[Senate Hearing 111-752]
[From the U.S. Government Publishing Office]
S. Hrg. 111-752
FINANCIAL DERIVATIVES ON ENERGY MARKETS
=======================================================================
HEARING
before the
COMMITTEE ON
ENERGY AND NATURAL RESOURCES
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
TO
EXAMINE FINANCIAL TRANSMISSION RIGHTS AND OTHER ELECTRICITY MARKET
MECHANISMS
__________
MARCH 9, 2010
Printed for the use of the
Committee on Energy and Natural Resources
______
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COMMITTEE ON ENERGY AND NATURAL RESOURCES
JEFF BINGAMAN, New Mexico, Chairman
BYRON L. DORGAN, North Dakota LISA MURKOWSKI, Alaska
RON WYDEN, Oregon RICHARD BURR, North Carolina
TIM JOHNSON, South Dakota JOHN BARRASSO, Wyoming
MARY L. LANDRIEU, Louisiana SAM BROWNBACK, Kansas
MARIA CANTWELL, Washington JAMES E. RISCH, Idaho
ROBERT MENENDEZ, New Jersey JOHN McCAIN, Arizona
BLANCHE L. LINCOLN, Arkansas ROBERT F. BENNETT, Utah
BERNARD SANDERS, Vermont JIM BUNNING, Kentucky
EVAN BAYH, Indiana JEFF SESSIONS, Alabama
DEBBIE STABENOW, Michigan BOB CORKER, Tennessee
MARK UDALL, Colorado
JEANNE SHAHEEN, New Hampshire
Robert M. Simon, Staff Director
Sam E. Fowler, Chief Counsel
McKie Campbell, Republican Staff Director
Karen K. Billups, 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................ 1
Brown, Garry, Chairman, New York State Public Service Commission,
on behalf of the National Association of Regulatory Utility
Commissioners.................................................. 20
Duane, Vincent P., Vice President and General Counsel, PJM
Interconnection, L.L.C., Norristown, PA........................ 24
Gensler, Gary, Chairman, Commodity Futures Trading Commission.... 14
Henderson, Michael W., Vice President & Chief Financial Officer,
Arkansas Electric Cooperative Coporation, Arkansas Electric
Cooperatives, Inc., Little Rock, AR............................ 43
Kelliher, Joseph T., Executive Vice President, Federal Regulatory
Affairs, FPL Group, Inc., on behalf of the Edison Electric
Institute and the Electric Power Supply Association............ 34
Murkowski, Hon. Lisa, U.S. Senator From Alaska................... 2
Wellinghoff, Jon, Chairman, Federal Energy Regulatory Commission. 3
APPENDIXES
Appendix I
Responses to additional questions................................ 57
Appendix II
Additional material submitted for the record..................... 81
FINANCIAL DERIVATIVES ON ENERGY MARKETS
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TUESDAY, MARCH 9, 2010
U.S. Senate,
Committee on Energy and Natural Resources,
Washington, DC.
The committee met, pursuant to notice, at 10:03 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. OK. Why do we not get started? Let me start
by welcoming our witnesses.
In the 110th Congress, an issue arose of the question of
overlap of jurisdiction between the Commodity Futures Trading
Commission over futures instruments and the new authority that
Congress had given to FERC over market manipulation and
regulated electricity markets. We thought that that issue had
been resolved with the colloquy on the floor and with report
language that we--at least I read to clarify that there was no
intent for CFTC to take over regulation of matters that had
been jurisdictional at FERC under the Federal Power Act and the
Natural Gas Act.
We come to this point with new legislation that has been
passed in the House, may be considered here in the Senate in
the coming months, that many tell us would make the problems
that FERC has in controlling markets under its purview more
difficult.
For several years now, many in Congress have been
criticizing regulatory agencies, CFTC as well as others, for
not regulating derivatives closely enough and thereby allowing
speculation to play too large a role although many have laid
some of the blame for the collapse of financial markets on lax
regulation allowing dangerous dependence on derivatives, but
now we have a more aggressive approach, which is welcomed by
the CFTC, to financial instruments.
Many of us are concerned that this perhaps, at least,
should not apply to things in electricity markets that have
traditionally been regulated by FERC. I think there is a
difference. FERC regulates electricity markets and the
instruments that are used in those markets under the Federal
Power Act. The Federal Power Act is concerned about rates.
Rates and contracts must be just and reasonable and not unduly
discriminatory or preferential. I think that is a key aspect of
what FERC's responsibility is.
The standard under which CFTC regulates derivatives and
futures contracts has to do with orderly markets that are not
manipulated. It does not have to do with the reasonableness of
rates.
We seem to be presented with 2 choices: create a bright
line between the jurisdiction of the 2 agencies or allow the
CFTC to decide what falls into its scope exclusively, thus
becoming, in effect, the arbiter of FERC jurisdiction under its
organic statutes. There may be other alternatives that I am not
thinking of, and we would be anxious to hear about that.
So these are the questions that are in my mind as we
approach the hearing. I think this is a difficult matter that
Congress needs to try to understand before we legislate in this
area.
Let me defer to Senator Murkowski for her comments.
STATEMENT OF HON. LISA MURKOWSKI, U.S. SENATOR
FROM ALASKA
Senator Murkowski. Thank you, Mr. Chairman. I would like to
welcome not only the 2 chairmen this morning for taking time
out of your busy schedules to appear before us today but those
that will appear on the second panel as well.
I have been amazed for about the past year with the number
of people that I have met in this Congress that say that the
one thing that they are looking for from the Federal Government
is certainty. It does not matter whether we are talking about
climate change, whether we are talking about energy
legislation, or banking reform. Stakeholders need to understand
what the rules are so that they can plan accordingly and they
can abide by them.
I often suggest that the one thing that we do pretty well
is implement the law of unintended consequences. As the Senate
considers Wall Street reform legislation, we know that our
legislative actions to regulate over-the-counter derivatives
will have consequences for physical energy markets. You get
asked the question how do we know this? It is because today we
are also receiving testimony from the State regulators, a
united industry, everyone from utilities, independent
electricity generators, renewable energy providers. They are
warning us that our actions could not only create regulatory
uncertainty but they could result in significant increases for
electricity prices.
As the Senate works on Wall Street reform legislation, we
can all agree that Congress must guard against a systemic risk
by improving the oversight, the transparency, and the stability
of financial markets.
The CFTC will certainly be provided with additional
regulatory authority aimed at addressing systemic risk in the
OTC market, but we need to carefully tailor congressional
action to avoid sweeping in the physical energy markets that
are regulated by the FERC. We do not want to be in a situation
where we have well-intentioned legislation that results in
burdensome, duplicative, or conflicting regulatory requirements
for critical power transactions. The resulting ambiguity does
nothing to increase transparency in the markets and could,
instead, lead to both gaming and forum shopping.
We are already seeing where a jurisdictional dispute
between the 2 agencies is leading to market uncertainty. The
financial transmission rights, or the FTRs, are used to hedge
against volatile transmission prices and are currently solely
regulated by the FERC. This is a point that the committee
reinforced in the 2005 Energy Policy Act.
In the 2008 Farm Bill, Congress tried to maintain the
existing jurisdictional lines between the CFTC and the FERC,
but despite these efforts, the CFTC is now considering whether
some transactions within the organized wholesale electric
markets like the FTRs are subject to its exclusive jurisdiction
under the Commodity Exchange Act.
I think it is important to note that these 2 agencies have
very different missions. FERC is tasked with ensuring just and
reasonable electricity rates for consumers, along with reliable
delivery of power. In contrast, the CFTC is charged with
policing the markets for fraud, manipulation, and abuse. I
think it is important that we keep these different goals in
mind as we work on financial reforms.
Now, we recognize, Mr. Chairman, that the Energy Committee
is not the lead on Wall Street reform efforts, but I am pleased
that many of our members have vested interest in this debate,
Senator Corker is involved with the Banking Committee and
Senator Lincoln, of course, as chairman of the Agriculture
Committee. I am confident that we can work collaboratively on
these jurisdictional issues in order to maintain just and
reasonable electricity prices for our consumers.
I look forward to the comments that we will hear this
morning.
The Chairman. Let me just mention here at the beginning
that we have an awkward circumstance which is fairly common
here in the Senate, that we have 4 votes starting at 11
o'clock. So what I have indicated to both Chairman Wellinghoff
and Chairman Gensler is that I would like, if they would, to
have them go ahead and testify, give us their views, and then
maybe we could ask them to have a seat in the audience and
bring forward the other 4 panelists for the second panel and
have them give their views. Only after we have heard from all 6
witnesses would we start our questions. That way if we have to
quit, which we will have to in about an hour, we will not be
denying anyone the right to testify.
So we do have our first panel here: the Honorable Jon
Wellinghoff, who is Chairman of the Federal Energy Regulatory
Commission, and the Honorable Gary Gensler, who is Chairman of
the Commodity Futures Trading Commission. We welcome you both
and appreciate you coming. Chairman Wellinghoff, why do you not
go ahead and then Chairman Gensler.
STATEMENT OF JON WELLINGHOFF, CHAIRMAN, FEDERAL ENERGY
REGULATORY COMMISSION
Mr. Wellinghoff. Thank you, Chairman Bingaman and Ranking
Member Murkowski, and Senator Corker. Thank you for the
opportunity to appear here today.
In the interest of time, Mr. Chairman, I would request that
my prepared written statement be entered into the record, and I
will summarize my testimony.
The Chairman. We will include every witnesses' full
statement in the record, and we will appreciate if you can make
the main points that you think we need to understand.
Mr. Wellinghoff. My testimony will address the energy
markets regulated by FERC and how they may be affected by
current or proposed laws focused on financial derivatives. I
will explain why consumers could face higher energy costs if
FERC's role and authority in these markets is reduced by laws
addressing financial derivatives.
The Commodity Futures Trading Commission regulates certain
financial derivatives under existing law and would regulate
additional financial derivatives under H.R. 4173, the Wall
Street Reform and Consumer Protection Act of 2009. FERC and the
CFTC have different missions. FERC is a rate regulator and
ensures that rates charged to energy customers are just and
reasonable. FERC also approves and enforces electric
reliability standards. The CFTC seeks to ensure that markets
are generally operated fairly and orderly, but has neither the
authority nor the expertise to ensure the reasonableness of
rates or oversee reliability of energy supplies. Shifting
jurisdiction over energy markets from FERC to the CFTC would
impair FERC's ability to protect energy consumers from
unreasonable energy rates, an especially important
consideration during our economic times. Similarly, expanding
the CFTC's authority in FERC-regulated markets could limit
FERC's ability to police against market manipulation in energy
markets.
In fiscal year 2009, FERC's efforts against market
manipulation and other types of violations led to $38 million
in civil penalties and $38 million in disgorgement. The scope
of future efforts by FERC could be narrowed under the
provisions such as those in H.R. 4173.
Also, uncertainty about regulatory authority and rules in
energy markets could chill investment or increase the cost of
capital investments, ultimately harming consumers. This
uncertainty could also slow investments in green energy such as
renewable resources.
The impetus for legislation on derivatives is from the
financial turmoil caused by certain unregulated financial
derivatives and other factors. The FERC-regulated markets did
not cause these problems. Thus, whatever decisions Congress
makes for currently unregulated financial derivatives should
not apply to the energy markets regulated comprehensively by
FERC. Any amendments to the Commodity Exchange Act should
preserve FERC's exclusive oversight of rates, terms and
conditions for energy transportation and wholesale sales, and
prevent dual regulation of energy markets by FERC and the CFTC.
Alternatively, FERC's jurisdiction can be maintained through
appropriate amendments to the Federal Power Act and the Natural
Gas Act. Either way, legislation on financial derivatives
should not impair FERC's ability to ensure that consumers have
a dependable supply of energy at just and reasonable rates.
Any appropriate improvements to the rules for FERC-
regulated markets can be made by FERC and do not require a
shift in authority to another agency. For example, 2 months
ago, FERC proposed to require several actions to strengthen
credit rules in RTO and ISO markets. The proposed actions
include reducing or eliminating the use of unsecured credit in
those markets and shortening the time allowed for posting of
additional collateral. In a separate action, the commission
asked for comments on whether to require comprehensive
reporting of resales of FTRs in secondary markets.
So while I and others continue to seek improvement in these
markets, I see no problem in these markets that would be solved
by reducing FERC's authority in the energy markets. No
regulatory failure has occurred that would warrant such a major
shift in oversight of these markets. These markets are vital in
meeting the energy needs of millions of Americans, and nothing
has been identified that warrants the uncertainty of inserting
a new regulator and a new regulatory regime.
The potential harm from taking regulation of the energy
markets away from FERC would be substantial. Investment and
infrastructure needed to both maintain reliability and to
develop clean, renewable energy resources could be impeded.
Consumer protection could be impaired, and the benefits to
consumers from viable competitive energy markets could be
compromised.
In short, the current system of FERC oversight and
comprehensive regulation of electric and gas markets is working
well. Changing that system will not enhance benefits to
consumers but only put them in jeopardy.
Thank you for holding this important hearing and for
inviting me to speak here today, and I would be happy to answer
questions after the other panels come up. Thank you, Mr.
Chairman.
[The prepared statement of Mr. Wellinghoff follows:]
Prepared Statement of Jon Wellinghoff, Chairman, Federal Energy
Regulatory Commission
introduction
Mr. Chairman, Ranking Member Murkowski and members of the
Committee: Thank you for the opportunity to appear before you today. My
testimony will address the energy markets regulated by the Federal
Energy Regulatory Commission (FERC), and how they may be affected by
current or proposed laws focused on financial derivatives. I will
explain why consumers could face higher energy costs if FERC's role and
authority in these markets is reduced by laws addressing financial
derivatives.
The Commodity Futures Trading Commission (CFTC) regulates certain
financial derivatives under existing law, and would regulate additional
financial derivatives under H.R. 4173, the Wall Street Reform and
Consumer Protection Act of 2009. FERC and the CFTC have different
missions. FERC is a rate regulator and ensures that rates charged to
energy customers are just and reasonable. FERC also approves and
enforces electric reliability standards. The CFTC seeks to ensure that
markets generally operate fairly and orderly, but has neither the
authority nor the expertise to ensure the reasonableness of rates or
oversee reliability of energy supplies. Shifting jurisdiction over
energy markets from FERC to the CFTC could impair FERC's ability to
protect consumers from excessive energy rates, an especially important
consideration during a recession. Similarly, expanding the CFTC's
authority in FERC-regulated markets could limit FERC's ability to
police against market manipulation in energy markets.
Also, uncertainty about regulatory authority and requirements in
energy markets could chill investments or increase the cost of capital
for infrastructure investments, ultimately harming consumers. This
uncertainty also could slow investments in ``green energy,'' such as
renewable resources and smart grid technology.
The impetus for legislation on financial derivatives is the
financial turmoil caused by certain unregulated financial derivatives
and other factors. The FERC-regulated markets did not cause these
problems. Thus, whatever decisions Congress makes for currently-
unregulated financial derivatives should not apply to the energy
markets regulated comprehensively by FERC. Any amendments to the
Commodity Exchange Act should preserve FERC's exclusive oversight of
rates, terms and conditions for energy transportation and wholesale
sales, and prevent dual regulation of energy markets by FERC and the
CFTC. Alternatively, FERC's jurisdiction can be maintained through
appropriate amendments to the Federal Power Act and the Natural Gas
Act, and I would encourage the Committee to consider this approach.
As my colleague, Chairman Gensler, testified recently to the House
Committee on Agriculture about certain financial markets: ``While
seeking to address the gaps and inconsistencies that exist in the
current regulatory structure of complex, consolidated financial firms,
the proposals also may have unintentionally encompassed robustly
regulated markets. . . .'' Similarly here, legislation by Congress on
financial derivatives should not impair FERC's ability to ensure that
consumers have an adequate supply of energy at just and reasonable
rates.
background
Since the late-1970s, Congress and FERC have encouraged competition
in the natural gas and electricity industries. In the natural gas
industry, Congress adopted the Natural Gas Policy Act of 1978 and the
Natural Gas Wellhead Decontrol Act of 1989, removing price controls on
first sales of natural gas. FERC also adopted pro-competitive
regulations, particularly Order No. 636, requiring the interstate
pipelines to unbundle their sales and transportation services.
In the electric industry, this effort has included legislation such
as the Public Utility Regulatory Policies Act of 1978 (facilitating
market entry by combined heat-and-power facilities and small renewable
energy facilities), the Energy Policy Act of 1992 (expanding FERC's
authority to require transmission service upon customer application,
and reducing barriers to entry by independent power producers) and the
Energy Policy Act of 2005 (reducing barriers to investment in the
industry, subject to protection against cross-subsidization by
ratepayers).
The Commission's efforts in the electric industry include the
landmark Order No. 888, issued in 1996. Order No. 888 required public
utilities to offer transmission service to others on non-discriminatory
rates, terms and conditions. Order No. 888 also encouraged the
formation of independent system operators (ISOs), to operate all of the
transmission facilities in a geographic area. ISOs were aimed at
encouraging competition by facilitating development of regional power
markets, and enhancing trading opportunities for a region's buyers and
sellers. Several years later, FERC's Order No. 2000 encouraged the
formation of regional transmission operators (RTOs), which perform the
same transmission functions as ISOs but generally are larger in
geographic scope. Today, RTOs and ISOs operate not only transmission
facilities but also markets for trading electric energy among
utilities.
RTO and ISO power markets and transmission services are tightly
integrated, and regulated to a greater extent than most other markets.
The rules for RTO and ISO markets are specified in lengthy tariffs
(hundreds or thousands of pages) reviewed and approved by FERC. In
order to analyze these tariffs, the Commission draws upon expertise in
various disciplines, including attorneys, economists, energy industry
analysts, and engineers. The tariffs contain numerous requirements and
mechanisms to ensure reasonable rates and a reliable supply of
electricity. These rules are carefully designed to facilitate
competitive forces within a heavily-regulated industry. The RTOs and
ISOs themselves are not ``self-regulating organizations,'' but are
legally considered to be ``public utilities'' and in fact are regulated
more extensively than other public utilities.
Generally, the Commission's responsibility in the energy industries
is to ensure that consumers have adequate supplies of energy at
reasonable prices. For example, Federal Power Act sections 205 and 206
require the Commission to ensure that the rates, terms and conditions
offered by RTOs, ISOs and other public utilities are just, reasonable
and not unduly discriminatory. This responsibility applies to wholesale
sales and transmission of electricity in interstate commerce, as well
as contracts or other arrangements and practices significantly
affecting those sales and services.
Commission staff monitors the energy markets to ensure that the
markets are functioning efficiently and appropriately. This is done by
monitoring market results and conditions and identifying anomalies.
When the available data does not explain the anomalies, staff examines
the matter and, if legitimate reasons are not found, investigations are
initiated to determine if fraud or manipulation has occurred.
The Commission also requires each RTO or ISO to have an independent
market monitor. The market monitors can review all market activities in
real-time. They also evaluate market rules and recommend changes,
review and report on the performance of these markets, and must refer
to the Commission any potential violations of the Commission's rules,
regulations or orders.
The Energy Policy Act of 2005 gave the Commission the authority to
assess substantial penalties (a million dollars a day per violation)
for fraud and market manipulation, including manipulation of RTO and
ISO markets. This authority will greatly help the Commission deter and
penalize the types of abuses we found during the California energy
crisis several years earlier. The Commission has initiated several
proceedings based on this authority, which applies to participants in
RTO and ISO markets as well as any other entity engaging in fraud or
market manipulation in connection with a FERC-jurisdictional
transaction.
FERC's efforts on market oversight and enforcement have increased
greatly in recent years. Ten years ago, FERC investigatory staff
consisted of 14 attorneys and a few support personnel within its Office
of General Counsel. Today, staff in FERC's Office of Enforcement
(including market oversight, investigations and audits) numbers over
180, including 40 attorneys in its Division of Investigations. For
fiscal year 2009, FERC's efforts yielded settlements worth
approximately $38 million in penalties and $38 million in disgorgement.
Six of those matters involved market manipulation claims and accounted
for approximately $20.8 million in penalties and $28.8 million in
disgorgement. A complete list of such actions for 2007-2009 is appended
as Attachment A to my testimony.
The Commission's transparency requirements are also quite
extensive. For example, every public utility (whether within or outside
of an RTO or ISO) must file a quarterly report listing every wholesale
sale it made during the preceding quarter. The RTOs and ISOs also have
substantial reporting requirements for bids and transactions in their
markets.
financial transmission rights
The question of CFTC regulation of energy markets has arisen in
several contexts. Examples include RTO/ISO markets for financial
transmission rights (FTRs), capacity markets and day-ahead markets.
Another example is the question of whether RTOs/ISOs should be
considered ``clearing'' organizations within CFTC jurisdiction. I will
focus here on FTRs, as an illustration of the possible effects of CFTC
regulation in these areas.
FTRs allow customers to protect against the risk of price increases
for transmission services in RTOs/ISOs. An FTR is a right to lock in
congestion costs between two specific points. For example, if the
transmission capacity going from Point A to Point B is 500 MW, but the
RTO or ISO seeks to send 600 MW of power from Point A to Point B when
calling on the least-cost generators to serve load, the path will be
congested, and the price of service will increase because a more
expensive generator at Point B will need to be dispatched. The increase
is referred to as congestion costs.
In general, load-serving entities in RTOs/ISOs are allocated either
FTRs or rights convertible into FTRs. The allocation is generally based
on usage during a historical period, as modified in certain
circumstances for later changes. While allocated FTRs are generally
limited to load-serving entities and to those who funded construction
of specific transmission facilities, other FTRs are auctioned and these
generally can be purchased by any creditworthy entity.
Historically, FTRs were developed to give load-serving entities
price certainty similar to the pricing methods in non-RTO/ISO markets.
In most cases, FTRs have terms of one year or less. In the Energy
Policy Act of 2005, however, Congress enacted Federal Power Act section
217, requiring FERC to use its authority in a way that enables load-
serving entities to secure FTRs on a long-term basis for long-term
power supply arrangements made to meet their customer needs.
Unlike ``futures contracts,'' FTRs are available only to the extent
allowed by the physical limits of the grid. All of the FTRs must be
``simultaneously feasible'' on the grid. Financial derivatives, by
contrast, are not limited by physical capacities and instead are
limited only by the willingness of market participants to take an
opposite ``bet.''
Also, markets for FTRs include hundreds or thousands of different
FTRs (for each pairing of receipt and delivery points) and thus are
much more fragmented and less liquid than typical contracts of fungible
commodities traded on futures exchanges. (Attachment B to my testimony
provides statistics on this point.) Since an FTR applies to a specific
pair of receipt and delivery points, it is not fungible with an FTR for
a different pair of points.
FTR markets do not pose systemic risk to the economy. All FTR
markets combined amount to roughly several billion dollars. This market
level fluctuates depending on the level of physical congestion in each
RTO and is expected to decrease substantially as more transmission is
built relieving congestion.
the commodity exchange act and proposed legislation
Questions have been raised about whether FERC-regulated energy
markets, including FTRs or other products, fall within CFTC
jurisdiction under the Commodity Exchange Act. Similar questions arise
under proposed bills on financial derivatives, such as H.R. 4173.
For example, some may argue that an FTR is a solely financial
arrangement and constitutes a futures contract under the Commodity
Exchange Act, or that an RTO or ISO is a ``derivatives clearing
organization'' under that Act. Either of these arguments, if accepted,
may establish CFTC jurisdiction.
Moreover, my understanding is that the CFTC construes its
jurisdiction under the Commodity Exchange Act to be exclusive. If so,
the issue could become, not whether to allow dual regulation by FERC
and the CFTC, but whether FERC regulation will be ended and replaced by
CFTC regulation, even though the CFTC has neither the authority nor the
expertise to ensure the reasonableness of price levels or oversee
reliability of energy supplies.
Under proposed legislation, some may argue that FTRs or other FERC-
regulated agreements fit within the definition of a ``swap.'' For
example, they may argue that the definition of ``swaps'' in proposed
legislation includes capacity contracts (giving a customer in an RTO/
ISO or bilateral market the right to buy electricity from a generating
facility or other resources). This argument, however, ignores the fact
that capacity contracts are critically important in ensuring the
reliability of future electricity supplies, i.e., that there is enough
``steel in the ground'' and other resources to meet those needs. Thus,
these agreements may be subjected to a regulatory scheme crafted for
circumstances entirely unrelated to, and arguably ill-suited for, the
energy markets.
congress should preserve ferc regulation of energy markets
In addition to offering FTRs, certain RTOs and ISOs operate day-
ahead and real-time energy markets, capacity markets and ancillary
service markets. The rules for determining the prices for various power
sales and transmission services--including congestion costs--are
inextricably intertwined in the tariffs and in software as an
integrated market design. This integrated design under comprehensive
FERC oversight differs significantly from the way in which many other
derivatives markets evolved, where the derivatives developed
independently from the markets for their underlying commodities.
All elements of these markets are approved by FERC, incorporated
into FERC-approved tariffs, and monitored closely by the independent
market monitors and FERC. Subjecting one or more of these to CFTC
regulation could disrupt the integrated functioning of RTO/ISO markets,
leading to market inefficiencies and higher energy costs for consumers.
For example, as noted above, load serving entities generally are
allocated FTRs as a means to hedge the transmission costs they incur
and, ultimately, recover from their customers. CFTC requirements on
position limits could conceivably require different allocations than
the tariff rules approved by FERC. A utility currently allocated, e.g.,
half of the FTRs on a transmission path it has used and funded for many
years could find its allocation reduced significantly, and find itself
unhedged against congestion costs.
Similarly, subjecting FTRs to CFTC clearing rules could conflict
with FERC-approved tariff provisions on creditworthiness. FERC-approved
tariffs reflect a balance between limiting the risk of defaults and
unduly increasing the costs incurred by market participants and,
ultimately, consumers. FERC also recognizes that different approaches
to credit may be warranted for different types of power market
participants (such as municipal utilities, cooperative utilities and
federal agencies), unlike the one-size-fits-all approach that may suit
other markets. There is no reason to assume that policies crafted by
the CFTC in a different regulatory context apply equally well here.
Any changes that may be warranted in FERC-regulated markets can be
made by FERC and do not necessitate a shift of authority to another
agency. For example, two months ago FERC proposed to require several
actions to strengthen credit rules in the RTO and ISO markets. The
proposed actions include reducing or eliminating the use of unsecured
credit in those markets, and shortening the time allowed for posting of
additional collateral. In a separate action, the Commission asked for
comments on whether to require comprehensive reporting of resales of
FTRs in secondary markets. I have also asked FERC staff to begin
conducting outreach with market participants on the idea of position
limits for FTRs and other energy markets. FERC is open to exploring
other issues as appropriate, including whether financial participants
in energy markets can create systemic risk and the usefulness of
``secondary markets'' for resale of FERC-regulated products and
services.
Congress has recognized FERC's role in ensuring that FTRs help
protect utilities and their customers from increases in the cost of
transmission service. As noted above, Congress in 2005 enacted Federal
Power Act section 217, requiring FERC to use its authority in a way
that enables load-serving entities to secure FTRs on a long-term basis
for long-term power supply arrangements made to meet their customer
needs.
Moreover, Congress has indicated that RTOs and ISOs should be
regulated exclusively by FERC. When Congress enacted the Food,
Conservation, and Energy Act of 2008 and addressed the regulatory gap
known as the ``Enron loophole,'' by giving the CFTC authority over
``significant price discovery contracts [SPDCs],'' the Conference
Report stated (on page 986) that ``[i]t is the Managers' intent that
this provision [on SPDCs] not affect FERC authority over the activities
of regional transmission organizations or independent system operators
because such activities are not conducted in reliance on section
2(h)(3) [of the Commodity Exchange Act].'' In a colloquy with Senator
Bingaman, Senator Levin emphasized this point, stating that ``it is
certainly my intention, as one of the amendment's authors--that FERC's
authority over RTOs would be unaffected.'' Cong. Rec., Dec. 13, 2007,
S15447. More recently, the House of Representatives passed H.R. 2454,
the American Clean Energy and Security Act of 2009, which (in section
351) would amend the Commodity Exchange Act to define ``energy
commodity'' as including ``electricity (excluding financial
transmission rights which are subject to regulation and oversight by
the Federal Energy Regulatory Commission.)''
Congress has taken care to avoid duplicative regulation elsewhere
in the electric industry. For example, the Federal Power Act exempts
state agencies from regulation as public utilities; preserves State
authority over local distribution and intrastate commerce (including
much of Texas); and exempts cooperatives from regulation as public
utilities if they are financed by the Rural Utilities Service. The same
approach of avoiding duplicative regulation is warranted here.
State regulators support FERC's jurisdiction in wholesale energy
markets instead of a shift of jurisdiction to the CFTC. Last month, the
National Association of Regulatory Utility Commissioners (NARUC)
adopted a resolution stating that FERC (and, within ERCOT, the state
commission) ``should continue to be the exclusive Federal regulator
with authority to oversee any agreement, contract, transaction,
product, market mechanism or service offered or provided pursuant to a
tariff or rate schedule filed and accepted by the FERC. . . .''
The impetus for legislation on financial derivatives is the
financial turmoil caused by certain unregulated financial derivatives
and other factors. As Chairman Gensler stated in recent testimony
before the House Committee on Agriculture: ``One year ago, the
financial system failed the American public. The financial regulatory
system failed the American public.'' He also stated that ``[w]e now
face a new set of challenges as the nation continues to recover from
last year's failure of the financial system and the financial
regulatory system.'' The FERC-regulated energy markets did not cause
these problems. Any response by Congress should address the source of
these problems, and not inadvertently sweep in the FERC-regulated
markets, since these have continued to perform well.
In short, FERC has many years of experience with the energy
markets. While I and others continue to seek improvements in these
markets, I see no problem in these markets that would be solved by
supplementing or displacing FERC oversight with CFTC oversight. No
regulatory failure has occurred that would warrant such a major shift
in oversight of these markets. These markets are vital in meeting the
energy needs of many millions of Americans, and nothing has been
proffered to warrant the uncertainty of inserting a new regulator and a
new regulatory regime.
The potential harm that would ensue, however, if the regulation of
the energy markets was taken from FERC could be substantial. Investment
in infrastructure needed both to maintain reliability and to develop
clean renewable energy resources could be impeded. Consumer protection
could be impaired and the benefits to consumers from viable competitive
energy markets could be compromised. In sum, the current system of FERC
oversight and comprehensive regulation of electric and gas markets is
working well. Changing that system will not enhance benefits to
consumers, but only put them in jeopardy.
conclusion
Late last year, Chairman Gensler testified that giving the Federal
Reserve certain authority in financial markets ``has the potential of
setting up multiple regulators overseeing markets and market functions
in the United States.'' He also stated that ``[w]hile it is important
to enhance the oversight of markets by both the SEC and CFTC, I think
Congress would want to closely consider whether it's best to set up
multiple regulators for some functions.'' The context of today's
hearing is different, but the concern is the same. Any improvements
warranted in FERC-regulated markets can be made by FERC. Interposing a
new regulator, or having multiple regulators, has not been justified,
is not needed and would be harmful.
The Chairman. Thank you very much.
Chairman Gensler, go right ahead.
STATEMENT OF GARY GENSLER, CHAIRMAN, COMMODITY FUTURES TRADING
COMMISSION
Mr. Gensler. Thank you, Chairman Bingaman, Ranking Member
Murkowski, and Senator Corker. It is an honor to be here today
and testify on behalf of the full commission, the CFTC.
Before I just turn to OTC derivatives reform, let me just
say one moment about what the CFTC is because I do not often
come before this committee. We regulate exchanges,
clearinghouses, other intermediaries to ensure--and I think Jon
captured this--to make sure the markets work efficiently, there
is integrity to markets, and they are free of fraud,
manipulation, and of course, that we are promoting
transparency, which is so important to the public markets. That
helps lower risk to the full American public.
We, of course, also have broad surveillance and enforcement
authority and are sort of a cop on the beat.
When Congress first brought regulation to the futures
markets, which were derivatives markets that existed since the
Civil War, they brought that regulation in the 1920s and 1930s.
They sought to ensure uniformity across the then-derivatives
markets which we called futures, and the CFTC was later formed
out of the Agriculture Department in the 1970s overseeing the
futures trading not only in the original grain products but
also in oil and natural gas, gasoline, electricity, and so
forth.
So the CFTC overseeing these derivative markets, coexists
and routinely cooperates with other agencies. We coexist, for
instance, with the Department of Agriculture that helps set
milk prices throughout the country, and we do coexist, I think
very well, with FERC, and as the chairman mentioned under the
Energy Policy Act of 2005, for example, this committee working
across parties and with the House set up new manipulation
standards for FERC, and we have worked jointly with them. I
think those authorities that were in EPAct are very important
to help protect the markets that FERC oversees.
