the
asset at cost rather than at market value. The result is not a cross
subsidy, technically, because the ratepayers' rates do not rise as a
result of nonutility affiliate's use. But there is a mismatch of risk
and reward. The utility ratepayers bear all the costs but receive only
part of the benefits.
The regulatory options for addressing these challenges again range
from prohibition to conditional permissions to unconditional
permissions. Examples: (a) prohibition on a public utility providing to
an affiliate any financial loan, guarantee or other benefit other than
the normal payment of dividends; (b) requirement that any goods or
services sold by a utility to an affiliate be priced at the higher of
book or market; (c) requirement that any goods or services sold to a
utility by an affiliate be priced at the lower of book or market; (d)
advance review of dividend payments to protect financial integrity of
the holding company system and the working capital of in-state utility
affiliate; and (e) advance approval for interaffiliate cost allocation
practices and contracts above a minimum dollar level.
4. Issuance of debt or equity
With the electric and gas industries now free of any federal
prohibitions on the types of corporate acquisition, utilities, their
holding companies or their affiliates may attempt securities
transactions that could trigger regulatory concern over leveraging, and
over acquisition prices in excess of underlying value (with the
expectation that captive ratepayers will fund the excess). The types of
transactions warranting attention include issuance of debt or equity,
and guarantees or assumptions of liabilities, (a) at the holding
company level, for utility or nonutility purposes; (b) at the utility
level, for utility purposes or nonutility purposes; and (c) at the
nonutility level, for utility purposes or nonutility purposes.
The regulatory options include, besides prohibiting, or permitting
without review, these transactions, the following: (a) the terms and
conditions of the security issuance must be consistent with the sound
and economical financing of the public utility businesses, i.e., that
there is neither excess nor insufficient debt, and that the debt be
reasonably adapted to the security structure of the utility and all
companies in the holding company system; (b) the fees associated with
the securities issuance must be reasonable and there may be no
conflicts of interest among the transacting parties and their advisers,
and (c) debt incurred by or guaranteed by a public utility must be used
for public utility purposes only.
B. In assessing corporate couplings, how do we ensure that benefits
justify the costs?
After dozens of utility mergers, the fundamental economic analysis
of whether a merger is, from the consumers' perspective ``worth it,''
remains unsettled. This ``merger equation'' involves four main
questions:
1. What should be the relationship of costs to benefits?
2. How should we measure costs?
3. How should we measure benefits?
4. If actual costs and benefits deviate from projections, who
is accountable?
There is no commonly held answer to these questions. In many
mergers, the questions never arise, let alone receive answers.
What should be the relationship of costs to benefits? The most
frequent answer is either (a) ``benefits must not be less than costs''
(sometimes called the ``no harm'' test), or (b) benefits must exceed
cost, but not necessarily by much (sometimes called the ``positive
benefits'' test). Another test, applied uniformly in prudence review,
and in standard financial analysis, but rarely in merger review, is
``Does the cost produce benefits at least equal to alternative,
feasible uses of the money?'' The roots of this third test are in the
common sense view of economic efficiency, that the ``public interest''
is harmed when a merger consumes resources that would allow a lower-
cost means of achieving benefits. In the regulatory community there has
been no systematic examination of these alternative equations, or of
the implications of allowing dozens of mergers to proceed without such
examination.
How should we measure costs and benefits? Savings asserted by
merger applicants have included: administrative/general savings, labor
savings, fuel savings, O&M savings, savings from coordination
efficiencies, savings from construction deferral and savings from bulk
purchases and other economies of scale.
As with the benefit-cost relationship, there is no common
regulatory treatment of costs. Some states require merger applicants to
quantify savings with the degree of specificity required in a rate
proceeding, or to accept rate reductions based on their assertions of
savings. Sometimes, however, applicants' assertions of savings are so
general that there is insufficient information on which to base a
credible cost-benefit judgment. Regulators also differ over the period
of time over which they must quantify savings. Nancy Brockway, NRRI's
Director of Multi-Utility Research and Policy, points out that there is
no industry standard for estimating likely merger synergies, and
typically no track record of proven synergies from other mergers by
which to assess forecast results from the proposal under review.
If actual costs and benefits deviate from projections, who is
accountable? A continuing difficulty is determining whether an asserted
merger benefit would have occurred without the merger. Otherwise merger
cost recovery from ratepayers would negate cost reductions that would
have occurred without the merger.
After-the-fact rate review is not enough. Some argue that
protection against cross subsidies and other risks lies in ratemaking.
The implication is that structural complexity poses no risk because
ratemaking will catch problems. This view is not fact-based. Ratemaking
depends on auditing. Auditing is not like a trip to the dentist, who
checks every tooth. Auditing is sampling. It cannot promise 100%
coverage--especially with limited regulatory resources. Allowing
structures that invite cross subsidies or complicate auditing increases
the probability of problems.
Reliance on after-the-fact disallowance also invites too-big-to-
fail situations. In the competitive world, poor decisionmakers fail.
But not always. We all are familiar with situations in which a
company's size or national importance pressures regulators to prop them
up. State commissions whose residents depend on the incumbent will tend
to save the company rather than exact the ultimate penalty--especially
since bankruptcy law addresses creditor rights, not consumer
protection. Given the inherent uncertainty of ``back-end''
accountability in the form of rate review, ``front-end'' accountability
in the form of advance review of financial risks becomes even more
critical.
IV. REGULATORY PREPAREDNESS FOR NEW STRUCTURAL TRANSACTIONS REQUIRES
MULTIDISCIPLINARY EXPERTISE AND A SHARED MULTIJURISDICTIONAL PURPOSE
A. Multidisciplinary analysis calls for a new array of regulatory
resources and skills
The GAO study cited state commission concerns about availability of
resources to deal with cross subsidies. That concern applies as well to
the larger set of questions throughout this testimony. Analysis of
corporate structure events requires expertise and resources in the area
of economics, engineering, finance and accounting, and business
management. In this subpart I give examples of the types of question
demanding new skills and resources.
1. Economics: What are the economies and diseconomies of scale for
the various components of utility service--production, transmission,
distribution, customer relations? What are the economies and
diseconomies of scope among various utility and nonutility activities
potentially coexisting within the same corporate family? How can
regulators gather this information in the context of reviewing merger
and acquisition proposals?
2. Engineering: For each of the major physical functions involved
in utility service, what are the geographic and size limits beyond
which reliability, quality and responsiveness of service are affected?
3. Finance and accounting: What are appropriate financial
structures for the various businesses within a utility holding company
structure? Do some structures pose the risk of corporate managers
channeling utility cash flow to nonutility businesses, in amounts
detrimental to the utility's optimal functioning? For example, can
there be ``safe harbors'' for various types of nonutility investments
by utility holding companies, such that should business failures occur,
no damage to the utility will result? Are there true benefits to
utility shareholders to having a utility holding company diversified
into other business, as compared to the shareholders diversifying their
portfolios individually?
In corporate acquisitions occurring within noncompetitive markets,
there is a risk of financial circularity: the acquiring company pays a
premium for a utility knowing that the premium can be recovered from
monopoly ratepayers. (Competitive markets, in contrast, cap premium
payments because the acquired entity cannot raise product prices above
market prices.) Given the circularity risk, what methods exist for
determining the appropriate size of acquisition premia? What regulatory
policies best line up the acquirer's desire to pay a premium, the
acquiree's insistence on a premium, and the ratepayer's legal right to
protection from rate increases associated with the premium? (Such
policies should encourage efficient mergers--meaning mergers that lower
costs--and discourage inefficient mergers.)
4. Business management: What are implications for efficient and
effective management when utility operations are geographically
dispersed, i.e., not operationally integrated? How do managers, and
regulators, determine these limits? What are the incentives, for
various management positions, which result from a mix of utility and
nonutility businesses in the same corporate family? Are these
incentives aligned with the public interest? What are the skill sets
necessary to manage, simultaneously and successfully, monopoly and
competitive businesses within the same corporate family? After several
dozen mergers and acquisitions in the electric and gas industries since
1985, what data are available to study these questions?
B. Multiple regulators of the corporate structure market need a shared
purpose
While eliminating federal statutory restrictions, Congress left
pre-existing state and FERC roles undiminished. The responsibility for
making those judgments necessary to prevent adverse effects on
consumers, markets (for power, gas and finance) and the general public
thus shifts to the regulators, federal and state, who must try to use
their existing jurisdictional tools to address the new challenges. This
situation creates opportunities for regulatory experimentation and
creativity, but it raises a fair question: Will the separate actions,
or inactions, of multiple jurisdictions produce a rational regulatory
policy on corporate restructuring in multistate markets?
I suggest that the current conversation on cross subsidies grow
into a discussion of this larger question: Do we need consistent
regulatory policies across jurisdictional lines to encourage utility
corporate structures that serve the public interest, and discourage
ones that do not? Can we achieve that consistency while still leaving
flexibility for individual jurisdictions?
This question need not trigger a federal-state dispute over a
jurisdictional zero-sum equation. There is opportunity for a
jurisdictional policy that allows for federal and state roles, and for
variation among the states on a number of issues. A rational policy
would distinguish between (a) the need for an efficient multistate
market for utility asset acquisitions, and (b) the need for responsible
state-level regulation to ensure efficient and reliable local service.
Without a concerted effort on the part of federal and state policy
makers to address the whole set of issues raised by utility mergers and
acquisitions, from cross-subsidies to federal/state jurisdiction,
however, we will dilute out ability to address the gaps left by the
repeal of PUHCA 1935. I hope this Commission, and the participants in
today's testimonial panels, can address this question.
V. CONCLUSION: THE REPEAL OF PUHCA 1935 DOES NOT RELIEVE REGULATORS OF
THEIR DUTY TO ADVANCE THE PUBLIC INTEREST THROUGH CORPORATE STRUCTURE
REGULATION
This testimony has focused on alertness, in the form of four types
of anticipatory actions: (a) identifying the types of utility corporate
structure transactions that trigger regulatory concern; (b)
establishing principles to guide market participants who fashion such
transactions; (c) recognizing the multidisciplinary ingredients to
effective regulatory review; and (d) revisiting the federal-state
relationship to ensure consistency in vision and implementation. The
present focus on cross subsidies is too narrow to accommodate these
larger, more far reaching questions.
Some have argued that to articulate and encourage a vision for
accountable corporate structures is to ``reconstruct'' PUHCA 1935, in
violation of Congress's 2005 intent. This argument is deficient in
logic, law and thoughtfulness. Section 203 of the Federal Power Act
requires the Commission to judge mergers by a ``public interest
standards. The 2005 Congress did not dilute this language, but rather
subjected more transactions to it. State merger statutes create similar
duties.
It remains regulators' continuous obligation to align corporate
structures with the public interest. With the repeal of PUHCA 1935,
that obligation becomes more difficult to fulfill. The acquisition of
remote utility properties, the mixing of utility and nonutility
businesses, and the use of unconventional ownership structures and
financing structures, all call for new resources and new expertise. The
dialogue created here by GAO and FERC is a worthy beginning, but it is
only a beginning.
Thank you for the opportunity to present this testimony. I look
forward to any questions from the Committee.
Senator Salazar. Thank you, Mr. Hempling. Let me start out
with you, Mr. Gaffigan. You, in your testimony talked about the
few substantive changes in FERC after the 2005 Act. You talk
about how we essentially have a system in place that's self
certification system. I think your conclusion is that FERC is
too over reliant on self reporting. That they don't have a risk
based approach to targeted auditing that the resources that
FERC has with only 34 auditors isn't sufficient for them to do
the job that we assigned to them under the 2005 EPACT.
Would the remedy there essentially be to give more
resources to FERC so that they could actually do the job that
was assigned to them by the Congress back in 2005? How big is
that deficiency?
Mr. Gaffigan. Right. I think the first step is to have them
sit down and do a real risk based approach, in other words,
understanding what's the portfolio of companies that they're
going to look at.
For example, if it is the 36 utility holding companies,
which ones are the highest risk? How involved are they? If we
have more mergers become involved what's the make up of the
companies? I mean, really complex types of issues.
That's going to really dictate and put them in a position
to say, alright, here's how many resources we need to cover
this. We're short. So I wouldn't go off and just say, look,
just throw a bunch of auditors at it. I would have them do the
risk based approach as our recommendation outlines. Then I
think, then they'll be in a position to give a good assessment
of what their resource needs might be.
Senator Salazar. Based on what you know, based on having
done the GAO report, how short do you think they are on
resources? Or do you think you can't answer that until you go
through the risk based analysis.
Mr. Gaffigan. I think to give you a good answer, you can't
answer that. I expect it to change over time. You know, we
could have more mergers than is expected and that would dictate
how much staff they're going to have.
I think they're in a position where, you know, when the SEC
went away, they used to do these audits. They were a group of
about 25 auditors. So they have gone away. The Division of
Audits has pretty much stayed the same within FERC.
Senator Salazar. Commissioner Kerr, on behalf of the
States. The concept here is that the States through their PUCs
do a lot of this work and so FERC essentially acts as a
backstop. Do the States have, I mean, your testimony is the
States don't have the resources. You're resource deficient.
What I'd like you to do is to talk about that a little bit
and also talk about the variance between the States because
knowing the reality of States some legislatures and Governors
will put more money into their commissions than others. And so
do we have a patchwork of regulation here for when deferring to
the State levels that is not workable.
Mr. Kerr. Senator, I would be fired I think if I said we
have all the resources at the State level we need and by my
colleagues. They wouldn't like that. I mean, obviously
resources are always scarce.
I think certainly the question is yes, that there is
variety from State to State or commission to commission when
you think about financial or human resources. I would say the
good human resources aren't always in the bigger States. I
mean, we're just variable, like any group of 50.
But I don't think, and I think that GAO's report bore this
out, I don't think there is tremendous variation in terms of
legal authority. I mean the report is pretty clear. There is
consistent authority found in statute or rules to look at
mergers, to audit, to have access to books and records.
Certainly in EPACT 2005 Congress expanded for all States
access to books and records of holding companies and
affiliates. So I think that the legal. There's not as much
legal variety or variation across the States. I think that the
report bears that out.
Now I will say that they did identify some discrepancies or
some variety, fairly minimal. I think that's why we're glad
that they've come and reported to us. It gives us a tool to
fill in some of those gaps. Certainly since the repeal of PUHCA
some States have gone in and asked for certain authorities from
their legislatures that they felt like they needed.
So, yes, as to financial and human. I don't think so from a
legal standpoint. In other words we have the authority to do
the job.
I think the answer for how do we handle that variability
from a resource standpoint is largely found in organizations
like NARUC, like the National Regulatory Research Institute,
which Mr. Hempling heads up for us. In fact we went looking at
the future and our responsibilities. We went out and found
someone like Mr. Hempling to come in and assist us.
At footnote 32 and 33 of my testimony I've listed some of
the work that we've done with the prospect and the reality of
PUHCA repeal to help prepare States. Academic reports,
substantive work to try to make sure that that variability we
can leverage the resources of the national organization and the
various States to try to even out and fill in and provide for
that variability.
Senator Salazar. Thank you.
Mr. Kerr. I would make one other just quick point too and
that is the level at which we are doing a better job in the
last two or 3 years of working with the financial community. I
think they know where we are now and we know where they are. So
I think the way, the manner and the level at which we
understand the private equity community, the fixed income side
of these issues.
We're much more sophisticated. I think we needed to be. I
think that is helpful. I do think that's across the board. I
mean that's at the national level and at the regional level and
we're doing a better job there.
Senator Salazar. Thank you, Commissioner Kerr.
Senator Murkowski.
Senator Murkowski. Thank you, Mr. Chairman. I apologize
that I was not here for the first half of this hearing.
Obviously a very important issue and one that I'm pleased that
has been brought before the committee.
I was over in the Indian Affairs Committee where we were
talking about the Indian Energy Act and the fact that we may
have put in place some good provisions, but we have lacked in
certain areas when it comes to providing things like loan
guarantees and the financial assistance. So it was an important
hearing over there too this morning. Busy morning.
Let me ask you, Mr. Gaffigan, well I wasn't here for Mr.
Kelliher's testimony. I did have an opportunity to review it.
You're arguing that the principle means for identifying the
cross subsidies is through the financial audits, the periodic
financial audits.
But the Commission highlights its rate making authority as
the most powerful and perhaps the most effective tool for to
prevent the cross subsidies. Do you agree that this rate making
authority can be an effective tool both at the State and
Federal level or is that a basic area of disagreement here?
Mr. Gaffigan. You know, rate making is part of it. I mean
our focus was on the compliance audit which formerly SEC did.
What I would say about rate making, you know, it occurs
infrequently. They could be many years apart. The audits can be
many years apart and in sort of a prospective look.
So what I would say it's a different tool. I think what the
compliance audits we're talking about offer a retrospective
look and a particular look at affiliate transactions and the
whole range of cost. FERC is looking at, you know, transmission
costs and the wholesale sale of electricity. So it doesn't
cover necessarily all the costs that ultimately a consumer can
pay.
So I would say they are complementary and what I would say
is that the compliance audits we're talking about are just as
important. That was the focus of our concern.
Senator Murkowski. I see. So it's not an either/or. You're
saying that it's a complementary process then.
Mr. Gaffigan. Absolutely.
Senator Murkowski. Mr. Owens, you've testified that this
increased Federal oversight over non-utility corporate
activities could actually create barriers to investment and
competition in the electricity markets. Which is exactly what
we were intending to do, to eliminate when we repealed PUHCA.