But at the same time, the CFTC does oversee the futures
markets in electricity and natural gas, whether they trade in
NYMEX or the Nodal Exchange or this new Intercontinental
Exchange.
In a well functioning market, derivatives help to mitigate
and lower risk, and of course, the financial crisis
dramatically showed how the unregulated over-the-counter
marketplace instead could heighten risk and concentrate risk.
So working together with Congress--and I see Senator Corker
because I know you are at the center of this on another
committee--working together, we are trying to regulate the
over-the-counter derivatives market. There are 3 essential
pieces, if I might say.
One is to regulate the dealers. These are the large swap
dealers. Usually they are part of an institution too big to
fail, but those swap dealers.
Two is to bring transparency into the markets requiring
transparent trading on trading platforms or even fully
regulated exchanges, coupled with aggregate position limit
authority.
Three is to lower risk further to bring standard
transactions to central clearing.
Now, electricity derivatives are part of that. Natural gas
derivatives may be part of that. Consistent with the way that
the CFTC and the FERC coexist to date in the futures markets, I
believe that both agencies should continue to coexist with each
of their very important and respective missions. We have a
strong relationship with the commission. We are working
actually with the FERC right now. Jon and I have met and the
staffs have met about the rule that he mentioned on lowering
risk in the RTO markets. Ours is just to give advice. They are
taking the lead, of course.
But as Congress works through OTC derivatives reform, I
think it should avoid wholesale statutory exemptions,
exemptions that could lead to the CFTC regulation of futures
contracts, swaps contracts, clearing or exchanges to be exempt
in a certain or particular market. We actually have some
history with exemptions, and any such statutory exemptions can
undercut the goal of comprehensive reform and weaken market
protection. It is particularly hard to craft such exemptions,
bright line exemptions, as the chairman mentioned, and
consistent with the public interest because markets evolve,
products evolve.
History demonstrates that such bright line exemptions can
lead to their own unintended consequences. What seems to be
well crafted, carefully crafted later becomes a significant
loophole. You know, when the Enron loophole was included in
statute in 2000, electronic trading facilities were at their
infancy, but as these electronic facilities went on, and by the
time it was addressed in 2008 in the Farm Bill, we had to bring
in unregulated markets that were actually larger than the
original regulated markets.
So I think the proponents of exemptions have argued and
they are concerned about additional CFTC regulation and they
think it is unnecessary. I think that our 2 agencies can work
well together. We have to date. We coexist with many other
agencies.
So I thank you for having me here. I understand you are on
a tight schedule. So I look forward to any questions as they
come up.
[The prepared statement of Mr. Gensler follows:]
Prepared Statement of Gary Gensler, Chairman, Commodity Futures Trading
Commission
Good afternoon Chairman Bingaman, Ranking Member Murkowski and
members of the Committee. Thank you for inviting me to testify
regarding the regulation of over-the-counter (OTC) derivatives,
particularly with respect to energy markets. I am pleased to testify on
behalf of the Commodity Futures Trading Commission.
The 2008 financial crisis left us with many lessons and many
challenges to tackle. Though there were certainly many causes of the
crisis, I think most would agree that the unregulated OTC derivatives
marketplace played a central role. We must now bring comprehensive
regulatory reform to the OTC marketplace for derivatives.
cftc regulatory regime
Before I discuss the details of much-needed OTC derivatives reform,
let me take a moment to discuss the Commodity Futures Trading
Commission's (CFTC) current oversight of particular derivatives
markets, called futures markets. Futures have traded since the Civil
War, when grain merchants came together to hedge the risk of changes in
the price of corn, wheat and other grains on a central exchange. It
took nearly 60 years until Congress first brought Federal regulation to
the futures markets. President Roosevelt and Congress further responded
to our last great financial crisis by strengthening regulation and
oversight of the commodities and futures markets through the Commodity
Exchange Act (CEA), which created the CFTC's predecessor within the
Agriculture Department.
The CFTC ensures that futures and commodity options exchanges
protect market participants and promote fair and orderly trading, free
from fraud, manipulation and other abuses. Exchanges are where buyers
and sellers meet and enter into transactions. The CFTC also oversees
clearinghouses, which enter the picture only after two counterparties
complete a transaction. Clearinghouses act as middlemen between and
guarantee the obligations of the two parties to the trade and take on
the risk that one party may fail to meet its obligations for the
duration of the contract. Centralized clearing has helped lower risk to
the markets for more than a century, in both calm markets and in the
stormiest of markets, such as during the 2008 financial crisis.
In addition to regulating exchanges and clearinghouses, the CFTC
regulates market participants, including futures commission merchants,
commodity trading advisors and commodity pool operators. The CFTC has
wide-ranging transparency efforts designed to provide the public much
information about commodity futures markets and trading. The agency
also has broad surveillance and enforcement powers to police the
markets for fraud, manipulation and other abuses.
cftc coordination with other agencies
While many different federal agencies oversee various cash markets
throughout the economy, Congress determined that the CFTC should be the
sole agency to oversee trading on futures exchanges. One of the
principal reasons that Congress mandated this exclusive jurisdiction
was to bring uniformity to the regulation of the regulated derivatives
markets. Importantly, the CFTC also was given the authority to provide
exemptions from regulatory requirements for specific instruments or
markets where it is in the public interest to do so.
Though the CFTC has exclusive jurisdiction over the futures
markets, it coexists and routinely cooperates with other agencies that
have jurisdiction over cash markets for the underlying commodities. The
Department of Agriculture, for example, regulates marketing standards
for corn and cash milk prices, while the CFTC regulates corn and milk
futures. The Grain Inspection, Packers and Stockyards Administration
oversees spot livestock markets, while the CFTC regulates livestock
futures. The Treasury Department oversees the issuance of all Treasury
Bills, Notes and Bonds, while the CFTC oversees futures contracts based
on those instruments. The Federal Reserve Board oversees interest rate
levels, while the CFTC oversees interest rate futures. The Federal
Energy Regulatory Commission (FERC) oversees important aspects of the
energy markets, including monitoring natural gas pipelines and
regulating for just and reasonable wholesale electricity rates and
interstate transmission service of electricity, while the CFTC oversees
futures markets and certain electronic trading facilities for natural
gas and electricity derivatives.
regulation of energy futures markets
A transparent and consistent playing field for all physical
commodity futures--from agricultural products, such as corn and wheat,
to energy products, such as crude oil and natural gas--should be the
foundation of our regulations. In the energy markets, the CFTC
currently oversees the trading of futures and options on futures on
crude oil, heating oil, natural gas, gasoline and electricity, among
others, traded on designated contract markets, such as the New York
Mercantile Exchange (NYMEX), and on an exempt commercial market--the
Intercontinental Exchange (ICE).
Vibrant energy futures markets are vital to the American economy.
In 2009, more than 377 million energy futures and options contracts
were traded on CFTC-regulated exchanges. The highest volume crude oil
futures market was NYMEX's West Texas Intermediate crude oil contract
with 137 million contracts. That is the equivalent of 137 billion
barrels of oil--equal to the United States usage for about 11 years--
with a notional value of nearly $9 trillion. The largest contract in
natural gas was NYMEX's Henry Hub contract with 48 million contracts.
That is the equivalent of 480 billion mmBTU's of natural gas with a
notional value of $2.17 trillion. Energy futures and options markets
also include very significant trading in electricity contracts, which,
as a class, had more than 26.4 million contracts traded representing 7%
of the overall futures and options trading volume in the energy sector.
Congress has continued to reaffirm the CFTC's role in regulating
futures markets. In the 2008 Farm Bill, Congress broadened the CFTC's
authority to regulate derivatives, including energy derivatives, traded
on previously-exempted electronic trading facilities, called exempt
commercial markets (ECMs). If a contract that is traded on one of these
facilities is found to perform a significant price discovery (SPDC)
function, the trading of that contract on that facility is subject to
heightened regulation and required to comply with key core principles
that also apply to the trading of futures contracts.
The Commission has so far determined that the ICE Henry Financial
LD1 Fixed Price Contract traded on the ICE--the largest volume natural
gas swap contract traded on an ECM--serves a significant price
discovery function, and thus subject to heightened regulation.
Following the statutory obligations of the 2008 Farm Bill, the CFTC is
analyzing--and has sought public comment on--an additional 42 energy
contracts, including natural gas and electricity contracts, to
determine whether they meet the criteria to be regulated as SPDCs.
otc derivatives regulation
Nearly 60 years after the futures markets were regulated, the first
OTC swap was transacted in 1981. During its early years, the OTC
marketplace was highly tailored to meet specific risk management needs.
Contracts were negotiated between dealers and their corporate customers
seeking to hedge specific financial risks. In contrast to the regulated
futures markets, these early OTC derivatives were not traded on
exchanges. Instead, OTC derivatives were transacted bilaterally, with
dealers standing between their various customers. In this market
structure, dealers keep transactions on their books, leaving the
financial institutions more interconnected with all of their customers
and limiting the amount of relevant pricing information available to
the public.
In the last three decades, the over-the-counter derivatives
marketplace has grown up, but it remains largely unregulated. Since the
1980s, the notional value of the market has ballooned from less than $1
trillion to approximately $300 trillion in the United States--that's
$20 in derivatives for every dollar of goods and services produced in
the American economy. The contracts have become much more standardized,
and rapid advances in technology--particularly in the last ten years--
now can facilitate transparent trading of much of this market on
electronic platforms. While so much of this marketplace has changed
significantly, the constant that remains is that it is largely
unregulated and still dealer dominated.
It is now time to bring comprehensive regulation to this large and
economically significant market. In well functioning markets,
derivatives are meant to mitigate and help manage risk in the economy.
Even if not for the 2008 financial crisis, this market should be
regulated to achieve these goals. The financial crisis only highlights
this in dramatically revealing how unregulated OTC derivatives and
their dealers actually can heighten and concentrate risk to the great
detriment of the American public. The need for broad based reform is
the ultimate lesson of AIG and the broader risks brought about by the
unregulated OTC derivatives market.
Effective reform requires many pieces. I will focus on the three
essential components that should be enacted to promote transparency and
reduce risk to the American public.
First, we must establish an explicit regulatory framework for swap
dealers and major swap participants.
Second, we must bring transparency to these markets by requiring
that standardized derivatives be traded on regulated trading platforms.
Third, we must lower the risk to the American public of financial
institutions that have become both ``too big to fail'' and ``too
interconnected to fail'' by requiring that their standardized
derivatives be brought to central clearinghouses.
Regulating the Dealers
There is now broad consensus that dealers should be regulated for
all of their derivatives business, both customized transactions and
standardized ones. Swap dealers and major swap participants should
maintain sufficient capital and meet margin requirements on their swap
businesses to lower risk to the American public. They should be
required to meet business conduct standards to a) promote market
integrity by protecting against fraud, manipulation and other abuses
and to b) lower risk through uniform back office standards for netting,
processing and documentation. This should include authority for
regulators to set aggregate position limits for OTC derivatives
contracts when they perform or affect a significant price discovery
function with respect to regulated markets. Swap dealers and major swap
participants also should meet recordkeeping and reporting requirements
promoting transparency to the regulators.
Transparent Trading Requirement
It is not enough, though, simply to promote transparency to the
regulators. Financial reform will be incomplete if we do not make the
OTC derivatives marketplace transparent to the public.
The majority of the OTC market, by some estimates more than three
quarters of the market, could be cleared by a clearinghouse. Customized
contracts--those that are so tailored that they cannot be cleared by a
clearinghouse or listed on a trading platform--should be allowed to be
transacted bilaterally, with the dealers subject to comprehensive
regulation for these transactions.
This leaves the important public policy question of whether to
require standardized OTC transactions to be brought to transparent,
regulated, trading platforms. An opaque derivatives market,
concentrated amongst a small number of financial institutions, though,
contributed to bringing our financial system to the brink of collapse.
Public market transparency greatly improves the functioning of existing
securities and futures markets. We should shine the same light on the
OTC derivatives markets. The more transparent a marketplace, the more
liquid it is.
The more transparent a marketplace, the more competitive it is. And
the more transparent a marketplace, the lower the costs for hedgers,
borrowers and, ultimately, their customers. The best way to bring
transparency is through regulated trading facilities and exchanges--
including establishing a mechanism to provide for the timely public
reporting of key trading data. Such centralized trading venues not only
bring greater transparency, but increase competition in the markets by
encouraging market-making and the provision of liquidity by a greater
number of participants. A greater number of market makers brings better
pricing and lowers risk to the system.
Further, clearinghouses would be far more able to assess and mange
the risk of OTC derivatives with the benefit of transparent trading
markets. A critical element of managing clearinghouse risk is marking
all cleared positions to a reliable and transparent market price.
Absent the transparency provided by trading venues, clearinghouses
have less reliable prices when marking to market the derivatives they
clear and, thus, are less able to manage their risk and protect the
public.
Some on Wall Street have suggested that they could support a
clearing requirement, but see no need for a transparency requirement.
But make no mistake: transparency is an absolutely essential component
of reform. Congress should require that all standardized OTC derivative
transactions be moved onto regulated transparent exchanges or trade
execution facilities.
Mandating Clearing of Standardized Derivatives
Congress also should require derivatives dealers to bring their
completed standardized derivatives transactions to regulated
clearinghouses.
Currently, OTC derivatives transactions stay on the books of the
dealers, often for many years after they are arranged. These dealers
engage in many other businesses, such as lending, underwriting, asset
management, securities trading and deposit-taking. When there is a
better alternative through central clearing, why leave these
derivatives transactions on the books of the swap dealers when these
institutions are possibly ``too big to fail?'' Bilateral derivatives
also leave a financial institution possibly ``too interconnected to
fail.'' Leaving standardized OTC derivatives transactions on the books
of the banks further aggravates the Governments' dilemma when faced
with a failing institution. Central clearing would greatly reduce both
the size of dealers as well as the interconnectedness between Wall
Street banks, their customers and the economy.
Some corporations have expressed concerns regarding posting the
collateral required to clear a contract. While this is a legitimate
public policy debate, I believe that the public is best served by
lowering risk to the system as a whole. An exemption from clearing for
this large class of transactions would allow dealers to keep
significant risk on their books--risk that could reverberate throughout
the entire financial system if a bank fails. Further, it is not clear
that posting collateral necessarily increases costs to end users, since
dealers charge corporations for credit extensions when the corporations
do not post margin.
If Congress ultimately determines that commercial end-users'
transactions should be exempt from a clearing requirement, the
exemptions should be narrow. Data from the Bank for International
Settlements shows that dealer-to-dealer transactions comprise 40
percent or less of the market in most contracts. Contracts with
financial firms make up the bulk of transactions with non-dealers. For
instance, swaps with non-dealer financial firms make up 57 percent of
the interest rate derivatives markets. Exempting transactions with non-
dealer financial firms exposes the American public to great risk by
leaving the broader financial system significantly interconnected
through their standard derivatives transactions. At a minimum,
legislation should mandate that trades between dealers and other
financial firms be cleared on regulated clearinghouses. Hedge funds,
for example, should not be exempt from a clearing requirement with
respect to their OTC transactions.
Further, any commercial end-user exception from clearing should not
bring along an exemption from a transparency requirement. Commercial
end-users have raised concerns about posting margin if they are
required to clear their transactions. Separating the trading
requirement from the clearing requirement can address this concern, if
need be. Indeed, most commercial end-users would benefit from greater
transparency than Wall Street currently provides.
regulation of electricity derivatives
As we move to bring comprehensive reform to the OTC derivatives
marketplace, the new authorities granted to market regulators will
necessarily relate to existing authorities of other federal regulators.
Specifically, CFTC authorities for OTC energy derivatives would relate
to the FERC's authority under the Natural Gas Act and the Federal Power
Act, including the authority to regulate certain activities of Regional
Transmission Organizations (RTOs) and Independent System Operators
(ISOs). Consistent with the CFTC's and FERC's currently co-existing
regulatory authorities, both agencies should continue to apply their
authorities to the activities that are within their respective
jurisdictions.
The CFTC has exclusive jurisdiction over the trading and clearing
of futures contracts, whereas the FERC has jurisdiction over other
defined aspects of the energy markets, including regulating interstate
transportation rates and services for natural gas pipelines and
regulating wholesale sales of electricity and interstate transmission
rates and services. The FERC also has important enforcement authorities
under the Federal Power Act and the Natural Gas Act to prosecute
manipulation in the electricity and natural gas markets. Contracts for
the immediate or forward delivery of electricity--like all cash and
forward contracts for other commodities--are not regulated by the CFTC.
Congress has provided the agencies with adequate tools to work
cooperatively. The CEA provides the CFTC with authority to exempt
instruments and markets from its regulations if it is determined to be
in the public interest to do so. OTC derivatives reform should extend
this exemptive authority with the CFTC's oversight of the swaps market.
Any potential overlaps in oversight can be addressed through memoranda
of understanding and other cooperative working relationships between
the two agencies. Pending legislation also should maintain the FERC's
enforcement authorities under Section 222 of the Federal Power Act and
Section 4A of the Natural Gas Act.
In contrast, wholesale statutory exemptions preventing the
application of any CFTC regulation--including the regulation of futures
contracts, swaps contracts, clearing or exchange trading--for any
instrument or market that is regulated by the FERC undermine the
effectiveness of comprehensive reform. Congress should avoid any
bright-line exemption that runs the risk of creating the next
regulatory loophole. Instead, Congress should follow the long
established model under which the CFTC coexists with other agencies
with oversight of cash and forward markets.
History demonstrates that bright-line statutory exemptions or
exclusions granted at one point in time can have unintended
consequences and often fail to adequately account for subsequent
developments. Markets evolve rapidly. What may seem like a carefully
crafted exclusion today can become a significant and problem-filled
loophole tomorrow. When the Enron loophole was included in statute in
2000, electronic trading facilities were in their infancy. By the time
Congress addressed the loophole as part of the Farm Bill in 2008, the
unregulated electronic trading of natural gas swaps was on a par with
the trading of natural gas futures on the regulated market. As the
Amaranth case demonstrated, traders took advantage of the unregulated
exempt facility to avoid position limits and other regulations
established for the regulated futures markets. Proponents of the
exemptions had argued that additional CFTC regulation was unnecessary.
Our experience, though, indicates that comprehensive and consistent
oversight must be applied.
closing
I thank you for inviting me to testify today. I look forward to
working with you in the coming months to implement comprehensive reform
of our financial regulatory system. I will be happy to answer any
questions you may have.
The Chairman. Thank you both for your excellent testimony.
If we could just ask the 4 panelists in the second panel to
come ahead and give their testimony, and then we will have some
questions of all 6 witnesses.
Let me introduce this second panel as they are coming
forward. We have the Honorable Garry Brown, who is Chairman of
the New York Public Service Commission and Chair of NARUC's
Committee on Electricity. We have Mr. Vincent Duane, who is
with PJM Interconnection in Norristown, Pennsylvania. We have
the Honorable Joseph Kelliher, representing Edison Electric
Institute and The Electric Power Supply Association, and Mr.
Michael Henderson, who is representing the Arkansas rural
electric coops in Little Rock.
Thank you all very much for being here. Why do we not
start--let us see. I introduced you in the order of right to
left, so why do we not just have you go ahead in that order,
please.
STATEMENT OF GARRY BROWN, CHAIRMAN, NEW YORK STATE PUBLIC
SERVICE COMMISSION, ON BEHLAF OF THE NATIONAL ASSOCIATION OF
REGULATORY UTILITY COMMISSIONERS
Mr. Brown. Good morning, Chairman Bingaman, Ranking Member
Murkowski, and members of the committee. My name is Garry
Brown. I am the Chair of the New York State Public Service
Commission. I also serve as the Chair of the Electricity
Committee on the National Association of Regulatory Utility
Commissioners on whose behalf I am testifying here today.
I am honored to have the opportunity to appear before you
this morning and offer our perspectives on financial
transmission rights and electricity market mechanisms.
It is our understanding that some of the proposals being
contemplated by Congress would provide the CFTC with oversight
of OTC risk management products, including mandatory
centralized clearing and exchange trading of all OTC products.
NARUC believes that this approach could be detrimental to
electricity and natural gas retail consumers. There is a
diverse group of end users consisting of electric and natural
gas utilities, suppliers, customers, and other commercial
entities who rely on OTC derivative products and markets to
manage electricity and natural gas price risks for legitimate
business purposes, thereby helping to keep commodity costs
stable for retail consumers. In these situations, the mandatory
centralized clearing of all OTC contracts as envisioned in
proposed legislation will increase expenses associated with
hedging activity and ultimately end-use prices due to increased
margin requirements.
State utility commissions regulate companies that rely on
legitimate hedging activities and transaction in natural gas
and electricity markets to keep commodity costs stable for
retail customers. These companies use both exchange-traded and
OTC derivatives to reduce their exposure to volatile spot
markets which enables them to make sound medium-and long-term
business decisions. A requirement for mandatory centralized
clearing of all OTC contracts would increase the expenses
associated with hedging activities and ultimately consumer
prices due to increased margin requirements.
Utilities would have to finance needed cash margins in the
capital markets and pass these costs to customers through the
ratemaking process or take other offsetting actions such as
cutting back capital projects. Similarly, public utilities
could lose access to long-term power supply contracts called
pre-pays because the expense of ongoing cash margins would be
prohibitive. We also understand that rural electric
cooperatives could be forced to borrow large sums at
unaffordable rates. In cases where these costs would prove to
be too high, the energy supplier would need to reduce or cease
hedging altogether, thus negatively impacting the ability to
manage price volatility, resulting in higher costs to
consumers. In short, consumers need the industry to have both
cleared and OTC options available to provide price stability
and lower costs.
Additionally, the effect of margin requirements resulting
from mandatory clearing for electric utilities could have the
unintended consequence of reducing or eliminating legitimate
hedging practices and jeopardizing or reducing investments in
such things as Smart Grid technology and other infrastructure.
We recognize the intent of the legislation is to minimize
or eliminate manipulation in the OTC market, especially by
speculators. One approach to address this concern is to have
the mandatory requirements and a carefully crafted exemption
from the requirements for legitimate utility transactions.
Another concern that NARUC members have is the effect the
various legislative proposals may have upon electric
transmission entities. The proposed reforms, as we understand,
would cause regulatory uncertainty with regard to the oversight
of regional transmission organizations and independent system
operators. This uncertainty and/or overlapping jurisdiction can
lead to negative effects on liquidity, market confidence, and
reliability.
NARUC believes that the Federal Energy Regulatory
Commission and, for the Texas/ERCOT region, the Public Utility
Commission of Texas, as the regulators with the necessary
expertise and statutory mandates to oversee wholesale
electricity markets to protect the public interest and
consumers. Energy markets currently regulated by FERC and PUCT
under accepted tariffs or rate schedules should continue to be
subject to their jurisdiction, including over physical and
financial transmission rights and market oversight, and should
not be themselves subject to CFTC jurisdiction as a
clearinghouse due to the financial and other settlement
services they provide those transacting in regional electricity
markets.
In conclusion, NARUC supports passage of financial reform
legislation ensuring that electric and natural gas markets
continue to have access to OTC risk management products as a
tool in their legitimate hedging practice to provide more
predictable and less volatile energy costs to consumers, and
would respectfully offer the following policy recommendations
for inclusion in any financial reform legislation.
The legislation should weigh the costs of potential end-
user cost increases versus the benefits of new standards for
the clearing of OTC risk management contracts.
Any Federal legislation addressing OTC risk management
products should provide for an exemption from mandatory
clearing requirements for legitimate utility hedging
activities.
Any exemption to the mandatory clearing requirement for OTC
derivatives should be narrowly tailored so as not to allow
excessive speculation in natural gas and electricity markets.
FERC should continue to be the exclusive regulator at the
Federal level--and the PUCT for Texas/ERCOT--charged with the
statutory obligation to protect the public interest and
consumers, with authority to oversee any agreements, contracts,
transactions, products, market mechanisms, or services offered
or provided pursuant to a tariff or rate schedule.
Thank you and I would be happy to answer questions later.
[The prepared statement of Mr. Brown follows:]
Prepared Statement of Garry Brown, Chairman, New York State Public
Service Commission, on Behlaf of the National Association of Regulatory
Utility Commissioners
Good morning Chairman Bingaman, Ranking Member Murkowski, and
Members of the Committee: My name is Garry Brown, and I am Chairman of
the New York State Public Service Commission (NY PSC). I also serve as
Chair of the Electricity Committee of the National Association of
Regulatory Utility Commissioners (NARUC), on whose behalf I am
testifying here today. I am honored to have the opportunity to appear
before you this morning and offer our perspective on financial
transmission rights and electricity market mechanisms.
NARUC is a quasi-governmental, non-profit organization founded in
1889. Our membership includes the 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 assure the establishment and
maintenance of such utility services as may be required by the public
convenience and necessity and to assure that such services are provided
under rates and subject to terms and conditions of service that are
just, reasonable and non-discriminatory.
Congress is currently considering financial reform legislation with
the goal of ensuring that gaps in regulation, oversight of markets and
systemic risk do not lead to economic instability, but improve
transparency and reduce systemic risk in the over-the-counter (OTC)
derivatives markets. NARUC has consistently supported federal
legislative and regulatory actions that fully accommodate legitimate
hedging activities by electric and natural gas utilities; however, we
are concerned that some legislative proposals could have adverse
effects on the retail rates of electric and natural gas consumers.
It is our understanding that some of the proposals being
contemplated by Congress would provide the Commodity Futures Trading
Commission (CFTC) with oversight of OTC risk management products,
including mandatory centralized clearing and exchange trading of all
OTC products. NARUC believes that this approach could be detrimental to
electricity and natural gas retail consumers. There is a diverse group
of end-users, consisting of electric and natural gas utilities,
suppliers, customers, and other commercial entities who rely on OTC
derivative products and markets to manage electricity and natural gas
price risks for legitimate business purposes, thereby helping to keep
commodity costs stable for retail consumers. In these situations, the
mandatory centralized clearing of all OTC contracts--as envisioned in
proposed legislation--will increase expenses associated with hedging
activity, and ultimately end-user prices, due to increased margin
requirements.
Electric and natural gas companies use derivatives to ``hedge,'' or
lock in, the price of commodities they plan to buy or sell in the
future. These companies use clearinghouses and exchanges (such as the
New York Mercantile Exchange or NYMEX) when those markets provide the
best deal. Often, however, OTC transactions--which are arranged
company-tocompany or between a company and a bank--provide the lowest
cost and/or the most stable pricing. In centralized clearing and
exchange trading, the clearinghouse or exchange steps between buyers
and sellers and guarantees payment by requesting a significant cash
``margin'' from both parties. These cash margins, a form of collateral,
represent a portion of the value of each contract. For companies whose
core businesses involve buying and selling energy commodities, cash
margin requirements would translate into significant additional
borrowing costs and/or reduced investment, which could require new
borrowing at a time when business loans and other financing are both
more expensive and harder to get.
State utility commissions regulate companies that rely on
legitimate hedging activities and transactions in natural gas and
electricity markets to keep commodity costs stable for retail
customers. These companies use both exchange-traded and OTC derivatives
to reduce their exposure to volatile spot markets, which enables them
to make sound medium-and long-term business decisions. A requirement
for mandatory centralized clearing of all OTC contracts would increase
the expenses associated with hedging activity, and ultimately consumer
prices, due to increased margin requirements.
Utilities would have to finance needed cash margins in the capital
markets--and pass those costs to customers through the ratemaking
process--or take other offsetting actions, such as cutting back capital
projects. Similarly, public utilities could lose access to long-term
electric power supply contracts called pre-pays because the expense of
ongoing cash margins would be prohibitive. We also understand that
rural electric cooperatives could be forced to borrow large sums at
unaffordable rates. In cases where these costs would prove to be too
high, the energy supplier would need to reduce or even cease hedging
altogether, thus negatively impacting the ability to manage price
volatility--resulting in higher costs to consumers. In short, consumers
need the industry to have both cleared and OTC options available to
provide price stability and lower costs.
Additionally, the effect of margin requirements resulting from
mandatory clearing for electric utilities could have the unintended
consequence of reducing or eliminating legitimate hedging practices and
jeopardizing or reducing investments in Smart Grid technology and other
infrastructure; similarly, natural gas utilities and production
companies could reduce capital devoted to infrastructure and natural
gas exploration.
We believe that the laudable goals of reform that ensure market
transparency and adequate regulatory oversight can be accomplished by
means other than mandatory clearing of OTC risk management contracts
and the anticipated extra expense. For example, a requirement that
natural gas and electric market participants engaging in legitimate
hedging report all OTC derivative transactions to a centralized data
repository, like the CFTC, would provide sufficient market transparency
without the costs associated with mandatory clearing.
We recognize the intent of the legislation to minimize or eliminate
manipulation in the OTC market, especially by speculators. One approach
to address this concern is to have the mandatory requirements and a
carefully crafted exemption from the requirements for legitimate
utility transactions.
Another concern that NARUC members have is the effects the various
legislative proposals may have upon electric transmission entities. The
proposed reforms, as we understand, would cause regulatory uncertainty
with regard to the oversight of Regional Transmission Organizations
(RTOs) and Independent System Operators (ISOs). This uncertainty and/or
overlapping jurisdiction can lead to negative impacts on liquidity,
market confidence and reliability.
NARUC believes the Federal Energy Regulatory Commission (FERC) and,
for the Texas/ERCOT region, the Public Utility Commission of Texas
(PUCT), as the regulators with the necessary expertise and statutory
mandates to oversee wholesale electricity markets to protect the public
interest and consumers, should not be preempted by financial reform
legislation from being able to continue exercising their authority to
protect consumers and ensure reliable, just and reasonable service.
Energy markets currently regulated by FERC and the PUCT under accepted
tariffs or rate schedules should continue to be subject to FERC or PUCT
jurisdiction, including over physical and financial transmission rights
and market oversight, and should not themselves be subject to CFTC
jurisdiction as a clearinghouse due to the financial and other
settlement services they provide those transacting in regional
electricity markets.
In conclusion, NARUC supports passage of financial reform
legislation ensuring that electric and natural gas market participants
continue to have access to OTC-risk management products as tools in
their legitimate hedging practices to provide more predictable and less
volatile energy costs to consumers, and would respectfully offer the
following policy recommendations for inclusion in any financial reform
legislation:
The legislation should weigh the costs of potential end-user
utility cost increases versus the benefits of new standards for
the clearing of OTC-risk management contracts used by natural
gas and electric utilities for legitimate hedging purposes.
Any federal legislation addressing OTC-risk management
products should provide for an exemption from mandatory
clearing requirements for legitimate utility hedging activity
in natural gas and electricity markets.
Any exemption to the mandatory clearing requirement for OTC
derivatives should be narrowly tailored so as not to allow
excessive speculation in natural gas and electricity markets.
FERC should continue to be the exclusive regulator at the
Federal level--and the PUCT for Texas/ERCOT--charged with the
statutory obligation to protect the public interest and
consumers, with authority to oversee any agreement, contract,
transaction, product, market mechanism or service offered or
provided pursuant to a tariff or rate schedule filed and
accepted by the FERC, or the PUCT for Texas/ERCOT.
Thank you and I would be happy to answer any questions.
The Chairman. Thank you very much.
Mr. Duane, go right ahead.
STATEMENT OF VINCENT P. DUANE, VICE PRESIDENT AND GENERAL
COUNSEL, PJM INTERCONNECTION, L.L.C., NORRISTOWN, PA
Mr. Duane. Thank you. Good morning, Mr. Chairman, Ranking
Member Murkowski, and members of the committee. I am delighted
to be here. Thank you for the invitation.
The focus of the jurisdictional debate between the CFTC and
FERC, at least the live question that we are facing today, is
focused on the organized wholesale electricity markets. These
ISO/RTO environments have been created as a product of FERC
regulatory initiative. We are operators, grid operators, with
the responsibility to keep the lights on, and we administer
markets, but these are markets unlike any other. These are very
heavily regulated markets, reduced to writing, and filed as
tariffs before the FERC.
So why have these environments attracted this attention?
Concededly, there are certain products that you will see in
these organized wholesale electricity markets that have
financial elements to them. They are forward, and the
environment itself is a centralized environment. So there are
appearances in these ISO/RTO environments that look like
exchanges and there are products that have attributes that look
like derivatives that have been traditionally the focus of the
CFTC.
I am not here today to speak to some of the issues my
industry colleagues will address in the OTC markets. I am not
here to talk about mandatory clearing or end-use exemptions. I
am here just on the question of the ISO/RTO organized markets
and the products and services they provide. I am here for PJM,
but you will see an attached statement to my testimony that
reflects the thoughts of the Midwest ISO in Carmel, Indiana;
the Southwest Power Pool in Little Rock, Arkansas; the
California ISO; and ERCOT in Austin, Texas.