Can you elaborate a little bit more on this line?
Mr. Owens. If the rules aren't clear. If the rules appear
to be preemptive of activities that the States have underway
where they also review a range of activities that companies are
engaged in, it could create tremendous confusion and delay in
getting a range of financing approvals. It could also
potentially could create tension between the State commissions
as well as the Federal Energy Regulatory Commission if the
rules are not clear and the rules are not collaborative.
Ratemaking is a very comprehensive responsibility that both
the States and FERC have. I do agree with the earlier comments
that it's just not an audit. It's the looking of all aspects of
a company's operations.
But the rules have to be clear. The rules have to be
understandable. The rules have to be implemented in a way that
it does not create confusion and uncertainty.
Senator Murkowski. Mr. Hempling, you have left the door
open. You invited the question from Senator Salazar and myself
on the issue of preemption. Your testimony provides for
revisiting the Federal/State relationship to achieve consistent
regulatory policies across jurisdiction lines with respect to
cross subsidies.
Are these the code words for Federal preemption? Talk a
little bit about where you were going when you kind of left
that question hanging there.
Mr. Hempling. Thank you very much, Senator. I in fact meant
the opposite. But first let me address the issue of preemption,
deference and backstop, three words that have been used
frequently this morning.
There is absolutely no, in my opinion, congressional intent
in the 2005 statute to authorize FERC to make decisions that
are preemptive of States. I'm concerned that that word has
departed from the way I learned it in law school. I went to law
school a long time ago. But I think somewhat more recently than
some of the other panelists.
Preemption, technically, simply means that the State law
becomes invalid and inoperative under State law. I don't think
anything in the 2005 statute could have that effect. There is
the possibility that the FERC could find that the range of
conditions imposed at the State level are insufficient as a
matter of Federal law. Therefore the Federal Energy Regulatory
Commission could add to them.
But there is no authority in FERC to declare that somehow
the State law conditions are inoperative or unlawful. To the
extent the prior panelists meant preemption in that way,
there's no legal basis for it. I think perhaps they were using
it in a non-legal way.
But I think it has caused confusion because the issue here
is not a matter of deference to States. The FERC has
independent legal authority. By the way in the context of
section 203, that authority is not confined to the protection
of wholesale customers. I'm sure the chairman and his lawyers
know that.
The only wholesale notion in the Federal Power Act has to
do with rates. But in the context of mergers and acquisitions
and restructurings under section 203, the public interest
includes all customers both wholesale and retail. There is no
legal authority in FERC to create in some party a burden to
prove to FERC that somehow State conditions are inadequate.
The FERC has an independent obligation to ensure that all
customers are protected. The fact that FERC might come in to
say we like the Washington State conditions, but we think more
are necessary. That's not called preemption the way I learned
it in law school. That's called exercising independent
authority to strengthen.
I know of many States who would be very pleased to have
FERC play that role because the States either lack the
resources or the political support to impose as many conditions
as they would like. So when we talk about cooperation and
complementing each other. It is in the exercise of independent
authority at the State and the Federal level.
My concern about consistency actually is consistent with
what Mr. Owens and others have said is that I want to see clear
signals sent to the marketplace. Some mergers and acquisitions
are going to be good. We've got corporate boundaries that were
drawn almost 100 years ago.
Some of them are old and need to be replaced with larger
companies that have better economies of scale. Other mergers
are going to be inefficient because they are motivated by the
wrong desires. We need this concept of consistent rules that
are clear so that the marketplace knows how to react.
That's where I think collaboration can occur. Thank you for
the opportunity.
Senator Murkowski. I appreciate your statement there. Thank
you, Mr. Chairman. I've gone over my time.
Senator Salazar. Thank you very much, Senator Murkowski.
Let me ask a question of you, Mr. Owens for EEI. One of the
things that was predicted back in 2005 when we working on EPACT
and the repeal of PUHCA was that we were going to see merger
mania, 70 years of regulation under PUHCA ended in 2005 and
everybody said we were going to see major merger mania. It
hasn't happened.
Looking ahead, what do you see? Do you see the possibility
of merger mania in the utility world?
Mr. Owens. If I knew that answer I wouldn't be here. I'd be
a rich man. Let me stop being a--I would say it really depends
on market conditions and whether companies can see benefits
that will accrue to customers as well as benefits that would
accrue from technology improvements.
You can't predict whether a merger is going to occur or
not. As all the panelists have indicated there are a range of
issues that are presented when a company considers merging with
another company or acquire another company. The bottom line of
all those considerations are savings to consumers,
technological advancements, economies of scale, economies of
scope.
Senator Salazar. Let me try to pinpoint my question a
little bit more.
Mr. Owens. Yes.
Senator Salazar. We see what's happening in the airline
industry today where there are a number of conversations about
mergers and the airline industry. We have seen it over the last
ten, fifteen years with respect to what happens in the
financial industry and the banking industry with respect to
mergers.
Mr. Owens. Yes.
Senator Salazar. We have not seen a merger mania.
Mr. Owens. That's right.
Senator Salazar. A significant movement in that way in last
several years with respect to regulated utilities. Do you, in
terms of the way that EEI sees the world, is that something
that you are thinking might happen? Do you think it's not going
to happen? I mean what are your economists----
Mr. Owens. Wall Street would love to see it happen. They
indicate that there are too many companies. I mentioned earlier
that many of our companies are undergoing tremendous investment
in infrastructure. Based upon the major investment in
infrastructure it is likely that some companies will not be
able to have the finance ability to build a major new facility.
They may find that they have a stronger balance sheet if they
combine with other companies. So that's one condition that
could lead to greater mergers.
There's uncertainty with respect to what happens under the
concerns about climate change. Companies have different levels
of resources. Companies that are not heavily coal based may see
an opportunity or an advantage in combining with a company that
has a broader array of resources.
Again all of these are pretty speculative. They really
depend upon changing conditions. But I don't think they're so
far fetched.
There are international companies that are looking at the
U.S. market and the dropping of the value of the dollar and the
strong balance sheets that some of the international companies
have. They may view that they can see opportunities in
acquiring a U.S. company and providing economies to that U.S.
company. I think we're in an environment where that can occur.
We look at all of that and say we don't see a tremendous
rise in mergers potentially occurring. But we think the factors
that could lead to mergers, many of those factors are presented
today.
Senator Salazar. So it could, in fact, happen, which in the
sense makes the importance of this hearing and having a FERC
that has the adequate oversight work well.
Mr. Hempling, I'll come back to you, Mr. Gaffigan. On this
question of preemption, I think I understand what you were
saying that this is not really a preemption in the legal sense.
You have independent authority at FERC. You have independent
authority with the State Regulatory Commissions. So those
independent authorities need to be exercised in the public
interest.
The question I would have for you then is how do we make
sure that these independent authorities get exercise in a way
where they're essentially part of the same team of protecting
the public interest as opposed to having, you know, one big cop
at the Federal level and another cop at the State level. How do
you create that kind of collaboration so there is consistency
with respect to the regulation?
Mr. Hempling. I was afraid somebody would ask such a
thoughtful question and not that the other questions haven't
been thoughtful. It's a difficult way to answer it without
getting stuck in the canard that I'm proposing a ``one size
fits all'' which is a phrase people often use to describe a
solution they don't like.
I want to first emphasize that I'm not talking about the
need to have a single approach to every transaction. I think
the prior panel made clear that depending on whether it's a
partnership, a SCEcorp or other sorts of arrangements, there
need to be different types of tools. I think what has to happen
is much more difficult than what we're addressing. That is
there has to be some consensus about the nature of the
corporations that we want serving the company.
There's something episodic and opportunistic about the way
it's working right now. I was never among the ones who
predicted merger mania. I don't think the concern is the speed
at which these transactions or the rate at which they occur.
I think the question is what is the nature of the
companies. Are we indifferent when a Warren Buffet acquires a
Washington or an Oregon utility? Are we indifferent when a
private equity firm acquires a utility? Do we care whether the
long term shareholders have been replaced by short term
shareholders?
My concern is that there is lacking a dialog among
regulators at the State and Federal level and together as to
what it is we're trying to achieve here. Because if one were to
infer from the present regulatory stance the inference would be
that whatever the ``market'' produces in terms of couplings is
what is right. I'm concerned that the market is not
sufficiently competitive or disciplined or overseen for us to
have that type of trust in it.
So I'll simply concede that I have no direct answer to your
question, yet. But I believe it's the main one we have to
address, sir.
Senator Salazar. Ok. Why don't we keep--my time is up. So,
Commissioner Kerr and Mr. Gaffigan, if you'll quickly respond
and then we'll turn it over to Senator Murkowski.
Mr. Kerr. I think I agree with Mr. Hempling. I think the
trouble is it is so difficult. Things are moving so fast. It's
hard to make that distinction. You know, Mr. Buffet's
involvement in the utility industry has been, I think,
successful and welcome. Certainly if you look at the disaster
that became ENRON, you know, that basically evolved off a
utility platform. It began as a typical utility platform that
evolved.
I think my basic point is we can't know prescriptively,
prospectively what we are going to need or where these
investments are going to come from. I absolutely agree with Mr.
Hempling that we know the type of investor, the longer term
horizon, the folks who understand the unique public service
obligation of these entities. It's more difficult to sort
through and figure out who is Warren Buffet and who is Gordon
Gecko. I can see that. I don't see how you're going to do that
in advance.
Senator Salazar. Do you think, Commissioner Kerr, that Mr.
Hempling suggestion on the need for the dialog between FERC and
the States is adequate?
Mr. Kerr. I think absolutely. I think we have that. I mean,
I think one of the points that I want to make clear that might
have slipped by during the first panel is the policy statement
that FERC has adopted was based on a technical conference that
had representatives of two State commissions including Oregon
which is really the preeminent case of ring fencing and the
effectiveness of protecting the underlying utility from the
ENRON debacle.
So I think that dialog is ongoing. I mean, can we do more
as the GAO suggests? Yes, certainly, we might be able to. I
think both FERC and the State and NARUC have indicated, an
absolutely, a willingness to do more if that's what we need to
do.
Senator Salazar. If you take about 20 seconds, Mr.
Gaffigan.
Mr. Gaffigan. I can. I just want to add to Mr. Hempling,
the merger mania concerns we heard were not the numbers and the
rate. It was: what are things going to look like? That's the
concern we had. We don't have a concern about regulatory gaps,
as Mr. Owens implies.
We have a concern about how are these States going to deal
with this issue of more complex companies coming in and
potentially putting themselves in the situation of having to
approve a merger. They could face things that are more daunting
than what was faced in the 1930s and the whole reason for PUHCA
in the first place.
Senator Salazar. Senator Murkowski.
Senator Murkowski. Just very quickly to finish up my
questions. This should be a, you know, 30-second answer from
each of you. With FERC do we have in place sufficient customer
protections in light of PUHCA repeal? Now Mr. Gaffigan you
mentioned you're not concerned that there have been any
regulatory gaps that have resulted as a consequence of the
repeal.
But do we have sufficient customer protections, consumer
protections in place?
Mr. Gaffigan. Our concern was not with the rules. It's with
enforcement of the rules. That's our main concern. I think
that, you know, FERC has an opportunity to do some things in
the recommendations that I think will provide that assurance.
That's all our recommendations were saying. I think we
heard even from all the Commissioners, some element of, yes,
there might be some value there. Some stronger than others, but
even Commissioner Kelliher, Chairman Kelliher was talking about
it. In his comments he says well, I'm going to have the staff
consider the GAO recommendations, carefully consider.
That's all we're saying, that the rules are there. It's the
enforcement of the rules that we're concerned about.
Senator Murkowski. Commissioner Kerr.
Mr. Kerr. I think the rules and the authorities are there,
but at the State and Federal level I think there's an awareness
of the issues and the potential concerns with respect to
consumer protection at both the State and Federal level. I
think there's a working relationship that gives us the
opportunity to make sure that consumers are protected. I think
with the GAO report we've got a critique from an independent
agency that's made some suggestions that will further benefit
the points we already have.
So I don't think I could ever answer you absolutely, are we
perfect. But I think we are where you should expect us to be
when you adopted EPACT 2005.
Senator Murkowski. Good.
Mr. Owens.
Mr. Owens. I also think the rules are there. I think the
elements to make sure that the rules are carried out are there.
I do believe that I will agree here with the GAO that there
could be continuing collaboration with the States.
FERC has and the States have several collaboratives that
undertaking today. I would encourage that they seek to fill any
resource gaps by working more closely together. More clearly
identifying, as Mr. Hempling said, if there are concerns about
the evolution of different organizational structures then I
think the States and the FERC need to collaborate.
I think it is appropriate if they believe that those
structures are structures that are creating adversity with
respect to looking at affiliated arrangements. There should be
a dialog about that rather than adopting rules that would lead
to uncertainty and raise the overall cost of capital and
frustrate utility investment infrastructure.
So I would be in support of greater collaboration, greater
clarity and having FERC and the States work together.
Senator Murkowski. Mr. Hempling, you get the final word.
Mr. Hempling. Thank you, Senator. A comment on substance
and then a comment on attitude. Concerning substance, I think
FERC has to be more hip to the possibility that the motivations
behind certain transactions are not long term and may deviate
from the public interest. There needs to be more skepticism
there.
They need to start subjecting the mergers and acquisitions
to attest showings of economies and efficiencies restrictions
of leveraging. They need to examine empirically the sufficiency
of resources at the Federal and the State level.
A word on attitude. The Federal Power Act is not a
backstop. The Federal Power Act is not a statute that defers.
The Federal Power Act is a command to the Federal Energy
Regulatory Commission to protect the consumer. It takes nothing
away from Federal/State relations for the Federal Energy
Regulatory Commission to say we must play a lead role here with
the resources that we have.
So I'm looking for a modification of their attitude in that
respect. Thank you very much.
Senator Murkowski. Thank you.
Thank you, Mr. Chairman.
Senator Salazar. Thank you very much, Senator Murkowski.
Mr. Gaffigan, Chairman Kelliher argued in his testimony that
the financial health of the holding company is not evidence as
to whether cross subsidization is occurring. From your point of
view in your review, are there other threats to the well being
of a utility and its rate payers, of the financial health of
the parent company might be a good indicator of?
Mr. Gaffigan. I think our point in our report was there are
a lot of financial indicators that FERC could look at to assess
its risk, not just financial statements. There's a whole range
of things. We, in our recommendation, indicated that they look
at that portfolio and come up with some good measures of
financial risk. So we think there's a lot of opportunities for
them to look at the risk of financial companies by looking at a
lot of different types of financial information.
Senator Salazar. Mr. Hempling, in EPACT 2005 we gave FERC
new authorities and obligations to review mergers. Specifically
we required the middle law to find that there would be no cross
subsidization or encumbrance of assets for the benefit of the
affiliate as a result of the merger. In your view have FERC's
modification of their merger rules adequately implemented this
requirement?
Mr. Hempling. There's one difference I would have with FERC
is to their rules and that concerns the measurement for the
appropriateness of inter-affiliate relations. If I'm not
mistaken the rule is that there is a sale by an affiliate to
the utility the price cannot exceed market.
That's a deviation from the Holding Company Act rule which
is an at cost rule. The notion had always been that the sale
from an affiliate to the utility should be at the lower of cost
or market. The reason for that is to avoid a situation that has
occurred in a number of States where an asset like generation,
which had been charged for to ratepayers at an embedded cost,
depreciated over time, that that generation migrates to an
affiliate and then the output is sold back to the utility at a
higher market price thereby depriving the utilities ratepayers
of the bargain for which they many years before had paid.
So I would recommend that FERC, if I'm not mistaken on that
rule, modify it so that the sale from the affiliate to the
utility is the lower cost or market. Other than that, sir, I
would say that the rules themselves given their purpose are
reasonable in light of the congressional intent. I did make the
statement earlier that I think there's more here than just
those issues.
Senator Salazar. So your view is then that there ought to
be a modification of that rule on the part of FERC. Are there
statutory changes that you would make a recommendation to this
committee that we ought to look at?
Mr. Hempling. That's a good question. It deserves a long
answer, but I'll give you a short one. I would like to see FERC
apply to mergers and acquisitions a better defined test than
the test that presently exists which is merely, ``consistent
with the public interest.'' That's a generic phrase seen often
in regulatory statutes.
I like the notion of the FERC requiring that mergers
demonstrate that life will be better off in the industry with
the merger than without. That the purpose of the merger is to
create economies and efficiencies associated with the coupling
which could not be achieved by lower cost means. That's not the
standard that exists in the new statute. It was the standard
that exists in the old statute.
Let me warn people who are about to run to their cell
phones. I'm not suggesting that we bring back the Holding
Company Act with all its prohibitions. I am suggesting there's
a middle ground where we screen mergers and insist that the
ones that occur are the ones that do serve the public interest
by adding efficiencies.
Senator Salazar. Now is that something to be accomplished
by change in the law or is it something that can be
accomplished through modifications of the rules by FERC?
Mr. Hempling. FERC could do it under its present authority.
It could define the phrase consistent with the public interest
to require the creation of efficiencies and economies. They
could do it under present authority. If they do not then
there's reason to talk about modifying the statute in that
regard.
Mr. Kerr. You've succeeded in getting a Commissioner to
argue with the head of our research institute. I'm sure that
wasn't your intent. But just let me say this I think I agree
with Mr. Hempling as we sit here today.