Speaking of the products, the focus is the FTR product.
What needs to be understood here is that the FTR is the means
by which we as a transmission provider discharge our obligation
to provide firm transmission service under FERC's open access
regime. The full complement of FTRs, which is derived from the
physical capability of the transmission system, is allocated to
the transmission customers that pay for the transmission
system. It is not decorative architecture. It is not a
financially engineered product that we market, and we market to
whomever wants to buy it at whatever volumes. Rather, it is
integral to our function as a transmission service provider
squarely under the Federal Power Act and the FERC jurisdiction.
As far as some of the services, we clear and risk manage
this FTR bilaterally not in a multilateral manner. As a result,
the DCO, or the derivatives clearing organization, principles
that you will find in the Commodity Exchange Act are just
wholly unworkable for the functions we provide predominantly
because the RTO is not engaged in what I would view as the
hallmark of a clearinghouse organization, that being
multilateral clearing.
So what we are proposing is that there should be a bright
line. There should be some clarity that reflects the existing
architecture in these wholesale electricity markets and
reserves the jurisdiction, as has been the case for the past 10
years, to the Federal Energy Regulatory Commission. If
necessary, complementary clarity can be given to the CFTC,
recognizing their primacy in the area of exchange environments,
clearinghouse environments, and to the extent they have
jurisdiction over the financial OTC products. I think that is a
clarity that can be brought.
I want to close on the question of investigation and
enforcement. There has been much debate in this area. I do not
think the issue is so much a question of competing or
overlapping jurisdiction. I think it is one of coordination.
Schemes can be put in place by unscrupulous market participants
that are multidimensional that cut across interrelated markets
and interrelated environments with different regulators
providing oversight.
What we should do in any legislation is in the interests of
consumer protection and sound public policy, encourage
interagency coordination in these areas, build on the
cooperative models that are already in place between the FERC
and the CFTC to encourage data sharing and other coordination
in this area.
With that, let me close and make myself available to
questions. Thank you.
[The prepared statement of Mr. Duane follows:]
Prepared Statement of Vincent P. Duane, Vice President and General
Counsel, PJM Interconnection, L.L.C., Norristown, PA
My name is Vincent Duane and I serve as the Vice President and
General Counsel for PJM Interconnection, L.L.C. (``PJM''). PJM is a
FERC-regulated Regional Transmission Organization (``RTO'') responsible
for ensuring the reliable and non-discriminatory planning and operation
of the transmission grid and the fair and efficient administration of
wholesale electric markets. PJM serves 51 million people in an area
that includes all or parts of New Jersey, Pennsylvania, Delaware,
Maryland, the District of Columbia, Virginia, North Carolina, West
Virginia, Kentucky, Ohio, Michigan, Indiana, Illinois and Tennessee--an
area representing approximately 19 percent of the nation's Gross
Domestic Product.
Thank you Chairman Bingaman and the Committee for inviting PJM to
address this important subject. We recognize this Committee's key role
in considering the impact of proposals to effect regulatory reform of
our nation's financial markets.
Our country's financial markets are both varied and complex. And
while the innovation and evolving sophistication of our financial
institutions should be encouraged generally in order to manage risk,
spur investment and realize efficiencies, the need for increased
supervision over the trading of certain products in certain
environments can no longer be doubted. However, let's keep our ``eye on
the ball'' by recalling why and where we need regulatory reform.
Consider those products related to the purchase, sale and
transmission of electricity which are undertaken in fully transparent
environments administered by the nation's Regional Transmission
Organizations (``RTOs'') and Independent System Operators (``ISOs'').
The transacting of these products in these environments should not be
seen as warranting either a new regulator or a new regulatory
construct. This is so, quite simply because the RTO/ISO products and
their environments are already subject to comprehensive and proactive
regulation by the Federal Energy Regulatory Commission (``FERC'').
With Congress' help, much important work needs to be done by the
Commodity Futures Trading Commission (``CFTC'') to increase oversight
and control and restore to a sounder footing the trading of certain
financial products, such as swaps, in certain environments, such as
over-the-counter platforms. But to direct the CFTC through the passage
of new legislation or enable the CFTC, under an expansive
interpretation of the existing Commodity Exchange Act, to assert
regulatory jurisdiction in an area already fully occupied by the FERC
is wasteful and an unwelcome distraction from the important job of the
day: reforming the oversight of those products and trading environments
that are unduly opaque and presently are lightly or inadequately
supervised.
Although I am testifying solely on behalf of PJM, several of the
other RTO/ISOs, including the California ISO (operating in California),
the Southwest Power Pool (operating in all or parts of the states of
Kansas, Nebraska, Arkansas, Missouri, Oklahoma, New Mexico, Texas, and
Louisiana), ERCOT (operating in the state of Texas) and the Midwest ISO
(operating in 13 states in the Midwest) have authorized PJM to
represent their concurrence in the attached statement reflecting
sentiments and concerns similar to those stated in my testimony on
behalf of PJM. See Attachment A, ``Joint Statement of Identified RTOs/
ISOs''.
1. What Is PJM?
PJM is a FERC-regulated RTO responsible for ensuring the reliable
and non-discriminatory planning and operation of the transmission grid
and the fair and efficient administration of wholesale electric
markets. The PJM region incorporates 56,000 miles of transmission
lines, 1,250 generating plants and 6,000 substations. PJM has 250
intertie points with adjacent systems in the Eastern Interconnection,
which means that along with managing the PJM system, our operators
manage the interface between PJM and seven adjacent electric systems.
2. Overview of this Testimony
My testimony today will address the following areas:
An overview of the extensive involvement of FERC in both the
creation and oversight of RTO/ISOs;
A description of certain RTO/ISO forward markets which some
contend are subject to oversight by the CFTC;
The extensive regulation of these RTO/ISO forward markets by
FERC and the Congress' authorization of these markets under
FERC jurisdiction;
The incongruity of CFTC regulation if applied to direct how
RTOs/ISOs establish their products or perform their services
and the problems that would arise from inconsistent, or worse,
conflicting regulation should the CFTC seek to apply existing
Commodity Exchange Act provisions to these products or
functions; and
A potential legislative path forward that symmetrically
defines the exclusive functions belonging to each agency and
similarly defines those areas where shared interests and
jurisdiction are implicated and thus where inter-agency
coordination is warranted.
3. An Overview of FERC Regulation of RTO/ISOs
PJM is one of seven RTO/ISOs in the United States. Together these
entities serve over two-thirds of the nation. The map* below depicts
the respective operational areas for each of the RTOs.
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* Map has been retained in committee files.
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RTO/ISOs are a creature of FERC regulation and Congressional
pronouncements. These independent electricity grid operators were
established to fulfill Congressional policy by introducing competitive
forces to liberalize the traditional monopolistic utility industry. The
restructuring of the industry began with the Public Utility Regulatory
Policies Act of 1978, which introduced nascent competition to the
supply (generation) side of the industry. This legislation was followed
by a succession of laws, including the Energy Policy Act of 1992, which
began efforts to unlock the bulk delivery (transmission) side of the
industry. From these beginnings emanated FERC's landmark Orders No. 888
and No. 2000 in 1996 and 1999 respectively. These orders demonstrate
FERC's commitment to independent, ``open access'' operation of the
power grid (not dissimilar from how air traffic controllers operate
independently from individual airlines). FERC determined that RTO/ISOs
were the best means to effectuate the open access provisions of the
Energy Policy Act of 1992. While neither Congress nor FERC has ever
compelled transmission owners to cede control over their transmission
systems to independent operators, this Committee and Congress
affirmatively encouraged this action by instructing FERC, through
section 219(c) of the Energy Policy Act of 2005, to offer rate
incentives to transmission owners that joined such organizations.\1\
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\1\ As the majority of the Texas grid is wholly intrastate and not
interconnected with the rest of the Eastern Interconnection, the
Electric Reliability Council of Texas (ERCOT) operates as an ISO in the
state of Texas. Other than for regulation of ERCOT's compliance with
national reliability standards, ERCOT is subject to the regulation of
the Public Utility Commission of Texas rather than the FERC.
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This history of Congressional and FERC action introducing
competitive forces to the utility industry is sometimes referred to as
``deregulation.'' But as was often noted by former FERC Chairman Joseph
Kelliher, this terminology, particularly when applied to describe the
functions of RTO/ISOs, is entirely misleading. In point of fact, FERC's
regulation of RTO/ISOs is pervasive. Moreover, unlike market regulators
(such as the Securities and Exchange Commission and the CFTC) whose
functions are probably best described as oversight based upon required
disclosure, FERC is a traditional ``rate regulator'' with a mandate
grounded in the Federal Power Act of 1935. What distinguishes FERC from
those agencies overseeing the financial and commodity markets is its
obligation to ensure that prices in wholesale electricity markets, and
the terms and conditions of the various products and services used to
establish prices in these markets, are ``just and reasonable.''
Each of the many functions performed by RTOs/ISOs as grid operators
and market administrators is measured against this standard. Unlike
clearinghouses, exchanges, boards of trade and the like, RTOs and ISOs
cannot establish unilaterally their rules of operation provided only
that those rules conform to broadly stated principles or best
practices. Instead, RTOs/ISOs are subject to a FERC-administered
program comprehensively regulating their planning of the transmission
grid, their dispatch of generation operation of the grid, their
compliance with reliability standards and their administration of the
markets they operate. As a consequence, every material action taken by
an RTO/ISO in performing these functions must be authorized by a rule.
Every rule must be embodied in a tariff, which is designed through an
open process with active participation by the customers subject to
these rules. And every tariff provision must be filed with and
adjudicated by the FERC to meet the requirements of the Federal Power
Act.\2\
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\2\ 16 USC 824d Sec. 205.
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Moreover, RTOs/ISOs' administration of markets cannot be separated
from their operation of the grid. Rather, RTOs/ISOs rely on the markets
they operate as tools to more efficiently dispatch generation, manage
congestion on the grid and ensure that electricity procured through the
RTO and ISO spot markets is provided at the least cost to wholesale
customers. RTOs/ISOs operate according to the principle that
competitive forces employed in transparent market environments provide
price signals that incentivize behavior consistent with the reliable
day-to-day operation of grid.
4. Financial Transmission Rights in RTOs/ISOs
(a) What is An FTR?
I have spoken thus far of ``products'' and ``environments.'' The
RTO/ISO environments offer a product known as a ``financial
transmission right'' or FTR to ensure ``firm'' transmission for
electric transmission customers. Because this product is integral to
the functioning of RTO/ISO markets, it has been in existence in PJM
more or less since the inception of our markets. Despite successful
operation of the FTR product, under FERC regulation, for more than 10
years in PJM, this product has recently drawn renewed attention from
the CFTC.\3\
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\3\ Certain RTOs and ISOs operate forward capacity markets. These
markets have even less of the attributes of a futures product than the
FTR referenced herein.
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The FTR is a forward right or obligation with some attributes seen
in swap contracts and other attributes seen in futures contracts.\4\
But several other essential attributes of FTRs are entirely unique so
as to strain even the most liberal definition of a swap or futures
contract, as those terms are employed, respectively, in the H.R. 3795
and the Commodity Exchange Act. Moreover, as I will explain, the FTR is
a necessary component to the means by which RTOs/ISOs discharge their
basic mission in providing open access transmission service and
ensuring just and reasonable market outcomes for consumers--a mission
whose regulation Congress has squarely entrusted to FERC.
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\4\ As noted in the Joint Statement of RTOs/ISOs, Attachment A,
other RTOs/ISOs make available similar products to what is known in PJM
as a ``Financial Transmission Right'' or ``FTR''. Although the products
may have a different name in each RTO or ISO, they all operate
essentially the same.
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With the establishment by RTOs/ISOs of organized wholesale
electricity markets, a system was needed to prioritize equitably firm
access to the grid. Transmission customers, typically utilities and
competitive suppliers serving retail consumers, pay a priority charge
to receive ``firm'' transmission service. Firm service allows these
customers to deliver, with a high degree of certainty, energy from
resources located in one place on the grid to meet consumption located
in a different place on the grid. Yet the ability of any transmission
system to deliver electricity from point A to point B is limited by the
physical capability of the system to transfer power within the bounds
of the thermal and voltage constraints governing reliable operation of
the system.
The electricity markets operated by RTOs/ISOs typically employ a
construct known as ``locational marginal pricing'' or LMP to signal
demand for and attract supply of wholesale electricity. This means
simply, that the real time price of electricity at point A may differ
from the price at point B depending on whether the transmission system
can deliver the lowest cost electricity generated by the marginal
resource on the system to points A and B. As administered by RTOs/ISOs,
LMP reflects the actual cost of delivering electricity from point A to
point B in a manner corresponding to the physical flow of electrons on
the grid between these two points. As compared to non-RTO/ISO
transmission systems, LMP markets allow for a more efficient use of the
transmission system by avoiding unnecessary curtailment of service and
inaccurate and distorted pricing of transmission service whereby
certain customers must subsidize in their rates the service provided to
others. The provision of transmission service in LMP markets, however,
exposes customers, including firm transmission customers, to price
volatility when there is congestion on the grid.
RTOs/ISOs solve this problem by providing firm transmission
customers with FTRs. In a nutshell, these financial transmission rights
provide the holder a right to deliver power from point A to point B
with protection against the risk that prices at point B might be higher
than at point A. PJM allocates FTRs principally to utilities that serve
retail customers (including cooperatives, municipal utilities and
competitive retail providers in those states with programs to instill
competition in retail service). These rights in total reflect the
physical capability of the transmission system to deliver electricity;
they are finite and their number is determined through analyses
conducted by the RTO/ISO. The allocation of these finite rights is made
to those transmission customers representing consumers that have paid
for the fixed investment in the transmission system and are thus
entitled to rights to the electricity transfer capability of this
system. The FTR is the means by which RTOs/ISOs in LMP markets assure
the provision of ``firm transmission,'' consistent with FERC's open
access directives, such that these customers are protected against the
price volatility associated with multiple transactions occurring
through constrained parts of the grid.\5\
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\5\ Pennsylvania-New Jersey-Maryland Interconnection, 81 FERC
61,257 at 62,240-241 (1997).
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As I hope is apparent, the FTR is inextricably linked to both the
locational priced energy markets and the provision of firm transmission
service by RTOs/ISOs. It is also closely linked to the transmission
system planning processes--the means by which the grid is expanded to
meet growing need--another set of RTO/ISO functions subject to
extensive FERC regulation. In theory, a transmission system could be
built to accommodate all desired delivery transactions without
congestion--which is to say, without a price difference between points
A and B. In this system, FTRs would be unnecessary. In fact, some might
comment that the role of the RTO/ISO should be to design, build and
operate a transmission system so robust as to eliminate FTRs.\6\ And
while it is true that RTO/ISOs look for opportunities on their systems
to eliminate points of chronic congestion by expanding transfer
capability and thereby reducing the need for FTRs, in reality all
transmission planners must strike a balance between the costs and
societal tolerance for massive transmission infrastructure versus the
costs of congestion.
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\6\ In this respect, an RTO/ISO and its FTR product is quite
distinct from financial institutions and the derivative instruments
they design and market. While a financial institution is seeking to
expand the market for the instruments it sells, RTOs/ISOs are
continuously examining opportunities to enhance the physical capability
of the grid so as to reduce the need for FTRs.
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(b) FERC and Congress' Historic Oversight of FTRs
FERC Oversight--The FTR is rooted deeply both in FERC regulation as
well as in actions of this Committee and the Congress as a whole. For
instance, virtually from the inception of PJM's markets, FERC directed
the creation of FTRs as a means to allocate to transmission customers
equitable access to the transmission grid. In PJM, the FTR product was
approved by the FERC more than a decade ago upon the creation of PJM's
organized markets in 1997. In Pennsylvania-New Jersey-Maryland
Interconnection, 81 FERC 61,257 (1997), FERC found that FTRs
``provide an effective method of protecting against incurrence of
congestion costs when suppliers engage in transactions that use their
firm transmission service reservations.'' Id. 62,257, 62,260. FERC
also concluded that PJM's ``allocation of FTRs'' to transmission
providers ``to meet native load requirements (i.e. the customers for
whom the transmission grid was planned and constructed in the first
instance)'' was appropriate. Id. 62,260.
In connection with these approvals, the Commission further found
that there needed to be ``a process for auctioning FTRs beyond those
retained by . . . transmission customers.'' Id. 62,260. Accordingly,
in 1999, and after considerable scrutiny, FERC accepted PJM's design of
an FTR auction process that would both (i) provide an efficient means
to distribute excess FTRs, and (ii) allow FTR holders the choice to
sell those FTRs which they had been allocated and buy FTRs on different
pathways that might more effectively hedge their power supply
procurements. PJM Interconnection, L.L.C., 87 FERC 61,054 (1999).
Congress Has Directed FERC In Regulating FTRs--Congress'
recognition of FTRs in organized wholesale electricity markets and its
involvement in directing FERC in its regulation of this product is most
evident from Section 217 of the Energy Policy Act of 2005 (the ``native
load'' provision). Through Section 217, Congress directed FERC to:
exercise the authority of the Commission under this Act in a
manner that . . . . enables load-serving entities to secure
firm transmission rights (or equivalent tradable or financial
transmission rights) on a long term basis for long term power
supply arrangements made, or planned, to meet such needs.
This direction to FERC (as well as Congress' choice of FERC as the
implementing agency) shows Congress' intent to treat FTRs as tools
available to load serving entities to meet their power supply needs
rather than as another type of derivative instrument to be regulated
separately and, perhaps, inconsistently, by the CFTC, which would claim
no expertise or experience regulating the interstate transmission of
wholesale electricity.
Congress further underscored the inextricable link of these rights
to the underlying physical delivery of power to customers by creating,
in Section 217(b) (2), an actual entitlement for load serving entities:
to use the firm transmission rights, or equivalent tradable
or financial transmission rights, in order to deliver the
output or purchased energy, or the output of other generating
facilities or purchased energy to the extent deliverable using
the rights, to the extent required to meet the service
obligation of the load serving entity.
Congress addressed how such rights are to be transferred by stating
in section 217(b) (3) (A) and (B) that:
(A) To the extent that all or a portion of the service
obligation covered by the firm transmission rights or
equivalent tradable or financial transmission rights is
transferred to another load-serving entity, the successor load-
serving entity shall be entitled to use the firm transmission
rights or equivalent tradable or financial transmission rights
associated with the transferred service obligation.
(B) Subsequent transfers to another load-serving entity, or
back to the original load-serving entity, shall be entitled to
the same rights.
Congress also addressed the disposition of any excess rights not
needed to meet an entity's load serving obligation by providing clear
authority to FERC to address their disposition:
CERTAIN TRANSMISSION RIGHTS--The Commission may exercise
authority under this Act to make transmission rights not used
to meet an obligation covered by subsection (b) available to
other entities in a manner determined by the Commission to be
just, reasonable and not unduly discriminatory or preferential.
Finally, Congress directed FERC to undertake a rulemaking to
implement portions of Section 217, a rulemaking that led first to FERC
Order No. 681, a 250-page final rule on long term FTRs, followed by
FERC Order No. 681-A, a subsequent rehearing Order on the subject, and,
finally, compliance filings by the RTO/ISOs.
In summary, through Section 217, Congress stated its intention that
FERC regulate FTRs comprehensively, including their formation, initial
allocation, and transfer among various entities, as well as the trading
of any excess FTR rights available. PJM believes that Section 217 makes
clear that the Congress intended for the FERC to act over FTRs because
of their inextricable link to the underlying transmission grid and
electricity market structure. The plain language of Section 217
indicates, in our opinion, Congress' desire that the FERC's regulation
should be pervasive in this area, guided by its expertise in
transmission regulation.
As a result, PJM believes clarification is sorely needed given the
uncertainties introduced as a result of the potential for an expansive
reading of the existing Commodity Exchange Act or potentially from new
financial reform legislation to introduce overlapping regulation by two
separate agencies.
5. The Problem Of Competing FERC and CFTC Jurisdiction
As mentioned at the outset of my testimony, the wisdom in holding
today's hearing is that it offers an opportunity to confirm whether we
are keeping our ``eye on the ball'' as we develop needed financial
market reform regulation. Aside from reasons of inter-agency comity,
inefficient duplicative regulation, and distraction, there are
immediate and practical reasons to delineate clearly in statute the
respective regulatory responsibilities of FERC and the CFTC when it
comes to RTO/ISO products and environments.
The notion of dual or overlapping jurisdiction in this area is
challenged by the exclusivity of jurisdiction afforded to the CFTC
through the Commodity Exchange Act and reinforced through proposed
reform legislation. For instance, the existing Commodity Exchange Act
states that where a contract falls under provisions of the Commodity
Exchange Act, it is subject to the ``exclusive jurisdiction'' of the
CFTC. See CEA Sec. 2(a)(1)(A), 7 U.S.C. Sec. 2(a)(1)(A). This grant
of exclusive authority raises at least the potential that FERC could be
divested of any jurisdiction over the FTR and any market settlement
functions involving FTRs that the CFTC might regard as ``clearing.''
Yet, as I trust is evident from this testimony, the FTR does not stand
in isolation from other market, grid operation and grid planning
functions performed by RTOs/ISOs and that are regulated comprehensively
by FERC. The FTR is not merely decorative to the architecture of RTO/
ISO programs; it plays an integral role in the basic design of these
programs.
At least four concerns are apparent.
First, the ``exclusivity'' provision of the Commodity Exchange Act
could cause the FTR and its transaction and settlement functions being
subjected to less control under CFTC oversight than they are today
under FERC rate regulation. FERC's regulatory paradigm of tariff
filings and agency adjudication is considerably more extensive and
intrusive than the market oversight performed by the CFTC. Neither the
RTOs/ISOs that administer the transacting and settlement of FTRs nor
industry participants in the FTR markets support an outcome that would
result in less regulation of this product.
Second, if the FTR is subjected to settlement, clearing and credit
risk management principles well suited for many financial instruments,
but incongruous to FTRs, the future of the FTR in RTO/ISO markets is
quite uncertain. Again, this consequence might not be terribly
problematic if the FTR could be regarded as a ``nice to have'' risk
management tool, but hardly indispensible to the needs of wholesale
customers in managing their power purchases. As this testimony has
tried to show, this is not the case. In fact, the FTR is essential to
FERC's policy of ensuring that transmission customers, in RTO/ISO
environments, can obtain firm open access service needed to meet the
demands of their retail consumers. The FTR's importance to this
objective is underscored by the attention this Committee paid to the
product in the Energy Policy Act of 2005.
Third, while the FTR auction markets attract some non-traditional
energy market participants, including financial entities, it would be a
mistake to therefore assume that these markets can be ``cleared'' under
the Derivative Clearing Organization ``core principles'' currently in
place under the Commodity Exchange Act.\7\ The FTR is infrequently
priced through pre-scheduled auctions that generally occur once a
month. Buyers of FTRs are not in any legal sense matched with sellers.
While PJM manages the credit risk exposure presented by holders of some
FTR positions, these positions are not ``marked-to-market'' by PJM and
there is no workable method for variation margining. Due to these and
other attributes unique to FTRs and despite much exploration, PJM has
never found a CFTC-registered clearinghouse, including those active in
clearing energy commodity transactions, interested in or able to clear
the FTR positions of PJM's market participants. So, assuming that the
practical consequences of CFTC oversight do not eliminate outright the
FTR as PJM fears, the alternate scenario is one where the CFTC in
bringing its expertise in overseeing market clearing and settlement,
spends much time and resource requiring registration and reporting,
only to find that no change or ``improvement'' to how our FTRs are
transacted, settled and credit risk managed is achievable in a real or
practical sense.
---------------------------------------------------------------------------
\7\ CEA Sec. 5b(c)(2), 7 U.S.C. ' 7a-1(c)(2).
---------------------------------------------------------------------------
Fourth, instruments traded in a manner or in an environment
contrary to the requirements of the Commodity Exchange Act are, in a
sense, ultra vires, and their enforceability is at risk of
challenge.\8\ Somewhat ironically, the CFTC's renewed interest in the
established FTR products, motivated presumably by a desire to reduce
perceived systemic risk associated with FTR markets, may be having
quite the opposite effect. Should the CFTC claim that the FTR is now
jurisdictional under the Commodity Exchange Act, the legal integrity of
these products becomes less certain and a risk materializes that a
counterparty with outstanding obligations under an FTR might assert
that the obligation is void and unenforceable. Injecting this risk into
the FTR markets is completely unnecessary and easily avoided by
Congress drawing clear jurisdictional bounds that recognize FERC's
settled authority in this area.
---------------------------------------------------------------------------
\8\ See, e.g., Transnor (Bermuda), Ltd. v. BP North America
Petroleum, 738 F. Supp. 1472, 1990 U.S. Dist. LEXIS 4423, Comm. Fut. L.
Rep. (CCH) P24829, 1990-1 Trade Cas. (CCH) P68998 (S.D.N.Y. 1990).
---------------------------------------------------------------------------
6. Complications Raised by the Wall Street Reform and Consumer
Protection Act of 2009 (HR 4173) and A Proposed Path Forward
In closing, I would like to address the bill that passed the House
of Representatives in December, 2009: the Wall Street Reform and
Consumer Protection Act of 2009 (HR 4173) and respectfully offer
suggestions for an alternate path forward.
The House Bill acknowledges existing and potential future
overlapping jurisdiction between the CFTC and FERC in the area of RTO/
ISO markets. It does not, however, seek to resolve this overlap; nor
does the proposed legislation offer much by way of guidance to the
affected agencies in collaborating to ensure RTOs/ISOs face a workable
regulatory environment and one that does not afflict these markets with
competing and inconsistent regulatory directive from separate agencies.
Rather, the House Bill directs the CFTC and FERC to evolve a memorandum
of understanding to resolve conflicting regulation and ensure
cooperation and coordination where warranted.
PJM believes legislation can, and should, reserve to FERC exclusive
jurisdiction over the existing organized wholesale electricity market
architecture administered by RTO/ISOs, which has operated effectively
under FERC regulation for more than a decade.\9\ Similarly, new
legislation offers the opportunity to reaffirm the CFTC's existing
exclusive jurisdiction over exchange and clearinghouse environments and
provide that agency expanded authority in over the counter energy
markets.
---------------------------------------------------------------------------
\9\ Organized wholesale electricity markets have not operated
without flaw since their inception--the notable example being a failure
in 2001-02 in the western markets, including the market operated by The
California ISO. Importantly, this failure had little or nothing to do
with credit risk management or market clearing functions where the
CFTC's expertise lies. Rather, the problems at the time in that market
are generally accepted to have resulted from (i) inadequate design of
the complex rules defining the physical marketplace and (ii) actions by
certain market participants to exploit these deficiencies. The CFTC
would not profess expertise in this first area. And while its
investigatory and enforcement expertise is exemplary, (i) effective
enforcement in RTO/ISO markets demands a deep understanding of
complexities characterizing the physical electricity market that only
the FERC possesses, and (ii) since 2001-02, with passage of the Energy
Policy Act of 2005, FERC has been vested with significant additional
enforcement authorities and resources. In short, reference to the
events in the western markets in 2001-02 is not a compelling basis to
support the introduction of CFTC regulation to RTO/ISO markets.
---------------------------------------------------------------------------
This ``bright line'' would distinguish clearly RTO/ISO environments
from other electricity trading environments and would afford market
operators, such as PJM, certainty that the products and services they
make available under their FERC-accepted tariffs do not need further
registration or approval by the CFTC in order to be fully compliant and
legally sound. This clarity at the ``front end,'' which is to say with
the establishment and definition of the RTO/ISO's products and services
and the rules associated with them, will eliminate the potential of
irreconcilable direction as to the same subject matter from different
regulators.
While perhaps desirable in theory, carrying forward this clarity
beyond ``front end'' regulation to further define separate and distinct
agency duties when it comes to the investigation and enforcement of
fraudulent behavior or market manipulation (having ``one cop on the
beat'') poses different challenges. Some degree of interrelationship
among various trading environments is a reality that must be accepted
in designing the optimum regulatory construct. A trading firm can put
on a position in one market environment hoping to influence the value
of other positions it may hold in a distinct market environment. This
behavior is not uncommon and may be perfectly acceptable. But under
particular circumstances such trading, coupled with fraudulent behavior
and viewed holistically, could be manipulative or otherwise present an
undesirable distortion of commodity prices. Where a scheme crosses two
or more market environments implicating the respective jurisdictions of
distinct regulators, inter-agency cooperation is plainly warranted in
order to protect market integrity and consumer welfare. Legislation
addressing concurrent FERC and CFTC enforcement jurisdiction should
borrow from established principles of comity and cooperation that exist
today among banking, securities and commodity regulators. By
replicating these principles, legislation can either establish for the
CFTC and FERC, or direct the agencies to themselves establish, similar
protocols as are in place today between the CFTC and the Securities and
Exchange Commission that describe shared duties and provide for more
robust cooperation, including information sharing, when dealing with
investigation and enforcement matters that cross agency boundaries.\10\
---------------------------------------------------------------------------
\10\ Legislation could offer guidance to the agencies in this area.
For instance, Congress could instruct that one enforcement agency defer
to the lead of the other in whose jurisdictional area the alleged
scheme principally originated.
---------------------------------------------------------------------------
Finally, PJM is advocating for a ``bright line'' that would respect
the existing FERC regulation of the current architecture of the
electricity markets administered by RTOs/ISOs. While this architecture
is regularly built out and redesigned by both FERC and the RTOs/ISOs
themselves, legislation could anticipate the potential (which seems
remote) for the RTO/ISO to develop in the future a wholly new class of
products or programs that would be jurisdictional under the Federal
Power Act, but also implicate provisions of the Commodity Exchange Act.
The ``bright line'' we urge to protect the existing architecture of
RTO/ISO markets from conflicting directives need not apply after the
effective date of new legislation to wholly new programs--ones that
cannot be envisioned today but might possibly evolve in RTO/ISOs at
some future date.
The following points and illustration summarize a possible
legislative path forward:
Congress should define the status quo, as of the effective
date of new legislation, and plainly state that the direct
regulation over the products and services provided for by an
RTO/ISO under its FERC filed tariff is exclusively the province
of FERC.
Legislation can make equally clear that the direct oversight
of electricity products (financial swaps, futures contracts,
etc) in over-the-counter, exchange or clearinghouse
environments is solely the responsibility of the CFTC.
Legislation can anticipate the possibility that RTOs/ISOs
might develop in the future wholly new products or services,
that while jurisdictional under the Federal Power Act and
therefore offered under FERC-accepted tariffs, still cross into
jurisdictional areas for which the CFTC has responsibility. In
these cases, directing that the two agencies negotiate a
workable sharing of functions could provide a compromise
meeting the needs of both agencies.
Finally, legislation should distinguish between the direct
regulation, oversight, reporting and rule compliance of market
operators, from the important additional responsibility imposed
on each agency to investigate and prosecute manipulation and
schemes undertaken by market participants that are designed and
intended to distort pricing. Given the potential
interrelationship among exchange, over-the-counter and RTO/ISO
electricity markets, sound public policy warrants a high degree
of inter-agency coordination, to allow information sharing and
cooperation between the agencies in investigating and
prosecuting fraudulent activities that span two or more
interrelated market environments.
7. Conclusion
Again, PJM thanks the Committee for the opportunity today to share
our thoughts on the potential for FERC and CFTC dual and potentially
inconsistent regulation of certain RTO/ISO products essential to load
serving entities and thus retail electricity customers. PJM's fellow
RTOs/ISOs that have endorsed the statements set forth in Attachment A
also appreciate your consideration of their views. We stand ready to
offer further assistance as the Committee reviews this important issue.
attachment a.--joint statement of california iso, electric reliability
council of texas (``ercot''), midwest iso, pjm interconnection and the
southwest power pool
1. Financial transmission rights (FTRs) are an integral part
of the provision of firm transmission service. Although they go
by different names in each of the RTOs and ISOs, the products
are essentially the same. FTRs are awarded, initially to load
serving entities (i.e., providers of electricity to
residential, commercial and industrial customers) and others
who contribute to the fixed costs of the grid through their
payment of transmission rates. These customers have
historically shouldered the embedded costs of building and
maintaining the transmission system.
2. FTRs are a financial instrument that can be created only
by the RTOs/ISOs as their number and composition is determined
based upon the transmission system topology and the physics of
physical power flows. As such, they differ substantially from
standardized, stand-alone derivatives in which parties exchange
cash flows based upon price changes tied to a notional quantity
of a commodity, but not inextricably tied to the actual
delivery of a physical commodity. Moreover, because FTRs are
inextricably intertwined with the electricity markets and
reliability functions of RTOs and ISOs, it is impractical and
inefficient to regulate FTRs separately or differently from the
underlying provision of electric transmission service.