I do think though when we start thinking about our future,
our sense of the public interest in this arena is evolving.
We're probably moving away from the concept of pure economic
efficiency or lowest cost. We are confronting environmental
challenges that are going to have us view the role of the
utilities, perhaps, somewhat differently.
We may want the lower cost of capital that is available to
the typical utility applied to, for instance, renewable
generation opportunities. They are not the most economically,
efficiently currently as you all know wrestling with the tax
credit issues. So what we're going to want tomorrow in the
public interest may not be what we have traditionally viewed as
purely economically efficient investments or structures.
That was the key point that I wanted to make is we know
it's changing rapidly. We're not sure where we're going to be
with respect to how we serve the public interest in this vital
segment of our economy and so my personal view is that more
flexibility at the current time. As long as you all are
comfortable that we and our Federal colleagues know what we're
doing, I think more flexibility at the current time is what we
need to meet the challenges we confront because our concept of
how this segment of our society is going to be dealt with is
evolving rapidly. It's not purely a matter of economic
efficiency anymore.
Mr. Hempling. I consider Commissioner Kerr's statement as
an enhancement to my suggestion. I fully agree with it.
Senator Salazar. Thank you very much.
There are a number of other questions which I know Chairman
Bingaman and other Senators on the committee have and so those
will be sent to you. We would ask that you respond to those
questions.
We thank you for your testimony here this morning. We have
learned a lot. It will guide us as we will move forward. Thank
you very much. The meeting is adjourned.
[Whereupon, at 11:44 a.m. the hearing was adjourned.]
[The following statement was received for the record.]
Statement of Michael E. Boyd, President, CARE, Sunnyvale, CA
I watched the May 1st Committee Hearing on the adequacy of FERC's
consumer protection with much dismay. After waiting seven years for
refunds for California's energy consumers for the seventy one billion
dollars of energy overcharges imposed on California's consumers during
the 2000--2001 energy crisis I am frankly not surprised that FERC
Chairman Kelliher hears and sees no evil in the energy markets. This is
because Chairman Kelliher is part of the problem. The Senate need look
no farther than to where Mr. Kelliher came from before he became
Chairman, working heading up VP Dick Cheney's 2001 Energy Task Force to
know why FERC's consumer protection program is an oxymoron. Mr.
Cheney's Energy Task Force likely was the architect of the program set
up to transfer a huge amount money from energy consumers in the West to
the very power generators and energy marketers FERC is supposed to
regulate. This plan to privatize the profit for a few energy insiders,
has resulted in a huge socialization of the costs of deregulation on
the backs of energy consumers nationwide. Our group CAlifornians for
Renewable Energy, Inc. (CARE) has brought a law suit before the US 9th
Circuit Court of Appeals challenging the FERC's Decisions regarding the
crisis (attached).*
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* Document has been retained in committee files.
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The FERC decisions addressing the 2000-1 western energy crisis did
not hold hearings or other proceedings including the affected
ratepayers. CARE's efforts were the only direct ratepayer
participation. All the other parties to the proceedings were regulated
utility companies, energy commodity traders, governmental ``non-public
utilities'' and state and federal government agencies that implemented
the policies and practices leading to the energy crisis. Those harmed
include CARE members, specifically those members who are low-income and
people of color, who had their utility service turned-off because of
the exorbitant rates charged. By denying the affected plaintiffs the
opportunity for a fair hearing before the FERC it has deprived
plaintiffs of their constitutional rights. Yet CARE's concerns and
injuries were not considered during the proceedings in question. This
is a violation CARE's due process rights.
I would like an opportunity for energy consumers to be given the
opportunity that FERC was unwilling to provide us to be heard by the
U.S. Senate Committee on Energy and Natural Resources on the adequacy
of FERC's consumer protection or the lack thereof.
APPENDIX
Responses to Additional Questions
----------
Responses of Mark Gaffigan to Questions From Senator Bingaman
Question 1. Your report recommends that FERC adopt a risk-based
analysis in selecting candidates for audits of affiliate transactions.
Chairman Kelliher indicates that FERC already this [sic]. Is there a
difference between what you are suggesting and what the Commission
already does?
Answer. We believe there is a difference between what GAO suggests
and the Commission's current practice. During the course of our year-
long engagement, key senior FERC officials described the process for
selecting companies to audit as informal; they did not mention the
mechanisms the Chairman described in his testimony as a risk-based
approach. When we asked FERC staff for a record of a risk-based
analysis, or the criteria FERC would have used to conduct such an
analysis, they were unable to provide them and consistently told us
audit selections were based on informal discussions with knowledgeable
senior FERC staff.
While FERC officials may consider risk in these discussions and, as
we noted in our February 2008 report, may believe their judgments
provide a reasonable picture of risk, we believe a risk-based audit
planning approach should be more systematic. A more systematic approach
would more reliably guide FERC in assessing individual company risks
and the overall risks posed by the companies collectively, and would
ensure that its audit selection process remained consistent when staff
in key positions change.
As we noted in our report, some federal agencies develop their own
statistical measures of risk using quantitative models. This method may
be appropriate for FERC, but there are others. FERC's approach will
need to flexible enough to meet its current and expected future
auditing demands now that it is solely responsible for detecting
potential cross-subsidization. In our recommendations, we did not
prescribe a method for developing and implementing a more formal, risk-
based approach; our intent was to give the Chairman flexibility to
identify the most appropriate method. In any case, designing a formal
risk-based approach will take time and effort, and FERC may want to
consider consulting with outside experts.
Question 2. Chairman Kelliher argues that the financial health of a
holding company is not evidence as to whether cross-subsidization is
occurring. Are there other threats to the well-being of a utility and
its ratepayers that the financial health of the parent company might be
a good indicator of?
Answer. It is not our view that the health of the parent company is
an indicator of cross-subsidization, but rather that FERC should
develop appropriate financial metrics to identify companies' risks and
the potential pressures that could lead to unauthorized cross-
subsidization. FERC could incorporate these metrics into its audit
selection process.
Responses of Mark Gaffigan to Questions From Senator Domenici
Question 1. Does FERC have in place sufficient customer protections
in light of PUHCA repeal? Has the repeal of the Holding Company Act
resulted in any regulatory gaps?
Answer. We did not analyze all federal and state regulations to
determine whether the repeal of PUHCA 1935 resulted in any regulatory
gaps; however, as we noted in our report, we are concerned that while
FERC has taken significant steps to enact its new authorities, it has
not yet made sufficient changes to its processes to protect consumers
from harmful cross-subsidies. As we note in our report, while FERC has
many rules prohibiting cross-subsidies, it has taken few formal steps
to detect violations of these rules. We believe that implementing our
recommendations would improve FERC's oversight and help it better
protect consumers.
Question 2. You argue that the principal means of identifying
cross-subsidies is through periodic financial audits. However, the
Commission has highlighted its ratemaking authority as a powerful tool
to prevent cross-subsidies.
Do you agree that ratemaking can be an effective tool at both the
state and federal level? If not, why don't you believe that improper
cross-subsidies can be prevented through ratemaking?
Answer. In our report, we recognized that FERC retains a limited
ratemaking role and, as such, may have opportunities to examine costs
incurred by utilities and decide which costs may be lawfully included
in rates charged to customers. However, we also noted that rate reviews
are infrequent and are generally prospective--they do not always
include the retrospective analysis of costs incurred and compliance
with FERC's ratemaking rules that would be necessary to detect cross-
subsidies.
Question 3. GAO notes that since PUCHA's repeal, through last July,
FERC reviewed 15 proposed mergers--about the same number as the same
period prior to the Act's repeal. Do you believe any of these mergers
hurt consumers and resulted in accumulation of market power?
Answer. We did not examine the positive or negative implications
for consumers of the mergers that have occurred since EPAct 2005 was
enacted, nor the market power implications of these mergers.
Question 4. You advocate for the Commission to adopt a more risk-
based audit approach. Isn't FERC already doing a risk-based audit
approach? Doesn't the Commission need the flexibility to address their
high-priority areas of policing market manipulation, market power
exercise, and reliability?
Answer. We believe there is a difference between what GAO suggests
and the Commission's current practice. During the course of our year-
long engagement, key senior FERC officials described the process for
selecting companies to audit as informal; they did not mention the
mechanisms the Chairman described in his testimony as a risk-based
approach. When we asked FERC staff for a record of a risk-based
analysis, or the criteria FERC would have used to conduct such an
analysis, they were unable to provide them and consistently told us
audit selections were based on informal discussions with knowledgeable
senior FERC staff.
While FERC officials may consider risk in these discussions and, as
we noted in our February 2008 report, may believe their judgments
provide a reasonable picture of risk, we believe a risk-based audit
planning approach should be more systematic. A more systematic approach
would more reliably guide FERC in assessing individual company risks
and the overall risks posed by the companies collectively, and would
ensure that its audit selection process remained consistent when staff
in key positions change. Furthermore, such and approach should be
flexible enough to meet FERC's current and expanded future auditing
demands now that it is solely responsible for detecting potential
cross-subsidization.
It is clear that, as a result of statutory and regulatory changes,
FERC has many additional and important responsibilities beyond those
related to cross-subsidization and FERC needs flexibility to determine
how best to address its high priority areas. However, it is equally
clear that FERC is the sole federal agency responsible for ensuring
that harmful cross-subsidization does not occur and may be the only
regulatory agency with sufficient scope and access to effectively
detect cross-subsidies. Given that Congress has entrusted FERC to
``ensure'' that unauthorized cross-subsidies do not occur, we are
encouraging FERC to develop a formal, comprehensive, risk-based, audit
approach to detect when such subsidies may be occurring and to seek
additional resources, if needed.
______
Responses of Suedeen G. Kelly to Questions From Senator Bingaman
Question 1. Do you believe that FERC has acted to fulfill
sufficiently the statutory obligation to ensure that no cross-
subsidization or encumbrance of assets will occur as a result of a
merger?
Answer. I believe FERC can, and should, exercise more leadership to
ensure that no cross-subsidization or encumbrance of assets will occur
as a result of a merger. To date, we have deferred to the states to
require sensible and appropriate corporate structures to protect
against cross-subsidization or encumbrance of assets. We should do more
than we have done--without preempting the states. For example, we could
take a more active role in explaining, for the states, (1) where the
problems lie with corporate structures; (2) the importance of
preventing the possibility of cross-subsidization instead of merely
taking care of it through the ratemaking process after it has occurred;
and (3) potential corporate structures that are productive, versus non-
productive. We need to be vigilant regarding the possibility of
interstate conflicts because, when we defer to states that have
different rules, there is the potential for interstate conflicts and
for the imposition of undue burdens on entities that do business in
multiple states.
We should also establish principles related to how corporations
should be structured that could guide the states without preempting
them.
We should also consider the possibility of adopting states'
corporate structure requirements as our own. When we merely defer to
the states, their structural requirements remain theirs alone. If we
adopted these requirements as ours, it would give FERC the ability to
use our audit and enforcement assets to ensure compliance in the event
the states do not have adequate audit and enforcement resources.
Question 2. Do you believe that FERC's cross-subsidization
protection is adequate to protect ratepayers?
Answer. I believe FERC's reliance on the ratemaking process is not
adequate to protect ratepayers from cross-subsidization. Ratepayers are
better protected when appropriate requirements for how corporations
should be structured are in place to prevent cross-subsidization or
encumbrances of assets from occurring. As I explained in my answer to
Question 1, above, FERC could do more, without preempting the states,
to ensure appropriate corporate structure requirements are in place and
are complied with.
Question 3. Is there anything that we need to change in the law to
give you sufficient authority to protect consumers adequately or to be
sure that you do so?
Answer. I believe EPAct 2005 gives the Commission sufficient
authority to protect consumers adequately. I believe the Commission
could use enhanced auditing and enforcement resources to better ensure
compliance with the law.
Responses of Suedeen G. Kelly to Questions From Senator Domenici
Question 1. GAO's Report finds that FERC relies primarily on self-
reports to detect inappropriate cross-subsidization. Is this correct?
If not, what does FERC rely on to police cross-subsidization?
Answer. If inappropriate cross-subsidization were to occur, FERC
would rely on its usual enforcement tools to detect it. These are self-
reports, hotline calls and audits.
Question 2. Is the Commission doing enough follow-up to ensure that
companies are complying with merger conditions and that improper cross-
subsidizations are not occurring? Why isn't FERC using a risk-based
audit approach as GAO suggests? GAO also notes that FERC has only 3
ongoing audits on cross-subsidization. Why isn't FERC taking a more
proactive approach to auditing?
Answer. FERC does not use a formal, risk-based approach like that
described in the GAO Report to plan its audits. Instead, FERC uses, and
has always used, an informal, but reasoned, approach in allocating
audit resources. The GAO's Report makes suggestions that FERC should
consider to improve its approach to audit planning. Whether FERC builds
risk-based assessments into its enforcement mandate, as the GAO
recommends, or some other methodology that is clear, predictable, fair
and sufficiently straightforward such that market participants can
understand it and know what rules they must follow, it is imperative
that the Commission adopt and communicate its objectives, scope and
vision for its enforcement strategy. Enhanced audit and enforcement
resources would enable the Commission to take a more proactive approach
to auditing for inappropriate cross-subsidization.
Question 3. Do you all agree with Chairman Kelliher that ratemaking
is a powerful enforcement tool for detecting cross-subsidization?
Please elaborate on how the Commission uses its ratemaking authority to
protect consumers.
Answer. The Commission's ratemaking tool with respect to cross-
subsidization prevents the flow-through into rates of costs deemed to
represent cross-subsidies. Thus, the ability of this tool to detect a
cross-subsidy is limited to the following situation: (1) the utility
applies to FERC for a rate increase; (2) the utility seeks a rate
increase based on an historic test year; (3) the chosen historic test
year includes a cross-subsidization event and resulting cost; and (4)
the utility seeks to recover that cross-subsidization cost in its new
rates.
Question 4. Your colleagues appear to be in agreement that FERC
should take a flexible approach in order to collaborate with state
regulators and not preempt state authority. Do you disagree with the
Commission's policy to accept state cross-subsidization protections
absent evidence that additional measures are needed to protect
wholesale customers or where states lack authority in this area?
Answer. I agree with my colleagues that FERC should not preempt
state cross-subsidization protections. However, I believe FERC should
exercise more leadership in determining whether additional measures are
needed to protect wholesale customers. Instead of relying on some third
party to alert us to the need for additional measures, we could, for
example, expand our merger policy to establish principles regarding
corporate structure requirements that we believe would be appropriate
and productive. This would likely also be helpful to merger applicants
who would have more certainty around the issue of appropriate
structural requirements. We should also consider the possibility of
adopting the corporate structure requirements imposed by a state in a
particular merger as our own.
Question 5. You conclude your testimony by stating that we must
``make sure we are doing all we can to guard the American consumer from
cross-subsidization and other forms of exploitation.'' Are you
proposing a legislative fix? If so, what and at what level? The federal
or the state?
Answer. I believe EPAct 2005 gives the Commission sufficient
authority to protect consumers adequately from cross-subsidization and
encumbrances of assets. I believe the Commission could use enhanced
auditing and enforcement resources to better ensure compliance with the
law.
______
Responses of David K. Owens to Questions From Senator Bingaman
Question 1. Do you believe that FERC's merger review adequately
implements the new authority given them in EPAct?
Answer. The Edison Electric Institute (EEI) believes that the
Federal Energy Regulatory Commission's (FERC's or the Commission's)
merger regulations and merger review process fully implement the
Commission's new authority under the Energy Policy Act of 2005 (EPAct
2005). These regulations and review process also maintain the
Commission's tradition of ensuring that mergers are in the public
interest, will not adversely affect markets, and will protect and
benefit consumers as a condition of approving the mergers.
As I noted in my prepared testimony, the Commission has put in
place a number of new regulations specifically aimed at implementing
the new authority relating to mergers and acquisitions that FERC
received in EPAct 2005, both under the Public Utility Holding Act of
2005 (PUHCA 2005) and revised section 203 of the Federal Power Act
(FPA). Those new regulations track the provisions of EPAct 2005 very
carefully in order to implement Congress's intent.
FERC's section 203 regulations specifically incorporate provisions
aimed at preventing inappropriate cross-subsidization by utilities of
their affiliates and inappropriate encumbrance of utility assets for
non-utility purposes. Companies proposing mergers or acquisitions
subject to section 203 must ensure that such cross-subsidies will not
occur, in accordance with the provisions of the statute and
regulations. Moreover, the Commission has gone further and imposed
similar constraints under FPA sections 205 and 206, requiring that all
companies subject to FERC's rate jurisdiction ensure that utility-
affiliate transactions are priced according to strict rules aimed at
protecting utility customers.
Under FERC's PUHCA 2005 regulations, if a utility is part of a
holding company that has a centralized service company (which typically
consolidates services such as accounting, construction, legal,
operations, maintenance, real estate, and risk management services as a
means to reduce costs to consumers), the Commission has required
service companies to keep detailed records in a new section of the
Uniform System of Accounts, and to file detailed information with the
Commission in a lengthy new FERC Form 60 that will ensure transparency.
These recordkeeping and reporting requirements complement the detailed
requirements that already apply to utilities themselves under the FPA
and FERC regulations. The PUHCA 2005 regulations also mandate FERC and
state commission access to holding company records, in keeping with the
new statute.
These new regulations complement the Commission's existing merger
policy and regulations at 18 C.F.R. Part 33. Under that existing policy
and regulations, the Commission also examines the market effects of a
proposed merger including the degree of concentration of companies in
the affected markets, the anticipated benefits to consumers, and
measures to prevent market power or other potential negative
consequences of a merger.
In addition, the Commission requires public utilities that
participate in holding company cash management programs to file
participation agreements explaining how the programs manage utility and
affiliate cash and borrowing. The companies also must maintain detailed
records of utility participation in the programs, and must notify the
Commission if proprietary capital ratios fall below 30 percent within
any given quarter year. The Commission has recognized that cash
management programs help to reduce the cost of borrowing and increase
liquidity within holding companies, while thus ensuring that the
programs are subject to Commission review.
In sum, EEI believes that the Commission is taking its merger
responsibility and authority very seriously, including the new merger
and cross subsidy provisions of EPAct 2005. FERC is carefully
implementing its responsibility and authority to ensure that mergers
and other transactions subject to FPA section 203 are fully in the
public interest and are carefully structured to protect consumers.
Question 2. Do you believe that FERC's cross-subsidization
protection is adequate?
Answer. As mentioned in the answer to Question 1, FERC has put in
place strict regulations applicable to utility-affiliate transactions
under FPA sections 203, 205, and 206 to protect against inappropriate
cross-subsidization and encumbrance of utility assets.
Under these regulations, the Commission must approve any wholesale
power sales between a franchised public utility with captive customers
and its market-regulated power sales affiliates. In addition, sales of
non-power goods and services by a utility with captive customers to a
market-regulated power sales affiliate or a non-utility affiliate must
be priced at the higher of cost or market, and purchases by such a
utility from such an affiliate must be priced no higher than market,
unless authorized by the Commission. The Commission also may impose
additional cross-subsidization restrictions on affiliate transactions,
as appropriate, on a case-by-case basis.
Further, the Commission examines the potential for cross-subsidies
and encumbrances of utility assets in the context of mergers and other
transactions subject to its review authority under FPA section 203, as
required by amendments to that section in EPAct 2005. The Commission
also has imposed constraints on sharing of staff and information and
brokering of power between franchised public utilities with captive
customers and market regulated power sales affiliates.
In addition, the Commission's regulations reflect that most state
utility commissions also oversee utility-affiliate transactions and
have rules protecting regulated retail customers against inappropriate
cross-subsidy. The Commission has signaled that it will review such
measures and seeks to complement rather than preempt them as needed to
ensure adequate customer protection. The Commission has also shown its
willingness to step in if state safeguards are inadequate or states do
not have authority to impose conditions to protect consumers from
improper cross-subsidization or encumbrance of utility assets.
Together, these regulations effectively prohibit cross-subsidy or
encumbrance of utility assets for non-utility purposes absent
Commission approval based on a public interest determination. They also
ensure that a utility's regulated customers are well protected against
inappropriate cost-shifts in transactions between a utility and an
affiliate. In summary, the Commission has significant means to prevent
cross-subsidization, including its broad ratemaking and merger review
authorities under the FPA, and it is exercising that authority actively
to protect electricity consumers.
Responses of David K. Owens to Questions From Senator Domenici
Question 1. Does FERC have in place sufficient customer protections
in light of PUHCA repeal? Has the repeal of the Holding Company Act
resulted in any regulatory gaps?
Answer. In EEI's view, FERC has robust, effective, and complete
customer protections in place. The Commission has built a comprehensive
framework of regulations and enforcement to ensure that:
electricity generators have transmission access to wholesale
customers, so the generators can compete to offer the services
customers need at competitive prices;
transmission providers provide fair, equal, and open access
to the transmission grid while also ensuring reliability;
integrated utilities maintain very strict separation of
generation and transmission functions;
utility-affiliate transactions are carefully scrutinized to
prevent inappropriate cross-subsidization and encumbrance of
utility assets to the benefit of an affiliate unless in the
public interest;
utility mergers and acquisitions are carefully scrutinized
to ensure that they are in the public interest;
utility wholesale and transmission rates are just and
reasonable;
competitors in markets cannot exercise market power or
manipulate markets; and
utilities and service companies keep detailed records and
file detailed reports that enable the Commission and the public
to review and understand utility assets, finances, and
operations.
These protections complement equally effective measures by state
utility commissions, the Securities and Exchange Commission (SEC), and
the Federal Trade Commission (FTC). State utility commissions oversee
the full range of utility activities, in particular as those activities
may affect retail customers. Most states have counterpart regulations
and oversight to complement the FERC provisions just described. In
addition, the states actively oversee resource planning and siting
activities. The SEC regulates stock issuances and transactions by
shareholder-owned utilities, holding companies, and affiliates. The SEC
regulations ensure that companies provide accurate financial
information through its reporting requirements such as the annual Form
10-K, through regulations implementing the Sarbanes-Oxley Act of 2002,
which ensures that companies maintain robust internal and external
accounting controls and auditing oversight to ensure accuracy of their
financial records and reports, and in oversight of company prospectuses
associated with stock transactions and the stock exchanges. The FTC has
regulations and guidelines that govern the accuracy of consumer
advertising and claims, including by participants in electricity
markets. Along with state consumer advocates, the FTC also participates
in FERC rulemakings to provide its views on consumer protection issues.
Repeal of the Public Utility Holding Company Act of 1935 (PUHCA
1935 or the 1935 Act), and its replacement by PUHCA 2005 and revised
FPA section 203, has not created regulatory gaps. Instead, repeal of
the 1935 Act appropriately recognized that an array of other fully
effective consumer protection measures are now in place, and the 1935
Act was imposing unnecessary additional constraints that were impeding
investment in needed new utility facilities.
Question 2. You testified that increased federal oversight over
non-utility corporate activities could create substantial barriers to
investment and competition in electricity markets--the reason PUHCA was
repealed. Please elaborate.
Answer. As Congress was considering legislation that ultimately
evolved into EPAct 2005, EEI and a wide array of others encouraged
Congress to repeal PUHCA 1935 because that Act was viewed as layering
unnecessary federal statutory and regulatory constraints on the utility
industry, thereby impeding investment in the industry. The 1935 Act,
for example, imposed geographic constraints on utility holding
companies that prevented holding companies from engaging in utility
activities in non-contiguous states. This discouraged consolidation of
companies that could otherwise have provided economies of scale to the
benefit of utility customers and the development of companies that
could specialize in certain aspects of the utility business (nuclear
generation, transmission, etc.) on a national basis. In addition, the
1935 Act effectively prohibited investment in the utility industry by
investors in other industries. It also failed to recognize the host of
protections that have been put in place in the decades since the 1935
Act was enacted, so that FERC, the SEC, the FTC, and states now
robustly regulate utility, holding company, and affiliate activities,
without the need for the PUHCA 1935 constraints.
In addition, Congress, FERC, and state commissions have put very
effective cross-subsidy and utility asset protections in place, to
ensure that utility assets are not inappropriately used for the benefit
of affiliate or other companies to the detriment of utility consumers.
With these significant protections in place, there is no regulatory gap
and simply no need for additional federal regulation of non-utility
activities.
The investment community recognizes that with repeal of PUHCA 1935,
Congress removed unnecessary impediments to investment in energy
infrastructure, and granted new authorities to FERC and the states to
protect consumers. As stated earlier, FERC is working closely with the
states to address any gaps in their regulatory authority to protect
consumers from improper cross-subsidizations or encumbrance of utility
assets.
Increased federal oversight is unnecessary and would be
inappropriate because it would intrude into areas of investor
activities that are unrelated to utility activities. Additional federal
oversight also would add confusion and raise uncertainty within the
investment community. At a time when the energy industry's capital
investment is expected to be at its highest level in recent decades to
address growing demand, aging infrastructure, and environmental
concerns, unnecessary additional mandates or restrictions would be a
major step backwards. Instead, we should be striving to provide
simplicity, clarity, and stability in the rules to stimulate major new
investment, especially given that existing federal and state laws
already amply protect utility consumers.
______
Responses of Joseph T. Kelliher to Questions From Senator Bingaman
Question 1. We gave the Commission new authority and obligations in
the review of mergers as a partial compensation for repeal of PUHCA.
GAO reports that you have not changed the review of mergers
sufficiently to fulfill the obligation to be sure that no cross-
subsidization or encumbrance of assets will result from a merger. You
disagree. What has the Commission done to ensure that no harmful cross-
subsidization or encumbrance of assets will occur as a result of a
merger?
Answer. In December 2005, the Commission revised its regulations
specifically to address possible cross-subsidization or encumbrance of
assets resulting from a merger or other FPA section 203 transaction.
Merger applicants must make what is called an ``Exhibit M'' filing,
which is a detailed showing (based on facts and circumstances known or
reasonably foreseeable) that the merger will not result (at the time of
the transaction or in the future) in the following activities by a
traditional public utility that has captive customers or that operates
Commission jurisdictional transmission facilities, in each case for the
benefit of an associate company: (a) the transfer of facilities, (b)
the issuance of securities, (c) the pledge or encumbrance of assets,
and (d) the execution of contracts other than approved contracts for
non-power goods and services. Also, the applicants must disclose any
pledges or encumbrances of utility assets existing at the time of the
application. If the applicants cannot provide adequate assurances
against such activities, they must demonstrate that the activities are
consistent with the public interest.
Following two technical conferences, which sought input from state
commissioners and others on what additional measures (including ring-
fencing) the Commission should take to protect customers against
inappropriate cross-subsidization, in July 2007 the Commission also
issued an FPA section 203 Supplemental Policy Statement. This policy
statement provided clarification and guidance on the types of section
203 transactions that do not raise cross-subsidy concerns and guidance
on the types of commitments applicants could make and the ring-fencing
measures applicants could offer to address potential cross-subsidy
concerns. First, the Commission adopted a policy to defer to state
commissions where the state adopts or has in place ring-fencing
measures to protect customers unless those measures are inadequate to
protect wholesale customers. If, based on the record of the transaction
before the Commission, however, the state measures are inadequate to
protect customers in a given case, the Commission will adopt
supplemental measures as appropriate. Or, if the state does not have
authority to act on a section 203 transaction, the Commission will fill
any regulatory gap by imposing ring fencing protections where
appropriate. It is important to note that where the Commission does
defer to ring-fencing protections adopted by the state, the
Commission's approval of the proposed section 203 transaction is
premised on compliance with those ring-fencing protections and the
Commission may audit and enforce compliance with those protections just
as it enforces any additional protections it may accept or impose for a
particular transaction; failure to abide by the restrictions
constitutes a violation of the Commission's order approving the
transaction. In addition, the Commission made clear in the Supplemental
Policy Statement that, if it approves a transaction under section 203
(with or without ring-fencing measures), the Commission retains
authority under FPA section 203(b) to later impose additional cross-
subsidy protections or modify any previously-approved measures.
Second, the Supplemental Policy Statement also provided specific
guidance on the types of protections companies might adopt to make the
demonstration required by Exhibit M, referred to above, where a state
has not required or does not have authority to require ring-fencing
provisions. For example, the Commission stated that a ring-fencing
structure related to internal corporate financings, i.e., money pool or
cash management transactions, could include some or all of the
following elements, depending on the circumstances of the proposed
transaction:
(1) the holding company participates in the money pool as a
lender only and it does not borrow from the subsidiaries with
captive customers;
(2) where the holding company system includes more than one
public utility, the money pool for subsidiaries with captive
customers is separate from the money pool for all other
subsidiaries;
(3) all money pool transactions are short-term (one year or
less), and payable on demand to the public utility;
(4) the interest rate formula is set according to a known
index and recognizes that internal and external funds may be
loaned into the money pool;
(5) loan transactions are made pro rata from those offering
funds on the date of the transactions;
(6) the formula for distributing interest income realized
from the money pool to money pool members is publicly
disclosed; and,
(7) the money pool administrator is required to maintain
records of daily money pool transactions for examination by the
Commission by transaction date, lender, borrower, amount and
interest rate(s).
Thus, while not adopting a set of mandatory one-size-fits-all
federal ring-fencing protections in the Supplemental Policy Statement,
the Commission gave detailed guidance regarding the types of
restrictions that, from the federal viewpoint, might be appropriate
depending upon the particular facts presented. It made clear that the
forms of ring-fencing protections listed were examples of protections
the Commission would consider in evaluating proposed ring-fencing
measures and stated that appropriate ring-fencing measures would depend
on the facts presented and the specifics of an applicant's corporate
structure, to be evaluated on a case-by-case basis. It also noted that
the listed measures were among those typically approved by the
Securities and Exchange Commission (SEC) and/or adopted by state
commissions.
In addition to the adoption of the new FPA section 203 requirement
for an Exhibit M filing and the policies and guidance set forth in the
Supplemental Policy Statement, the Commission announced in one of the
first mergers following the effective date of the new section 203
provisions, National Grid plc, 117 FERC 61,080 (2006), that it would
impose on all section 203 transactions involving a holding company a
condition that members of the holding company adhere to specific
pricing restrictions on non-power goods and services transactions
between ``unregulated'' companies and their public utility affiliates
with captive customers. Further, because cross-subsidy concerns
regarding both power and non-power goods and services transactions can
arise not only at the time of a proposed merger, but rather on an
ongoing basis, the Commission in July 2007 also adopted in its
regulations non-power goods and services pricing restrictions on all
transactions between unregulated companies and their public utility
affiliates with captive customers. Similar restrictions were adopted
with respect to affiliate power sales in June 2007. The Commission also
adopted recordkeeping and reporting requirements for utility holding
companies and their service companies, and detailed accounting
requirements for centralized service companies. These requirements will
enhance the ability of the Commission and the public to monitor for
cross-subsidization.
Also, in response to PUHCA 2005, the Commission's Office of
Enforcement is auditing affiliated transactions to detect and deter
cross-subsidization. Three such audits are scheduled for FY08. These
three audits include some of the largest utility holding companies. If
information gained from these audits or elsewhere indicates a need for
increased auditing, I will either shift resources to such audits or, if
necessary, seek additional resources from the Congress.
Importantly, all of these new requirements are in addition to the
Commission's traditional and broad ratemaking authority to disallow
rate recovery of costs found unjust and unreasonable as improper cross-
subsidies. This authority applies to all utilities, whether or not they
engage in cross-subsidies resulting from a merger.
Question 2. GAO reports that your cross-subsidization protection is
largely dependent on self-reporting by violators. You indicate that
your enforcement authority gives you assurance that such self-reporting
will be protective. Does not the possibility of large fines or
penalties discourage self-reporting? Why would utilities report
violations if they expect to be faced with a stiff fine?
Answer. The Commission does not rely on self-reporting to prevent
improper cross-subsidization. In the context of cross-subsidization,
the Commission does not assume utilities will self-report violations.
As stated in my testimony, cross-subsidization by its very nature does
not lend itself to being self-reported. Ratemaking is a complicated
process which relies on the development of an extensive record on costs
and revenues, and determination of the proper allocation of costs
between jurisdictional and non jurisdictional operations, the
appropriate distribution of costs between and among the various
jurisdictional services, and the selection of an appropriate rate of
return. Under these circumstances, self-reports would not be an
effective method to monitor cross-subsidization. Further, with respect
to the Commission's pricing standards imposed on non-power goods and
services transactions between regulated and non-regulated affiliates to
prevent inappropriate cross-subsidization (i.e., pricing at cost or at
market), while it is possible that an accounting or similar type of
error resulting in inappropriate pricing or an inappropriate allocation
of costs might be self-reported, for the most part a violation of the
pricing standards also would not lend itself to self-reporting. Rather,
violations of these standards would be detected in a rate case or
through audit.
In contexts other than cross-subsidization, however, self-reports
are an important part of the Commission's enforcement efforts. The
Commission first announced its views on self-reports in the October
2005 Enforcement Policy Statement. We stated there that we place great
importance on self-reporting, as companies are in the best position to
detect and correct violations of our orders, rules, and regulations,
both inadvertent and intentional, and should be proactive in doing so.
Moreover, as we pointed out, when companies self-report violations to
the Commission it facilitates remedies to affected parties.
Accordingly, the Commission decided to give credit to companies that
self-report, and indicated that such credit could eliminate or reduce
the otherwise applicable penalty for the violation.
The Commission's experience since the issuance of the Enforcement
Policy Statement confirms that self-reports reinforce the agency's
enforcement program. Even though a majority of the investigations
settled under the guidelines of the Enforcement Policy Statement have
involved penalties for self-reported violations, the number of self-
reports has actually increased during the relevant period. Thus, for
example, so far in FY08, we have received 33 self-reports, whereas at
this time a year ago, we had received only 16 self-reports.
Utilities consider reporting violations even if they face stiff
fines because of the credit that the Commission gives to companies for
self-reporting. Since issuing the Enforcement Policy Statement, the
Commission has approved twelve settlements totaling $42.2 million where
the investigations were initiated after a company self-reported a
violation. In each of these settlements, the penalty amount would have
been higher if the particular company had not self-reported the
violations.
Again, however, self-reports are not relied upon and have never
been relied upon as an effective means of monitoring inappropriate
cross-subsidization.