3. FTRs have been regulated by the FERC (and in the case of
ERCOT, the Public Utility Commission of Texas) since their
inception in the PJM market over 10 years ago. In addition,
Congress determined in EPACT 2005 that FTRs are integrally tied
to meeting the power procurement needs of load serving
entities. FERC not only regulates FTRs, but FERC directed PJM
and other ISOs/RTOs to develop a hedging tool to allow load
serving entities to manage congestion risk associated with
their longer term power procurements. By the same token, the
portion of the Texas grid served by ERCOT is entirely
intrastate. As a result, regulation of FTRs in Texas is
undertaken by the Public Utility Commission of Texas in a fully
integrated manner.
4. Duplicative or conflicting regulation of financial
transmission rights is not in the interest of consumers. FERC
(and, in the case of ERCOT, the Texas PUC) should be able to
maintain their respective roles as the regulators of these
products given their pervasive regulation of both ISO/RTO
markets and the provision of transmission service by ISOs/RTOs.
This regulation comprehensively spans the full span of physical
grid operations--from the planning of the transmission grid, to
ensuring day to day reliability of the grid, to the dispatch of
generation and demand resources to meet consumption in real
time. The uncertainty created by the unclear regulation of FTRs
under current law as well as complications created by the
provisions of the new legislation should be addressed in the
legislation now being considered.
5. Although the RTOs and ISOs do not believe that Congress
intended there be two regulators of the FTR product, the RTOs
and ISOs do believe that cooperation is needed in areas where
activities in a CFTC-regulated market may affect a FERC or
Texas PUC-regulated market and vice versa. This is not an area
of regulatory overlap, but instead an area where the exercise
of the authority of each regulator over their respective
jurisdictional market should be coordinated and complementary.
As a result, cooperation, including data sharing, should be
required by this Congress in those areas where FERC's or the
Texas PUC's regulation of the RTOs and ISOs has an impact on
CFTC's regulation of markets under its jurisdiction and vice
versa.
The Chairman. Thank you very much.
Next is the Honorable Joseph Kelliher who used to be head
of FERC, of course, and we are glad to have him back before the
committee. Go right ahead.
STATEMENT OF JOSEPH T. KELLIHER, EXECUTIVE VICE PRESIDENT,
FEDERAL REGULATORY AFFAIRS, FPL GROUP, INC., ON BEHALF OF THE
EDISON ELECTRIC INSTITUTE AND THE ELECTRIC POWER SUPPLY
ASSOCIATION
Mr. Kelliher. Thank you, Mr. Chairman, Ranking Member
Murkowski, and members of the committee. I appreciate the
invitation and it is good to be back before the committee. I
took care to sit in Jon's seat when Chairman Wellinghoff got
up. I thought that was the right seat for me to take.
Thank you for the invitation to testify today on financial
transmission rights and electricity markets and how that
regulation may be impaired by financial regulatory reform
legislation.
I do also want to take the opportunity to offer views on
over-the-counter energy commodities transactions and the need
for an energy end-user exemption from any mandate to force OTC
transactions onto exchanges.
I am testifying today on behalf of EEI and EPSA.
As FERC chairman, I was on the giving end of regulation. I
am now on the receiving end of regulation, and it is a
different perspective. But I want to offer both perspectives on
really 2 fundamental questions before the committee and before
the Senate: one, whether there should be an energy end-user
exemption from any mandate to force exchange trading; and 2,
whether exclusive FERC regulation of wholesale power and gas
markets should be bifurcated by the introduction of CFTC
regulation. We believe that, one, there is a need for an energy
end-user exemption and that, 2, exclusive FERC regulation
should not be disrupted by the introduction of CFTC regulation.
EEI and EPSA support the goals of the administration and
Congress to improve transparency, stability, and oversight of
financial markets, including OTC derivatives markets. We do not
disagree with the need for derivatives reform generally, but
the rationale for OTC derivatives reform is to lower systemic
risk and lower costs through transparency. However, energy
derivatives, energy commodities played no role in the 2008
financial crisis. Energy commodity trading poses no systemic
risk. Commodities as a category represent about 1 percent of
derivatives and energy commodities are a slice of that 1
percent. So forcing exchange trading will not reduce risk
associated with energy commodity trading, but it will have
significant real costs to consumers.
The collateral requirements will be tremendous, on the
order of hundreds of millions of dollars for electricity
companies. One example is with respect to PJM. Requiring
electricity suppliers and PJM--last month, PJM held an auction.
There was an auction in New Jersey. New Jersey acquires
electricity supply for its utilities through an auction. That
auction--New Jersey utilities purchased 2,500 megawatts for a
3-year term last month. If that entire volume were forced to
trade on an exchange, electricity suppliers would have had to
post about $1 billion in collateral, and that $1 billion would
have been added to the bids into the New Jersey market and that
$1 billion would have been borne by New Jersey consumers. So
dead capital used for collateral is better used elsewhere in a
capital-intensive industry, for infrastructure such as new
generation or transmission, for Smart Grid projects, energy
efficiency, technology, clean energy projects.
So while we disagree with the merit of forcing exchange
trading, we agree on the need for greater transparency. We
think that can be achieved with the reporting requirements
rather than forcing exchange trading. So we do think there is a
need for an express energy end-user exemption and that that
exemption should not be too narrow.
With respect to FERC regulation, I think there is a need
for legislation to protect FERC's regulatory authority over
FTRs and other energy products. There is, in my view, no
justification for financial reform legislation to reform the
regulation of wholesale power and gas markets that, frankly,
require no reform. I think legislation should clarify the
electricity products and services provided under FERC-approved
tariff and subject to FERC regulation should be exempt from
duplicative regulation by the CFTC.
One example is FTRs. FERC has exclusive jurisdiction over
transmission service. FTRs are inextricably connected to
transmission open access service. They are a central means by
which FERC assures transmission customers have firm, open
access transmission service. A shift in jurisdiction would
undermine open access transmission, something that has been
important to Congress for 30 years.
The stated rationale to introduce CFTC regulation of FTRs
is the need to close a loophole, but I respectfully submit that
there is no loophole. There is no regulatory gap. FTRs are
comprehensively regulated by FERC. There is no need to subject
these transactions to duplicative regulation. FTR auctions are
governed by tariff rules set by FERC. The FTR transactions are
fully transparent and that information is available through RTO
Web sites. FTR markets are subject to the FERC anti-
manipulation rule and FERC has conducted investigations of
alleged manipulation of FTR markets. So, in short, there is no
gap.
The House bill included an MOU that purported to address
the regulatory concerns between FERC and CFTC jurisdiction, and
I respectfully suggest that the MOU in the House bill will
prove a completely ineffective means to resolve jurisdiction
between the 2 agencies. I think Congress decides jurisdiction
not agencies. That FERC and CFTC have an honest disagreement on
interpreting the law, a disagreement that goes back 3 years,
the disagreement revolves around the ambit of FERC's anti-
manipulation authority. That disagreement, I respectfully
suggest, is not going away. But at this point, only courts or
Congress can resolve the dispute between the agencies because
it is, I think, an honest disagreement. They are reading the
law differently. Then an MOU is no sort of resolution to the
question.
So with that, I thank you for the opportunity to testify,
and I am happy to answer any questions you might have. Thank
you.
[The prepared statement of Mr. Kelliher follows:]
Prepared Statement of Joseph T. Kelliher, Executive Vice President,
Federal Regulatory Affairs, FPL Group, Inc., on Behalf of the Edison
Electric Institute and the Electric Power Supply Association
Mr. Chairman, Ranking Member Murkowski, and Members of the
Committee: My name is Joseph T. Kelliher, and I am Executive Vice
President--Federal Regulatory Affairs for FPL, Group, Inc. I appreciate
the opportunity to appear before you today to testify about how
financial transmission rights and other electricity market mechanisms
may be impacted by the financial regulatory reform legislation which
has passed the House of Representatives and is before the Senate.
FPL Group is a public utility holding company headquartered in Juno
Beach, Florida. FPL Group is one of the Nation's largest electricity
companies, a premier clean energy company with two principal electric
subsidiaries, NextEra Energy Resources, LLC, a competitive generation
company that operates in 26 states and is the largest wind developer in
the .United States, and Florida Power & Light Company, a vertically
integrated utility in Florida. These two FPL Group companies own,
operate or control nearly 43,000 megawatts of electric generation
facilities. The issues the Committee is examining today are equally
important to both NextEra Energy Resources and Florida Power and Light
Company. They are as important to the ability of a vertically
integrated utility to deliver reasonably priced electricity as they are
to the ability of a wind developer and independent power producer to
sell their electricity output.
At FPL, Group, I am responsible for federal regulatory policy for
both NextEra Energy Resources and Florida Power and Light Company. I
have spent my entire professional career working on energy policy
matters, serving in a variety of roles in both the public and private
sectors. Previously, I served as Chairman of the Federal Energy
Regulatory Commission (FERC), a FERC Commissioner, a senior policy
advisor to the Secretary of Energy, and Majority Counsel to the House
Energy and Commerce Committee. I also have had a variety of private
sector roles.
While FERC Commissioner, I asked Congress during development of the
Energy Policy Act of 2005 to grant FERC authority to prevent and
penalize market manipulation. I did so because I believed there was a
regulatory gap in FERC's authority to prevent market manipulation that
needed to be filled. During my chairmanship FERC implemented its anti-
manipulation rules and began to conduct market manipulation
investigations. Many of these investigations were conducted jointly
with the Commodity Futures Trading Commission (CFTC). Some FERC
enforcement actions have resulted in jurisdictional disputes between
FERC and CFTC.
I am testifying today on behalf of the Edison Electric Institute
(ELI) and the Electric Power Supply Association (EPSA). ELI is the
trade association of U.S. shareholder-owned electric companies, with
international affiliates and industry associate members worldwide. The
U.S. members of ELI serve 95 percent of the ultimate electricity
customers in the shareholder-owned segment of the industry and
represent about 70 percent of the total U.S. electric power industry.
EPSA is the national trade association for competitive wholesale power
suppliers, including generators and marketers. EPSA members include
both independent power producers and the competitive wholesale
generation arms of certain utility holding companies. The competitive
sector operates a diverse portfolio that represents 40 percent of the
installed generating capacity in the United States. EPSA members do
business nationwide, both in the two-thirds of the country served by
Regional Transmission Organizations (RTOs) or Independent System
Operators (ISOs) and the remaining one-third of the country dominated
by traditional vertically-integrated utilities. My examples and context
are from FPL Group's perspective but are representative of EFT and EPSA
member concerns and requests.
My testimony today:
Details the importance of over-the-counter (OTC) derivatives
to well-functioning electric markets and explains the need for
a specific energy end-user exemption from any mandate that OTC
transactions clear or trade on CFTC-regulated exchanges; and
Requests that the Committee support legislation to clarify
that electricity products and services provided under a FERC-
approved tariff and subject to regulatory oversight by FERC,
such as financial transmission rights (FTRs), should be exempt
from duplicative regulation by the CFTC.
EEI and EPSA support the goals of the Administration and Congress
to improve transparency, stability, and oversight of financial markets,
including OTC derivatives markets. However, when crafting legislation
for that purpose, it is essential that policymakers preserve the
ability of electric and natural gas companies to use OTC energy
derivatives and similar financial products and FTRs for prudent,
legitimate business purposes. A large group of end-users has
communicated this message to Congress on numerous occasions).\1\
Further, a group of energy end-users that includes virtually the entire
utility, electric power and natural gas industries has also emphasized
the importance of these products to the energy sector.\2\ Utilities,
independent electricity generators, renewable energy providers, and
other market participants rely on these products and markets to manage
wholesale electricity and natural gas price risk. By prudently managing
our risk we are better able to keep rates stable and affordable for our
consumers.
---------------------------------------------------------------------------
\1\ See October 2, 2009 letter to Members of the U.S. House of
Representatives and February 3, 2010 letter to Members of the U.S.
Senate from the Coalition for Derivatives End-Users (attached).
\2\ See January 21, 2010 letter to Members of the U.S. Senate from
the Energy End-Users Coalition (attached).
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I recognize that this Committee does not have jurisdiction over the
financial market reform legislation. However, you do have a very
important jurisdictional issue at stake: Unless it is properly crafted,
the financial market reform legislation will encroach upon this
Committee's jurisdiction over electricity and natural gas markets
regulated by FERC under the Federal Power Act and the Natural Gas Act.
Specifically, it could interfere with wholesale electricity markets
under FERC's jurisdiction that are managed and overseen by RTOs and
ISOs and the market under the Public Utility Commission of Texas'
jurisdiction in the case of the Electric Reliability Council of Texas
(ERGOT). It could create a duplicative, overlapping and potentially
conflicting regulatory regime with both FERC and the CFTC imposing
regulatory requirements and overseeing transactions. It could shift
regulatory jurisdiction from a consumer protection and reliability
agency with expertise in electricity markets--an agency dedicated to
assuring just and reasonable prices--to a financial regulatory agency
with no such background or duty. The legislation will create tremendous
regulatory uncertainty and introduce regulatory and business risk in an
area where there is now repose. As a result, consumers would see higher
prices for electricity and natural gas and greater price volatility.
As I will explain, RTOs and ISOs efficiently dispatch generation
resources to minimize fuel costs and enable the RTO/ISO customers
(utilities, generators, marketers) to manage the cost of congestion on
the transmission system by the use of FTRs. In our parlance, customers
use FTRs to ``hedge'' their congestion costs. Some may argue that FTRs
resemble a derivative product or swap that should be subject to the
CFTC's jurisdiction. Indeed the RTOs and ISOs themselves could be
subject to the CFTC's jurisdiction unless the reform legislation is
properly crafted. However, in contrast to derivatives, FTRs are
integrally tied to the physical delivery of electricity and must be
physically feasible. Moreover, they provide a uniquely important
hedging tool to electricity suppliers and consumers who produce,
transport, and consume electricity on a continuous basis and do so in a
fully transparent market. In addition, FTRs already are comprehensively
regulated by FERC and the RTOs and ISOs themselves. There simply is no
need to subject these transactions and organizations to costly,
duplicative and potentially conflicting oversight by two agencies. This
Committee clearly has a strong interest in making sure the legislation
does not encroach on FERC's oversight authority over electric and
natural gas markets.
The Administration has called upon Congress to enact major
financial reform legislation because of the dramatic failures we have
experienced in financial markets and failed government oversight of
those markets. Those failures simply are not present in electricity and
natural gas markets regulated by FERC. In short, there is no regulatory
gap that needs to be filled by expanded CFTC authority over markets
currently effectively regulated by FERC.
When considering any increased regulation and requirements for OTC
derivatives markets, it is important to note that end-user commodity
derivatives transactions do not pose the type of ``systemic risk''--
i.e., ``too big to fail''--that Congress is seeking to eliminate
through the proposed legislation. In fact, from a quantitative
perspective, the entire commodities market is less than one percent of
the global OTC derivatives market, and the energy commodity portion is
only a fraction of that one percent. Therefore, we believe that
Congress should strike the proper balance in its regulatory reform
efforts by establishing energy market oversight rules that allow for
prudent use of OTC risk management products while also providing
regulators with the tools needed to protect consumers against market
manipulation and systemic risk.
With its competitive power company, renewable energy provider, and
vertically integrated utility, FPL Group looks at the impact of
financial reform legislation from the perspective of our customers, who
are wholesale and retail electric consumers. We certainly support the
goal of financial regulatory reform, but the ability of electric and
natural gas companies to use OTC energy derivatives for legitimate
business purposes should be preserved. In addition, the CFTC should not
have the authority to regulate wholesale electricity markets and
transactions that are already subject to a FERC-approved tariff. This
would result in costly, duplicative and overlapping regulation over our
sector. The balance of my testimony focuses on that problem.
I will briefly describe and explain: (i) why utilities and
electricity generators use FTRs and OTC derivatives products; (ii) the
cost to consumers of unnecessary overregulation of these OTC
derivatives transactions; and (iii) why FERC has and should retain
exclusive jurisdiction over wholesale electricity markets.
To understand the role of FTRs and OTC derivatives in wholesale
electricity markets, I will begin with a short explanation of how those
markets are currently structured and regulated. Most of NextEra Energy
Resource's generation assets operate within RTOs or ISOs. In fact, over
65% of Americans, or 134 million customers, live in regions served by
RTOs and ISOs. These organizations administer formal, ``organized''
wholesale electricity markets; these markets are subject to detailed
rules and oversight by FERC. Utilities are required to file tariffs to
comply with FERC's requirements. These organizations also operate the
electric grid in their areas and independently administer transmission
assets to ensure access to transmission on a nondiscriminatory basis.
RTOs and ISOs also have independent market monitors who certify that
these markets are operated fairly and without unmitigated market power.
All RTOs and ISOs and the transactions that occur in them currently are
regulated exclusively by FERC (except: ;RCOT, which is regulated by the
Public Utility Commission of Texas).
When RTOs and ISOs were first organized, the utility members
retained their rights to move electricity from their generators to
their customers by using physical transmission ``paths.'' Administering
a physically-based system of transmission rights proved to be both
cumbersome and inflexible over time. And it was not very good at
managing congestion. The problem with these physically-based systems is
that the demand for electricity varies by a factor of two every day,
and so the economic pattern of transmission flows varies from hour-to-
hour and day-to-day. A fixed set of physical transmission rights does
not fit this reality.
As RTOs and ISOs evolved, and their markets became more efficient--
which means less expensive for consumers--the system of physical
transmission rights evolved to a system of financial transmission
rights or FTRs. FTRs are also an integral part of markets that are
based on locational marginal pricing with security constrained economic
dispatch (also known as LMP pricing), which I will discuss briefly
below. All RTOs and ISOs have adopted, or are moving to adopt, a form
of LMP, though some of the details vary from region to region. LMP has
proven to be the most efficient way within an RTO to take maximum
advantage Of the physical capability of the transmission system while
maintaining reliability. LMP provides the mechanism to dispatch
generation according to which generators are the least expensive to run
at the time they are needed to serve the load.
FTRs are integral to the proper functioning of competitive electric
markets. FTRs allow electric market participants to manage their
electricity and transmission price risk when delivering power on the
grid.
However, in order to better understand FTRs, one must understand
LMP. In RTO/ISO electricity markets, generators receive the
``locational'' price for the electricity they put on the grid at what
is known as the ``point of injection.'' The utilities, known as local
distribution companies (or LDCs), pay the locational price at the point
where they withdraw power from the grid. Differences in these two
locational prices typically arise as a result of congestion on the
transmission system. Congestion is like a kink in a hose. The
transmission system is too clogged to allow lower cost generation on
one side of the kink to flow to the other side. That means a higher
cost generator runs even though a lower cost generator is available
elsewhere on the transmission system--that is behind the kink.
Consequently, where there is a difference between these two prices, the
generator or LDC will be subject to congestion fees that are paid to
the RTO/ISO.
In order to give market participants the ability to manage the
differences in the locational prices, RTOs and ISOs sell, or auction,
FTRs on a long-term, year-ahead and short-term basis. Ownership of an
FTR thereby allows the entity to recoup some of the congestion fees.
But these FTR markets are already heavily regulated by the FERC:
RTOs sell a quantity of FTRs that corresponds to the
capacity of the transmission system--neither more nor less. So
the ``supply'' of FTRs is based on the physical characteristics
of the transmission system and regulated consistent with that;
The auctions are designed to sell FTRs in combinations that
are most highly valued by market participants--and the auctions
themselves are governed by tariff rules established by FERC;
Auction proceeds go to transmission owners and LDCs;
Ownership of an FTR does not allow a market participant to
change the value of that FTR; vrR transactions are fully
transparent--the ownership of each FTR is available for all to
see on RTO/ISO web sites;
Settlement or payouts of FTRs are based on bidding by
generators and load-serving entities for power sales and
purchases, consistent with anticipated power production and
consumption by market participants and reflecting congestion on
the transmission system; and
FTR markets are subject to FERC's anti-manipulation rule.
The auctions have detailed rules about how FTRs can be purchased.
As a general rule, the FTRs auctioned by the RTOs are those that have
not already been claimed by the LDCs, who have preferential access to
FTRs. In addition, FTR holders are subject to credit requirements. The
RTOs and ISOs administer the FTR markets, subject to FERC's extensive
oversight. There is no regulatory gap and there is no basis to
introduce duplicative regulation of this market.
Generators and LDCs buy FTRs to manage, or hedge, the amount they
will have to pay for congestion. Without the ability to hedge this
risk, costs would go up, and customers would be subject to the
volatility that results from the all-too-regular occurrence of
transmission congestion. Some have criticized the fact that non-utility
players are involved in the market for FTRs. But it is essential to
have a variety of players and the liquidity they bring to the market.
The market monitors also review all of the above.
Another way that generation companies manage risk is by entering
into transactions to sell some of the electricity that they will
generate in advance. They do those transactions with credit-worthy
counterparties. For example, a generator might sell an amount of
electricity for one agreed price for all hours in the summer months of
June through September. The generator will then know that it will
always get that price for that amount of electricity during those four
months. The generator foregoes the prospect of getting higher prices
absent the sale but, more importantly, it avoids the risk that prices
will fall below the fixed price it is paid by the buyer of the
electricity. A generator also can do the same thing with respect to the
fuel it buys to run the plants. The generator might transact in the OTC
market for natural gas or lock in fuel costs for its gas power plants.
Risk management is also important to clean energy companies.
NextEra Energy Resources is the leading wind energy company in the
United States. While most of the output from our wind projects is sold
under power purchase agreements, we do operate some merchant wind
projects that sell into the market on a daily basis. Many other wind
energy companies in the U.S. rely heavily on merchant sales. Wind
energy companies hedge the power output of merchant wind projects to
provide necessary certainty to support project financings and corporate
earnings projections. As an example, a company can sell the physical
output from its wind projects into the daily market and receive the
daily market floating price for power. To hedge the risk of price
volatility in the daily markets, the company could enter into a ``fixed
for floating power swap''. A typical power swap transaction would
involve the wind energy company receiving a fixed price for power from
a counterparty (typically a bank) and paying the daily market floating
price for power to that counterparty.
Another way to manage risk is through put options that provide
downside price protection for merchant wind project financings. A put
option provides a company with the right to sell power to a
counterparty (typically a bank) at a strike price and in return the
company pays the bank an upfront premium for this option. As an
example, assume the current power market was $50/MWh, but a power price
of only $40/MWh was required to provide sufficient cash flows to
support the debt payments in a project financing. The company could
enter into a power put option; pay a counterparty an upfront premium
for the right to sell power to them with a strike price of $40/MWh. If
the price of power dropped below $40/MWh, the company would have the
right to sell power to the counterparty for $40/MWh to protect project
cash flows. If the price of power went up to $60/MWh, the company would
continue to sell power into the daily market and would not exercise the
put option.
The growth of clean energy could result in new products to manage
risk, such as a weather derivative for wind resources. The concept
would be for a counterparty to take on the variability of the wind
resource as measured against a long-term historical wind index. The
wind energy company would receive a payment from the counterparty if
the wind resource came in lower than the historical average wind index
and pay the counterparty if the wind resource came in higher than the
historical average wind index.
It would be difficult to support a merchant wind business without
having OTC derivatives available to hedge market price risk. Banks
would be unwilling to lend money without the ability for projects to
lock in prices and provide certainty on project cash flows. These types
of nonstandard, or customized, products are important to the wind
business.
Our customers benefit from this hedging and trading activity. We
are in a position to agree to longer-term power sales contracts with
wholesale customers; the price terms under those contracts are in large
part possible because of the relative price stability that hedging
provides to our portfolio. It is our experience that retail customers
in particular want prices for power sales to be stable rather than
subject to the fluctuations and uncertainties of the spot market.
Without hedging and trading, we simply would not be able to do that.
These types of hedging transactions are not always done on an
exchange because we tailor the product we sell to the needs of the
purchaser; in other words, these are not necessarily standardized
products. Even certain products that could be considered standardized
are often contracted for under specific, customized delivery, credit or
capital terms.
In RTO/ISO markets, electric utilities that have divested their
power plants must buy power to serve their customers. In the Northeast
and Mid-Atlantic states, utilities periodically enter the market to
purchase full requirements service to meet their load obligations.
These transactions are highly customized. The products sold include
energy in quantities that match the utilities' load in each hour of the
day delivered to the utilities' service territory. The utility also
passes system balancing costs and transmission costs to the seller as
part of the transaction. These transactions are highly customized and
cannot be executed on an exchange. Energy companies that make these
customized sales often hedge their positions with standardized
products.
Some would argue that advance sales of power, where the price is
based upon an average of other sales or an index, are futures
transactions and would subject them to the CFTC's exclusive
jurisdiction. We disagree. These are wholesale and retail power sales
already regulated by FERC and state utility commissions, respectively,
and should not be regulated by the CFTC.
NextEra Energy Resources would not be able to offer customized
products greatly valued by customers if it could not hedge its future
price risk. Requiring NextEra Energy Resources to conduct all of its
transactions on exchanges, with standard rather than customized
contracts to meet its customers' needs, and subjecting those
transactions to costly central clearing requirements, would undoubtedly
result in significant price increases for its customers. These examples
illustrate why we support an end-user exemption for both wholesale and
retail market participants.
In addition to concerns about FTRs and other hedging activities, I
want to mention a concern that the RTOs and ISOs themselves could
arguably become subject to the CFTC's jurisdiction as ``derivatives
clearing organizations'' under some versions of the financial reform
legislation. RTOs and ISOs routinely settle hundreds of millions of
dollars of financial transactions entered into by their markets'
participants. If any of those transactions are classified as
derivatives transactions, the RTOs and ISOs could be classified as
derivatives clearing organizations to the extent that they provide
``clearing'' services for the transactions. That, in turn, could mean
that these organizations themselves would be subject to the CFTC's
jurisdiction, in addition to the FERC's jurisdiction. This would add
untold complexity and expense, and drive up the costs of these
organizations, which would be passed on to electricity consumers.
The Senate Banking and Agriculture Committees are considering
financial reform legislation that may subject all of the types of
transactions I have described above to the CFTC's jurisdiction. Some
versions of the proposed legislation would require transactions that
are now done ``over the counter'' to be cleared and/or traded on CFTC-
regulated exchanges. The requirement to clear and/or trade such
transactions on an exchange would materially increase both wholesale
and retail electricity prices. Transactions conducted on an exchange
are subject to substantial margin requirements, while transactions that
are not conducted on an exchange do not have the same margin
requirements. The consequences of the margin requirement are
significant.
Today, credit-worthy companies like NextEra Energy Resources and
Florida Power & Light routinely engage in OTC derivative transactions
with other creditworthy counterparties. These transactions are often
not subject to a margin requirement due to the creditworthy nature of
the parties. Rather we typically rely on each other's balance sheets,
or the value of other assets, as security for the trade. However,
margin is typically required only when exposure has reached a mutually
agreed upon limit. Exposures above such limit are then subject to
margining requirements. Thus parties to off-exchange transactions pay
less overhead, which benefits our customers.
Analysis by members of the large end-user energy group previously
mentioned has found that the increased costs of forced trading on
exchanges would be hundreds of millions of dollars for the average
utility or generation company. The margin requirement would tie up
large amounts of cash, creating ``dead'' capital at a time when the
power sector faces the need to invest hundreds of billions of dollars
in clean energy technologies, energy efficiency, the smart grid, and
additional transmission capacity.
It is critical that these companies continue to have access to the
OTC market for these hedges. Requiring suppliers to hedge on an
exchange would expose them to significant liquidity risk for cash
margining. The cost of this risk would ultimately be borne by the
utilities' customers via higher prices charged for the full
requirements service. For example, in February utilities in New Jersey
purchased approximately 2,500 MW for a three-year term. If this entire
volume were hedged on an exchange, suppliers would have had to post
about $1 billion in cash to cover initial margin and variation margin.
This $1 billion would have been added to bids accepted for the auction
and ultimately would have been borne by consumers in New Jersey. There
are a number of other states that conduct similar auctions. They would
face a similar cost premium to reflect the additional working capital
costs that suppliers would have to bear if the OTC markets are not
available for the hedging needed to provide these types of products.
Competition would also decline as the liquidity risk would simply be
unacceptable to many suppliers. It is a basic tenet of markets that
fewer participants would result in higher prices to customers.
Therefore, if financial reform legislation requiring clearing for
these transactions were enacted, consumers would see their prices
increase because an additional and unnecessary layer of cost would be
added to the marketplace--without a commensurate reduction in risk.
Initial reform proposals have included a number of vague or
ambiguous terms that will need to be clarified prior to passage of a
final measure. The aim of all of the financial reform proposals has
always been to focus on the large financial players whose transactions
can pose systemic risk. Without a specific exemption, it will not be
clear whether electricity end-users are also intended to be covered and
subject to the various new requirements. Something this important and
costly needs to be clear and should unambiguously exempt end-users
managing commercial risk from the clearing and exchange-trading
requirements. Unless the terms of the legislation are precise,
determining which parties and transactions are subject to a clearing
requirement will be left to the broad discretion of the CFTC. CFTC
Chairman Gensler and his staff have stated on numerous occasions the
position that virtually all OTC transactions, including FTRs, should be
cleared or traded on exchanges; we respectfully disagree.
As a result, we believe that the legislation should clarify that
FERC is the sole regulatory authority governing electricity products
and services provided under a FERC-approved tariff and subject to
regulatory oversight by the FERC, with the same true for the Public
Utility Commission of Texas for ERGOT.
It is important for Congress to make clear that FERC retains
exclusive authority under the Federal Power Act over all wholesale
electric markets and transactions subject to a FERC tariff. As
indicated in the discussion of FTRs, financially settled transactions
are an integral component of RTO/ISO markets. Consistent with the
purposes of the Federal Power Act, they ensure the efficient and
reliable physical generation, transmission and wholesale delivery of
electricity at just and reasonable rates. In addition to the Federal
Power Act authority, FERC has a duty under the Energy Policy Act of
2005 to ensure these markets are not subject to manipulation or abuse.
Wholesale electricity markets are already pervasively regulated by
FERC, and the introduction of CFTC regulation either creates
duplicative regulation or transfers FERC jurisdiction to the CFTC. It
does not fill a regulatory gap, since there is no gap in this area. If
there are two regulators, the rules will inevitably be different
depending upon which agency imposes them. Gamesmanship, abuse and
market manipulation all thrive under this kind of overlapping and
confusing regulation. In my view, bifurcated jurisdiction of these
markets will invite market manipulation. Clear and unambiguous
authority for FERC to regulate these transactions is essential. There
is already litigation over which agency has authority to police
manipulation by futures market participants that affects FERC
jurisdictional markets. We cannot afford further confusion over
regulatory jurisdiction.
Some have suggested that the problems created by duplicative
oversight over these markets by both FERC and the CFTC could be worked
out by directing the two agencies to enter into a Memorandum of
Understanding delineating who will do what. I believe that approach
will be ineffective. As I indicated earlier, the Commodity Exchange Act
confers upon the CFTC ``exclusive'' jurisdiction over certain aspects
of futures transactions, namely futures trading on exchanges Other CFTC
authority is non-exclusive. FERC and CFTC disagree on their respective
authority under current law, reflected in litigation over FERC's
efforts to police alleged market manipulation by futures participants
that affected FERC-jurisdictional markets. This is an honest
disagreement, but one that is fundamental and has persisted for years.
There is no reason to believe this disagreement will disappear,
especially if Congress enacts legislation that grants CFTC additional
discretionary authority in any legislation with significant ambiguity
and replete with undefined terms. The House bill appears to leave it up
to CFTC to determine where FERC jurisdiction ends. The plain fact of
the matter is that FERC and CFTC disagree on their respective legal
authority under current law. The enactment of legislation such as the
House bill would only sharpen that disagreement. To the extent there is
disagreement between two federal agencies on how to interpret their
legal authority, that disagreement can only be resolved by the courts
or Congress, not by a Memorandum of Understanding between agencies with
a good-faith disagreement. That is why a simple memorandum of
understanding between FERC and the CFTC would be fundamentally
inequitable and unworkable. Any such deliberation would seem to
inevitably result in the CFTC's assertion of exclusive jurisdiction
over matters which have historically been the legitimate purview of
FERC.
To address the concerns I have outlined, we respectfully request
the members of the Committee to support legislation that: (1) clarifies
FERC's plenary and exclusive jurisdiction over products and services
provided under a FERC-approved tariff and subject to regulatory
oversight by the FERC (except for ERGOT, which the legislation should
recognize is subject to the Public Utility Commission of Texas's
jurisdiction), and (2) confirms that RTOs and ISOs, and ERCOT, would
not be subject to CFTC regulation as if they were NYMEX-like futures
exchanges or derivatives clearing organizations. We would welcome the
opportunity to work with the Committee to develop legislation to
address our concerns.