Question 3. You point to the recent order conditioning the Puget
Sound acquisition on your review of Washington state's ring-fencing
requirements. Your merger policy statement indicates that you will
follow this pattern in all merger reviews, i.e., that you will
determine if the state's protection is sufficient and if it is not will
impose conditions of your own. Washington is acknowledged by many to
have a vigorous ring-fencing requirement. How will you determine if a
state's requirements are sufficient in this and other cases since there
does not appear to be a set of specific criteria for making this
determination in the merger policy statement, nor a minimum set of
actions that you would take if the state's protections were found to be
insufficient?
Answer. The Commission will review the adequacy of a state's ring-
fencing requirements on a case-by-case basis. The diversity of
transactions addressed by FPA section 203 cautions against adoption of
one-size-fits-all criteria or a minimum set of ring-fencing
restrictions, at least at this early stage of the Commission's
experience with its broader authority under FPA section 203. For
example, the acquisition of a franchised public utility with captive
customers by a holding company with unregulated subsidiaries may raise
very different issues than the acquisition by such a utility of a
similar, neighboring utility with captive customers. As the Commission
gains experience analyzing cross-subsidization issues under its
expanded section 203 authority, its case-by-case analysis may lead to
adoption of generic policies or minimum actions applicable to certain
types of cases. Finally, as noted in the response to Question 1, the
Commission's recent Supplemental Policy Statement already identifies
seven specific ring-fencing protections a merger applicant might
propose where a state has not required or does not have authority to
require ring fencing provisions.
Responses of Joseph T. Kelliher to Questions From Senator Domenici
Question 1. GAO's Report finds that FERC relies primarily on self-
reports to detect inappropriate cross-subsidization. Is this correct?
If not, what does FERC rely on to police cross-subsidization?
Answer. The GAO Report is not correct. As I pointed out in my
response to GAO, the Commission has never relied on self-reports as its
primary enforcement mechanism to prevent inappropriate cross-
subsidization. Cross-subsidization, by its very nature, does not lend
itself to being self-reported.
The Commission relies on other tools to police cross-subsidization.
The Commission has in place affiliate pricing restrictions--applicable
to all public utilities, not just those involved in mergers--addressing
both power and non-power sales between affiliates. The Commission also
has specific and detailed record retention rules for holding companies
and their affiliates, as well as a new standardized Uniform System of
Accounts (adopted in October 2006) that must be followed by all
centralized service companies, thus providing greater transparency to
protect ratepayers from paying improper service company costs.
Centralized service companies must also file an annual report (Form No.
60) containing financial information and information related to non-
power goods and services provided to affiliates. Information collected
in this form is available electronically to market participants and the
public for use in detecting potential cross-subsidization. Other types
of service companies (e.g., a special purpose service company) also
have an annual reporting requirement containing a narrative description
of the service company's functions during the prior calendar year.
These measures coupled with our ratemaking authority, compliance
measures, auditing, and the penalty authority under EPAct 2005 provide
adequate customer protection and policing over regulated entities'
transactions.
Question 2. Is the Commission doing enough follow-up to ensure that
companies are complying with merger conditions and that improper cross-
subsidizations are not occurring? Why isn't FERC using a risk-based
audit approach as GAO suggests? GAO also notes that FERC has only 3
ongoing audits on cross-subsidization. Why isn't FERC taking a more
proactive approach to auditing?
Answer. Given the Commission's other responsibilities, especially
with respect to its new authority to oversee reliability of the
nation's bulk power system and to police against market manipulation,
we believe that we are taking appropriate steps to ensure that
companies are complying with merger conditions and that inappropriate
cross-subsidization is not occurring.
With respect to audits, we have already performed an audit
involving merger conditions (NSTAR, Docket No. FA07-1) and are in the
process of conducting audits of several holding and service companies'
books and records. Also, as part of our annual audit planning cycle,
the Commission will take additional audits into consideration with our
other priorities and the number of available resources.
Contrary to GAO's understanding, the Commission does and will
follow a risk-based approach in selecting the merger and PUHCA audit
candidates. Our risk-based approach entails a comprehensive review of
audit materials obtained from the SEC; examination of financial
information contained in FERC Form No. 60, FERC Form No. 1, and SEC
filings; rate information gathered from Commission filings; and
discussions with the Commission's legal and technical experts. The
risk-based approach described above results in a preliminary risk
assessment that takes into account, for example, the amount and type of
costs reported in the FERC Form No. 60 and FERC Form No. 1; compliance
problems gleaned from the non-public audit reports previously issued by
the SEC; information on affiliated transactions included in SEC filings
as well as other pertinent financial information affecting stock and
bond prices; a review of the federal and state commissions' actions
regarding affiliated transactions; and discussions with Commission
legal and technical experts. Finally, shortly after the audit
commences, the Commission audit staff discusses the audit scope,
objectives and any other matters with state commission officials.
Moreover, it is important to note that the Commission commenced the
three audits shortly after PUHCA 2005 went into effect in February
2006. The companies selected for the FY08 audit cycle were initial
audits and included some of the largest utility holding companies in
the nation.
Responses of Joseph T. Kelliher to Questions From Senator Menendez
THE GAO REPORT
Question 1. My home state of New Jersey has a strong Board of
Public Utilities, one which has implemented strong regulations which
protect electricity consumers. But consumers in other states are not so
lucky, and rely on the Federal Energy Regulatory Commission. This GAO
report comes at a time when consumers are paying high and rapidly
rising prices for electricity. Consumers are being hit by rising prices
for food, fuel, and electricity, and their trust in government is at an
all time low. This is a dangerous combination, and even the appearance
of weak oversight is simply unacceptable. It is not enough to rely on
self-reporting, and your audits need to be more transparent. I am
concerned that the FERC does consider the rising electricity prices to
be a priority. I would like you to explain how you determine which
companies to audit. What evidence leads you to investigate one company
or another? What are the tell-tale signs of cross subsidization?
Answer. The Commission uses a risk-based approach in selecting the
merger and PUHCA audit candidates. This risk-based approach entails a
comprehensive review of audit materials obtained from the SEC;
examination of financial information contained in FERC Form No. 60,
FERC Form No. 1, and SEC filings; rate information gathered from
Commission filings; and discussions with the Commission's legal and
technical experts. The risk-based approach described above results in a
preliminary risk assessment that takes into account, for example, the
amount and type of costs reported in the FERC Form No. 60 and FERC Form
No. 1; compliance problems gleaned from the non-public audit reports
previously issued by the SEC; information on affiliated transactions
included in SEC filings as well as other pertinent financial
information affecting stock and bond prices; a review of the federal
and state commissions' actions regarding affiliated transactions; and
discussions with Commission legal and technical experts. Finally,
shortly after the audit commences, the Commission audit staff discusses
the audit scope, objectives and any other matters with state commission
officials.
Question 2. Surely, after a report like this, you must see the need
to improve the transparency of your audits and oversight if nothing
else. What opportunities do you see to improve how you protect
consumers?
Answer. The Commission audit process provides transparency to the
public when an audit is initiated and completed. Companies that are the
subject of an audit from the Commission receive an audit commencement
letter that is available to the public. The commencement letter alerts
the public to the audit scope areas, the time period to be covered by
the audit, and the legal basis for conducting the audit. Further,
contact information is included in the commencement letter for the
audit team members and management in the Division of Audits in the
Commission's Office of Enforcement.
The Commission's audit reports are also public and provide the
users of our public audit reports the opportunity to get information
about the audit objectives and scope, audit methodology, background
information, as well as audit findings and recommendations, where
applicable. As a result of the GAO report, the Commission has improved
its audit reporting by including an enhanced audit methodology section
in all of its public audit reports. In contrast, the SEC previously
issued non-public audit reports at the completion of its holding
company audits. Thus, the Commission's enhanced audit methodology and
practice of publishing audit reports provide the public and the
regulated community with greater transparency than was previously
provided by the SEC.
MERGERS
Question 3. The concerns raised by the GAO report ring true for me
because I watched the FERC review the proposed merger between PSEG and
Exelon a few years ago. This proposed merger would have created the
largest utility in the country. At that time, the New Jersey Board of
Public Utilities raised a host of concerns, ranging from market power
to reliability of service to increased consumer costs. At the time, it
appeared to me that the FERC approved this merger without addressing
these questions. Obviously, the Energy Policy Act of 2005 has increased
the FERC's responsibilities. If the FERC was reviewing this merger
today, would the process be different? What steps would the FERC now
take to investigate the impact of this proposal on consumer prices?
After such a merger, could New Jersey still enforce its own strong
consumer protections?
Answer. In the order authorizing the merger of Exelon and PSEG, the
Commission addressed the issues of the merger's effect on market power
and consumer rates and imposed conditions to mitigate market power.
First, in order to address any market power concerns, the Commission
required the merger applicants to abide by a commitment they had made
to divest 6,600 megawatts of generation, consisting of 2,600 megawatts
of ``virtual divestiture'' of nuclear generation (in the form of
required long-term energy sales from nuclear generating units) as well
as the divestiture of 4,000 megawatts of fossil-fired capacity. This
was the largest divestiture ever ordered by this agency. Moreover, the
divestiture was applied to both baseload and peaking units, in order to
more completely address the merged firm's ability and incentive to
withhold output and potentially drive up the price of power in the
relevant markets. In addition, as a further condition of the
Commission's authorization, Exelon was required to make a subsequent
demonstration, based on the plants that were ultimately divested and
the buyers of those plants, that actual market concentration would be
sufficiently reduced to mitigate any merger-related harm to
competition.
Second, while the Commission does not have jurisdiction over retail
rates, it does protect consumers from cost increases by looking at the
merger's effect on wholesale rates, which in turn can affect retail
rates. In the Exelon case, and consistent with Commission policy, the
merger applicants were required to hold customers harmless from any and
all merger-related costs. Specifically, the Commission accepted
applicants' commitment not to seek to recover any merger-related costs
in wholesale rates without showing quantifiable offsetting savings. In
this way, the Commission ensured that wholesale customers were fully
protected from any merger-related costs.
Regarding concerns about reliability, only two claims about
reliability were raised in the FERC proceeding. One was found to be
unrelated to the merger, but it was considered in another case where
the Commission found that a joint operating agreement between Midwest
Independent Transmission System Operator, Inc. and PJM Interconnection,
L.L.C. (PJM) addressed the concern. The Commission found that the other
concern was fully addressed by an applicant study of the PJM-East
capacity market in the merger proceeding. In fact, the applicants
argued that, given Exelon's record in operating nuclear power plants,
the merger would enhance reliability by combining Exelon's expertise in
running nuclear plants with PSEG's existing fleet of nuclear plants. No
party questioned Exelon's claims that its expertise in operating
nuclear plants could enhance reliability.
After EPAct 2005, as part of its merger analysis, the Commission
specifically considers whether a merger will result in inappropriate
cross-subsidization of a non-utility associate company or pledge or
encumbrance of utility assets for the benefit of an associate company.
Merger applicants must file evidence demonstrating that the merger will
not result in inappropriate cross-subsidization at the time of the
merger or in the future. We impose additional ring-fencing protections
as needed on a case-by-case basis, giving deference to state regulatory
ring-fencing requirements unless we find those requirements
insufficient or the state does not have authority.
In addition, in the Commission's order on the merger of National
Grid and KeySpan Corporation,\1\ the Commission announced a new policy
to require all merging parties to abide by a code of conduct regarding
power and non-power goods and services transactions between the utility
subsidiaries and their affiliates. The code of conduct: (1) requires
our approval of all power sales by a utility to an affiliate, (2)
requires a utility with captive customers to provide non-power goods or
services to a non-utility or ``non-regulated utility'' affiliate at a
price that is the higher of cost or market, (3) prohibits a non-utility
or non-regulated utility affiliate from providing non-power goods or
services to a utility affiliate with captive customers at a price above
market price, and (4) prohibits a centralized service company from
providing non-power services to a utility affiliate with captive
customers at a price above cost. These requirements offer further
protection of a utility's captive customers against inappropriate
cross-subsidization.
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\1\ National Grid plc, 117 FERC 61,080 (2006).
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In EPAct 2005, Congress largely ratified the merger test the
Commission used to render the proposed Exelon/PSEG merger. For that
reason, if the FERC were reviewing the Exelon/PSEG proposed merger
today, the process would not be different except that the Commission
would address the new requirement to make specific findings that the
proposed merger will not result in inappropriate cross-subsidization or
encumbrance of utility assets. Applicants would be required to file an
``Exhibit M'' making this demonstration and the Commission would
determine whether the record supported a finding that the new statutory
requirement was met. The authority of the New Jersey Commission to
protect its retail customers would not be affected by a Commission
decision to approve the merger.
RELIABILITY PRICING MODEL
Question 4. Chairman Kelliher, I would also like to discuss a
regional consumer protection issue. As you know, our nation faces an
urgent need for increased investment in transmission and generation
infrastructure. To provide the market signal needed to build this
infrastructure, you have approved the so-called ``Reliability Pricing
Model'', or RPM, for the RTO which included New Jersey. I hear many
different things about RPM. Some people tell me that it's working,
paying for upgrades to old plants, and that new generation is in the
queue. Others disagree. But I know two things for certain: The RPM is
costing New Jersey consumers billions of dollars, and we are seeing
very few new entrants bringing generation online. In PJM as a whole,
consumers have made $26 billion in forward capacity payments, but only
2,500 megawatts of new generation have come on-line. This is about 10
times what 2,500 megawatts of new generation should cost. Do you see
anything wrong with this picture? Is the RPM system working? What steps
is the FERC taking to ensure that these vast sums of money will result
in new generation? Does FERC have any plans on how to change RPM if the
new capacity they have projected does not come online? When considering
changes to the RPM system, how can FERC reduce its costs to consumers?
Answer. The principal goal of RPM is to address the long-term
reliability needs of all electricity customers within the PJM
footprint, including New Jersey customers. During the past several
years, reliability concerns arose within several areas within PJM due
to: (1) a surge in planned generator retirements, (2) steadily growing
demand, and (3) a slowdown of new generation entry.
RPM was proposed to the Commission as the solution to these
problems. The RPM proposal was submitted to the Commission following
extensive, multiyear, stakeholder discussions and was supported by the
vast majority of PJM stakeholders, including generators, load serving
entities, municipalities, state commissions and consumer groups.
In the RPM market design, all existing as well as new capacity
resources--generation, demand-side resources (including energy
efficiency resources), and transmission enhancements--that meet
specified criteria are eligible to offer capacity into the auction and
receive capacity payments. This provision, the uniform price auction
method, and various other features and provisions of the RPM were
agreed to by the parties to the RPM Settlement Agreement. Furthermore,
to increase the opportunities for competition from new generation
entry, suppliers enter into forward contracts for delivery three years
in advance to ensure that reliability goals are met and that existing
as well as new capacity resources are assured of sufficient revenues to
either retain their current investment in PJM, or invest in new
capacity resources.
Over the four auctions completed through January 2008,
approximately 4,375 MW of new, upgraded, or reactivated generation
capacity was offered and accepted. In addition, 7,443 MW of demand-side
resources, imports, and withdrawn or cancelled retirements were also
offered and accepted into the RPM auctions. The breakdown is as
follows:
New Generation 1,036.1
Generation Upgrades 2,989.9
Generation Reactivation 348.7
Forward Demand Resources 1,373.0
Withdrawn or Canceled Retirements 3,082.0
Net Increase in Capacity Imports 2,987.5
Total Impact (MW) 11,817.2
These initial results appear promising, particularly compared to
the capacity market construct that was in place prior to RPM. That
earlier capacity market failed to produce market-clearing prices
sufficient to induce new generation or forestall planned generation
retirements in PJM. However, at this early stage in the RPM process, it
is too early to draw conclusions on the success of the RPM. The RPM has
only been in place for less than one year, and its first four auctions
have been transitional in nature, and were undertaken at relatively
short intervals in rapid succession with forward periods of less than
three years.
Nevertheless, the Commission is already undertaking several
initiatives to ensure the proper functioning of markets operated by
PJM, including RPM. These include a thorough assessment of the
performance of RPM and determination of the changes that may be
necessary in order to ensure better performance in terms of market
efficiency and costs to consumers.
The Commission recently issued a Notice of Proposed Rulemaking on
Wholesale Competition in Regions with Organized Electric Markets,\2\
which proposes changes that will improve the operation of organized
wholesale electric markets in the areas of: (1) demand response and
market pricing during a period of operating reserves shortage; (2)
long-term power contracting; (3) market-monitoring policies; and (4)
the responsiveness of regional transmission organizations (RTOs) and
independent system operators (ISOs) to stakeholders and customers, and
ultimately to the consumers who benefit from and pay for electricity
services. In comments to that proceeding, stakeholder groups such as
the American Forest and Paper Association and the Portland Cement
Association put forth specific proposals to modify existing capacity
markets.
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\2\ Wholesale Competition in Regions with Organized Electric
Markets, Notice of Proposed Rulemaking, 73 Fed. Reg. 12,576 (March 7,
2008), FERC Stats. & Regs. 32,628 (2008).
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The Commission held a technical conference on May 7, 2008, to
discuss such proposals and more generally the operation of forward
capacity markets in the PJM and ISO New England regions. The conference
featured, for example, different perspectives on the markets from a
broad cross-section of stakeholders, including RTOs, independent
experts, and customer representatives.
Also, in a recent order on a motion filed by RPM Buyers\3\
requesting a technical conference to examine the performance of RPM,\4\
the Commission directed PJM to expand the scope of an independent
assessment of RPM that is currently being undertaken by an outside
consultant, the Brattle Group, to include the concerns raised by RPM
Buyers. The consultant's report is expected to be completed by the end
of June 2008. The assessment will be presented to PJM stakeholders
shortly thereafter and it is expected that any necessary changes to RPM
will be fully considered at that time. The Commission directed PJM to
submit a summary of the proceedings of the stakeholder deliberations on
the report within 15 days of the conclusion of those proceedings.
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\3\ RPM Buyers include: state regulatory commissions, municipal
electric utilities, joint power agencies, a rural electric cooperative,
end-use customers, state consumer advocate offices, and load serving
entities (LSEs) in the PJM region.
\4\ PJM Interconnection, L.L.C., 123 FERC 61,037 (2008).
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Based on the outcome of these and related initiatives, the
Commission will determine whether changes to the RPM capacity market
are required and take appropriate steps to implement any necessary
reforms. Among other things, the Commission is evaluating the merits
and demerits of alternative capacity market designs and resource
adequacy approaches. It is also actively working to foster much greater
participation of demand-side resources in RTO capacity markets, which
will reduce the overall need for investment in new generation
facilities. The significant impact and greater potential of these
resources are already evident from the results of both PJM's and ISO
New England's Forward Capacity Market auctions thus far.
RGGI, TRANSMISSION, PLANNING
Question 5. Chairman Kelliher, my home state of New Jersey is one
of several states which are leading the nation in the fight against
global warming. New Jersey has joined the Regional Green House Gas
initiative. To meet its goals, New Jersey has embarked on an ambitious
program which aims to get 20% of its energy from renewable sources by
2020. In order to do this, they use revenues from a cap and trade
system to fund investments in renewables and energy efficiency.
However, some neighboring states are not members of RGGI but are part
of PJM regional transmission organization. What will the FERC do to
help New Jersey meet its clean energy goals?
Answer. The Commission has been working to remove regulatory
barriers to development of renewables and to ensure that demand-side
resources, including energy efficiency, have access to wholesale power
markets and the transmission grid comparable to that of supply-side
resources. For example, the Commission recently modified its policy
concerning the allocation of some of the costs of interconnecting
certain generators to the grid. The Commission recognized that the
original policy, which was developed when most generators had
considerable flexibility on where they located, had become a barrier to
many generation projects under development now, particularly renewable
projects. See California Independent System Operator Corp., 119 FERC
61,061, reh'g denied, 120 FERC 61,244 (2007). The Commission is also
acting to improve the speed with which proposed generation projects,
many of which are renewable projects, are interconnected with the grid.
The Commission held a December 11, 2007 technical conference to explore
the current backlog in the interconnection request ``queues'' of ISOs
and RTOs, including PJM, and recently followed up with a March 20,
2008, order providing guidance on possible reforms and directing the
ISOs and RTOs to report on the status of their reform efforts. See
Interconnection Queuing Practices, 122 FERC 61,252 (2008).
Question 6. The FERC has designated a broad swath of the mid-
Atlantic as a ``National Interest Electrical Transmission Corridor''.
While building some new transmission is certainly necessary, new power
lines could also be used to deliver coal-fired electricity from older,
less efficient plants into RGGI states, completely undermining the
initiative. How will the FERC regulate PJM in order to prevent this
from happening?
Answer. The Secretary of Energy, rather than the Commission, is
responsible for designating National Interest Electric Transmission
Corridors under section 216(a) of the Federal Power Act. Nevertheless,
I share your view that transmission upgrades are needed in the PJM
footprint. Such upgrades are critically important to ensuring access to
new renewable generation. Precisely which transmission lines might be
the subject of an application for a Commission construction permit
under FPA section 216, or which transmission lines will ultimately be
constructed in the Mid-Atlantic Area National Interest Electric
Transmission Corridor, let alone the sources of power that those lines
would access (coal, natural gas, nuclear, or renewable), is speculative
at this time.
______
Responses of Philip D. Moeller to Questions From Senator Bingaman
Question 1. Do you believe that FERC has acted to fulfill
sufficiently the statutory obligation to ensure that no cross-
subsidization or encumbrance of assets will occur as a result of a
merger?
Answer. Yes, I believe the Commission has acted to sufficiently
fulfill its statutory obligation to ensure that no inappropriate cross-
subsidization or encumbrance of assets will occur as a result of a
merger. I endorse Chairman Kelliher's comprehensive response to this
question, and I wish to emphasize several points. Notably, it should be
recognized that our most significant and long-standing authority
relates to our ratemaking review and FERC's ability to find and prevent
inappropriate cross subsidization prospectively through the ratemaking
process.
Recent actions taken by the Commission include the a new regulation
that requires the filing of a statement demonstrating that a proposed
merger will not result in cross-subsides, and imposition of pricing
restrictions on all non-power goods and services transactions between a
holding company's affiliates and any of its other affiliates with
captive utility customers. In July 2007, a Supplemental Policy
Statement was issued to clarify Section 203 of the Federal Power Act.
That statement adopted a policy that included deference to state
commissions on ring fencing measures and provides guidance when a state
has not implemented ring fencing measures.
Additionally, since the enactment of Energy Policy Act of 2005
(EPAct 2005), merger applicants must pledge, under penalty of law, that
they will not engage in inappropriate cross-subsidies as the result of
a merger.
Question 2. Do you believe that FERC's cross-subsidization
protection is adequate to protect ratepayers?
Answer. Yes. In light of my answer above, I believe the
Commission's cross-subsidization protections are currently adequate 1
to protect ratepayers. If the circumstances were to change, I would act
quickly and forcefully to ensure that cross-subsidies will not occur.
Question 3. Is there anything that we need to change in the law to
give you sufficient authority to protect consumers adequately, or to be
sure that you do so?
Answer. No, at this time I do not believe that a change in the law
is necessary to enhance the Commission's authority to protect
consumers. However, I remain open to supporting a statutory change if
it can be demonstrated that such a change is warranted to better
protect consumers.
Responses of Philip D. Moeller to Questions From Senator Domenici
Question 1. GAO's Report finds that FERC relies primarily on self-
reports to detect inappropriate cross-subsidization. Is this correct?
If not, what does FERC rely on to police cross-subsidization?
Answer. No, the GAO report is not correct. While self-reports are
an important mechanism for public utilities to self-identify prohibited
conduct, the Commission primarily relies on audits and the ratemaking
review process to detect inappropriate cross-subsidization.
Question 2. Is the Commission doing enough follow-up to ensure that
companies are complying with merger conditions and that improper cross-
subsidizations are not occurring? Why isn't FERC using a risk-based
audit approach as GAO suggests? GAO also notes that FERC has only 3
ongoing audits on cross-subsidization. Why isn't FERC taking a more
proactive approach to auditing?
Answer. I believe the Commission is conducting adequate follow-up
to ensure that companies are both complying with merger conditions and
that inappropriate cross-subsidization is not occurring. After
conferring with our Audit staff, I have been assured that the
Commission employs a risk-based audit approach, but this approach is
not formalized; allowing sufficient flexibility in a case-by-case
application.
With respect to the question of why the Commission does not conduct
more cross-subsidization audits, the Commission made a conscious
decision to allocate its audit resources to concentrate on other more
serious matters, such as market manipulation, that have a more
significant impact on customers' rates. Ultimately, I believe that our
allocation of audit resources reflects the agency's priorities and
yields the highest return; that is, the maximum protection for the
nation's ratepayers.
Question 3. Do you all agree with Chairman Kelliher that ratemaking
is a powerful enforcement tool for detecting cross-subsidization?
Please elaborate on how the Commission uses its ratemaking authority to
protect consumers.
Answer. Yes, I completely agree with Chairman Kelliher that our
ratemaking authority is a powerful enforcement tool for detecting
inappropriate cross-subsidies. The ratemaking process requires
extensive documentation of relevant costs corresponding to the function
these costs are assigned to for accounting purposes. During our review
of public utility rates, inappropriate cross-subsidies can be detected
and removed.
The states have similar tools to prevent the recovery of
inappropriate costs in their ratemaking processes. Moreover, the
ratemaking function applies to all utilities, not just the few that may
be involved in mergers at any given time.
Responses of Philip D. Moeller to Questions From Senator Menendez
THE GAO REPORT
My home state of New Jersey has strong Board of Public Utilities,
one which has implemented strong regulations which protect electricity
consumers. But consumers in other states are not so lucky, and rely on
the Federal Energy Regulatory Commission.
This GAO report comes at a time when consumers are paying high and
rapidly rising prices for electricity. Consumers are being hit by
rising prices for food, fuel, and electricity, and their trust in
government is at an all time low. This is a dangerous combination, and
even the appearance of weak oversight is simply unacceptable. It is not
enough to rely on self-reporting, and your audits need to be more
transparent.
I am concerned that the FERC does consider the rising electricity
prices to be a priority.
Question 1. I would like you to explain how you determine which
companies to audit. What evidence leads you to investigate one company
or another? What are the tell-tale signs of cross subsidization?
Surely, after a report like this, you must see the need to improve
the transparency of your audits and oversight if nothing else. What
opportunities do you see to improve how you protect consumers?
Answer. I endorse the answers given by Chairman Kelliher but as I
noted in my testimony before the Committee, the Commission should
always be open to suggestions on improving the transparency of all of
its functions, including the audit function. I welcome any specific
suggestions on improving the transparency of our audit function.
Moreover, my experience here at the Commission has proven that its
staff is highly sensitive to rising prices, and is doing all that it
can ensure rates are just and reasonable.
MERGERS
Question 2. The concerns raised by the GAO report ring true for me
because I watched the FERC review the proposed merger between PSEG and
Excelon a few years ago. This proposed merger would have created the
largest utility in the country. At that time, the New Jersey Board of
Public Utilities raised a host concerns, ranging from market power to
reliability of service to increased consumer costs. At the time, it
appeared to me that the FERC approved this merger without addressing
these questions.
Obviously, the Energy Policy Act of'2005 has increased the FERC's
responsibilities. If the FERC was reviewing this merger today, would
the process be different? What steps would the FERC now take to
investigate the impact of this proposal on consumer prices? After such
a merger, could New Jersey still enforce its own strong consumer
protections?
Answer. Chairman Kelliher thoroughly describes the Commission's
actions pertaining to the proposed merger between PSEG and Exelon,
which occurred prior to my arrival at the Commission. However, as a
result of changes to our regulations in December 2005, the Commission
now requires that merger applicants file an ``Exhibit M'' to
demonstrate that a merger will not result in inappropriate cross-
subsidies to (or from) an affiliate.
RELIABILITY PRICING MODEL
Question 3. Chairman Kelliher, I would also like to discuss a
regional consumer protection issue. As you know, our nation faces an
urgent need for increased investment in transmission and generation
infrastructure. To provide the market signal need to build this
infrastructure, you have approved the so-called ``Reliability Pricing
Model'', or RPM, for the RTO which included New Jersey.
I hear many different things about RPM. Some people tell me that
it's working, paying for upgrades to old plants, and that new
generation is in the queue. Others disagree. But I know two things for
certain: The RPM is costing New Jersey consumers billions of dollars,
and we are seeing very few new entrants bringing generation on-line.
In PJM as a whole, consumers have made $26 billion in forward
capacity payments, but only 2,500 megawatts of new generation have come
on-line. This is about 10 times what 2,500 megawatts of new generation
should cost. Do you see anything wrong with this picture? Is the RPM
system working?
What steps is the FERC taking to ensure that these vast sums of
money will result in new generation?
Does FERC have any plans on how to change RPM if the new capacity
they have projected does not come online?
When considering changes to the RPM system, how can FERC reduce its
costs to consumers?
Answer. I again endorse the answer given by Chairman Kelliher
relating to your questions on the Reliability Pricing Model (RPM). I am
closely monitoring the status of the RPM design, including the
promising results of the most recent forward capacity auction (held in
May 2008). These results, reflecting a downward movement in capacity
prices, are trending in the right direction for ratepayers.
RGGI, TRANSMISSION, PLANNING
Question 4. Chairman Kelliher, my home state of New Jersey is one
of several states which are leading the nation in the fight against
global warming. New Jersey has joined the Regional Green House Gas
initiative. To meet its goals, New Jersey has embarked on an ambitious
program which aims to get 20% of its energy from renewable sources by
2020. In order to do this, they use revenues from a cap and trade
system to fund investments in renewables and energy efficiency.
However, some neighboring states are not members of RGGI but are part
of PJM regional transmission organization.
What will the FERC do to help New Jersey meet its clean energy
goals?
Answer. From my perspective, the Commission can best help New
Jersey meet its clean energy goals by promoting policies that allow the
needed transmission lines to be constructed. Although New Jersey
certainly has some renewable resources that can be developed within its
state, other regions have better access to lower cost and more reliable
renewable resources. As a percentage of a consumer's electricity bill,
transmission lines are a relatively inexpensive way to move the best
renewable energy resources to the markets that require (and demand)
them.
One of my efforts has focused on the development of hydrokinetic
technologies for in-river, wave and tidal power that has the potential
to produce significant amounts of renewable energy. FERC has promoted
changes in its hydropower licensing process to develop such renewable
resources.
Question 5. The FERC has designated a broad swath of the mid-
Atlantic as a ``National Interest Electrical Transmission Corridor''.
While building some new transmission is certainly necessary, new power
lines could also be used to deliver coal-fired electricity from older,
less efficient plants into RGGI states, completely undermining the
initiative.
How will the FERC regulate PM in order to prevent this from
happening?
Answer. I concur with the response provided by Chairman Kelliher.
The Secretary of Energy, rather than our Commission, is responsible for
designating National Interest Electric Transmission Corridors under
section 216(a) of the Federal Power Act.
______
Responses of Marc Spitzer to Questions from Senator Bingaman
Question 1. Do you believe that FERC has acted to fulfill
sufficiently the statutory obligation to ensure that no cross-
subsidization or encumbrance of assets will occur as a result of a
merger?
Answer. Yes. As I stated in my testimony before the Committee, I
believe that FERC has fulfilled its statutory obligation to ensure a
proposed merger or other transaction will not result in the improper
impairment of utility assets or subsidization of non-utility
affiliates.
Since the enactment of the Energy Policy Act of 2005, FERC has
undertaken several initiatives to establish regulations and policies
governing cross-subsidization and asset impairment attendant to review
of transactions under section 203 of the Federal Power Act. While FERC
initiated several rulemakings after the enactment of the Energy Policy
Act of 2005 to implement the new authorities granted by Congress, FERC
knew that it needed to revisit these issues as it gained additional
experience under the new regulations. Accordingly, FERC held two
technical conferences that specifically addressed how FERC should
supplement the protections against cross-subsidization that were
implemented in the original rules and whether the Commission's existing
competition analysis is sufficiently rigorous to analyze mergers. As
described in Chairman Kelliher's response, the result of these
technical conferences was a Supplemental Merger Policy Statement which
provides, among other things, guidance to the industry regarding the
types of measures applicants could offer to demonstrate that their
proposed transaction does not raise cross-subsidization concerns. The
technical conferences also led to the adoption of restrictions on
affiliate transactions between franchised public utilities that have
captive customers or that own or provide transmission service over
jurisdictional transmission facilities, and their market-regulated
power sales affiliates or non-utility affiliates.
These measures, in addition to our ratemaking authority, compliance
measures, auditing, and the penalty authority under the Energy Policy
Act of 2005, provide adequate consumer protection and discipline over
regulated entities' transactions. They ensure that when FERC examines
any proposed merger--a review that is based on the specific facts
developed in the record--no improper impairment of utility assets or
subsidization of non-utility affiliates will take place.
All of FERC's activities in this regard have focused on fulfilling
Congress's objective for the repeal of the Public Utility Holding
Company Act of 1935--encouragement of greater investment in the utility
industry and removal of unnecessary burdens while at the same time
ensuring that there is no harm to competition and no harm to
ratepayers.
Question 2. Do you believe that FERC's cross-subsidization
protection is adequate to protect ratepayers?
Answer. Yes. After the enactment of the Energy Policy Act of 2005,
FERC adopted supplementary measures to focus on the potential for
improper cross-subsidization in addition to the ongoing scrutiny and
consumer protections through FERC's traditional ratemaking authority.
These measures include, but are not limited to: specific pricing
standards for non-power goods and services transactions between
affiliates if one of the affiliates has captive customers or
transmission customers; specific and detailed record retention rules
for holding companies and their affiliates; a new standardized Uniform
System of Accounts that must be followed by all centralized service
companies; and annual reporting requirements for various forms of
service companies. Each of these measures is detailed in Chairman
Kelliher's response. Notably, the application of these protections is
not limited to mergers and other corporate transactions. Rather, these
protections facilitate FERC's statutory mandate to ensure that no
entity receives or grants an undue preference with respect to any
transmission or sale subject to FERC's jurisdiction.
Question 3. Is there anything that we need to change in the law to
give you sufficient authority to protect consumers adequately, or to be
sure that you do so?
Answer. I do not believe statutory change is required. FERC has
implemented and continues to implement the beneficial authority granted
by Congress in 2005 to ensure reliable and plentiful wholesale energy
supplies at just and reasonable rates. At this time, I believe FERC has
sufficient resources to implement its responsibilities. However, FERC's
efforts to protect ratepayers are evolving. Therefore, I concur with
Chairman Kelliher that FERC will seek additional authority or funds
from the Congress if we believe that more resources are necessary to
ensure FERC's continued vigilance to protect ratepayers.