As you have heard from New York Public Service Commission Chairman
Garry Brown, the National Association of Regulatory Utility
Commissioners (NARUC) shares our industry's position on these critical
issues. At its meeting in February, NARUC expressed its strong support
for exclusive FERC jurisdiction over any agreement, contract,
transaction, product, market mechanism or service offered or provided
pursuant to a tariff or rate schedule filed and accepted by the FERC,
or the Public Utility Commission of Texas for Texas/ERCOT.\3\
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\3\ CS-1 Resolution on Financial Reform Legislation Affecting Over-
the-Counter Risk Management Products and Its Impacts on Consumers,
adopted by the NARUC Board of Directors, February 17, 2010 (attached).
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We believe that Congress should recognize and preserve FERC's
exclusive jurisdiction. Electric and gas utilities, electricity
generators, and renewable energy providers utilize FTRs and OTC
derivatives to manage risk with the ultimate aim of helping to ensure
stable and affordable rates for our customers. We do this by using
derivatives transactions to hedge against price volatility in natural
gas and wholesale electric power--two of the most volatile
commodities--that already are substantially regulated. Adding CFTC
regulation and costly new requirements to this mix will not resolve the
issues that Congress wants to address in the wake of the financial
crisis, but will serve only to increase energy costs that will
ultimately be passed on to our customers. CFTC regulation should be
left to areas where their expertise carries benefits, such as by
focusing on the transactions and market participants that could yield a
systemic risk that would jeopardize our economy or financial system.
I appreciate the Committee's invitation to testify today and your
willingness to examine these issues. I hope that I have provided you
with a sense of the impact of duplicative regulation of energy
transactions and how it would result in higher costs for companies like
FPL Group, which in turn would result in higher costs for our
customers. I would be pleased to answer any questions you may have.
The Chairman. Thank you very much.
Mr. Henderson, go right ahead.
STATEMENT OF MICHAEL W. HENDERSON, VICE PRESIDENT & CHIEF
FINANCIAL OFFICER, ARKANSAS ELECTRIC COOPERATIVE CORPORATION,
ARKANSAS ELECTRIC COOPERATIVES, INC., LITTLE ROCK, AR
Mr. Henderson. Thank you, Mr. Chairman, Ranking Member to
this committee. I would like to thank you for the opportunity
appear this morning. I also would like to take this opportunity
to thank our home State Senator, Senator Lincoln, as well as
the chairman and ranking member and other members of the
committee that is working together to come up with a global fix
for this issue.
I have submitted my written testimony on behalf of the 17
rural electric cooperatives of the State of Arkansas who
represent 470,000 consumers in rural Arkansas, as well as
another 30,000 outside the State of Arkansas that are served by
the 17 cooperatives, as well as 42 million additional rural
electrification consumers.
For us, this issue is all about cost. Our mission is to
keep costs as low as possible. That is one of the keys for
rural America to be able to provide a little economic
prosperity for that region. So that is our sole purpose for
being here today is to try to keep costs as low as possible.
Speaking of costs, the issues of FTRs and CRRs--those
really originated as a way to balance cost for providing
transmission service. So we have used those as an integral part
of the cost of service of transmission. So we think that should
remain in the area of FERC that is charged with determining
just and reasonable rates.
We also think that if you take the regulatory authority of
those and put them into CFTC, that will fractionalize that
ratemaking ability. So it makes it tougher for one entity to
have control over determining a cost for all, and again for us,
it is providing the lowest cost possible.
We do think there are some negative aspects of having 2
regulatory authorities. As others have alluded to, there is
additional liquidity facilities that could be required. That
would be very costly to us.
The arena that we conduct business in under FERC, we know
most of the parties. The kind of parties we are doing business
with are like-kind entities. When you pull that market out and
interject additional financial entities, other commercial
entities, those are counter-parties we do not necessarily know.
Default risk goes up for us. So that is an additional cost
exposure that we would face.
We think there are some positives to 2 regulatory
authorities, though. You know, 2 sets of eyes are always better
than one. We think greater transparency that others had
mentioned is a positive attribute. We think greater protection
against market manipulation by having that extra set of
authority provides benefit. We do see a role for CFTC acting
more as a judiciary auditor type function, as kind of an
overseer but not really a policymaker or a regulatory provider.
So, in short, what we offer up or request is that status
quo relief for the FERC regulation remain in place, that we are
open and accept the idea of a bright line, you know, making a
more clear definition of the different roles.
That is the comments I have today. So I would take any
questions anyone has.
[The prepared statement of Mr. Henderson follows:]
Prepared Statement of Michael W. Henderson, Vice President & Chief
Financial Officer, Arkansas Electric Cooperative Corporation, Arkansas
Electric Cooperatives, Inc., Little Rock, AR
Mr. Chairman and committee members, it is an honor to appear before
this committee. Thank you for this opportunity to share the views of
the electric cooperatives of Arkansas pertaining to regulation of
financial transmission rights (``FTR''), congestion revenue rights
(``CRR'') and other related components of providing electric
transmission services to our consumer-owners, I would also like to
thank our home state senator, Senator Blanche Lincoln, who since
becoming Chairman of the Agriculture Committee has taken an intense
interest in this issue, and we appreciate her efforts to craft a common
sense global fix to this issue.
Seventeen Arkansas electric cooperatives provide electric power to
approximately 468,900 consumer-owners in Arkansas, and another 29,229
in adjoining states. Electric cooperatives provide service to 62
percent of the land area, and 74 of the 75 counties in Arkansas. The
electric cooperatives in Arkansas provide service on a not-for-profit
basis to some of the poorest service territories in the nation. Nation
wide, electric cooperatives provide electric power services to
approximately 42 million consumer-owners in 47 states.
Arkansas Electric Cooperative Corporation (``AECC'') is a
generation and transmission cooperative that provides power supply and
transmission delivery service to the 17 distribution cooperatives in
Arkansas. AECC provides transmission service to its native load within
three separate transmission control areas: Entergy, American Electric
Power (``AEP'') and the Southwestern Power Administration (``SWPA''),
an agency of the Department of Energy. AEP and SWPA operate within the
Southwest Power Pool (``SPP''), a regional transmission organization
(``RTO'') under the regulation of the Federal Energy Regulatory
Commission (``FERC''). AECC strategically determined it was in its
member's best interest to share in the utilization of the transmission
systems of Entergy, AEP and SWPA to prevent duplicating infrastructure.
Therefore, AECC is a transmission dependent utility relying on fair and
equitable access to the transmission grid through the SPP RTO.
Cost pressures on transmission delivery services are constantly
increasing. The physical cost of AECC providing transmission service to
rural Arkansans increased 60.8 percent from 2004 to 2009. That is a
compounded annual increase of 9.97% per year. Managing transmission
costs is vital to meeting our goal of providing reliable electric
service at the lowest possible cost, and helping to improve the quality
of life for rural Arkansans.
The intention of many of the derivatives regulation reform
proposals being proposed in Congress, including the financial reform
bill that passed the U.S. House of Representatives (H.R. 4173), to
protect market participants is certainly laudable. In fact, we believe
the CFTC should continue to look for market manipulation in the
bilateral OTC natural gas and power markets. These investigations occur
after transactions have been made and should not impede the smooth
running of FTRs and CRRs. However, we feel that derivatives regulation
proposals should respect the fact that the inclusion of RTO FTRs and
CRRs, which are more closely attached with the physical service
reliability requirements of providing electricity, is not appropriate
as they do not fit the characteristics of other commodities for which
legislative proposals would regulate. We are concerned that proposed
legislation could inadvertently make it difficult and more expensive
for AECC to deliver power in an RTO market.
Most RTOs operate both a real-time and day-ahead market for
electric power. These markets establish locational marginal prices
(``LMPs'') for energy based on the bid price of the last unit
dispatched to meet load in the RTO region. The level of congestion in
different parts of the transmission system can change hourly;
therefore, the cost of power generated and consumed in different parts
of the system can vary greatly and is extremely volatile. That
volatility is challenging for utilities because the LMPs not only
establish the cost of power for utilities buying energy out of the
market or selling energy into the market at any particular location,
the LMPs also establish the cost for utilities that generate with their
own power resources to deliver that power to their consumers. Utilities
are paid the LMP price for energy they generate at one point of the
system, and simultaneously pay the LMP price for energy at the point
where it is withdrawn to serve their consumers. Thus any difference in
the LMP between the ``source'' of the power, and the ``load sink'',
change the cost of delivered power due to congestion incurred for
delivering through the RTO-managed transmission system. Congestion
costs for a utility are determined by a positive difference between the
cost paid to serve their load at a location minus the revenue received
for power generated at a different location.
In order to help utilities hedge congestion cost risk, the FERC
requires RTOs that operate real-time and day-ahead LMP markets, to make
FTRs or CRRs available to market participants. By virtue of payments
for physically firm network transmission service, load serving entities
like AECC are annually allocated certain financial revenue rights by
the RTO in order obtain FTRs or CRRs. FTRs and CRRs are monthly, annual
or other periodic financial instruments that entitle holders to
congestion revenues along a particular transmission path. These FTR and
CRR revenues help offset the costs incurred by utilities to deliver
energy over the congested transmission paths. As load profiles change
and sources of supply change over time, these unbundled financial
instruments can be bought and sold to align a market participant's
congestion protection with the ever changing congestion exposure that
results from the need to use frequently changing transmission paths.
Consequently, FTRs and CRRs were created to help market participants
maintain balance over time between the financial costs of providing
transmission service with the requirements of providing physically
reliable transmission service in a constrained and congested
transmission system.
As previously discussed, AECC participates in the SPP RTO. The SPP
is currently evaluating and designing how it will develop the FTR or
CRR market for its area of responsibility. Other RTOs such as the RIM
and Midwest Independent System Operator (MISO) already operate
congestion rights markets. Even though the FTRs and CRRs have been
separated from the physical cost of delivery, they remain an integral
part of the overall cost of service.
The electric cooperatives of Arkansas and cooperatives across the
country are concerned that proposed legislation would place regulation
of FTRs and CRRs under the regulatory oversight of the Commodities
Futures Trading Commission (CFTC). Oversight by the CFTC would fragment
load serving entities' ability to manage their transmission costs. The
FERC comprehensively regulates all jurisdictional wholesale sales and
jurisdictional interstate transmission service, pursuant to the Federal
Power Act, as an integral part of the overall electric market
structure. Sections 205 and 206 of the Federal Power Act give FERC
authority to ensure that the rates, terms and conditions of all
jurisdictional wholesale sales of power and all jurisdictional
transmission service in interstate commerce are just and reasonable. In
order to fulfill that duty, FERC has required RTOs to file tariffs at
FERC governing every aspect of their markets. The design, operation and
governance of RTOs financial rights, and the obligations of parties who
participate in the markets, and the means which the RTOs monitor the
markets for market power and market manipulation, are all filed at
FERC, and bought and sold pursuant to FERC filed tariffs. Mismanagement
of the markets by the RTOs and misconduct in those markets by
participants are both subject to penalties from FERC. An exception to
this FERC regulation is in Texas. In the State of Texas a single grid
operator called the Energy Reliability Council of Texas (ERCOT)
operates a day ahead and real time market and administers CRR's to
hedge congestions. The ERCOT is overseen by the Public Utility
Commission of Texas (PUCT) who serves the single regulator for
commercial power and transmission markets in Texas.
AECC believes keeping all components of transmission costs
regulated by a single entity will ensure lower overall cost for its
members. If the FTR and CRR markets are allowed to be regulated by an
entity outside of the FERC (or PUCT in Texas), market participants
could be forced to maintain multiple backup credit facilities (credit
facility for FERC physical transactions and credit facilities for FTR/
CRR market). A weakened economy and constrained capital resources at
financial institutions are already resulting in higher cost credit
support facilities. Another factor to consider is that market
participants in a FERC regulated market are mostly entities of the
utility sector serving end-use load. The credit risk for utility market
participants is generally less than a market that has a higher
concentration of counterparties that trade speculatively. One way to
eliminate and avoid counterparty risk is to force participants to
provide cash collateral sufficient to cover the full exposure of all
trades executed. But this option increases cost to end-use utility
consumers and idles large amounts of cash making it more difficult for
utilities to maintain capital expenditures on infrastructure to provide
reliable electric service.
In conclusion, on behalf of 468,900 electric cooperative consumers
in Arkansas and approximately 42 million electric cooperative consumers
throughout the nation, the electric cooperatives believe it is in the
best interest of utility consumers to ensure regulation of FTRs and
CRRs remain under the regulatory authority of the FERC and the PUCT in
Texas. RTO markets and RTO-created products are integral to the RTOs
regulatory reliability mission. FERC and the PUCT should also maintain
jurisdiction over physical forward transactions, whether or not those
transactions ultimately result in physical forward delivery or are
booked out. There are other energy hedging products that are available
for use by the general public. These are appropriately regulated by the
CFTC but the FTR and CRR markets should remain under the oversight of
the FERC or PUCT in Texas. In my opinion, the global fix prescribed by
Senator Lincoln could help keep the cost of providing electricity to
Arkansas consumers as well as electric consumers across the nation
lower.
Mr. Chairman, thank you for the opportunity to share our concerns
with you and the Committee on Energy and Natural Resources.
The Chairman. Thank you very much.
Why do we not find a couple of other chairs and ask
Chairman Wellinghoff and Chairman Gensler to please come to the
table. The rest of you stay at the witness table too, and we
will do some questions here as long as we are able to. I think
we can get all 6 folks there. Good.
I will start with a question to Chairman Wellinghoff and
just ask, reference has been made to this provision in H.R.
4173 that directs FERC and the CFTC to develop a memorandum of
understanding to establish procedures, to share information,
and avoid conflicting and duplicative regulation by the 2
agencies. To what extent do you think this helps? This is a
resolution of the concern and Congress should basically allow
that provision to solve the problem.
Mr. Wellinghoff. Mr. Chairman, I basically agree with
Chairman Kelliher that Congress does need to solve the problem
with respect to jurisdiction.
I think certainly we can enter into a memorandum of
understanding with the CFTC and would like to do so regarding
our respective investigatory powers and the ability to get
information from markets that we each regulate so that we can
establish and preserve our regulatory authority to ensure that
there is no fraud and manipulation in the markets. The CFTC
certainly may need information from some of the markets that we
oversee and vice versa, and I think that kind of sharing and
cooperation is necessary, but I do not see personally a
memorandum of understanding with respect to the issue of
jurisdiction. I really think that is something that Congress
needs to do with a bright line.
Mr. Gensler. If I might.
The Chairman. Yes, go ahead.
Mr. Gensler. What the House of Representatives included in
the various agreement between Chairman Waxman and Chairman
Peterson that worked through that actually went well beyond a
memorandum of understanding, and I would be supportive of going
beyond that. It had a very explicit savings clause for the good
work that this committee and Congress did in that anti-
manipulation area, the EPAct rules of 2005. It had other
various savings clauses for FERC jurisdiction with regard to
regulation of electricity and natural gas under their tariffs.
It had some savings clauses, of course, for the CFTC as well.
Then it actually directed that we use our 4(c) exemptive
authority. Under the 1992 provisions, we can, without
determining whether something is a future or not, actually
exempt various activities.
So I think it was actually far more than what Chairman
Kelliher was talking about. There was a lot more, and working
with this committee, I think we can sort this through and
working with this relationship, I think we can.
The Chairman. It does seem unusual, though, for Congress to
say that you can decide what is exempt rather than Congress
deciding what is exempt. Am I confused about that?
Mr. Gensler. I think what it is we as an agency are
overseeing markets to ensure they are fair and orderly, these
derivative marketplaces. The FERC has very important
jurisdiction and mission as well. So we coexist, as we coexist
with the Department of Agriculture, we coexist with the
Department of the Treasury. Treasury issues physical Treasury
securities. We oversee futures of Treasuries. We currently
oversee natural gas and electricity futures that trade on
NYMEX. I do not think this committee wants to take that away
from the CFTC, but if you want to give it to FERC, you know,
the Congress can do that. So it is a coexisting between
missions going forward.
The Chairman. Let me ask on this specific that Joseph
Kelliher talked about there, the auction that occurred, the PJM
auction I gather, in New Jersey last month. What is your
thinking about the role the CFTC would play on that kind of a--
--
Mr. Gensler. I am glad you asked it. I understand the facts
on that, probably none. I think it is a red herring, with all
respect to Chairman Kelliher. I think it is probably a cash
transaction that is excluded under the Commodity Exchange Act.
We do not cover cash or physical spot or forward contracts.
If Congress were to move forward and actually suggest that
we cover broad, over-the-counter derivatives, it would only be
the standard transactions that would be recommended to be
brought to central clearing, and I think the transaction he was
describing, if it were an over-the-counter derivative, would
actually be customized or tailored.
We do think there are 2 debates here, as many of the
panelists said. There is a debate of a little jurisdictional
thing here between the FERC and the CFTC, which I think we can
sort through with the good help of the committee. There is this
end-user question, which I have taken a public policy
perspective. I think we lower risk to the American public by
having all of these transactions that are standard in
clearinghouses, but if you exempt the energy transactions, I
would just ask Congress not to exempt all the financial
transactions.
The Chairman. But the idea of having an energy end-user
exemption, which has been suggested by several, is something
that you think might make sense?
Mr. Gensler. No. I am actually very much publicly on the
record saying that I think that if it is a standard
transaction, it would be best to be brought into central
clearing and central trading. I understand the votes probably
are not there for that, sir. So if there is an exemption for
central clearing for end-users in the energy market, I think
that should not sweep an end-user for trading. Transparency is
unarguably a good thing. You could have them required to be
transparent and still allow them to be bilateral and not be
centrally cleared.
The Chairman. Let me ask Chairman Kelliher if he had any
comment on that.
Mr. Kelliher. I do not think the example in the testimony
was a red herring. I think it did involve standard products
that would be forced to clear on the exchange, but I can submit
more information for the record of the hearing.
The Chairman. I think that is a useful example for us to
try to understand how these different policies would be
affected there.
Senator Murkowski.
Senator Murkowski. Thank you, Mr. Chairman.
I am trying to determine whether or not we really do have a
regulatory gap. Mr. Kelliher, you mentioned that you do not
believe that one exists. You said there is no loophole to
close. There is no regulatory gap to plug. I would ask the
question both to you, Chairman Wellinghoff and Chairman
Gensler, do we have a regulatory gap here or is Mr. Kelliher
correct in that the FTRs are already regulated by FERC through
its review and its approval of the RTO tariffs.
Mr. Wellinghoff. Ranking Member Murkowski, thank you for
the question.
I believe there is no regulatory gap whatsoever. We do
fully and completely regulate the FTRs.
To the question of the issue of what would be swept in
under the CFTC's authority, if they take in the FTRs, as I
understand it, that ultimately would sweep in the whole market
because ultimately they would require the RTO market, in
essence, to be a clearing market under their regulations. So I
think Chairman Kelliher is correct in his New Jersey example as
well, and again, it is one step that would move us to a place
that I think we do not need to go.
We do not need an exemption because, in fact, there is
nothing to exempt. We, in fact, fully regulate this area
already, the FTRs. So I see no loopholes at all.
I would also add that I do not believe that creating bright
lines creates loopholes. I cannot see that connection.
Mr. Gensler. We probably have a little bit different
perspective on this. I do think that bright lines in this area
could have the unintended consequences because markets evolve
and change, and it goes to the Senator's question about these
financial transmission rights. We at the CFTC have not taken a
public position as to whether they come under the Commodity
Exchange Act. In essence, the right question is are they
futures.
But I think that the FERC does take the leadership here and
should continue to take the leadership here, but we do not know
how this contract or this market may evolve. I do not even
think PJM might know how they might evolve.
Congress has asked that one agency, the CFTC, have broad
and uniform jurisdiction, exclusive jurisdiction, on derivative
contracts. We can use the exemptive authority to stand down, to
stand back when it is ambiguous, and sometimes it is not clear
and FTR is an example where it has begun to be not clear, but
where we are just giving some advice, for instance. Jon and I
have had a good relationship about this around this risk
management situation. I am glad to have the FERC taking the
lead, but we do not know this ambiguity will evolve over time.
Senator Murkowski. Let's discuss that further, Chairman
Gensler, both Mr. Kelliher and Mr. Wellinghoff indicated that
in their opinion the energy providers do not pose this systemic
risk to the broader economy. As we are looking to address
financial reform regulation, that is a different area. Would
you agree with them that within the energy market with those
energy providers, they do not pose that systemic risk?
Mr. Gensler. I think that the financial system so terribly
failed the American public, and part of that is this over-the-
counter derivatives world. So I believe that we need to be in
greater transparency, and we can do that on the standard
transactions. I think that is actually a positive to the
consumers that FERC protects if we brought the standard
transactions into transparent trading venues. I am not talking
about the FTRs. I am talking about over-the-counter
derivatives.
Senator Murkowski. You do not think that the FTRs that are
traded through the RTOs are standardized?
Mr. Gensler. I do not know the answer to how they will
evolve, and the commission has not taken a view as to whether
they are futures under the Commodity Exchange Act. But I think
that the broad market, whether it is natural gas derivative
where somebody is just hedging a natural gas risk, could be
standardized.
Having said that, many are customized. Many are tailored
and should remain tailored. Corporations--the very good
testimony from Mr. Henderson. They need to be able to tailor
and hedge their risk. Garry Brown's testimony. I believe they
need to be able to tailor and hedge their risks. But we also
want to protect the public and lower risk and add transparency.
Senator Murkowski. Mr. Brown, you spoke to the expense to
the consumer. Are we able to quantify what those expenses may
be, or at this stage, is it relatively hypothetical in terms of
what the consumer might anticipate?
Mr. Brown. It is somewhat hypothetical in the sense that we
are not quite sure, as this panel indicates, which products in
the end would be covered by this. But the numbers that we hear
on a nationwide basis is that it could require utilities to put
up billions in additional collateral, and that is money that
would then be taken from all the other things that utilities
need to do, building infrastructure, promoting renewables, all
the other things we have got the utilities doing right now.
We used a key phrase in our testimony. We should compare
the costs of this with the benefits. I cannot disagree with Mr.
Gensler that there are potential benefits, but the question is,
is it worth the potentially billions of dollars of costs? Is
there any evidence that indicates we really need to require
that at this point in time? I think our viewpoint there is no
jurisdictional gap. We have got the Federal Energy Regulatory
Commission, and we would prefer to keep our State/Federal
arguments focused on Commissioner Wellinghoff's agency rather
than have a jurisdictional confusion about who is overseeing
what.
Senator Murkowski. Thank you, Mr. Chairman.
The Chairman. Senator Lincoln.
Senator Lincoln. Thank you, Mr. Chairman.
The Chairman. Who I should point out, of course, is chair
of the committee with primary jurisdiction over the CFTC. So
she has a vital interest in this.
Senator Lincoln. Thank you, Mr. Chairman. I do so
appreciate you and Senator Murkowski holding the hearing today.
As you mentioned, we do share an interest in this very complex
issue and certainly look forward to working with both of you
all as we move forward in solving some of these problems and,
as Chairman Gensler mentioned, putting our economy back on
track and providing confidence in the marketplace as we do so.
I do want to also take the opportunity to thank my
constituent, Michael Henderson, for coming up from Little Rock
today to provide his testimony. Michael is the VP and CFO of
Arkansas Electric Cooperatives and the coops do provide a
critical service to the people of our State. I want to thank
you, Michael, and all of the folks at the coops in Arkansas for
what you all do. We are grateful and we are grateful for your
comments about looking out for our consumers, particularly
those in rural America.
Mr. Chairman, I am particularly interested in finding a
path forward that does respect the missions and the expertise
of both of these agencies, the CFTC and the FERC. I have stated
publicly that these agencies and our committees can draft that
compromise. I feel very confident. We may have to leave for a
vote, but we certainly want to make sure that all of you all
are committed to continue to sit around the table and figure
out what that compromise needs to be and can be.
But I also remember the words of Robert Frost which said
``good fences make good neighbors.'' Being a farmer's daughter
and understanding when someone's cows get into your wheat crop,
it is not a good thing. You want to make sure that with good
fences, you do produce good neighbors, and I think as hard as
Chairman Gensler and Chairman Wellinghoff work together, it is
critical for them to have a clear understanding from us in
terms of what our intentions are, that there are no regulatory
ambiguities, I believe is what Mr. Brown mentioned earlier. I
think that is really important.
I do see a compromise where FERC would get clear control of
the regional transmission organizations. RTOs are clearly in
their jurisdiction and the existing final products that are
used. The CFTC would continue to exercise exclusive control of
the New York Mercantile Exchange and the Intercontinental
Exchange, as well as energy futures and swaps.
Nothing would prevent one agency from notifying the other
of concerns. You are already working together, and I think that
is important. Concerns that you may have--hopefully, you will
notify one another, which would help assist in enforcement.
This is common sense, and I think it is just and equitable
results of what we are trying look for.
I would say, as we converse and talk about gaps, it is not
as much gaps in regulation as it is overlap. Any of that
ambiguity that may exist we in Congress I think have a
responsibility to put clarity to, and I hope that we will. I
think in these economic times, no one wants duplicative
regulation. We want to put our economy back on track. We want
to provide confidence to consumers and make sure that folks can
turn their lights on and still afford it. There is no doubt
that all of those things are our objectives.
So I want to thank the NRECA and the EEI, the EPSA for
their willingness to work with me certainly and others, I
think, on a global fix. Mr. Henderson mentioned a global fix. I
hope that is the objective we can set before us and come
together in coming up with what we need to do there.
I just would leave these couple of questions with you.
Chairman Wellinghoff, you know the New York Mercantile Exchange
is currently registered and regulated by CFTC. NYMEX was
founded in the 1870s I think. Do you think that the FERC should
be regulating futures contracts on NYMEX?
Mr. Wellinghoff. No, absolutely not. We only have an
interest to the extent that we may need information with
respect to activities in that exchange, and we certainly have a
cooperative agreement with the CFTC do do that and require that
information to the extent that it may somehow impact a physical
market and the manipulation or fraud that may be going on and
we may be investigating that physical market. But we certainly
have no interest in regulating it.
Senator Lincoln. To that end, Chairman Gensler, you know
PJM is a regional transmission organization which was created
by and overseen by FERC. As I understand it, PJM started
operating I think in 1999, 11 years ago. Do you think the CFTC
should be regulating PJM, its products or its participants?
Mr. Gensler. Chairman? Can I call her chairman? She is my
chairman. Chairman Lincoln, there is a possibility in the
future it would. It depends how markets evolve. I think that
FERC take the leadership over RTOs. Most, probably 99 or 98
percent, of the products have no implication whatsoever in the
derivatives marketplace. But I do think that Congress, in
giving exclusive jurisdiction to one agency to oversee
derivatives, whether they be futures products or not, gives
some uniformity and consistency. So I cannot predict how this
small market might evolve or mutate in the future, and I am
concerned about bright line tests and I have sort of got some
scars on my own back from the Enron loophole and the
experiences we had there.
Senator Lincoln. But you are basically talking about what
might be a futures in the future, or you are talking about a
product that may evolve out of what transpires with PJM perhaps
in terms of its products----
Mr. Gensler. I think that is right, and to the extent that
there is a centralized marketplace where buyers and sellers
meet over derivatives contracts, I think Congress does want one
agency. You know, I will go and the career staff will go, but I
mean, to have one agency to do that and coexist with other
agencies that oversee the physical markets, as we do with the
Department of Agriculture that, of course, you know so well.
Senator Lincoln. I appreciate that.
As you both know, I have suggested this global fix or
coming to find a global fix, a concept to resolve these
jurisdictional disputes between FERC and CFTC. I think several
industry groups have expressed a willingness to work together
to come up with whatever this fix needs to be. Would your
agencies be willing to work with us on a solution of that type?
Mr. Gensler. We are always willing to work with all
members, but certainly the chairman.
[Laughter.]
Senator Lincoln. The other gentleman is going to be at the
table too, and I look forward to working with him and his staff
and others. But I do believe that particularly in this day and
age with the economic circumstances we find ourselves in, that
the duplicative regulation is just not appropriate, and I do
believe that we have got to be able to determine and figure out
where that overlap exists and what problems it is causing and
make sure that we get you 2 gentlemen----
Mr. Gensler. I would certainly hope that we would continue
our very good relationship and in trying to avoid some
duplication, as you say, that we do not create the gap line,
the fault line because it really does evolve. These markets,
all markets evolve so much, and that is one of the hard lessons
I have had to take from this financial crisis, that markets
that we did not look at, credit default swaps where you had a
blip on the radar screen or electronic trading, and then we end
up with an Enron loophole and a swaps loophole. Certainly
looking back now, I think what could we have done differently
and I was part of that.
Senator Lincoln. I do not disagree that there are very few
Americans out there that would argue that over the past 15 to
20 years, there has been a tremendous evolution of financial
instruments out there, and as they have evolved--you are
exactly right--their markets have. The only way that we have
known what our problem has been is looking in that rear view
mirror to see what that $400 trillion marketplace was. We do
not want to keep looking in the rear view mirror. We want to
look forward and we want to have, without a doubt, you all in
the capacity that you need to be to have that transparency, the
oversight that is necessary to ensure that as we move forward,
that we are not dealing with the kind of issues and the kind of
things that were happening that no one knew about. So we will
look forward to working with you.
Mr. Chairman, I certainly look forward to working with
you. I have never found a more thorough or dedicated member of
the body that does not get down to the details--the devil in
the details as Mr. Chairman Bingaman does. So I appreciate it.
Thank you.
The Chairman. Thank you very much.
Let me just ask Mr. Duane going back to this example of the
auction that occurred. PJM had the auction last month we were
advised. Could you describe that? Are these standardized, this
RTO? Are these customized? What was the circumstance there?
Mr. Duane. I would have to coordinate with former Chairman
Kelliher to exactly understand his example, but I think his
point is a valid point.
PJM runs auctions in our energy markets and we run auctions
in our FTR markets and capacity markets. These products are
very specific. For instance, on the FTRs, there are literally
tens of thousands of combinations that could constitute an FTR.
We, in running those auctions, have from time to time been
in discussions with third party clearing organizations as to
whether they would be interested in providing the sorts of
clearing services that Chairman Gensler might like to see in
those markets, and not only is it cost prohibitive, but they
are really unable to provide the services given the unique
attributes of this product that is really not a financial
product. It is, as we have discussed, tied to the financial
transmission service.
So somewhat ironically we are having a lot of discussion
about something conceptually that even if we were to try and
mandate the clearing of these FTR products out of these
auctions, I am not sure it could even happen, which causes me
concern and it causes our market participants concern that the
product may just die and go away, exposing customers to the
very volatile prices that are attendant to the electricity
commodity.
The Chairman. What I am understanding--and I may be very
confused here, but what I am understanding the House
legislation to provide is that the CFTC would be given
authority to make a determination that PJM is a designated
clearing organization, and if they did that, then presumably
that would cause a whole new set of requirements to be put in
place. Is that wrong, Chairman Gensler?
Mr. Gensler. Actually we have that clear authority right
now.
The Chairman. Oh, you do.
Mr. Gensler. Yes. We have that clear authority right now.
The Chairman. What do you think the House--with regard to
PJM, what do you believe the House legislation allows you to do
that you currently cannot do?
Mr. Gensler. What the House legislation does is it sets up
a clear number of savings clauses for FERC and then sort of
directs us to look at our exemptive authority. We have not
had--under the exemptive authority, somebody would have to come
and actually file--it is a formal filing to do that exemption,
and then we would go through it. If somebody did that on these
financial transmission rights, we would dispatch with it. You
know, a number of months it takes to dispatch with it. We would
probably work closely with Chairman Wellinghoff as well.
But under the Commodity Exchange Act right now, we can do
this.
The Chairman. So you do not believe the House legislation
gives you any additional authority that you do not currently
have over PJM?
Mr. Gensler. The House legislation is a broad and very
important legislation about over-the-counter derivatives, but
that discussion is really well--I think Mr. Duane would
probably agree--different and removed in a sense from the PJM
discussion.
The Chairman. So you do not think the language of the House
bill contemplates regulation by the CFTC of PJM or similar
organizations.
Mr. Gensler. I think it contemplates that we work closely
with FERC. Frankly, I think it is with FERC taking the lead on
any of this. As Chairman Wellinghoff has, I think, artfully
said, they have a whole unified approach to this regulation.
But to the extent that any entity--it could be a
nonfinancial company in America--any entity starts to have some
centralized market, centralized derivatives markets and so
forth, then a derivatives regulator could get involved. That is
the CFTC. I think that is where the uncertainty or ambiguity
might be for PJM.
But under the Commodity Exchange Act right now if, as you
say, something was a clearing organization, we have authorities
there already.
The Chairman. Mr. Kelliher, did you have a point of view on
that?
Mr. Kelliher. The House bill is complicated to read because
you have to read a couple different sections--you asked me. Did
you ask Chairman Wellinghoff or me?
The Chairman. No, I meant you and then I am glad to hear
from Chairman Wellinghoff, too.
Mr. Kelliher. Page 589 of the House bill has a section that
to me suggests some authority is transferred to the CFTC. This
is the exemption section I think Chairman Gensler is referring
to. But it talks about how the CFTC may exempt from its
regulation agreements, contracts, or transactions that are
entered into pursuant to a FERC tariff if CFTC determines that
the exemption will be consistent with the public interest and
CFTC cannot unreasonably deny any request by FERC for such
exemption. So to me that suggests that the default is some
level of FERC regulation shifts to the CFTC unless the CFTC
decides otherwise. It is really the combination of--the MOU
provision and this section in tandem I think suggest there is a
change.
The Chairman. Chairman Wellinghoff, did you have a point of
view there?
Mr. Wellinghoff. I do not think the House bill--well, I
think this disagreement of jurisdiction predated the House
bill, first of all. We saw the House bill as a vehicle perhaps
for us to set a bright line and we went in with that
discussion. The House chose not to do that, but instead created
this MOU construct that quite frankly I think leaves it
primarily to the CFTC under their current authority to
determine whether there is an exemption. We believe there
should be a bright line like Senator Lincoln. I think that the
Congress needs to set a line. The RTOs and things under FERC's
tariff are within our jurisdiction and NYMEX, ICE, and other
things are within the CFTC's jurisdiction. So that is really
what we were hoping for. We did not get that out of the House
bill. But we hope to be able to work with you and with Chairman
Gensler to move forward on that.
The Chairman. Chairman Kelliher, did you have another----
Mr. Kelliher. I will make just one small comment on how the
jurisdictional disagreement between the agencies started. It
really started a few years ago when FERC was implementing the
anti-manipulation provisions of the Energy Policy Act that you
took the lead on, and trying to faithfully follow the intent of
the committee and Congress, you used certain terms that
suggested FERC's authority to police manipulation is much
broader than its authority to set rates. So FERC, interpreting
that, thought manipulation in the futures market that affects
FERC jurisdictional markets is something Congress wanted FERC
to police.
CFTC, I cannot say unreasonably--if I were the CFTC
Chairman, I would have thought, wait a minute. That is
intruding into our jurisdiction. We have exclusive jurisdiction
in certain areas. So there immediately was a disagreement
between the agencies that has persisted and I think is
aggravated by the House bill. But I think it is an honest
disagreement, but at this point I think it is immutable. It has
been in the courts.
Mr. Gensler. Yet, if I might to the tchairmen on my right,
the CFTC and FERC work cooperatively on this. It was that
Amaranth case, a joint investigation. We filed the cases a day
apart and ultimately had some joint settlement. So there is a
lot of actually--even in that case--really working together.
Now, the defendant filed in the court and asked for this
jurisdictional thing. But my predecessors at the CFTC were
really sort of working jointly, I guess, with Mr. Chairman
Kelliher at the time.
Mr. Kelliher. I agree. The 2 agencies have actually worked
very well to exercise their enforcement authorities,
notwithstanding the disagreement.
The Chairman. As I indicated before, we have now started 4
votes on the Senate floor. So I appreciate everybody being
here. I think this has been useful testimony. I thank everyone
for coming and we will try to come to a resolution. Thank you.
[Whereupon, at 11:14 a.m., the hearing was adjourned.]
APPENDIXES
----------
Appendix I
Responses to Additional Questions
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Responses of Garry Brown to Questions From Senator Bingaman
Question 1. What would CFTC jurisdiction over FTRs (or any other
RTO/ISO product) mean for the ratepayers of the state of New York?
Answer. FERC has presided over the design and implementation of
these markets and has therefore developed an understanding of them. The
full potential ramifications of CFTC jurisdiction over such markets is
unclear and such uncertainty can negatively impact market confidence
and liquidity and thereby damage the markets. Any increase in costs due
to imposition of CFTC oversight is likely to impact all resources such
that the increased costs would become a straight pass-through to
consumers; the net impact is likely to be a tax on ratepayers.
But, we can construe a scenario where, under certain conditions, it
might be possible that if FERC and CFTC had joint enforcement
jurisdiction with FERC maintaining the primary authority over FTRs,
benefits to ratepayers may accrue. This situation could be similar to
FERC's authority over the installed capacity market where FERC
establishes the rules and regulations but DOJ also reviews the
antitrust implications of secondary transactions associated with those
markets.
Question 2. What value do you believe FTRs provide to New York
ratepayers? How would CFTC regulation of FTR markets alter that value
proposition?
Answer. In New York, FTRs provide benefits to ratepayers by
allowing their service providers to hedge congestions costs and reduce
price volatility, and also benefit ratepayers in that revenues from the
sale of FTRs are credited to ratepayers in the delivery portion of
their bills. If the move to primary CFTC jurisdiction negatively
impacts market confidence and/or liquidity, the result would be lower
FTR sale prices and hence a smaller credit to ratepayer bills. As I
noted above, however, under certain conditions joint enforcement
jurisdiction may be beneficial.
Responses of Garry Brown to Questions From Senator Murkowski
Question 1. Is there currently a regulatory gap we're trying to
plug for electric market mechanisms like Financial Transmission Rights?
Aren't FTRs already regulated by FERC through its review and approval
of RTO tariffs?
Answer. FTRs are currently regulated by FERC. However, secondary
market trading of FTRs is not presently policed by FERC and such
trading can raise concerns with regard to gaming of the markets. FERC
is currently posing questions regard their review of secondary FTR
markets in a rulemaking proceeding (RM10-12).
Question 2. Why can't utilities clear their derivative transactions
on exchanges like other standardized commodities?
Answer. As my testimony points out, the concern is that doing so
could raise costs to consumers. If a company trades on an exchange, it
must meet collateral requirements, and the costs of those collateral
requirements including transactional costs will ultimately be passed on
to the consumer. Alternatively, if a company determines that these
costs are too high (making the instrument or transaction not cost
effective), then the consumer suffers the price volatility risks of
unhedged transactions.
Question 3. Does NARUC support an outright exemption for both
wholesale and retail market participants?
Answer. Yes. We support an exemption for those entities that rely
on OTC products and markets to manage price risks for legitimate
business purposes including utilities, suppliers, and customers.
Response of Garry Brown to Question From Senator Stabenow
Question 1. Please share your views on whether the mandatory
reporting of energy commodity contracts to regulated swap or derivative
repositories is a regulatory solution that would meet the public policy
goals of increasing market transparency, mitigating systemic risk, and
providing price transparency, without hindering the ability for end-
users to hedge their commercial risk or increasing costs to consumers.
Answer. As was discussed on page 5 of my written testimony, we do
believe that such reporting would provide sufficient market
transparency without the costs associated with mandatory clearing.
______
Responses of Vincent P. Duane to Questions From Senator Bingaman
Question 1. Could you describe the ways in which utilities as well
as other market participants come to own FTRs?
Answer. As a regional transmission organization (RTO), PJM serves
as a transmission provider, obligated under the Federal Energy
Regulatory Commission's (FERC) regulations, to provide open access,
non-discriminatory transmission service to customers seeking such
service within PJM's footprint. One type of transmission service that
PJM is required to offer, again pursuant to FERC directive, is firm
transmission service. Although some customers purchase transmission
service to export power from PJM into neighboring regions,
overwhelmingly, customers who purchase firm transmission service
(either network or point-to-point) do so to meet the needs of the end-
use consumers or retail customers that they serve. Firm service allows
transmission customers, (public utilities, municipal utilities,
cooperative utilities and competitive retail suppliers) to move
electricity from one point on the system (typically a generation
station or hub) to another point (typically a load bus) on a ``firm''
basis, which is to say without further cost beyond the transmission
charges they pay to PJM for firm service.
In organized wholesale electricity markets, such as the one
administered by PJM, prices can differ by location at various points on
the system. These differences result from transmission constraints,
limiting the volume of electricity that can be moved reliably across
the system. When such constraints exist, PJM, as the system operator,
must re-dispatch higher cost generation behind the constraint. The
higher cost that results behind the constraint is referred to as
congestion cost. In order to provide ``firm'' service as mandated by
FERC, and in order to recognize the native load rights of those
customers that historically have paid for the transmission grid, PJM
provides firm transmission customers with a mechanism to protect
against congestion costs. This mechanism is the FTR.
FTRs are made available to firm transmission customers as a means
to hedge against congestion charges. The amount of FTRs is finite; it
is limited by the physical capability of the transmission system and
calculated using a complex algorithmic model that PJM refers to as a
``simultaneous feasibility analysis.'' Every 12 months, PJM will
conduct a simultaneous feasibility analysis to determine the level of
FTRs that can be allocated over the next 12 month period (or planning
period).
Wholesale customers may choose to hold their FTRs or sell them to
other market participants, which may include other transmission
customers, generators, or trading firms (including financial
institutions). Thus, the FTR Auctions permit other market participants
to bid for and acquire specific FTRs and provides a market-based method
to determine the value of those FTRs. In this case, while the economic
value of the FTR, which is to say the price realized by that FTR in an
auction, will inure to the customer who originally received the
allocation from PJM, the ultimate holder of the FTR (depending on
auction outcomes) might be a different entity--potentially another load
serving utility, or other type of market participant, including a
financial institution.
In summary, the value of all FTRs inures to those transmission
customers who pay in rates for the fixed costs of the transmission
service (firm transmission customers) in recognition of their historic
payments for the cost of building out and maintaining the grid that
serves them. This is true whether the transmission customer continues
to hold the FTR or whether it receives the realized price of the FTR in
an FTR Auction (its auction revenue rights). The auction allows
transmission customers to buy and sell FTRs to obtain a particular
portfolio of FTRs to best hedge their particular congestion exposures.
It also efficiently allows for an FTR to be held by the entity that
places the greatest value on it (i.e., the one who bids highest for it
in the auction). Finally, FTR holders are free to bilaterally contract
to sell their FTR to another party outside the auction environment.
Such bilateral transfers are reported to PJM and are subject to
particular rules addressing the creditworthiness of the transferee.
Question 2. Would CFTC jurisdiction over FTRs (or any other RTO
product) compromise open access to the PJM transmission system for
market participants? If yes, how?
Answer. Yes. As described above, the FTR is the means by which
those RTOs administering locationally priced markets provide firm
transmission service to their load serving customers, consistent with
FERC Order No. 888 open access mandates. To treat the FTR as a CFTC-
regulated ``swap'' or ``futures contract'' would impose on RTOs
requirements relating to the trading, settlement and credit risk
management of the product that could radically alter the FTR in a
manner which would frustrate its fundamental purpose--namely to provide
a means for wholesale customers to serve their native load at a
predictable price consistent with the concepts of ``firm'' transmission
service--frustrating the RTO in its mission as a FERC regulated
transmission provider and wholesale electric market administrator.
Open access could revert to a system of physically firm
transmission service with re-dispatch costs indiscriminately socialized
across all users of the transmission system and a greater reliance on
physically curtailing or interrupting transmission schedules. The
efficiencies, greater use and optimization of a transmission system
brought about by applying market-oriented tools (such as locational
pricing and FTRs) to provide ``financially firm'' open access is well
documented. The loss of this efficiency, and the sub-optimal use of the
transmission system that would follow, will reduce competition and
increase costs overall to consumers in PJM.
Finally, CFTC jurisdiction could require RTOs such as PJM to
register as derivatives clearing organizations (``DCOs''). RTOs would
then have to establish admission and financial eligibility standards
for organizations who wish to do business within RTO markets. Users of
PJM markets range from very large utilities to very small municipal
systems, as well as industrial and commercial customers. FERC's
regulation has been designed to ensure nondiscriminatory access to
these markets by all commercial entities, regardless of size. Any
requirement that PJM impose these new financial eligibility standards--
standards that are more applicable to traders on large exchanges--could
prove difficult and costly for small entities such as small utilities,
renewable resource developers and end-use customers. In essence, this
would be placing a barrier to PJM's competitive wholesale markets with
little demonstrated concomitant benefit.
Question 3. Your testimony states that PJM has never found a CFTC-
registered clearinghouse interested in or able to clear the FTR
positions of PJM's market participants. Could you describe the reasons
why registered clearinghouses declined to take the business of clearing
FTR positions in PJM?
Answer. In 2004, PJM's management met repeatedly with
clearinghouses and clearing organizations to examine the potential for
credit clearing services to be provided to PJM's members. PJM was
advised in this matter by Deloitte & Touche. Based on these
discussions, the following basic challenges became apparent: (1)
calculating variation margin (or marking the position to market) would
be difficult or impossible given the infrequently established reference
prices that in turn result from FTR Auctions occurring only once every
month, and insufficient secondary market trading of FTRs between
auctions, (2) the risk of unforeseen grid outages and other physical
factors that can dramatically affect the expected future value of an
FTR position, making it very difficult for a clearinghouse to properly
assess price risk; (3) the differing tariffs governing FTRs among
various RTOs, which limit the opportunity for netting of FTR positions
across several RTOs, as would be necessary to support a viable
clearinghouse; and (4) PJM's inability at that time to novate positions
to the clearinghouse due to the absence of clear legal authority to
effect such novation. Some of these challenges are surmountable. Others
could be managed only by significantly redefining the product as it
exists today, potentially so radically as to reduce or eliminate the
value of the FTR as a hedging tool for firm transmission customers.
Question 4. If the CFTC found that PJM was required to become a
Designated Clearing Organization, what steps would PJM have to take? Do
you have cost estimates for those steps? From whom would you recover
those costs?
Answer. If the CFTC were to determine that PJM is a DCO, PJM would
be required to register with the CFTC and to demonstrate that it
complies with the CFTC's ``Core Principles'' applicable to DCOs. As
explained below, most of the CFTC's DCO Core Principles are not well-
suited for RTO markets because RTOs do not provide ``clearing
services'' within the meaning of the Commodity Exchange Act (``CEA'')
and offer products that (a) are integrally related to physical energy
and transmission services, and (b) are not ``futures,'' or other forms
of derivatives.
The DCO Core Principles include:
Financial Resources.--DCOs must demonstrate adequate
financial, operational, and managerial resources to discharge
their regulatory responsibilities. RTOs do not maintain default
insurance, guarantee funds, or other tiers of protection (e.g.,
an intermediary default structure analogous to the role of
futures commission merchants with respect to DCOs) to mitigate
the impact of a participant default. Instead, RTOs require
market participants to provide financial security (except where
unsecured credit is permitted). When a member's financial
security is exhausted, the RTO will allocate the default
shortfall to its members through a ``default allocation
assessment'' according to the terms of the RTO's Operating
Agreement. If RTOs were required to adopt some or all of the
financial safeguards used by DCOs, it would force PJM's members
to accept substantially higher operating costs and capital
requirements (e.g., margin). PJM's Members then would likely
pass these costs on to ratepayers.
Participant and Product Eligibility; System Safeguards.--
DCOs must establish appropriate minimum standards for the DCO's
participants and products. In addition, DCOs must establish and
maintain a program of oversight and risk analysis to ensure the
ongoing integrity of the DCO as a whole (including emergency
procedures for data backup and disaster recovery).
All RTO market participants are members of the RTO. There are no
tiers of members (e.g., clearing or non-clearing members) and
no minimum financial membership criteria, although members must
comply with PJM's credit policies. This is consistent with
FERC's general policy of encouraging open access to the RTO
markets. Requiring RTOs to limit their membership, would
undermine long-standing FERC policy regarding open, non-
discriminatory transmission and power markets.
Similarly, if RTOs are required to clear their products and
services (including) FTRs) in a manner comparable to a DCO
clearing futures contracts, RTOs may be forced to substantially
modify or even eliminate those products because the RTO may not
be able to conform simultaneously with both FERC's and the
CFTC's regulatory requirements. For example, DCOs typically
mark positions to market and collect variation margin based
from market participants on a daily basis. FTRs are priced
infrequently through auctions that typically occur only once a
month. Each auction includes both buyers and sellers, but
unlike a futures exchange where buyers and sellers enter into
equal and opposite standardized contracts, the FTRs and the FTR
market are defined by the physical characteristics of the
transmission system. Because each FTR is essentially a
customized product, FTR buyers and sellers cannot be matched to
standardized contracts, and there is no certainty that any
particular FTR will be priced in any given auction.
Notwithstanding the CFTC's regulatory requirements for DCOs,
PJM cannot calculate its exposure using a current market
reference price with any regularity, and therefore as a
practical matter, cannot use daily demands for incremental
collateral to manage risk.
At a minimum, certain DCO Core Principle concepts, including daily
margining and calculation of value-at-risk, would need to be
translated to work within the limits of the RTO market.
Notably, the CFTC's regulatory requirements for credit risk
management policies would need to be adjusted to rely more on a
retrospective examination of price behavior and statistical
modeling, and less on a real-time analysis of actual market
conditions. Although some aspects of the regulatory program for
DCOs may be beneficial, they are mostly incompatible with and
cannot reasonably be applied to RTO markets and products.
Settlement Procedures.--DCOs must be able to complete
settlements on a timely basis, even under adverse conditions.
In addition, DCOs must adequately record the flow of funds
associated with each cleared transaction, and must comply with
the terms and conditions of any netting or offset arrangements
with other clearing organizations. RTOs already maintain robust
settlement systems. If necessary, these systems likely could be
adapted to comply with the DCO Core Principles.
Protection of Customer Funds.--DCOs must develop and enforce
standards and procedures to protect member and participant
funds. This concept is inapposite to RTOs because RTOs are not
themselves market participants. Indeed, definitional
requirements imposed on RTOs by FERC, requiring independence,
prevent RTOs from proprietary trading in its own account while
at the same time serving as a custodian for accounts of
customers also participating in the RTOs markets. Again, this
principle follows from the intermediary structure of seat
holders and ``futures clearing merchants'' characterizing
exchanges and clearinghouses respectively. This structure does
not characterize RTOs.
Rules and Procedures.--DCOs must publish all rules and
operating procedures, including rules to ensure the efficient,
fair, and safe management of events when members or
participants become insolvent or otherwise default on their
obligations. In addition, DCOs must demonstrate adequate
ability to monitor and enforce compliance with the DCO's rules
(such as, through either internal resources or arrangements
with an outside compliance organization). RTOs have the ability
to allocate member defaults through a ``default allocation
assessment'' that is similar to the procedure used by DCOs in
the event of a member default. Other aspects of the DCO Core
Principles do not reasonably apply to RTOs. For example, the
``customer priority rule'' cannot apply to RTOs because RTOs do
not themselves engage in the markets they administer.
Similarly, although DCOs are required to maintain extensive
surveillance and enforcement programs, this role in RTO markets
is performed by FERC and the RTO's independent market monitor.
RTOs are not self-regulatory organizations as that concept is
applied by the CFTC; rather they are heavily regulated
organizations subject to comprehensive oversight by the FERC.
Reporting and Recordkeeping.--DCOs must provide to the CFTC
all information necessary for it to oversee the DCOs'
activities. In addition, DCOs must maintain all business
records for five years in a form acceptable to the CFTC. RTOs
already comply with extensive FERC reporting and recordkeeping
requirements. Although RTOs likely could comply with this DCO
Core Principle, the CFTC's reporting and recordkeeping
requirements may be duplicative of, and less comprehensive
than, the requirements already imposed by FERC.
The DCO registration process takes approximately six months from
the date when a DCO application is submitted, unless the CFTC's
Division of Market Oversight grants an applicant's request for an
expedited 90-day review. The process of preparing the DCO application
is, however, time-consuming and expensive. Therefore, the complete
registration process will likely take considerably longer than six
months.
Question 5. Could you describe some of the attributes of FTRs that
you believe distinguish them from futures?
Answer. The CEA has never defined what constitutes a contract for
future delivery. However, precedent from the CFTC and various federal
courts has identified the following common characteristics of futures
contracts:
Standardized, non-negotiable terms.
Future delivery.
Ability to enter into equal and opposite offsetting
transactions.
Price at which the underlying commodity will be delivered in
the future is fixed on the date when a market participant
enters into a futures contract.
Offered to the public.
Secured with margin.
These elements of a futures contract generally do not apply to
FTRs.
FTRs are not standardized and are not fungible. Each FTR is based
on the hourly congestion price differences across a particular
transmission path in the Day-Ahead Energy Market (i.e., the price
difference between any two locational marginal price (``LMP'') points
within an RTO system). FTRs can vary in terms of quantity (in MW) and
duration (e.g., one month, three months, etc.). In each FTR Auction,
there are hundreds of thousands of possible FTR combinations upon which
market participants may bid. In contrast, NYMEX futures contracts for
electricity are based on the price of electricity between two fixed
time periods, and at a few highly liquid nodes.
FTR positions cannot be financially settled or closed-out through
offsetting transactions. A long (purchase) futures contract can be
settled by purchasing an equal and opposite ``offsetting'' short (sale)
futures contract. In contrast, FTRs must only be, as a whole,
``simultaneously feasible'' such that all outstanding positions remain
within the physical limitations of the transmission system. In other
words, for each long FTR position, there is not necessarily one single
equal and opposite short position held by another market participant. A
long FTR between two LMP points (A to B) may be closed out, in whole or
in part, by a combination of FTR positions involving different but
related LMP points (C to D and D to E, for example, where actual
physical flows on paths C to D and D to E involve some flow of
electrons across path A to B). This is fundamentally different from a
futures contract and how futures markets operate.
FTRs are not offered to the general public. FTRs are offered only
to members of a particular RTO, which typically consists primarily of
transmission owners, load serving entities, generation owners, electric
distributors, end-use commercial and industrial customers, and power
marketers.
FTRs are not secured through daily margin payments. Each RTO
establishes credit requirements according to a process set forth in its
respective, FERC-approved tariff. For example, some RTOs establish
credit requirements for market participants holding FTRs
retrospectively by reference to the historical value of the positions,
adjusted by a factor designed to reasonably anticipate atypical market
conditions. Because FTRs are allocated through an auction based
process, it is not possible to establish values for FTRs even on a
monthly basis. In each FTR Auction, only a small fraction of the
potential FTR combinations are bought or sold. As a result, there is
insufficient liquidity across the numerous FTR paths to establish daily
``market'' values for forward FTR positions, and therefore,
insufficient market information to support more frequent margin
calculations.
Question 6. In 2003, PJM revised its market rules so that FTRs were
available to all transmission service customers and PJM members. What
motivated that revision?
Answer. On June 1, 2003, in response to a request by customers to
provide them with more liquidity and flexibility, PJM supplemented the
direct allocation of FTRs with an allocation of ``auction revenue
rights'' or ``ARRs'' coupled with an Annual FTR Auction. This change
gave firm transmission customers the option to receive the economic
value of the FTR (as realized in an auction) or instead, simply convert
the ARR to the underlying FTR, so as to replicate the direct FTR
allocation outcome that existed prior to June 1, 2003. Auction revenue
rights can be regarded as the financial proceeds realized by selling
the underlying FTR in an auction. Since FTRs are specific to particular
geographic points on the grid, customers may find that they are unable
to receive an allocation of all the precise FTR paths they might
request. In such cases, they may prefer to retain the auction revenue
rights in place of the FTR, and use the proceeds realized by selling
one FTR to purchase another that better suits their changing supply
obligations or perception of expected patterns of congestion.
In short, the institution of an auction marketplace for FTRs in
2003, as requested by wholesale customers, provided further options to
those transmission customers entitled to an allocation of FTRs. First,
establishing a marketplace provided these customers a forum to sell
FTRs and buy alternate FTRs that might better match their hedging
needs, given the location and nature of the load they served. Second,
it provided efficiency through a transparent auction environment that
ensured that a party placing the greatest value on a specific FTR was
able to procure that FTR. Often, the party placing the greatest value
on a particular FTR (thereby willing to pay the highest price for this
FTR) is not the party to whom the FTR is originally allocated. In such
a case, the original holder would prefer receipt of the auction revenue
rights associated with that FTR (i.e., the price realized for that FTR
in the auction) rather than the FTR itself. This change was endorsed by
the PJM stakeholders and approved by the FERC.
Responses of Vincent P. Duane to Questions From Senator Murkowski
Question 1. Is there currently a regulatory gap we're trying to
plug for electric market mechanisms like Financial Transmission Rights?
Aren't FTRs already regulated by FERC through its review and approval
of RTO tariffs?
Answer. No, there is no regulatory gap that needs to be filled as
FTRs and the FTR Auction process are subject to pervasive regulation by
FERC. As stated in my testimony (Section 4b), virtually from the
inception of PJM's markets, FERC directed the creation of FTRs as a
means to allocate to transmission customers equitable access to the
transmission grid. In PJM, the FTR product was approved by FERC more
than a decade ago upon the creation of PJM's organized markets in 1997.
Furthermore, in section 217 of the EPACT of 2005 Congress states
its intention that FERC regulate FTRs comprehensively, including their
formation, initial allocation, and transfer among various entities, as
well as the trading of any excess FTR rights. PJM believes that Section
217 makes clear that the Congress intended for the FERC to regulate
FTRs because of their inextricable link to the underlying transmission
grid and electricity market structure. The plain language of Section
217 indicates, in our opinion, Congress' desire that the FERC's
regulation should be unambiguous in this area, guided by its expertise
in transmission regulation.\1\
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\1\ Testimony of Vincent P. Duane, Vice President & General Counsel
PJM Interconnection, L.L.C. Impacts of Potential Financial Markets
Reform Legislation on Organized Wholesale Electricity Markets'' March
9, 2010.
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Question 2. Why can't utilities clear their derivative transactions
on exchanges like other standardized commodities?
Answer. To the extent this question refers to derivative
transactions that take place in over the counter environments, PJM does
not take a position on the merits of clearing standardized derivatives
or an end user exemption to mandatory clearing. If the question refers
to arguably derivative products in RTO environments, such as the FTR,
PJM would respectfully reference its prior answers to Senator
Bingaman's questions 3-5 above.
Question 3. What role do financial entities play in the organized
wholesale electricity markets? I understand that in addition to
bringing in needed liquidity some financial entities, like J.P. Morgan,
have actual electric delivery obligations.
Answer. Financial entities can play an important role in wholesale
electricity markets. With the introduction of competitive retail
service in several PJM states, entities such as Morgan Stanley, Goldman
Sachs (J. Aron) and J.P. Morgan act as ``load serving entities'' in
PJM. Moreover, many traditional utility or energy companies maintain
proprietary trading businesses that, in part, financially optimize and
hedge the physical generation and load positions of their affiliate
utility operations, but also trade in PJM's markets, in much the same
manner as ``financial entities.'' For these reasons, PJM would suggest
that rather than drawing distinction between ``financial entities'' and
other entities, it may be more helpful to distinguish between
speculation and hedging, keeping in mind that both financial entities
and traditional energy companies can engage in both functions from time
to time.
Trading (by ``financial entities'' or energy company/utility
affiliates) is valuable to PJM's markets and promotes efficiency and
lower prices, up to a point. Excessive speculation, concentration of
risk, and abusive trading can distort pricing and result in costs to
consumers. PJM and FERC guard against these risks through active market
monitoring and enforcement by both an independent market monitor and
FERC itself. Furthermore, PJM continuously refines its market rules to
manage these risks, and is currently in dialogue with its stakeholders
and FERC about such concepts as the role of unsecured credit, position
limits, minimum net worth requirements for participants and limits on
aggregate financial guarantees.
Question 4. Aren't FTRs directly tied to the physical limitations
of the grid meaning there's a finite amount in the market? Please
explain.
Answer. Yes. FTRs are financially-settled products that
transmission customers use to hedge against the cost of congestion,
that are directly tied to the physical characteristics and limitations
of the transmission system. FTRs can be created only by RTOs or ISOs
and their number and composition is determined based upon the
transmission system topology and the physics of physical power flows.
Congestion occurs when the least costly resources available to
serve load in a given area cannot be dispatched because the physical
limitations of the transmission lines located between the source point
(sending end/generator) and the sink point (receiving end/customer
site) prevent the movement of electricity from these generation
resources to the load. FTRs help hedge congestion risk by providing
payments that are proportional to the congestion that transmission
customers would encounter over a specified transmission path.
In order to provide an effective risk management product, the FTRs
that are awarded through the auction process must correspond to the
actual transmission capabilities of the system. If too many FTRs are
awarded for a certain transmission path, the RTO would be over-
committed and the efficacy of the FTR as a hedging tool would be
compromised. To maintain the integrity of the FTR market, the FTR
Auction process relies on a linear algorithm that only awards FTRs to
bidders who have submitted a ``simultaneously feasible'' combination of
bids. A combination of bids is ``simultaneously feasible'' if the RTO's
actual transmission system can accommodate simultaneously transmitting
the electricity underlying each FTR transaction. Because of the physics
associated with transmitting electricity, the total quantity of FTRs
can increase above the nominal capacity of the transmission system if
there are prevailing flow and counterflow FTRs over the same
transmission path. However, even in this case, the total number of FTRs
in the market is absolutely limited by the physical characteristics of
the transmission system.
Question 5. In 1998, PJM, the largest wholesale electric market in
the world, asked the CFTC through a No Action letter to clarify certain
regulatory uncertainties related to the RTO's standing as a Derivatives
Clearing Organization. It is my understanding that the CFTC failed to
respond for over a decade but just recently turned to this issue, is
that correct? What was the agency's reason for failing to consider the
request in a timely manner? How is this regulatory certainty impacting
the organized markets?
Answer. On October 19, 2000, PJM filed a request with the CFTC's
then Division of Trading and Markets for no-action relief. As required
by CFTC rules, PJM periodically provided the Division with updated or
supplemental information. PJM believes that it has a very professional
and constructive relationship with the CFTC and its Staff. We are not,
however, privy to the CFTC's internal activities or deliberations
relative to PJM's no-action request, and accordingly, cannot offer the
Committee any insight on this subject.
PJM is concerned that if the present uncertainty continues,
decreased liquidity and increased volatility will ultimately raise
costs for consumers and compromise the integrity of PJM's markets. The
most troubling aspect of the recent public attention given by the CFTC
to the FTR markets is the potential for a defaulting FTR holder to
allege that the FTR is illegal and unenforceable because it was not
traded in an environment registered with or overseen by the CFTC.
Hopefully, this risk is remote. Resolution of the pending no-action
request in a manner which does not raise the specter that these
products needed to have been registered with the CFTC since their
inception would remove this risk.
Question 6. Didn't PJM at one point approach NYMEX regarding these
RTO-market instruments and the Exchange had zero interest in clearing
those products? Wasn't the rationale because the risk associated with
instruments like FTRs are tied to the realities of the system?
Answer. PJM has explored clearing services from a CFTC-registered
clearinghouse, but has never found a DCO willing or able to clear PJM's
FTR product. As discussed above in response to Senator Bingaman's
question 3, the physical characteristics of PJM's FTR product and the
special requirements of PJM's FERC-regulated markets make the clearing,
as defined by the CFTC, of FTRs impossible. Instead, PJM has
implemented credit policies and mechanisms to protect the integrity of
its markets that are tailored to its products and the services it
offers. These provisions, developed in consultation with FERC and
codified in its tariff, are as effective as the CFTC's Core Principles,
but also compatible with how RTO markets are required to function.
______
Responses of Joseph T. Kelliher to Questions From Senator Bingaman
Question 1. What would CFTC jurisdiction over FTRs mean for FPL
Group, its customers and, more generally, ratepayers located in RTO/
ISOs?
Answer. FPL Group has two principal subsidiaries: NextEra Energy
Resources, LLC, the owner of competitive generation assets and an
energy marketing company (NextEra Energy), and Florida Power & Light
Company (FPL), a vertically integrated utility in Florida. NextEra
Energy operates in 26 states and is the largest wind developer in the
United States.
The Commodity Futures Trading Commission (CFTC) jurisdiction over
FTRs may have a variety of impacts on NextEra Energy and its customers.
First, NextEra Energy would be eligible for certain regulatory
exclusions and exemptions because it is an ``eligible contract
participant'' (ECP), as currently defined by Commodity Exchange Act
(CEA). As an ECP, transactions involving FTRs would be exempt from all
but the anti-manipulation provisions of the CEA to the extent that FTRs
are considered to be transactions in ``exempt'' commodities. Therefore,
under current law, NextEra Energy's transactions in FTRs are subject to
overlapping anti-manipulation authorities by FERC and CFTC.
Should the CFTC assert jurisdiction over FTRs, NextEra Energy's
transactions in FTRs could be subject to clearing and margining
requirements, which would increase NextEra Energy's transaction costs.
These increased costs likely would be passed along to our ratepayers.
In addition, the CFTC could apply position limits to transactions in
FTRs, which could undermine or limit the ability of utilities and other
RTO participants to utilize this important tool in managing
transmission congestion costs.