Responses of Marc Spitzer to Questions from Senator Domenici
Question 1. GAO's Report finds that FERC relies primarily on self-
reports to detect inappropriate cross-subsidization. Is this correct?
If not, what does FERC rely on to police cross-subsidization?
Answer. GAO's finding that FERC relies primarily on self-reports to
detect inappropriate cross-subsidization is not correct. As detailed in
Chairman Kelliher's response, cross-subsidization does not lend itself
to self-reporting. While self-reports are an important part of FERC's
overall enforcement efforts, they are not the primary way by which FERC
detects inappropriate cross-subsidization. As discussed above, FERC has
adopted supplementary measures after the enactment of the Energy Policy
Act of 2005 to focus on potential cross-subsidization. However, one of
FERC's most effective policing mechanisms is the continued use of its
traditional ratemaking authority to protect ratepayers.
Question 2. Is the Commission doing enough follow-up to ensure that
companies are complying with merger conditions and that improper cross-
subsidizations are not occurring? Why isn't FERC using a risk-based
audit approach as GAO suggests? GAO also notes that FERC has only 3
ongoing audits on cross-subsidization. Why isn't FERC taking a more
proactive approach to auditing?
Answer. FERC is taking the necessary measures to ensure that
regulated entities are complying with merger conditions and that
improper cross-subsidization is not occurring. FERC does and will
follow a risk-based approach in selecting audit candidates. As Chairman
Kelliher describes in his response, FERC's risk-based approach is part
of a comprehensive review that considers various issues including, but
not limited to, financial information.
Further, I concur with Chairman Kelliher's assessment that, given
FERC's other responsibilities, FERC has been diligent to ensure
utilities are complying with merger conditions and that inappropriate
cross-subsidization does not occur. The number and scope of audits on
cross-subsidization will be determined in consideration of all FERC's
priorities and the number of available resources as FERC maintains its
oversight over cross-subsidization and other matters required by
statute or rule.
Question 3. Do you all agree with Chairman Kelliher that ratemaking
is a powerful enforcement tool for detecting cross-subsidization?
Please elaborate on how the Commission uses its ratemaking authority to
protect consumers.
Answer. I agree with Chairman Kelliher that ratemaking is a
powerful enforcement tool for detecting cross-subsidization. As
Commissioner Kerr testified on behalf of the National Association of
Regulatory Utility Commissioners, ``. . . the GAO report probably
underestimates the pervasive, positive role that rate making authority
plays. I don't mean to be trite. But I do believe that the old
expression that if you have them by the rates, their hearts and minds
will follow is in fact, an accurate assessment of the importance of
rate making authority as it affects the totality of the
relationship.''\1\ The same is true for federal ratemaking. Having
adjudicated both Federal and State rate cases, I can assure the
Committee such proceedings are an effective means of both discerning
financial chicanery and absolving the innocent.
---------------------------------------------------------------------------
\1\ Tr.79:17-24.
---------------------------------------------------------------------------
Before any costs can be recovered from wholesale customers served
under cost-based rates, FERC reviews those costs to determine if their
recovery would be just and reasonable. A public utility may not charge
rates subject to FERC's jurisdiction (wholesale sales in interstate
commerce) without notice to the public and approval by FERC under
section 205 of the Federal Power Act. A public utility may not recover
costs that are imprudently incurred. If a utility in a section 205 rate
proceeding seeks to flow through to wholesale customers costs of non-
power goods or services purchased from an affiliate, FERC will disallow
those costs if they are determined to be unreasonable or imprudently
incurred. Moreover, for any cost-based rate that is filed for approval
with FERC, FERC may institute a proceeding on its own motion or in
response to matters raised by others, including claims of potential
cross-subsidization. Additionally, an entity may file a section 206
complaint for FERC review to challenge allegedly improper cost
recovery.
Responses of Marc Spitzer to Questions from Senator Menendez
THE GAO REPORT
Question 1. My home state of New Jersey has [a] strong Board of
Public Utilities, one which has implemented strong regulations which
protect electricity consumers. But consumers in other states are not so
lucky, and rely on the Federal Energy Regulatory Commission. This GAO
report comes at a time when consumers are paying high and rapidly
rising prices for electricity. Consumers are being hit by rising prices
for food, fuel, and electricity, and their trust in government is at an
all time low. This is a dangerous combination, and even the appearance
of weak oversight is simply unacceptable. It is not enough to rely on
self-reporting, and your audits need to be more transparent. I am
concerned that the FERC does consider the rising electricity prices to
be a priority. I would like you to explain how you determine which
companies to audit. What evidence leads you to investigate one company
or another? What are the tell-tale signs of cross subsidization?
Surely, after a report like this, you must see the need to improve the
transparency of your audits and oversight if nothing else. What
opportunities do you see to improve how you protect consumers?
Answer. With respect to audits, I concur with Chairman Kelliher
that FERC uses a risk-based approach in selecting audit candidates.
However, as I stated in my testimony, the GAO Report does provide some
lessons for FERC. There is always room for improvement in our programs.
FERC continues to take steps to improve the transparency of its audit
and oversight functions. For example, as Chairman Kelliher notes in his
response, as a result of the GAO Report, FERC has improved its audit
reporting by including an enhanced audit methodology section in all of
its public audit reports.
Furthermore, FERC has recently taken actions to improve
transparency as to all of its enforcement activities. On May 15, 2008,
FERC issued a series of orders that provide further guidance regarding
our enforcement policies and regulations. FERC's Revised Policy
Statement on Enforcement provides guidance as to FERC's approach to
audits and investigations; the factors FERC's Enforcement Staff will
consider and processes they will follow in conducting audits and
investigations; and considerations that FERC will evaluate when
choosing an appropriate remedy for enforcement violations. I believe
that vigorous enforcement is critical to ensuring fair, open, and
transparent competitive markets. However, I also recognize that clarity
in our regulations and policies is essential to compliance by market
participants. Our existing enforcement program is new and will continue
to evolve as the Congress' objectives change. These orders demonstrate
FERC's commitment to responsiveness and to ongoing improvements in our
program.
MERGERS
Question 2. The concerns raised by the GAO report ring true for me
because I watched the FERC review the proposed merger between PSEG and
[Exelon] a few years ago. This proposed merger would have created the
largest utility in the country. At that time, the New Jersey Board of
Public Utilities raised a host [of] concerns, ranging from market power
to reliability of service to increased consumer costs. At the time, it
appeared to me that the FERC approved this merger without addressing
these questions. Obviously, the Energy Policy Act of 2005 has increased
the FERC's responsibilities. If the FERC was reviewing this merger
today, would the process be different? What steps would the FERC now
take to investigate the impact of this proposal on consumer prices?
After such a merger, could New Jersey still enforce its own strong
consumer protections?
Answer. Under the statutory requirements both before and after the
Energy Policy Act of 2005, FERC carefully reviews all merger
applications on a fact-specific basis to ensure any proposed
transaction is consistent with the public interest. I did not assume my
position on FERC until July 2006. However, as observed by Chairman
Kelliher in his response, FERC's review of the proposed Exelon/PSEG
merger after the Energy Policy Act of 2005 would address the new
requirement to make specific findings that the proposed merger would
not result in inappropriate cross-subsidization or encumbrance of
utility assets.
I agree with Chairman Kelliher that FERC's current merger test is
sufficient to analyze the effect a proposed merger may have on
competition, rates and regulation. FERC specifically sought comment on
this issue and carefully considered the matter in a technical
conference prior to issuance of FERC's 2007 Supplemental Merger Policy
Statement. If FERC finds that a proposed merger will have adverse
effects, it has the option to deny the merger, to condition merger
approval on measures to mitigate any resulting market power, or to
impose additional structural changes necessary to protect consumers. In
addition, FERC not only makes the finding that a proposed merger will
not result in inappropriate cross-subsidization of non-utility
affiliates or the encumbrance of utility assets for the benefit of an
affiliate, as required under the Energy Policy Act of 2005, but it has
in place affiliate pricing restrictions--applicable to all public
utilities not only those involved in mergers--to address both power and
non-power sales between affiliates.
RELIABILITY PRICING MODEL
Question 3. Chairman Kelliher, I would also like to discuss a
regional consumer protection issue. As you know, our nation faces an
urgent need for increased investment in transmission and generation
infrastructure. To provide the market signal need to build this
infrastructure, you have approved the so-called ``Reliability Pricing
Model'', or RPM, for the RTO which included New Jersey. I hear many
different things about RPM. Some people tell me that it's working,
paying for upgrades to old plants, and that new generation is in the
queue. Others disagree. But I know two things for certain: The RPM is
costing New Jersey consumers billions of dollars, and we are seeing
very few new entrants bringing generation on-line. In PJM as a whole,
consumers have made $26 billion in forward capacity payments, but only
2,500 megawatts of new generation have come on-line. This is about 10
times what 2,500 megawatts of new generation should cost. Do you see
anything wrong with this picture? Is the RPM system working? What steps
is the FERC taking to ensure that these vast sums of money will result
in new generation? Does FERC have any plans on how to change RPM if the
new capacity they have projected does not come online? When considering
changes to the RPM system, how can FERC reduce its costs to consumers?
Answer. There are numerous proceedings through which FERC is
examining the effectiveness of the PJM markets, including RPM. These
proceedings are the appropriate forum for parties to raise concerns
about the functioning of the markets and have the opportunity to be
heard. FERC's task in these docketed proceedings is to ensure adequate
new generation at just and reasonable rates.
On May 7, 2008 the Commission held a technical conference to
discuss the operation of forward capacity markets, specifically
focusing on RPM and its equivalent in the New England region. This
technical conference raised a number of issues, including those posed
by your question. FERC is considering the comments from that conference
as well as related filings in connection with bringing new, clean
generation into constrained load pockets.
RGGI, TRANSMISSION, PLANNING
Question 4. Chairman Kelliher, my home state of New Jersey is one
of several states which are leading the nation in the fight against
global warming. New Jersey has joined the Regional Green House Gas
initiative. To meet its goals, New Jersey has embarked on an ambitious
program which aims to get 20% of its energy from renewable sources by
2020. In order to do this, they use revenues from a cap and trade
system to fund investments in renewables and energy efficiency.
However, some neighboring states are not members of RGGI but are part
of PJM regional transmission organization. What will the FERC do to
help New Jersey meet its clean energy goals?
Answer. I am personally committed to ensuring FERC does what it can
to support states' efforts to implement renewable portfolio standards.
As a member of the Arizona Corporation Commission I supported a state
renewable portfolio standard of 15% by 2025. As someone who designed
two renewable portfolio standards at the state level (in 2001 and
2006), I am deeply respectful of state efforts in this regard.
I agree with Chairman Kelliher's description of FERC's efforts to
remove regulatory barriers to renewables and energy efficiency. FERC
has taken steps to support regulated entities' efforts to comply with
state renewable portfolio standards and the states' efforts to require
reductions in greenhouse gas emissions. For example, FERC supported the
proposal of the California Independent System Operator to finance
facilities to interconnect location-constrained renewable resources
such as wind, geothermal and solar generation to its transmission grid
.\2\ In this order FERC approved a mechanism that would remove barriers
to increased development of renewable energy.
---------------------------------------------------------------------------
\2\ California Independent System Operator Corporation, 119 FERC
61,061, order on reh 'g, 120 FERC 61,244 (2007).
---------------------------------------------------------------------------
Question 5. The FERC has designated a broad swath of the mid-
Atlantic as a ``National Interest Electrical Transmission Corridor''.
While building some new transmission is certainly necessary, new power
lines could also be used to deliver coal-fired electricity from older,
less efficient plants into RGGI states, completely undermining the
initiative. How will the FERC regulate PJM in order to prevent this
from happening?
Answer. The U.S. Department of Energy designated the National
Interest Electric Transmission Corridors in 2007. That designation
underscores the systemic under-investment in transmission across the
country, which Congress acknowledged in enacting section 219 of the
Federal Power Act (section 1241 of the Energy Policy Act of 2005).
Transmission congestion imposes reliability and economic burdens upon
consumers and requires greater transmission investment. Moreover, I
believe investment in the transmission grid will also support
investment in renewable generation and energy efficiency. However,
denial of an application for transmission or interconnection based upon
the fuel source of the generator could raise serious legal concerns.
The matter is perhaps better addressed as part of the consideration of
carbon policy pending in the Congress.
I concur with Chairman Kelliher's response. Until there is a
specific application related to the U.S. Department of Energy's
designation of a Mid-Atlantic Area National Interest Electric
Transmission Corridor, it is difficult to anticipate what actions FERC
should take in response.
______
Responses of Jon Wellinghoff to Questions From Senator Bingaman
Question 1. Do you believe that FERC has acted to fulfill
sufficiently the statutory obligation to ensure that no cross-
subsidization or encumbrance of assets will occur as a result of a
merger?
Answer. I take seriously the Commission's statutory obligation to
review applications filed pursuant to section 203 of the Federal Power
Act to ensure that a proposed transaction will be consistent with the
public interest, and will not result in cross-subsidization of a non-
utility associate company or the pledge or encumbrance of utility
assets for the benefit of an associate company, unless the Commission
determines that the cross-subsidization, pledge, or encumbrance will be
consistent with the public interest. I believe that the Commission has
acted appropriately to fulfill this statutory obligation by taking the
steps described in the response to your first post-hearing question to
Chairman Kelliher. I would particularly like to highlight the
Commission's commitment to adopt supplemental measures to protect
consumers against improper cross-subsidization where the record before
the Commission indicates either that a regulatory gap exists because a
state lacks the authority to act or that the measures adopted by a
relevant state commission are inadequate.
Question 2. Do you believe that FERC's cross-subsidization
protection is adequate to protect ratepayers?
Answer. Yes, for the reasons stated in my response to Question # 1
above. I also agree with Chairman Kelliher's statement that the
Commission's actions taken in the context of reviewing applications
filed pursuant to section 203 of the Federal Power Act are in addition
to the Commission's traditional and broad ratemaking authority to
disallow rate recovery of costs found unjust and unreasonable as
improper cross-subsidies.
Question 3. Is there anything that we need to change in the law to
give you sufficient authority to protect consumers adequately, or to be
sure that you do so?
Answer. No. I believe that the Commission has sufficient authority
to prevent improper cross-subsidization, and that the Commission
exercises that authority to provide adequate protection for consumers.
Responses of Jon Wellinghoff to Questions From Senator Domenici
Question 1. GAO's Report finds that FERC relies primarily on self-
reports to detect inappropriate cross-subsidization. Is this correct?
If not, what does FERC rely on to police cross-subsidization?
Answer. As Chairman Kelliher states in response to your first post-
hearing question, the Commission does not rely on self-reports as its
primary enforcement mechanism to prevent improper cross-subsidization.
I also agree with Chairman Kelliher's identification of several other
tools on which the Commission does rely for that purpose.
Question 2. Is the Commission doing enough follow-up to ensure that
companies are complying with merger conditions and that improper cross-
subsidizations are not occurring? Why isn't FERC using a risk-based
audit approach as GAO suggests? GAO also notes that FERC has only 3
ongoing audits on cross-subsidization. Why isn't FERC taking a more
proactive approach to auditing?
Answer. Chairman Kelliher states in response to your second post-
hearing question that in light of the Commission's other
responsibilities, especially with respect to the Commission's new
authority to oversee reliability of the bulk power system and to police
against market manipulation, the Commission is taking appropriate steps
to ensure that improper cross-subsidization is not occurring and that
companies are complying with merger conditions. Chairman Kelliher
further states that the Commission does and will follow a risk-based
approach in selecting companies for audits that address cross-
subsidization, and that the companies selected for the FY08 audit cycle
include some of the country's largest utility holding companies. I
agree with these statements. I would add that the Commission will seek
additional funds from the Congress if we determine that more resources
are needed to carry out our essential auditing responsibilities,
including cross-subsidization audits.
Question 3. Do you all agree with Chairman Kelliher that ratemaking
is a powerful enforcement tool for detecting cross-subsidization?
Please elaborate on how the Commission uses its ratemaking authority to
protect consumers.
Answer. The Commission has broad ratemaking authority to disallow
recovery in rates of costs found unjust and unreasonable as improper
cross-subsidies. I agree with Chairman Kelliher that exercising this
traditional authority is an important part of the Commission's
commitment to protecting consumers against improper cross-
subsidization.
Responses of Jon Wellinghoff to Questions From Senator Menendez
THE GAO REPORT
Question 1. My home state of New Jersey has strong Board of Public
Utilities, one which has implemented strong regulations which protect
electricity consumers. But consumers in other states are not so lucky,
and rely on the Federal Energy Regulatory Commission.
This GAO report comes at a time when consumers are paying high and
rapidly rising prices for electricity. Consumers are being hit by
rising prices for food, fuel, and electricity, and their trust in
government is at an all time low. This is a dangerous combination, and
even the appearance of weak oversight is simply unacceptable. It is not
enough to rely on self-reporting, and your audits need to be more
transparent.
I am concerned that the FERC does consider the rising electricity
prices to be a priority.
I would like you to explain how you determine which companies to
audit. What evidence leads you to investigate one company or another?
What are the tell-tale signs of cross subsidization?
Surely, after a report like this, you must see the need to improve
the transparency of your audits and oversight if nothing else. What
opportunities do you see to improve how you protect consumers?
Answer. I served as the State of Nevada's first consumer advocate
for customers of public utilities, and I recognize the importance of
ensuring that consumers' electricity rates are just and reasonable. I
agree that even the appearance of weak oversight can undermine public
trust in government.
The need for effective oversight extends to preventing improper
cross-subsidization. In responding to this question, Chairman Kelliher
states that the Commission does and will follow a risk-based approach
in selecting companies for audits that address cross-subsidization. I
agree with that statement, as well as with Chairman Kelliher's
description of sources that are relevant to that risk-based approach.
It is also noteworthy that the companies selected for the FY08 audit
cycle include some of the country's largest utility holding companies.
I would add that the Commission will seek additional funds from the
Congress if we determine that more resources are needed to carry out
our essential auditing responsibilities, including cross-subsidization
audits.
More generally, I agree with you that it is important to improve
the transparency of the Commission's audits. Both the GAO Report and
comments at a conference that the Commission held in November 2007
demonstrated that some aspects of the Commission's enforcement policies
are not well understood. Such confusion does not help consumers who are
the ultimate beneficiaries of those policies. To address this problem,
the Commission last week issued a package of orders that provide
greater transparency in our enforcement process. As the Commission
gains further experience in implementing our expanded enforcement
authority under EPAct 2005, we will continue to review our enforcement
policies and will make further changes as appropriate to improve
protection of consumers.
MERGERS
Question 2. The concerns raised by the GAO report ring true for me
because I watched the FERC review the proposed merger between PSEG and
Exelon a few years ago. This proposed merger would have created the
largest utility in the country. At that time, the New Jersey Board of
Public Utilities raised a host concerns, ranging from market power to
reliability of service to increased consumer costs. At the time, it
appeared to me that the FERC approved this merger without addressing
these questions.
Obviously, the Energy Policy Act of 2005 has increased the FERC's
responsibilities. If the FERC was reviewing this merger today, would
the process be different? What steps would the FERC now take to
investigate the impact of this proposal on consumer prices? After such
a merger, could New Jersey still enforce its own strong consumer
protections?
Answer. In EPAct 2005, the Congress largely ratified the
Commission's test for reviewing applications filed pursuant to section
203 of the Federal Power Act. With regard to such applications,
however, the Congress also directed the Commission to ensure that a
proposed transaction will not result in cross-subsidization of a non-
utility associate company or the pledge or encumbrance of utility
assets for the benefit of an associate company, unless the Commission
determines that the cross-subsidization, pledge, or encumbrance will be
consistent with the public interest. The Commission has taken a number
of steps since the enactment of EPAct 2005 to implement this new
statutory obligation, as Chairman Kelliher described in his prepared
testimony.
If a merger affecting the State arose today, New Jersey could still
enforce its own consumer protections. Indeed, the Commission would
consider the State's actions in determining whether to adopt
supplemental measures to protect consumers against improper cross-
subsidization.
RGGI, TRANSMISSION, PLANNING
Question 3. My home state of New Jersey is one of several states
which are leading the nation in the fight against global warming. New
Jersey has joined the Regional Green House Gas initiative. To meet its
goals, New Jersey has embarked on an ambitious program which aims to
get 20% of its energy from renewable sources by 2020. In order to do
this, they use revenues from a cap and trade system to fund investments
in renewables and energy efficiency. However, some neighboring states
are not members of RGGI but are part of PJM regional transmission
organization.
What will the FERC do to help New Jersey meet its clean energy
goals?
The FERC has designated a broad swath of the mid-Atlantic as a
``National Interest Electrical Transmission Corridor''. While building
some new transmission is certainly necessary, new power lines could
also be used to deliver coal-fired electricity from older, less
efficient plants into RGGI states, completely undermining the
initiative.
How will the FERC regulate PJM in order to prevent this from
happening?
Answer. I believe that climate change is one of the most serious
problems now facing our country. I commend the State of New Jersey for
its leadership on this issue, including its focus on increased
investment in renewable generation and energy efficiency. I agree that
renewables and demand resources, including energy efficiency and demand
response, are among our vital tools in combating climate change.
The Commission is taking important steps to remove regulatory
barriers to development of renewables and to ensure that demand
resources have appropriate access to wholesale power markets. For
example, the Commission has required transmission providers, including
PJM, to develop an open, transparent regional transmission planning
process. I believe that these planning processes will facilitate the
development of demand resources, in part because the Commission has
determined that demand resources capable of performing needed functions
should be permitted to participate in the planning process on a basis
comparable to other resources. Moreover, these planning processes can
account for regional and state energy initiatives such as New Jersey's
participation in the Regional Greenhouse Gas Initiative (RGGI). These
planning processes will ultimately reduce costs to consumers and
increase the competitiveness of utilities.
Chairman Kelliher's response to this question identifies other
examples of the Commission's efforts in these areas. I strongly support
the Commission's recent orders that modified our policy for allocating
some costs associated with transmission lines that are needed to
connect renewable generation to the grid. It is also noteworthy that
the Commission is seeking to dislodge the backlog in interconnection
request queues of independent system operators and regional
transmission organizations, including PJM.
In addition, it is worth noting that if a PJM market participant
were to incur increased costs of complying with environmental
requirements--including climate change legislation that may be enacted
at the federal level--that change would likely be reflected in bids
that the market participant submits into PJM's wholesale markets
subject to the Commission's jurisdiction. Based on PJM's economic
dispatch, market participants submitting higher bids generally would be
selected less frequently to serve consumers in PJM, including those in
New Jersey. Therefore, the plants owned by such market participants
would remain idle more often and would produce fewer greenhouse gases.
Finally, Chairman Kelliher correctly states that the Secretary of
Energy, rather than the Commission, is responsible for the designation
of any National Interest Electric Transmission Corridors (NIETC). The
Commission, however, may be presented with applications to site
transmission lines within a NIETC. The Commission has adopted
regulations that would apply in that situation. Those regulations make
clear that in reviewing a proposed project, the Commission will
consider all relevant factors on a case-by-case basis. As part of that
review, the Commission will look at alternatives, including--where
appropriate--alternatives other than new transmission lines. Such
alternatives may include demand resources, as well as upgrades to
existing facilities. This review will promote efficiency and
environmentally-sound solutions.
______
Response of James Y. Kerr II to Question From Senator Bingaman
Question 1. Would it be appropriate for FERC to establish specific
criteria for when it would consider state protections inadequate to
protect consumers, and to issue rules that would specify what kinds of
protections they would institute in those cases?
Answer. If FERC were to establish specific criteria for when it
would consider State protections inadequate to protect consumers or
issue rules that would specify what kinds of protections it would
institute in those cases, this approach might produce unnecessary
conflict between federal and State regulators. A prescriptive ``one
size fits all'' federal approach would limit the ability of State
commissions to craft appropriate safeguards. The underlying regulatory
relationships and transactions are unique and are best dealt with on a
case by case, fact specific basis. The appendix attached to NARUC's
written statement addressing the North Carolina Utility Commission's
decision in the Duke merger case describes the nature and scope of this
case by case approach.
The Commission sought input from State commissions before
finalizing its regulations under Federal Power Act (``FPA'') Section
203. FERC asked for the State views on the best way to prevent cross-
subsidization and how to coordinate federal/State merger review. The
current FERC policy on merger applications is to defer to State cross-
subsidization protections, unless there is evidence that additional
measures are needed to protect wholesale customers, or where States
lack authority to provide sufficient protections. This flexible
approach properly manages the jurisdictional overlap in this area. It
also reflects the reality that a wide variety of transactions are
subject to FPA Section 203 review and that there is more than one
mechanism to guard against improper cross-subsidization. NARUC
appreciates that FERC declined to impose a uniform federal rule on
cross-subsidization protections. A generic approach could have
displaced State merger conditions even if those conditions guarded
against improper cross-subsidization as effectively as the federal
rule. A potentially conflicting approach assumes a ``regulatory
failure'' on the part of State commissions. Federal and State
regulators have the common interest in policing improper cross-
subsidization. To that end, States have been vigilant in guarding
against cross-subsidies in the course of State merger review and in
other contexts.
Responses of James Y. Kerr II to Questions From Senator Domenici
Question 1. Does FERC have in place sufficient customer protections
in light of PUHCA repeal? Has the repeal of the Holding Company Act
resulted in any regulatory gaps?
Answer. The Commission has sufficient customer protections in
place. The exercise of complementary federal and State authority
results in comprehensive regulation. FERC has powerful regulatory tools
to prevent cross-subsidization, including the disallowance of the
recovery in rates for those costs found to reflect improper cross-
subsidies. As described in detail in the FERC Commissioners' testimony,
the Commission has adopted numerous implementing regulations and
policies under the Energy Policy Act of 2005 (``EPAct 2005'') to
enhance its ability to police cross-subsidization. In addition, FERC
has further strengthened its enforcement function to better protect
consumers.
The repeal of PUHCA has not resulted in any regulatory gaps. In
fact, EPAct 2005 filled in statutory gaps regarding holding company
mergers and generation facility acquisitions. For example, the Statute
added to the public interest determination for FPA Section 203 reviews.
The determination now requires a finding that a transaction will not
result in cross-subsidization of a non-utility associate company or the
pledge or encumbrance of utility assets for the benefit of an associate
company, unless such cross-subsidization, pledge or encumbrance is in
the public interest. Also, for every transaction approved under FPA
Section 203, FERC retains the authority to issue supplemental orders as
it may find necessary or appropriate with respect to that transaction.
State commissions have the obligation under State law to ensure the
establishment and maintenance of such energy utility services as may be
required by the public convenience and necessity. We have to ensure
that such services are provided at rates and conditions that are just,
reasonable and nondiscriminatory for all consumers. State commissions
have powerful regulatory tools to protect customers. Each State has
extensive ratemaking authority, which includes the right to disallow
recovery in rates of inappropriate or improper costs, including those
deemed to represent cross-subsidies. The exercise of State merger
review authority provides a means to protect consumer interests by
imposing conditions on any proposed transaction. In fact, the broad
statutory mandates to uphold the public interest and ensure reliable
service at just and reasonable rates have allowed State commissions to
establish detailed consumer protections not directly spelled out under
their broad statutory authority. State regulatory commissions have
traditionally had jurisdiction over the regulation of utilities in
various areas, including mergers and acquisitions, affiliate
transactions, audits and financial reporting. The repeal of PUHCA did
not change the States' authority in these areas.
Question 2. Do you believe any supplemental federal authority is
needed to police crosssubsidizations such as a federal ring-fencing
provision?
Answer. Supplemental statutory authority, such as a federal ring-
fencing provision, added to the FPA is not needed to police cross-
subsidizations. As per our response to Domenici Question 1, the
Commission already possesses extensive federal authority. And, FERC
effectively exercises its broad statutory authority to protect against
improper cross-subsidization. In fact, increased federal oversight over
non-utility corporate activities and structure could create substantial
barriers to investment in electricity markets, which would be contrary
to the intent of PUHCA repeal. Supplemental federal authority could
unnecessarily duplicate, and possibly contradict, consumer protections
already in place at the State level.
Question 3. What are your thoughts on Mr. Hempling's argument that
we should revisit the federal-state relationship to achieve consistent
regulatory policies across jurisdictional lines?
Answer. There is no need to revisit the federal-State relationship
to achieve consistent regulatory policies across jurisdictional lines,
given the absence of evidence of consumer harm caused by a regulatory
failure. The Commission and the States exercise their complementary
authority to result in consistent and comprehensive regulation. The
current approach properly balances the federal-State interests in this
area. It also promotes an efficient use of resources and fosters
greater federal-State coordination. For example, FERC collaborates with
the States on audits, recognizing that maintaining contact with State
regulators is mutually beneficial. NARUC has had an extensive and
constructive working relationship with FERC. The three NARUC/FERC
Collaboratives that cover cross jurisdictional areas--demand response,
competitive procurement and smart grid--demonstrate that the precedent
exists to continue working together.
______
Responses of Scott Hempling to Questions From Senator Bingaman
Question 1. In EPAct 05 we gave FERC new authorities and
obligations to review mergers, specifically, we required them to find
that there would be no cross-subsidization or encumbrance of assets for
the benefit of an affiliate as the result of a merger. Have FERC's
modifications of their merger rules adequately implemented this
requirement?
Answer. A rule prohibiting cross-subsidies, by itself, does not
prevent cross-subsidies, any more than a speed limit prevents speeding.
The risk of cross subsidies arises from corporate structures which make
cross subsidies (a) possible, and (b) desirable to the companies
involved. Given possibility and desirability. the rational actor's
decision to engage in cross subsidies is a product of the probability
of detection and the magnitude of the penalty.
The gap in cross subsidy prevention exists because FERC has not
identified, and discouraged, the types of corporate structures that
create the possibility and desirability of cross subsidies. Prior to
repeal, PUHCA 1935 limited the possibility of cross subsidies by
prohibiting, limiting or requiring advance review of structures that
mixed, within the same corporate family, utility and nonutility
businesses, or competitive and non-competitive businesses. FERC has
statutory authority, under the ``consistent with the public interest''
phrase in Section 203 of the Federal Power Act, to identify and limit
corporate structures and affiliations. FERC's decision not to do so
means that the risks of cross subsidies are higher now than prior to
2005, regardless of FERC's rules.
Given the increase in corporate complexity allowed by the
combination of PUHCA 1935 repeal and the absence of new FERC limits on
corporate structure, one would expect the resources devoted to cross
subsidy detection, and the frequency of detection efforts, to match the
greater risk. There is no evidence of such matching. Rational corporate
planners therefore can assume that if the rewards of cross subsidies
are high enough, the risk is worth taking.
Question 2. Some have argued that you can't prove a negative, i.e.,
that it is impossible to establish that there will be no cross-
subsidization. Would not a structural barrier between the holding
company and its utility affiliate provide the insurance that we were
seeking?
Answer. Please see response to Bingaman Question 1. The phrase
``structural barrier'' deserves some elaboration. FERC and state
regulators should insist that attention to the core utility business be
the focus of a utility corporation. Any distraction from that business
is inherently inconsistent with the core function. Regulators therefore
should define the types of businesses which may co-exist in a utility
corporate family without causing risks to customers. Such limits cause
shareholders no loss in legitimate value, because shareholders on their
own face no barriers in investing, separately, in whatever mix of
businesses best serves their portfolio.
Question 3. Is there something else that needs to be done in either
statute or rule to fulfill this obligation or to protect adequately
against cross-subsidization.
Answer. Should FERC adhere to its decision not to address cross
subsidy risk through structural limits, then it should identify with
more precision the detection procedures and resources. The GAO's
thoughts on the allocation of audit resources according to risk
principles are worth considering. Moreover, those who through their
structural choices increase the risk of cross subsidies should pay the
freight for audit detection, just as any public corporation pays for
its own audit. FERC therefore should consider a schedule of audit fees
that vary with a corporate family's structural complexity. Otherwise a
cross subsidy occurs at the outset, as all ratepayers or all taxpayers
must pay for higher audit costs necessitated by the structural choices
of a discrete set of companies.
Responses of Scott Hempling to Questions From Senator Domenici
Question 1. 1. Does FERC have in place sufficient customer
protections in light of PUHCA repeal? Has the repeal of the Holding
Company Act resulted in any regulatory gaps?
Answer. Based on my career of advising over 20 state commissions
while I was in private practice, and on my current responsibilities
which involve ascertaining and fulfilling the research needs for all
state commissions, I conclude that there are gaps in consumer
protections due to the repeal of PUHCA 1935. As explained in my
submitted written testimony, the following factors combine to create
uncertainty and insufficiency in the area of consumer protection: (a)
the elimination of all federal limits on utility corporate structure,
which elimination allows structures that create a direct conflict
between the utility's public service obligation and its opportunities
to seek profit outside of its utility service business; (b) FERC's
over-reliance on rate cases, as distinct from structural limits, to
identify and correct cross subsidies; (c) insufficient information
about the frequency, quality and consequences of regulatory efforts to
detect and eliminate cross subsidies; and (d) the gap between
regulatory resources (both human and statutory) and the new
opportunities to engage in conflict-causing structures and behaviors.
Question 2. I understand you opposed PUHCA repeal. Do you think
Congress made a mistake when it repealed the Holding Company Act? Do
you think the 1935 Act should be reenacted?
Answer. Throughout the long debate about the future of PUHCA 1935,
in which I was active as early as 1989, I avoided the bipolarity of
statements such as ``I oppose PUHCA repeal'' and ``I support PUHCA
repeal.'' The bipolarity of the debate moved to the margin the correct
question, which is: ``How do we modernize federal structural regulation
so as to promote the diversity and competitiveness of electricity
markets while ensuring that customers receive the best possible service
at reasonable cost?'' This more complex question requires one to ask:
``Is it wise to permit corporate structures that place utility
executives in a conflicted position, where they have the choice of
actions which are profitable but which undermine customer interests?''
My position throughout the debate was that stark repeal caused such
conflicts, whereas leaving the statute unchanged impeded the injection
of diversity and competitiveness.
Given this statement of the issue, I believe Congress erred in not
replacing PUHCA 1935 with a modern statute that accommodated the
concerns set forth elsewhere in my comments. Re-enactment of PUHCA 1935
would not be the answer; creating a statute that allowed those
corporate structures that promote diversity and competitiveness but
precluded structures that embodied conflicts of interest would be the
answer.
As explained in my written testimony, my views set forth here are my
own; not those of NRRI or of any state commission.