CFTC regulation of FTRs is likely to be different than FERC
regulation in other respects. While FERC has allowed most FTRs to be
allocated to load-serving utilities on a long-term basis to assure just
and reasonable rates, I would expect the CFTC may require auctioning of
all FTRs, which would make it much more expensive for load-serving
utilities to manage congestion risk. Moreover, CFTC may also disfavor
long-term transmission rights, and shorten the term of FTRs. That would
be directly contrary to legislative provisions in the Energy Policy Act
of 2005 that govern FERC, but not the CFTC, so those provisions do not
bind the CFTC. This approach would expose consumers to transmission
congestion risk, greater price volatility, and less predictable prices.
Under the proposed amendments to the CEA contained in H.R. 4173, it
appears that FTRs may fall within the definition of a swap. If that is
correct, under the amended CEA, FTRs would be subject to the exclusive
jurisdiction of the CFTC, notwithstanding FERC's traditional role as
the principal regulator of RTO and ISO markets. This jurisdictional
change would create uncertainty about the FERC's continuing oversight
role, if any, over FTRs and other aspects of RTO markets. As swaps,
FTRs may be subject to mandatory clearing (depending upon whether they
are considered hedges and whether parties who enter into hedges are
considered Major Swap Participants under the legislation), which, as
noted above, may subject them to margining requirements and increase
NextEra Energy's transaction costs. Regulatory uncertainty typically
increases transaction costs, which likely would have to be passed along
to ratepayers.
Question 2. Are EEI members that operate within RTO and ISO markets
recipients of allocated FTRs? How would these members and their
ratepayers be affected by CFTC jurisdiction over FTRs? What would it
mean for these companies and their ratepayers if FTR allocations were
revised or altered?
Answer. EEI's members are U.S. shareholder-owned electric companies
that serve 95 percent of the ultimate customers in this segment of the
industry and represent approximately 70 percent of the U.S. electric
power industry. Many EEI members operate within RTO and ISO markets
that offer FTRs or comparable products.
The manner in which transmission customers acquire FTRs is governed
by the terms of the applicable RTO or ISO tariff, which is subject to
FERC regulation. In many markets, FTRs are awarded through an auction
process. In each auction, bids submitted by prospective FTR holders are
evaluated using a software algorithm that determines the most economic
combination of bids that still falls within the limits of the system's
actual capacity (i.e., the best combination that is ``simultaneously
feasible''). Notably, some otherwise economic bids may not clear the
FTR auction due to the physical limitations of the transmission system.
RTO and ISO markets that allocate FTRs through an auction also may
provide firm transmission customers with a form of ``auction revenue
rights'' to offset the cost they incur acquiring FTRs that correspond
with their transmission positions. Auction revenue rights are not FTRs,
but in the markets where they exist, they can typically be converted
into FTRs through the FTR auction process.
Some RTO and ISO markets also allocate FTRs through direct sales to
transmission owners, direct allocations for contributions made to
network upgrades, or conversions of transmission capacity associated
with certain existing transmission agreements.
CFTC jurisdiction over FTRs and the FTR auction process would
complicate RTO and ISO efforts to comply with FERC Order No. 2000 by
making it more difficult for transmission customers to manage their
congestion risk. Transmission customers who rely on FTRs would
immediately face substantial uncertainty as to whether FTRs qualify as
regulated futures contracts (under existing law or the proposed CEA
amendments) or swaps (under the proposed CEA amendments), or whether
they may be exempt from regulation under one or more statutory or
regulatory provisions. In addition, the FTR auction process would
create uncertainty as to whether RTOs and ISOs may need to register as
a contract market or comply with the requirements applicable to CFTC-
regulated ``trading facilities.'' More generally, the CFTC may assert
that the RTO or ISO provides clearing services that requires it to
register as a derivatives clearing organization. The uncertainty
resulting from any one of these scenarios would undermine the viability
of the FTR process.
If RTO and ISO market participants are unable to use FTRs to hedge
their congestion risk, many of EEI's members and their rate-paying
customers will be exposed to greater electricity price volatility and
less predictable prices.
Question 3. Are EPSA members that operate within RTO and ISO
markets recipients of allocated FTRs? How would these members and their
customers be affected by CFTC jurisdiction over FTRs? What would it
mean for these companies and their customers if FTR allocations were
revised or altered?
Answer. EPSA is the national trade association for competitive
wholesale power suppliers, including generators and marketers. EPSA
members include both independent power producers and the competitive
wholesale generation arms of certain utility holding companies. The
competitive sector operates a diverse portfolio that represents 40
percent of the installed generating capacity in the United States. EPSA
members do business nationwide, both in the two-thirds of the country
served by RTOs or ISOs and the remaining one-third of the country
dominated by traditional vertically-integrated utilities
Although merchant generators are not allocated FTRs by the RTOs,
these FTRs underpin the pricing, reliability and congestion management
of the entire RTO. Therefore, all of the consequences enumerated in the
response to question #2 would apply to EPSA members, who rely on well-
functioning RTO markets to provide wholesale electric service to their
customers.
Question 4. FPL Group's subsidiary NextEra Energy is a competitive
generator and the largest wind developer in the United States. Does
CFTC jurisdiction over FTRs or other products create a disincentive to
invest in renewable generation, transmission infrastructure, or new
technology?
Answer. Regulatory uncertainty is never an incentive to investment
in any endeavor, including renewable generation and transmission
infrastructure. To the extent that Congress determined that FTRs and
other ISO products were to be solely regulated by the CFTC and not the
FERC then the answer to your question would largely depend on the
nature of the regulations and consistency of oversight in conjunction
with the other interrelated FERC jurisdictional products associated
with building, interconnecting and running renewable generation or
transmission infrastructure.
CFTC regulation of FTRs would introduce significant risk into their
renewable energy development decisions, since they would bear the risk
associated with this uncertainty. Some wind developers build merchant
projects that are not backed by long-term contracts. The uncertainty
regarding FTRs would introduce significant risk in their investment
decisions, since they would bear the risk of transmission congestion.
Wind developers that build under contract are typically not the party
most concerned with congestion and transmission regulatory issues
because such risks are frequently passed on to the off-taker of the
power under the terms of the Power Purchase Agreement (PPA). However,
to the extent CFTC jurisdiction over FTRs and other ISO products
creates additional regulatory risks or uncertainty, or creates or
increases the risk of regulatory conflicts for products that were once
under a single regulatory construct for the off-taker, the off-taker is
likely to account for such risk by reducing the contract price paid
under the PPA. That would make some projects uneconomic.
Any reduction in prices received for the power would negatively
impact the ability of the developer, who will rely on the PPA price to
inform its investment decision, to obtain financing for the project. In
many if not most instances, a renewable investment that cannot be
financed will not be built.
Therefore, the primary issue is not so much one of an upfront cost
impact on NextEra Energy development, but one of regulatory uncertainty
and its likely implications on the economics of renewable investment.
Entry by the CFTC into traditionally FERC-regulated products will
disrupt and bifurcate the current unitary regulatory scheme, with such
regulatory uncertainty leading to a disruption of the marketplace,
resulting in increased costs in the areas of both compliance and risk
mitigation for all parties involved in the product chain and lower
prices for renewable project developers.
Question 5. Your testimony states that the requirement to clear
and/or trade transactions on an exchange would materially increase both
wholesale and retail rates. Has FPL Group sought to estimate the scope
of these rate increases?
Answer. As a competitive power company, renewable energy provider,
and vertically integrated utility, FPL Group has been closely following
the financial reform legislation from the perspective of its impact on
our customers, who are wholesale and retail electric consumers. FPL
Group has calculated the amount of additional margin that it would be
required to post if all OTC transactions were required to be traded on
exchange several times in the last year. FPL Group has made these
calculations to ascertain at a high level how much of an impact the
legislation would have on energy costs. NextEra Energy would be
required to post approximately $100,000,000\1\ in incremental margin
and FPL, our utility, would be required to post approximately
$600,000,000\2\ in incremental margin. The costs of transacting on
exchange or through a clearinghouse due to delivering large amounts of
incremental margin to the exchanges or clearinghouses would likely end
up as additional costs ultimately to be absorbed by end-users and
ratepayers.
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\1\ Calculation made as of September 30, 2009.
\2\ Calculation made as of March 24, 2010.
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Rather than trying to pin down all the variables needed to estimate
a dollar per megawatt impact to wholesale and retail rates, the real
focus should be on the broader issue of energy companies and end-users
having to raise enormous amounts of capital without a corresponding
increase in revenues at a time when that capital is needed to start
rebuilding the economy. Nevertheless, we believe such costs could end
up materially increasing wholesale and retail rates given the sheer
size of the incremental margin that will be needed.
The purpose of the broader financial regulatory reform legislation
is to reduce systemic risk in the financial sector. In my view, a
requirement to clear and trade energy commodities does not reduce
systemic risk in any fashion, and instead introduces liquidity risk
associated with posting margin. While FPL Group supports the goal of
financial regulatory reform, the ability of electric and natural gas
companies to use OTC energy derivatives for legitimate business
purposes should be preserved.
Responses of Joseph T. Kelliher to Questions From Senator Murkowski
Question 1. Is there currently a regulatory gap we're trying to
plug for electric market mechanisms like Financial Transmission Rights?
Aren't FTRs already regulated by FERC through its review and approval
of RTO tariffs?
Answer. There is no regulatory gap in the regulation of FTRs. FTRs
are fully regulated by FERC under FERC-approved tariffs, and have been
since the RTOs began using these products more than a decade ago. There
has been no assertion of a gap in regulation. Instead, a question has
been raised of whether or not FTRs have attributes of commodities or
derivatives, and, therefore, are subject to overlapping regulation by
CFTC under the CEA. We believe that allowing such regulatory overlap
would undermine the effectiveness of FTRs in addressing congestion
within the RTOs and raise costs to RTO participants and the consumers
they serve.
Question 2. Why can't utilities clear their derivative transactions
on exchanges like other standardized commodities?
Answer. EEI and EPSA members use OTC derivatives extensively to
manage commodity price risk for electric power, natural gas and other
fuels, as well as to contain risk-related costs when financing energy
infrastructure. A requirement to clear all derivatives transactions
would greatly reduce the ability of companies to find the customized
derivative products they need to manage their risks because
clearinghouses and exchanges require a high level of margin and
collateral for the derivatives and commodities products traded.
Customization of contracts is necessary for everything from
specific delivery points in electricity to quantities of natural gas.
Without the ability to use these customized transactions, energy
suppliers would be severely constrained in the types of products and
the costs of those products that could be offered to consumers. In
addition, for centrally cleared products to be effective,
standardization and a critical mass of market participants are
essential. For example, in the case of electricity, since its unique
physical nature precludes significant storage and requires that it be
consumed when generated in hundreds of physical markets, the
prerequisites for standardized and centralized clearing are missing.
So, electricity price risk cannot be managed through a selection of
exchange-traded contracts. Rather, such derivatives often require
customization in order to be effective.
While centrally cleared exchanges strictly require cash collateral,
individually negotiated OTC contracts allow hedging entities to use
alternative collateral structures such as asset liens, credit lines or
no collateral below agreed upon thresholds. Providing such flexibility
frees up scarce capital for investments in energy infrastructure.
Conversely, not allowing such collateral structures and forcing all OTC
transactions to clear through exchanges would unnecessarily divert
substantial capital from productive investments and drive up the price
of energy commodities.
Limiting access to these risk management tools by mandating the
clearing of OTC transactions would jeopardize the ability of energy
providers to manage risks, increase consumers costs and increase
excessive consumer exposure to market volatility. The OTC derivatives
markets' very purpose is to provide customized solutions that meet the
individual needs of customers with flexible products as well as
diversified margin and collateral requirements. Provisions requiring
clearing of transactions will only increase costs and limit market
participants' ability to manage risks without creating comparable
offsetting benefits.
Question 3. Mr. Kelliher, as a former FERC Chair, you've stated
that an MOU, as called for in the House-passed legislation, is
insufficient to resolve jurisdictional issues between FERC and CFTC.
Please explain.
Answer. As FERC Chairman, I entered into a number of Memoranda of
Understanding (MOU) with other federal and state agencies, including
the CFTC. An MOU is a useful vehicle for two or more agencies to
coordinate how they will exercise their respective legal authority in a
manner that avoids or minimizes conflict between the agencies, improves
their ability to discharge their respective statutory duties, and
provides greater transparency to the regulated community.
However, the MOU in the House bill has an altogether different
purpose. The purpose of the MOU provision in section 3009 is not to
coordinate how FERC and the CFTC will exercise their jurisdiction, but
to define the jurisdiction of the two agencies. With respect, I believe
that is the duty of the Congress and is not something that should be
the subject of a MOU.
Under section 3009(a)(1) the CFTC and FERC are directed to
negotiate an MOU to ``establish procedures for applying their
respective authorities in a manner so as to ensure effective and
efficient regulation in the public interest, resolving conflicts
concerning overlapping jurisdiction between the two agencies, and
avoiding, to the greatest extent possible, conflicting or duplicative
regulation.''
As was discussed at the hearing, there is a jurisdictional
disagreement between FERC and the CFTC. The heart of the dispute is
that FERC has interpreted the anti-manipulation authority granted by
Congress in the Energy Policy Act of 2005 as requiring it to police
market manipulation in futures market that affects jurisdictional
wholesale power and natural gas markets. The CFTC objects to this
interpretation, and would prefer that FERC limit the scope of its anti-
manipulation authority.
This disagreement has now endured for nearly three years, and has
spilled into litigation regarding FERC enforcement proceedings against
companies it believes engaged in market manipulation. There is no
reason to expect that either agency will alter its position, since both
agencies appear to interpret current law regarding their respective
jurisdiction and statutory duties differently. As a practical matter,
if the two agencies disagree on how to interpret current law, there is
no reason to expect an MOU can resolve that disagreement.
In my opinion, the MOU provision of H.R. 4173 will prove
ineffective because the agencies are unlikely to agree on
jurisdictional boundaries, and an MOU that defines the respective
jurisdiction of the two agencies is unlikely to be entered into. The
disagreement will continue.
Congress can compel two agencies to begin a discussion about a
possible MOU, but Congress cannot compel the agencies to agree on how
to interpret current law through the device of an MOU negotiation. If
Congress wants to ``resolv[e] conflicts concerning overlapping
jurisdiction between the two agencies'' it should pass substantive
legislation to define their respective jurisdictions.
At this point, it appears that only Congress or the courts can
define the respective jurisdiction of FERC and the CFTC, the Congress
through legislation that clarifies jurisdiction, the courts through
orders interpreting current law. A MOU is no sort of solution to the
jurisdictional disagreement between the two agencies.
Question 4. You've testified that forcing trading on exchanges
would cost hundreds of millions of dollars for the average utility or
generation company and that the margin and collateral requirements
would tie up large amounts of cash, creating ``dead'' capital. What
would the cost impact of CFTC regulation of FTRs and OTC transactions
be for a utility like Florida Power and Light?
Answer. If the current legislative proposals were to pass and all
standardized OTC transactions were required to be traded on exchange or
cleared, then FPL would be required to post approximately
$600,000,000\3\ in incremental margin. While FPL is considered a very
large utility, this number is consistent with other estimates of the
impact the OTC legislation could have on investor-owned utilities.
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\3\ Calculation made as of March 24, 2010.
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EEI President Tom Kuhn has stated that the increased costs of
requiring OTC transactions to be transacted on exchanges would be
``astronomical--in the neighborhood of hundreds of millions of dollars
annually for an average utility.''\4\ There are currently approximately
200 investor-owned utilities in the United States. The total cost to
the electric utility sector alone would be many billions of dollars.
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\4\ See For Utilities, Derivatives is not a Dirty Word, Energy
Daily, October 7, 2009.
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This amount does not include any amounts of incremental collateral
that would be required to be posted by other energy participants such
as: (i) non-investor-owned utilities, (ii) other end-users (wholesale
generators and other non-utility energy consumers), (iii) wholesale
commercial energy companies, (iv) dealers, (v) speculators, and (vi)
other energy commodity participants in the natural gas market. The
overall impact of the OTC legislation would be to cause thousands of
companies to either (i) raise billions of dollars in additional capital
for incremental margin, above and beyond what is required in the
current regulatory construct, or (ii) drop their hedging activities in
part or in total and take on market risk rather than trying to raise
capital.
In this slowly recovering economy, it is difficult to imagine the
impact on the financial markets as companies try and raise billions of
dollars within a short regulatorily mandated time period. To make
matters worse, those entities will have to raise those amounts without
being able to project a corresponding increase in revenues in order to
pay back the capital or deliver a return. Additionally, those billions
of dollars that would then be used for margining will displace capital
that would have otherwise been used for capital investment projects at
a time when capital investment is most needed.
With respect to possible CFTC regulation of FTRs and other RTO/ISO
products, that is more of a concern for NextEra Energy than it is for
FPL because FPL is not located in an RTO/ISO. The impact on NextEra
Energy, which transacts in the RTO/ISOs that sell FTRs, relates more to
regulatory uncertainty than direct costs. Entry by the CFTC into
traditionally FERC regulated products will disrupt and bifurcate the
current unitary regulatory scheme, with such regulatory uncertainty
resulting in increased compliance and risk mitigation costs for all
parties involved, and lower prices for renewable energy developers.
Question 5. Don't regulated utilities use instruments like FTRs to
keep consumer prices stable? You don't really make any money from
hedging, do you?
Answer. Regulated utilities use FTRs to help manage risk. They buy
FTRs to manage, or hedge, the amount they will have to pay for
congestion. Without the ability to manage this risk, costs would go up
and consumers would be subject to the volatility that results from the
occurrence of transmission congestion.
The purpose of hedging is not to make money, but instead to lock in
prices or remove volatility from various commodity inputs used to
generate or deliver electricity over a certain period of time.
The way a hedge works is when the value of the underlying commodity
is up, then the value of the hedge contract is down. And vice versa,
when the value of the underlying commodity is down, then the value of
the hedge contract is up. The net result of this is a stable price for
the hedging utility, which ultimately benefits retail electricity
consumers.
Question 6. Why do you believe it's necessary for Congress to
specify an end-user exemption for both wholesale and retail market
participants?
Answer. EEI and EPSA members engage in risk management transactions
in the OTC derivatives markets to help ensure stable and affordable
rates for customers in both the wholesale and retail electricity
markets. As previously noted, the high cash margin requirements of
clearing would significantly increase transaction costs for our members
and, ultimately, their wholesale retail customers. In addition, it
would tie up needed cash at a time when the cost of capital is high,
access to capital markets is uncertain, and our industry needs to
invest billions in renewable energy sources and clean energy
infrastructure. As a result, our more capital-constrained members may
choose to hedge fewer of their transactions, thereby increasing their
risks and passing potentially volatile pricing onto wholesale and
retail customers.
Response of Joseph T. Kelliher to Question From Senator Stabenow
Question 1. Please share your views on whether the mandatory
reporting of energy commodity contracts to regulated swap or derivative
repositories is a regulatory solution that would meet the public policy
goals of increasing market transparency, mitigating systemic risk, and
providing price transparency, without hindering the ability for end-
users to hedge their commercial risk or increasing costs to consumers.
Answer. EEI and EPSA believe that promoting greater regulatory
oversight and transparency of OTC derivatives markets through increased
financial reporting and authority to the CFTC to prevent manipulation
is a laudable goal of proposed financial reform. This transparency can
be achieved in a cost-effective way through mechanisms such as
mandatory reporting requirements and a central data repository, as
opposed to mandatory clearing for energy. Reporting all OTC
transactions to a central data repository would provide the CFTC a
window for the first time into the OTC markets, without hindering the
ability of end-users to efficiently manage their commercial risk. In
addition, we support the clearing of standardized derivatives between
large financial dealers, where appropriate, through regulated central
counterparties to reduce systemic risk and bring additional
transparency through information regarding pricing, volume and risk.
Energy suppliers welcome the increased regulatory oversight and
reporting through such a central data repository mechanism.
______
Responses of Jon Wellinghoff to Questions From Senator Bingaman
Question 1. How would CFTC jurisdiction over FTRs affect FERC' s
overall mission of ensuring just and reasonable rates?
Answer. CFTC jurisdiction over FTRs could significantly impair
FERC's ability to ensure just and reasonable rates. FTRs are an
important tool for protecting customers against the risk of price
increases for transmission services in RTOs/ISOs. Congress recognized
the importance of FTRs when it enacted FPA section 217 as part of the
Energy Policy Act of 2005, requiring FERC to use its authority in a way
that enables load-serving entities to secure FTRs on a long-term basis
for long-term power supply arrangements made to meet their customer
needs. CFTC jurisdiction over FTRs could lead to, e.g., limits on the
availability of FTRs for load-serving entities and thus less protection
for their customers against increases in transmission costs.
Question 2. Chairman Wellinghoff's testimony states that regulatory
uncertainty could slow investments in renewable resources or smart grid
technology. Would CFTC regulation of a financial instrument like FTRs
have such far-reaching impacts? Please explain.
Answer. Yes, CFTC regulation of FTRs could reduce investment in
such resources. For example, as indicated in my answer to your Question
#1, CFTC jurisdiction over FTRs could lead to limits on the
availability of FTRs for load-serving entities. A load-serving entity
considering whether to buy long-term power from a proposed wind farm
would need to consider the expected cost of transmission, particularly
if the wind farm would be far from the load. FTRs can help ensure that
the expected transmission costs are unlikely to increase significantly.
Without the certainty provided by FTRs, the load-serving entity might
decide to continue buying short-term power and the wind farm thus might
lack the customer commitment it needs to get financing and begin
construction.
Question 3. In his testimony, Vincent Duane from PJM
Interconnection stated that the FTR is inextricably linked to
locational priced energy markets. How could FERC and the CFTC fulfill
their respective missions if they individually regulate, according to
different standards, two ``inextricably linked'' products?
Answer. Duplicative regulation of RTO/ISO markets would not be
workable or wise. As I testified, all elements of RTO/ISO markets are
approved by FERC, incorporated into FERC-approved tariffs and monitored
closely by independent market monitors and FERC. CFTC regulation of one
or more of these elements, such as FTRs, could disrupt the integrated
functioning of these markets, leading to inefficiencies and higher
energy costs for consumers.
Question 4. How would CFTC jurisdiction over FTRs impair FERC' s
ability to protect against manipulation in the RTO markets?
Answer. Under the Commodity Exchange Act, the CFTC asserts
exclusive jurisdiction in the markets they regulate. Were the CFTC to
acquire exclusive jurisdiction over the FTRs currently traded in RTO/
ISO markets subject to FERC regulation, FERC's authority to prevent and
punish market manipulation in the RTO markets could be restricted.
Question 5. Do you believe that an FTR defined by a particular
source-sink combination is distinct from an FTR with a different
source-sink combination?
Answer. Yes. An FTR is a right based on congestion between two
specific points. An FTR for congestion between Pittsburgh and
Philadelphia is not fungible with an FTR between Pittsburgh and
Hagerstown, MD. A loadserving entity seeking to buy power in Pittsburgh
for delivery to customers in Philadelphia can benefit from an FTR
between those two points, but not from an FTR for delivery in
Hagerstown. PJM alone has thousands of such point-to-point combinations
of FTRs, making them much less fungible than typical futures regulated
by the CFTC.
Question 6. Much of the discussion at the hearing focused on FTRs,
which are available within RTOs and ISO markets. Do you have concerns
with respect to possible CFTC jurisdiction over products that are
available outside of RTO and ISO markets?
Answer. Yes. For example, the definition of ``swaps'' in H.R. 4173
could be construed to include bilateral capacity contracts. Under this
type of contract, a load-serving entity can assure its ability to meet
its customers' needs by buying the right to use certain resources?, a
power plant's output or a right to demand response) but does not have
to commit to buy a specific amount of energy at an agreed-upon price.
In an RTO/ISO market, capacity obligations help ensure that there will
be enough ``steel in the ground'' and other resources to meet the
aggregate needs of the market's customers. In bilateral markets,
capacity contracts can serve the same purpose for an individual
utility. In both organized markets and bilateral markets, capacity
contracts can be critical in ensuring that a proposed resource has a
projected revenue stream sufficient to allow development of the
resource.
Responses of Jon Wellinghoff to Questions From Senator Murkowski
Question 1. Is there currently a regulatory gap we're trying to
plug for electricity market mechanisms like Financial Transmission
Rights? Aren't FTRs already regulated by FERC through its review and
approval of RTO tariffs?
Answer. There is no regulatory gap. RTOs/ISOs are comprehensively
regulated by FERC. CFTC regulation of FTRs would not close a regulatory
gap but would instead impose duplicative and potentially conflicting
regulation.
Question 2. According to former FERC Chairman Joe Kelliher, who is
testifying today on the second panel, energy providers do not pose a
systemic risk to the broader economy. Instead, the entire commodities
market is less than I percent of the global OTC derivatives markets,
and the energy commodity portion is yet a fraction of that one percent.
Do you agree that these electricity market instruments do not pose
the kind of systemic risk Congress is trying to address in financial
reform regulation? Ifso, isn't this a good case for striking a
reasonable balance?
Answer. Amidst the recent meltdown of financial markets,
electricity market instruments regulated by FERC did not at any time
pose a systemic risk to the national economy. In addition to the
relatively small size of the markets for the instruments, FERC already
comprehensively regulates all RTO/ISO rates, terms, and conditions of
service, including reviewing, approving, and revising credit practices.
Question 3. There's a concern that under the new financial reform
legislation the RTOs and ISOs themselves could become subject to the
CFTC's jurisdiction as ``derivative clearing organizations.'' Is that
appropriate? If RTOs were subject to the CFTC's exclusive jurisdiction,
what additional rules and regulations would be required?
Answer. Regulation of RTOs/ISOs as ``derivative clearing
organizations (DCOs)'' would be inappropriate because RTOs/ISOs are
already regulated comprehensively by FERC. CFTC regulation of RTOs/ISOs
as DCOs could subject them to conflicting requirements or could impair
FERC's ability to protect consumers from excessive rates.
A DCO must demonstrate ongoing compliance with various ``core
principles'' set forth in the Commodity Exchange Act and the CFTC's
regulations. These core principles are used to evaluate the DCO's
capabilities in such areas as adequacy of financial resources, risk
management and settlement processes, and default procedures. The
differences between DCOs and RTOs/ISOs make it difficult to determine
the specific requirements the CFTC might impose on RTOs/ISOs.
Whether the CFTC would, or even could, adopt rules and regulations
to ``harmonize'' CFTC and FERC regulation of RTO/ISOs in order to
recognize their unique characteristics and avoid inconsistent
regulation is unclear.
Question 4. If RTO products--or the RTOs themselves--became subject
to the CFTC's exclusive jurisdiction, wouldn't that mean that FERC was
precluded from fulfilling its mandate that consumer electricity prices
be just and reasonable?
Answer. The CFTC asserts that its jurisdiction under the Commodity
Exchange Act is exclusive. If so, then CFTC regulation of RTO/ISO
products or of the RTO/ISOs themselves could limit FERC regulation and
prevent FERC from fulfilling its statutory obligation to ensure just
and reasonable rates.
Question 5. As we talk about the problems associated with
subjecting these transactions to a cash collateral clearing
requirement, it's easy to forget that transactions like FTRs are
already subject to credit requirements.
a. Can you please elaborate on how these credit requirements
now work?
Answer. FTRs provide revenue to the holder of those rights that can
be used to insure against the costs associated with physical congestion
on the electric grid. As you note, FTRs are subject to credit
requirements. Generally speaking, the credit requirements are
established based on an estimate of the cash flow associated with each
FTR owned. Practically speaking, this means estimating the revenue for
each year on a particular path, for example, between a location in
central Pennsylvania and a location in southern New Jersey, to assess
the risk that the FTRs, due to changes on the electric system, may not
yield a positive cash flow. In these instances, the party owning the
FTR will have to ``pay'' rather than receive payment. The risk being
assessed is for non-payment. Based on this analysis, credit is extended
based on factors relating to the risk profile of the particular market
participant. The market participant currently can post collateral to
meet this credit requirement using a combination of secured credit
(e.g., cash or letters of credit) and unsecured credit (e.g., parent
company guarantee). The RTO/ISO markets generally allow a certain
amount of unsecured credit for more creditworthy entities although some
have moved to prohibit unsecured credit in the FTR market and the
Commission's recent proposed rules on credit would remove unsecured
credit in all FTR markets.
b. Isn't FERC currently considering whether to increase these
credit requirements? Aren't you also examining whether to
require additional information regarding the reselling of FTRs
in secondary markets?
Answer. FERC has been actively looking at improving credit
management in the RTO/ISO markets since their inception and has made
several modifications. FERC addressed the issue generically in 2004
with a Policy Statement that spurred reforms on a case-by-case basis.
In light of the financial crisis, the Commission in January 2009 held a
technical conference to examine the effects of the crisis on wholesale
electric markets. More recently, the Commission issued proposed rules
on credit reforms (in Docket No. RM10-13-000) at its January 2010
meeting. The proposed rules would eliminate any use of unsecured credit
in the FTR auctions. The proposed rules also would require shorter
settlement cycles in all transactions, require minimum creditworthiness
criteria for market participation, clarify when a market administrator
may invoke ``material adverse change'' to require additional security,
and shorten the grace period for curing collateral posting
requirements.
Further, the Commission has opened an inquiry in Docket No. RM10-
12-000 into whether to require quarterly reporting of all bilateral
(secondary) sales of FTRs. Reporting such sales of FTRs could increase
the transparency of the FTR markets.
c. Finally, aren't public power entities often legally
prohibited from providing cash as collateral?
Answer. In the RTO/ISO markets, secured credit is obtained through
either a posting of cash as security or a letter of credit from a
creditworthy bank with offices in the United States. Traditionally,
public power entities have often not been required to post collateral.
As mentioned in response to the previous question, the Commission's
proposed rule would eliminate the ability to post unsecured credit for
FTRs, though we seek comments on whether some market participants, like
public power entities, should be exempt from the new proposed rule.
Question 6. Are FTRs ``standardized'' contracts or are these
customized products that are not fungible?
Answer. Each FTR is path-specific and its value reflects the
difference between the price of power at two particular locations on
the grid. There are thousands of paths in each market, each with its
own unique risk profile. FTRs are not fungible in the way that
instruments traded on NYMEX are fungible. Fungibility allows traders to
create new contracts and trade in and out of existing ones because each
new contract is exactly the same. Because only the RTO/ISO issues FTRs,
and does so only in a manner consistent with the physical constraints
on the system during defined auction periods, individual traders cannot
decide to create new FTRs outside of the RTO auctions.
Responses of Jon Wellinghoff to Questions From Senator Stabenow
Question 1. The House bill directs FERC and the CFTC to create
memorandum of understanding for the process of sharing information to
avoid duplicative regulation. It also gives the CFTC the authority to
exempt FTRs from its regulation only if the CFTC determines that the
``exemption would be consistent with public interest.'' It directs the
CFTC to ``not unreasonably deny any request made by the Federal Energy
Regulatory Commission for such an exemption.''
If this provision were to pass into law and the agencies could not
agree on an MOU in a timely manner or a lack of clarity in the
jurisdiction remained, I am concerned this may affect energy prices. In
a state like Michigan our manufacturers and households cannot afford
undue burdens like this and I am worried uncertainty leads to an
increase in prices. Do you agree with this and if so do you think that
keeping energy costs low via energy markets qualifies as within the
``public interest''?
Answer. Lack of clarity about who regulates the energy markets can
reduce the willingness of investors to support new energy
infrastructure or increase the return on capital they seek for making
investments in the face of such uncertainty. Both of these outcomes
could hurt consumers. Legislation clearly preserving FERC's
jurisdiction would avoid this uncertainty, and is far preferable to a
statutory requirement that two agencies resolve the issue by agreement.
Furthermore, while the Federal Power Act's concept of ``public
interest'' clearly includes keeping energy costs reasonable for
consumers, the Commodity Exchange Act's reference to ``public
interest'' is not parallel. The Commodity Exchange Act focuses on
whether markets operate fairly and orderly but, unlike the Federal
Power Act, contains no obligation to consider the reasonableness of
rates to customers.
Question 2. During his testimony, Mr. Gensler pointed to the
Amaranth case as a good example of the two agencies working together.
Please describe the situation, each agency's role and if there is
anything you would do differently.
Answer. Shortly after FERC first observed the anomalous trading
activity by Amaranth and initiated its investigation, it informed the
CFTC. Thereafter, the agencies worked well together in evaluating and
investigating the matter. Each agency brought a case against Amaranth,
though there were substantive differences in the two cases. FERC has a
Memorandum of Understanding with the CFTC under which FERC requests,
through the CFTC, data and information from the CFTCdesignated
``Contract Markets'' such as NYMEX. While FERC retains the ability to
acquire such information directly, through informal request or
Commission subpoena, FERC has respected the role of the CFTC as the
exclusive day-to-day regulator of the market and has used this process
consistently even though it is not as efficient as seeking the
information directly. The CFTC did take a position in the courts that
FERC did not have jurisdiction over an Amaranth-type case. FERC
strongly disagrees with that position, and depending on how the cases
progress, the courts may resolve that matter.
Question 3. If the CFTC determines that FTRs are futures contracts
how would that change your regulation of the market? Are there areas
where you see regulation of the market could be improved? If so, is it
possible for FERC to address them? Would legislation be required?
Answer. If the CFTC determines that FTRs are futures contracts, the
CFTC would then decide whether to impose its regulatory requirements on
FTRs or exempt them from CFTC regulation. If the former, the CFTC would
assert that its jurisdiction is exclusive, and FERC could be precluded
from regulating FTRs.
FERC considers on an ongoing basis whether improvements are
warranted in RTO/ISO markets. For example, two months ago, FERC
proposed (in Docket No. RM10-13-000) strengthening the credit
requirements in RTO/ISO markets. FERC will consider all comments
received on this proposal before taking final action. At the same time,
FERC opened an inquiry in Docket No. RM10-12-000 on whether to require
comprehensive reporting of bilateral (secondary) sales of FTRs. FERC
has comprehensive authority to regulate the rates, terms and conditions
of RTO/ISO markets, and does not see a need for additional legislation,
except for the purpose of preserving FERC's jurisdiction.
Question 4. Please share your views on whether the mandatory
reporting of energy commodity contracts to regulated swap or derivative
repositories is a regulatory solution that would meet the public policy
goals of increasing market transparency, mitigating systemic risk, and
providing price transparency, without hindering the ability for end-
users to hedge their commercial risk or increasing costs to consumers.
Answer. I do not have a position on the mandatory reporting of
energy commodity contracts to regulated swap or derivative
repositories, but FERC has imposed extensive reporting requirements in
the wholesale power markets. FERC currently requires all companies
authorized to sell physical power under its jurisdiction to report
their sales in detail on a quarterly basis. These reports include
counterparty information, price, quantity and location, and FERC makes
this information publicly available. FERC has adopted this requirement
to ensure that the public has access to the rates charged by power
sellers in compliance with the Federal Power Act and as a mechanism to
aid transparency in furtherance of the Commission's statutory mission
to ensure just and reasonable rates.
______
Response of Michael W. Henderson to Question From Senator Bingaman
Question 1a. Your testimony notes that the Southwest Power Pool
(SPP) is ``currently evaluating and designing how it will develop an
FTR market,'' which is one of many possible changes to the SPP market.
What is driving SPP and its market participants to evaluate changes to
its current market design?
Answer. The desire of SPP's members to implement a day-ahead energy
and ancillary services market is primarily driven to realize an annual
savings of one hundred million dollars ($100,000,000) identified in a
cost/benefit study.
Question 1b. Has uncertainty surrounding regulation of FTRs
influenced that evaluation in any way? If yes, how?
Answer. Our evaluation thus far has assumed FTRs will continue to
be regulated by FERC as a cost allocation vehicle not as a separate
market commodity. If financial reform legislation were to create
uncertainty, the stakeholders in SPP would have to reconsider whether
the move to an FTR market still provided consumers with net benefits.
In other words, the uncertainty could potentially deny consumers in SPP
the opportunity to save $100 million.
Responses of Michael W. Henderson to Questions From Senator Murkowski
Question 1a. Is there currently a regulatory gap we're trying to
plug for electric market mechanisms like Financial Transmission Rights?
Answer. No, in my opinion, there is no regulatory gap for those
mechanisms. Such mechanisms, like congestion rights, are an inherent
part of the cost of wholesale electric sales and transmission service
regulated by FERC.
Question 1b. Aren't FTRs already regulated by FERC through its
review and approval of RTO tariffs?
Answer. Yes.
Question 2. Why can't utilities clear their derivative transactions
on exchanges like other standardized commodities?
Answer. FTRs are not ``standardized commodities''. FTRs are unique
and noninterchangeable congestion reservation rights used by FERC to
allocate cost among transmission users. Many of the other hedging
transactions used by cooperatives are similarly difficult to treat as
``standardized commodities.'' They are used to provide carefully
tailored hedges for physical transactions that provide for delivery of
different volumes of energy for each of the 8760 hours of the year at
thousands of distinct delivery points. Even those hedging transactions
that might be susceptible to standardization are currently being traded
between sophisticated counterparties with individualized credit
requirements that recognize the different business structures, levels
of liquidity, and sources of security specific to different electric
utilities. Mandatory clearing on exchanges would force those ``round''
end-user transactions into ``square'' holes designed for financial
counterparties. Without providing the markets any greater protection,
such an approach could inevitably increase the cost of hedging for
utilities and thus raise either the cost of power or the volatility of
prices for retail electric consumers.
Question 3. You testified that the cost for the Arkansas Electric
Cooperative Corporation of providing transmission service to rural
Arkansans increased by over 60% from 2004 to 2009--that's about a 10%
increase per year. Would these costs have been even higher without the
use of hedging instruments like Financial Transmission Rights (FTR) and
Congestion Revenue Rights (CRR)?
Answer. FTRs and CRRs are not currently part of the SPP market.
Congestion costs are currently part of the transmission tariffs set by
FERC. If FTRs/CRRs are introduced in the SPP as a separate commodity,
they should only serve to attempt to fine tune the allocation of
congestion cost among users. But, as noted above, studies indicate
that, collectively, all consumers within the SPP footprint could save
as much as $100 B if the RTO develops FTR markets. Those savings are at
risk if financial reform legislation creates regulatory uncertainty by
imposing duplicative layers of regulation on those markets.
Question 4a. What would CFTC regulation of these financial products
like FTRs and CRRs mean to your consumers?
Answer. First, if financial reform legislation imposes duplicative
layers of regulation on FTRs and FTR markets, the SPP might choose not
to form those markets, denying consumer's significant potential
savings. If the SPP does establish the FTR markets and they are
regulated by both the FERC and the CFTC, there could be two different
regulators defining what an FTR `is,'' who can trade in FTRs, how they
are traded, and what the credit requirements are for trading the FTRs.
Those rules could conflict, raising the specter that a utility that
complies with its FERC tariff could be in violation of CFTC regulations
and vice versa. That uncertainty will make it extremely different for
utilities to use FTRs to hedge their risks in the SPP market. Moreover,
FERC can currently take all transmission costs into consideration when
setting transmission tariffs. If a portion of transmission costs are
regulated outside of FERC (such as by the CFTC), the opportunity for
financial and non-utility entities to extract value or inflict
additional cost to transmission users could exist. Regulation by CFTC
could open FTRs and CRRs values to more volatility and resulting in
less stable transmission cost. More volatile cost generally will result
in more volatile financial results and ultimately more expensive
capital cost as well as incurring duplicative regulatory costs for the
transmission users.
Question 4b. Would the costs associated with clearing prohibit the
use of these hedging instruments, thereby leaving consumers exposed to
volatile prices, or would you simply be forced to pass on the increased
costs to the end-user?
Answer. The cost of clearing would not technically prohibit the use
of these hedging instruments as long as the costs are included in FERC
approved tariffs. However, as an electric cooperative, any additional
costs are absorbed by our member consumers. Thus we face a Hobson's
choice. We must either charge our customers more for power to cover the
higher cost of hedging, or if those added costs are greater than the
value of the hedge, then we will be unable to hedge our market risks
and will instead expose our consumers to much greater price volatility.
Question 4c. What are the problems associated with cash collateral
requirements?
Answer. The two primary problems with collateral calls are the cost
of providing a credit facility and the availability of a credit
facility. If the SPP used FTRs and CRRs during the last quarter of
2008, AECC would have had to pay large fees for a credit facility if it
could even find a financial institution that could provide one. These
additional costs are borne by AECC's rural member consumers with no
service benefit.
Question 5. You noted in your testimony that all components of
transmission costs should be regulated by a single entity. What are the
practical problems of having two federal regulators?
Answer. Multiple regulators require duplicative compliance and
reporting by market participants. Duplicative compliance efforts will
drive up the cost for transmission users. FERC as regulator of the
physical transmission service would not be in a position to set a
tariff to include the market losses or gains incurred from transactions
in a financial market. Different objectives of multiple regulators can
result in conflicting rules making compliance difficult or impossible
to attain and potentially subjecting the market participant to
penalties from one regulator merely because they complied with the
rules imposed by the other regulator.
Question 6. Do you believe that advanced power sales should be
categorized as futures transaction, making them subject to the CFTC's
exclusive jurisdiction?
Answer. No. Advanced power sales are not commodities in my opinion.
A significant number of committed transactions in many markets take
place on an advance basis. Advanced power sales should be viewed in a
like manner as transactions for non-refundable hotel reservations or
airline tickets purchased days before actual travel or advanced
purchase of entertainment tickets before the event.
In the 2005 Energy Policy Act (EPAct), Congress recognized the need
for load serving entities to plan long-term to meet the needs of our
consumers. Rather than providing for transmission rights to be treated
as a traditional commodity, Congress required in new Federal Power Act
(FPA) sec. 217(b)(4) that FERC exercise its authority under the FPA to
ensure that load serving entities (like electric cooperatives) have
access to the long-term transmission rights they need to meet the long
term needs of their consumers. Congress recognized in this section that
the electric utility industry is a capital intensive industry in which
we rely on generation and transmission infrastructure that can take 30
years to pay off and that can be useful for another 40 years after
that. Congress understood when they drafted EPAct that we cannot plan,
finance, build, and maintain that infrastructure based entirely on spot
market purchases and sales. Instead, we must contract for both power
resources and the transmission capacity needed to deliver that power to
load months, years, and even decades ahead. Those contracts are
supported financially by the legal obligation of millions of retail
consumers to pay for the power that they use to heat their homes, run
their production facilities, and pump water to irrigate their crops.
EPAct is consistent with the federal government's long-standing
position that electricity is as an essential service imbued with the
public interest rather than as a commodity like soybeans or pork
bellies. That is why the physical market for electricity has long been
closely regulated by economic regulators, including the Federal Power
Commission and its successor the FERC and state PUCs, rather than the
CFTC.
______
Responses of Gary Gensler to Questions From Senator Bingaman
Question 1. The CFTC is currently examining whether Financial
Transmission Rights (FTRs) should be considered ``futures'' under the
Commodities and Exchange Act. Is the CFTC currently examining any other
FERC-approved instruments or products that are available pursuant to
Regional Transmission Organization (RTO) or Independent System Operator
(ISO) tariffs? If so, which instruments or products and why?
Answer. The CFTC has not taken any action to regulate the FTR
market which is currently regulated by the Federal Energy Regulatory
Commission (FERC). Additionally, the CFTC is not seeking to regulate
other current RTO products.
In 2000, PJM Interconnection, LLC contacted staff of the Commodity
Futures Trading Commission (CFTC) in regard to a possible exemption
from the Commodity Exchange Act (CEA) for PJM's FTR market due to
similarities between FTRs and futures contracts. In addition, some
information has been supplied by PJM to the CFTC staff in the
intervening years. In order to address potential concerns with respect
to the authorities of the two agencies, section 3009 of the House
passed version of H.R. 4173 requires cooperation between them. Section
3009 specifies:
SEC. 3009. MEMORANDUM.
(a)(1) The Commodity Futures Trading Commission and the
Federal Energy Regulatory Commission shall, not later than 180
days after the date of the enactment of this section, negotiate
a memorandum of understanding to establish procedures for--
(A) applying their respective authorities in a manner
so as to ensure effective and efficient regulation in
the public interest;
(B) resolving conflicts concerning overlapping
jurisdiction between the two agencies; and
(C) avoiding, to the extent possible, conflicting or
duplicative regulation.
(2) Such memorandum and any subsequent amendments to the
memorandum shall be promptly submitted to the appropriate
committees of Congress.
(b) The Commodity Futures Trading Commission and the Federal
Energy Regulatory Commission shall, not later than 180 days
after the date of the enactment of this section, negotiate a
memorandum of understanding to share information that may be
requested where either Commission is conducting an
investigation into potential manipulation, fraud, or market
power abuse in markets subject to such Commission's regulation
or oversight. Shared information shall remain subject to the
same restrictions on disclosure applicable to the Commission
initially holding the information.
Question 2. Does the CFTC believe it should be regulating FERC-
approved instruments or products offered by public utilities that are
not members of an RTO or ISO? If so, which instruments or products and
why?
Answer. The CFTC is not reviewing FERC-approved instruments or
products that are offered by public utilities that are not members of
an RTO or ISO.
Question 3. Does the definition of swaps or futures contained in
H.R. 4173, if enacted, require the CFTC to regulate any FERC-approved
instruments or products other than FTRs?
Answer. H.R. 4173, the Wall Street Reform and Consumer Protection
Act of 2009, provides for the regulation of the previously unregulated
Over-The-Counter (OTC) derivatives market including establishing
requirements for OTC dealers, requiring centralized clearing where
appropriate and providing for increased transparency of the OTC market.
Section 3009 of H.R. 4173 as passed by the House, preserves the
jurisdiction of both FERC and the CFTC.
Question 4. As was discussed at the March 9th hearing, FERC and the
CFTC are charged with different missions. The standard the CFTC applies
in its regulation addresses the orderly functioning of markets that are
not manipulated. Unlike FERC, the CFTC does not have the authority to
examine the reasonableness of rates. How would the CFTC apply its
mission to the markets for FTRs or other products offered pursuant to
RTO and ISO tariffs? Has the CFTC analyzed how a shift in the
regulatory objective would affect FTR markets and how that could
ultimately affect ratepayers?
Answer. The CFTC's mission is to protect market users and the
public from fraud, manipulation, and abusive practices related to the
sale of commodity and financial futures and options, and to foster
open, competitive, and financially sound futures and option markets. In
pursuing its mission the CFTC routinely cooperates with other agencies
that have jurisdiction over cash markets for the underlying
commodities. Such agencies include the Department of Agriculture, the
Securities and Exchange Commission, the Department of the Treasury, the
Federal Reserve Board, the Department of Energy, and FERC. In fact, the
CFTC and the FERC currently have a formal memorandum of understanding
(MOU) regarding the sharing of information and the confidential
treatment of proprietary energy trading data.
The CFTC recognizes FERC's authority and responsibility to assure
that consumers pay just and reasonable electricity rates and has no
intention of infringing on FERC's rate setting role.
Question 5. In his testimony, Vincent Duane from PJM
interconnection stated that the FTR is inextricably linked to
locational priced energy markets. How could FERC and the CFTC fulfill
their respective missions if they individually regulate, according to
different standards, two ``inextricably linked'' products?
Answer. Though the CFTC has exclusive jurisdiction over the futures
markets, it coexists and routinely cooperates with other agencies that
have jurisdiction over cash markets for underlying commodities. While
the missions of the two agencies are not identical, any differences can
be resolved The two agencies currently have Memoranda of Understanding
in place to formalize our relationship. In addition, Congress has
provided the CFTC with broad exemptive authority which can be used to
provide regulatory clarity where appropriate and in the public
interest.
Question 6. The CFTC is working with Congress to bring
comprehensive regulation to the over-the-counter derivatives
marketplace. Chairman Gensler has stated that regulatory reform should
ensure that clearable swaps are submitted to and settled through
central clearinghouses. How does the CFTC define ``clearable swaps''?
Answer. Clearable swaps are those sufficiently standardized to
allow clearing. The House of Representatives addressed the issue of
which swaps should be cleared in Section 3103(j) of H.R. 4173, the Wall
Street Reform and Consumer Protection Act of 2009, by providing that,
in general, a swap should be cleared if a clearing house accepts it for
clearing and the CFTC has determined that the swap is required to
cleared, by taking into account:
`(I) The existence of significant outstanding notional
exposures, trading liquidity and adequate pricing data.
`(II) The availability of rule framework, capacity,
operational expertise and resources, and credit support
infrastructure to clear the contract on terms that are
consistent with the material terms and trading conventions on
which the contract is then traded.
`(III) The effect on the mitigation of systemic risk, taking
into account the size of the market for such contract and the
resources of the derivatives clearing organization available to
clear the contract.
`(IV) The effect on competition, including appropriate fees
and charges applied to clearing.
`(V) The existence of reasonable legal certainty in the event
of the insolvency of the relevant derivatives clearing
organization or 1 or more of its clearing members with regard
to the treatment of customer and swap counterparty positions,
funds, and property.
The Senate-passed bill includes similar standards.
Question 7. There are several key attributes of FTRs:
a. The supply of FTRs is finite, limited by the physical
characteristics of the transmission system.
b. Before any FTRs are sold in an auction, RTOs and ISOs
allocate a certain number of FTRs to load serving entities
(LSEs)
c. The period of time between auctions can be quite long
Do these attributes, individually or in some combination,
distinguish FTR markets from commodity markets currently regulated by
the CFTC? If yes, can the CFTC identify how it might regulate markets
with such attributes? Is the CFTC prepared to regulate such markets?
Answer. While each futures market the CFTC regulates and its
underlying cash market are in some way distinctive, the CFTC has
neither taken a position on how FTRs should be regulated, nor sought to
regulate them.
Question 8. Given the long periods of time between auctions for
FTRs, how could any clearing entity mark positions to a reliable and
transparent market price?
Answer. In a response to an invitation from FERC Chairman
Wellinghoff to the CFTC to comment on the FERC Notice of Proposed
Rulemaking on Credit Reforms in Organized Wholesale Electric Markets
(FERC NPRM), on March 29, 2010, the CFTC staff of its Division of
Clearing and Intermediary Oversight addressed this issue in footnote
11:
In general, commodity futures and options markets operate
continuously, thus providing reliable pricing for frequent
settlements. Staff understands that FTR markets operate less
continuously, with auctions occurring at, e.g., monthly
intervals. Staff believes that it would be best practice for
each RTO or ISO to operate daily FTR auctions, which would
produce the most accurate pricing. However, staff understands
that, due to the nodal nature of FTRs, such daily auctions may
be subject to liquidity challenges. [citation omitted]
Therefore, staff recommends that each RTO or ISO be permitted
to mark FTR positions to models, provided that such models are
externally validated. Another alternative may be for each RTO
or ISO to mark FTR positions to quotes from the secondary
(i.e., bilateral) FTR markets. However, the feasibility of such
alternative depends on the depth and liquidity of such
secondary FTR markets.
Question 9. Individual FTRs are defined according to two specific
points on the transmission system: a source point (e.g. generator) and
a sink point (e.g. load location). According to PJM there over 60
million possible transmission paths that could define individual FTRs.
Does the CFTC believe that an FTR defined by a particular source-sink
combination is distinct from an FTR with a different source-sink
combination, assuming they cover identical periods of time? Are these
FTRs fungible (e.g., could they be netted against one another in the
clearing process)? Why?
Answer. The CFTC has not taken a position on the defining
characteristics of FTRs or whether or not one FTR position could be
used to offset another.
Question 10. Has the CFTC analyzed how ratepayers would be affected
if 1) FTRs with different source-sink combinations were deemed to be
distinct and 2) FTR markets were subject to clearing requirements?
Answer. No.
Question 11. In January of this year, FERC issued a Notice of
Proposed Rulemaking that would require participants to submit cash
collateral to the RTOs to participate in the FTR markets. How does this
proposal compare to the regulatory regime that would result from the
CFTC finding that FTRs are subject to its jurisdiction?
Answer. The CFTC has not considered what type of regulatory regime
would result from a CFTC finding that FTRs are subject to its
jurisdiction as the CFTC has not taken a position on whether FTRs are
subject to its jurisdiction. As stated in the answer to question number
9, Chairman Wellinghoff invited the CFTC to comment on the FERC NPRM
and staff of the CFTC's Division of Clearing and Intermediary Oversight
did so on March 29, 2010. A copy of the comment letter is included is
an attachment.
As page 4 of the comment letter states, ``[s]taff fully supports
FERC's proposals to require each RTO or ISO.to eliminate unsecured
credit in FTR markets. . .''.
Responses of Gary Gensler to Questions From Senator Murkowski
Question 1. Is there currently a regulatory gap we're trying to
plug for electricity market mechanisms like Financial Transmission
Rights? Aren't FTRs already regulated by FERC through its review and
approval of RTO tariffs?
Answer. In 2008 the financial regulatory system failed the American
public. We must now do all we can to ensure that it does not happen
again. While more than a year has passed and the system appears to have
stabilized, we cannot relent in our mission to vigorously address
weaknesses and gaps in our regulatory structure. One of the most
significant gaps is the lack of oversight of the OTC derivatives
market. As I stated in my written testimony, ``wholesale statutory
exemptions preventing the application of any CFTC regulation--including
the regulation of futures contracts, swaps contracts, clearing or
exchange trading--for any instrument or market that is regulated by the
FERC undermine the effectiveness of comprehensive reform. Congress
should avoid any bright-line exemption that runs the risk of creating
the next regulatory loophole.''...
``History demonstrates that bright-line statutory exemptions or
exclusions granted at one point in time can have unintended
consequences and often fail to adequately account for subsequent
developments. Markets evolve rapidly. What may seem like a carefully
crafted exclusion today can become a significant and problem-filled
loophole tomorrow. When the Enron loophole was included in statute in
2000, electronic trading facilities were in their infancy. By the time
Congress addressed the loophole as part of the Farm Bill in 2008, the
unregulated electronic trading of natural gas swaps was on a par with
the trading of natural gas futures on the regulated market.'' Congress
can assure comprehensive regulation of the derivative market and should
address concerns of overlap by providing regulatory agencies with
flexibility such as implimentive authority.
Question 2. According to former FERC Chairman Joe Kelliher, who is
testifying today on the second panel, energy providers do not pose a
systemic risk to the broader economy. Instead, the entire commodities
market is less than 1 percent of the global OTC derivatives markets,
and the energy commodity portion is yet a fraction of that one percent.
Do you agree that these electricity market instruments do not pose
the kind of systemic risk Congress is trying to address in financial
reform regulation? If so, isn't this a good case for striking a
reasonable balance.
Answer. As mentioned above, the CFTC has neither taken a position
on how FTRs should be regulated, nor sought to regulate them. I do not
believe it is appropriate to carve out from regulation any particular
financial instrument. The agencies can strike a reasonable balance and
modify that balance to take into account evolving changes in the
marketplace without requiring Congress to adopt changing legislation
over the years. In fact, Congress has provided the agencies with
adequate tools to work cooperatively. The CEA provides the CFTC with
authority to exempt instruments and markets from its regulations if it
is determined to be in the public interest to do so. OTC derivatives
reform should extend this exemptive authority with the CFTC's oversight
of the swaps market. Any potential overlaps in oversight can be
addressed through memoranda of understanding and other cooperative
working relationships between the two agencies. Pending legislation
also should maintain the FERC's anti-manipulation enforcement
authorities under Section 222 of the Federal Power Act and Section 4A
of the Natural Gas Act.
Question 3. There's a concern that under the new financial reform
legislation the RTOs and ISOs themselves could become subject to the
CFTC's jurisdiction as ``derivative clearing organizations.'' Is that
appropriate? If RTOs were subject to the CFTC's exclusive jurisdiction,
what additional rules and regulations would be required?
Answer. The CFTC has not taken a position on whether RTOs and ISOs
are or would become subject to CFTC jurisdiction as derivatives
clearing organizations. As passed by the House, Section 3102(a) of H.R.
4173, the Wall Street Reform and Consumer Protection Act of 2009, fully
preserves FERC's authority over RTOs and ISOs:
`(H)(i) Nothing in this Act shall limit or affect any
statutory authority of the Federal Energy Regulatory Commission
with respect to an agreement, contract, or transaction that
is--
`(I) not executed, traded, or cleared on a registered
entity or trading facility; and
`(II) entered into pursuant to a tariff or rate
schedule approved by the Federal Energy Regulatory
Commission.
Question 4. Chairman Gensler, you testified that standardized
derivatives should be cleared and exchange traded. Do you believe that
FTRs traded through an RTO are ``standardized''? If you do, does this
mean that in your opinion the CFTC should determine that FTRs are
``requirements to be cleared''? Pursuant to the House passed
legislation, H.R. 4173, would you consider FTRs to be ``swaps''?
Answer. The CFTC has not taken a position on whether FTRs are swaps
under H.R. 4173, the Wall Street Reform and Consumer Protection Act of
2009. Additionally, The CFTC has not taken a position on the defining
characteristics of FTRs.
Question 5. Do you believe that advanced sales of power--whether in
the organized wholesale markets or the traditional bilateral ones--are
``futures'' transactions that would subject them to the CFTC's
exclusive jurisdiction? Would you consider them ``swaps''?
Answer. Forward contracts, that is, cash contracts where shipment
or delivery is deferred for commercial convenience or necessity, have
been excluded from federal regulation of futures transactions since
1922.
Question 6. Please describe the additional rules and regulations
that will result from the CFTC's oversight of FTR products--in
particular the cash collateral and margin requirements. Has the CFTC
examined the impact on customers of requiring energy end-users to clear
OTC derivatives?
Answer. As mentioned above, the CFTC has neither taken a position
on how FTRs should be regulated, nor sought to regulate them. The CFTC
staff has not examined the impact on customers of requiring energy end-
users, or other end-users, to clear OTC derivatives. Central clearing
of as many OTC derivatives as possible is desirable to improve
financial integrity and inter-connectiveness of the OTC market.
With respect to OTC derivatives, as stated in my written testimony:
``Some corporations have expressed concerns regarding posting
the collateral required to clear a contract. While this is a
legitimate public policy debate, I believe that the public is
best served by lowering risk to the system as a whole. An
exemption from clearing for this large class of transactions
would allow dealers to keep significant risk on their books--
risk that could reverberate throughout the entire financial
system if a bank fails. Further, it is not clear that posting
collateral necessarily increases costs to end users, since
dealers charge corporations for credit extensions when the
corporations do not post margin.'' I would further add that,
although it is not certain that posting collateral would
necessarily increase costs to end users, it is certain that
requiring dealers to post collateral would protect end users
and their customers. Bringing OTC transactions into clearing
would impose collateral requirements on dealers. Credit
requirements are used to protect participants from the effects
of defaults by other participants.
Question 7. Does the CFTC view electricity as a necessary
commodity?
Answer. Yes.
Question 8. Shouldn't FERC's regulatory priorities be afforded some
deference?
Answer. Yes. The FERC oversees important aspects of the energy
markets, including monitoring natural gas pipelines and regulating for
just and reasonable wholesale electricity rates and interstate
transmission service of electricity, while the CFTC oversees futures
markets and certain electronic trading facilities for natural gas and
electricity derivatives. As stated above in answer to question two, the
Congress has provided the CFTC and the FERC with the authorities
necessary to coexist and cooperate in the public interest and both
agencies have done so over the years. Further directives to the two
agencies are contained in Section 3009 of H.R. 4173, the Wall Street
Reform and Consumer Protection Act of 2009, as passed by the House of
Representatives.
Question 9. Does the CFTC believe it has the authority to regulate
wholesale electricity markets and transactions that are already subject
to a FERC-approved tariff?
Answer. The CFTC oversees the futures markets in electricity and
natural gas whether they trade on NYMEX or the Nodal Exchange or the
IntercontinentalExchange. We regulate futures exchanges,
clearinghouses, other intermediaries to ensure the markets work
efficiently, there's integrity to markets and they're free of fraud,
manipulation.
Responses of Gary Gensler to Questions From Senator Stabenow
Question 1. The House bill directs FERC and the CFTC to create
memorandum of understanding for the process of sharing information to
avoid duplicative regulation. It also gives the CFTC the authority to
exempt FTRs from its regulation only if the CFTC determines that the
``exemption would be consistent with public interest.'' It directs the
CFTC to ``not unreasonably deny any request made by the Federal Energy
Regulatory Commission for such an exemption.''
Answer. Yes, that is correct and the CFTC historically as the
derivatives regulator has cooperated with other agencies with
jurisdiction over underlying commodities.
Question 2. If this provision were to pass into law and the
agencies could not agree on an MOU in a timely manner or a lack of
clarity in the jurisdiction remained, I am concerned this may affect
energy prices. In a state like Michigan our manufacturers and
households cannot afford undue burdens like this and I am worried
uncertainty leads to an increase in prices. Do you agree with this and
if so do you think that keeping energy costs low via energy markets
qualifies as within the ``public interest''?
Answer. I believe the two agencies will be able to reach an
agreement in a timely manner Congress directed that the CFTC and the
FERC complete an earlier MOU on the sharing of confidential information
within six months of the Energy Policy Act's August 8, 2005, effective
date. That MOU was signed on October 12, 2005--well in advance of the
deadline. At the time, the CFTC Chairman said, ``This MOU will result
in a more effective and efficient working relationship with FERC. It
will enable both agencies to work actively to assure the price
integrity of the markets for natural gas and other energy products.''
The FERC Chairman said, ``The fact that we have this agreement with the
CFTC four months ahead of schedule is a clear sign of the enhanced
cooperation and coordination between our two agencies. This means the
agreement is in place well before the winter heating season, when
already stressed energy prices will require vigilance. This agreement
will contribute to better coordination of enforcement.''
Question 3. During his testimony, Mr. Gensler pointed to the
Amaranth case as a good example of the two agencies working together.
Please describe the situation, each agency's role and if there is
anything you would do differently.
Answer. The CFTC believes it appropriate to refrain from commenting
in detail on the Amaranth matter while it is still being litigated by
FERC.
Question 4. Please share your views on whether the mandatory
reporting of energy commodity contracts to regulated swap or derivative
repositories is a regulatory solution that would meet the public policy
goals of increasing market transparency, mitigating systemic risk, and
providing price transparency, without hindering the ability for end-
users to hedge their commercial risk or increasing costs to consumers.
Answer. Bringing transparency to the over-the-counter derivatives
marketplace would lower costs by implementing a more efficient and
publicly available price discovery process. Trade reporting is an
important first step toward an increase in transparency. To promote
public transparency, standard over-the-counter derivatives should be
traded on exchanges or other trading platforms. The more transparent a
marketplace, the more liquid it is, the more competitive it is, then
the lower will be the costs for companies that use derivatives to hedge
risk. Transparency brings better pricing and lowers risk for all
parties to a derivatives transaction. During the financial crisis, Wall
Street and the Federal Government had no price reference for particular
assets--assets that we began to call ``toxic.'' Financial reform will
be incomplete if we do not achieve public market transparency.
Appendix II
Additional Material Submitted for the Record
----------
Statement of Michael E. Boyd, President, Californians for Renewable
Energy, Inc. (CARE)
Chairman Bingaman, Ranking Member Murkowski and members of the
Committee in behalf of energy and natural gas ratepayers in the West I
would like to thank you for an opportunity to provide rebuttal
testimony to the testimony provided to you by the current Chairman of
the Federal Energy Regulatory Commission (FERC), Wellinghoff, and the
former FERC Chairman, Kelliher, regarding the regulation of over-the-
counter (OTC) derivatives, particularly with respect to energy markets.
I am pleased to testify in support of the Commodity Futures Trading
Commission Chairman Gary Gensler testimony. I would like ask 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.
CARE was the first consumer, environmental, and social-justice,
non-profit (IRS 501(c)(3) Tax Exempt) corporation to blow the whistle
on energy market manipulation by the likes of Enron, in our October 6,
2000 complaint to the FERC under Docket EL01-2 et al. alleging the
rolling blackouts in the San Francisco Bay Area on June 14th and 15th
2000 where contrived by energy producers in concert with the California
Independent System Operator Board of Governors to drive up prices and
justify construction of more fossil-fuel burning power plants in
California. CARE will not give up on the return of seventy one billion
dollars in overcharges by power generators public and private, and
cancellation of forty three billion dollars in long-term energy
contracts negotiated by Governor Davis in secret that resulted from
these, and other market manipulations.
CARE is a party and an active participant in those proceedings
related to the 2000-1 western energy crisis. The FERC decisions
addressing the 2000-1 western energy crisis did not hold hearings
settlement negotiations or other proceedings that included 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.
shifting jurisdiction over energy markets from ferc to the cftc could
impair ferc's ability to protect consumers from excessive energy rates
is nonsense
The Commodity Futures Trading Commission (CFTC) regulates certain
financial derivatives under existing law, and would regulate additional
financial derivatives under H.R. 4173, the Wall Street Reform and
Consumer Protection Act of 2009 includes some energy derivatives
(futures).
Chairman Wellinghoff would have the Committee believe the FERC and
the CFTC have different missions claiming ``FERC is a rate regulator
and ensures that rates charged to energy customers are just and
reasonable. FERC also approves and enforces electric reliability
standards. The CFTC seeks to ensure that markets generally operate
fairly and orderly, but has neither the authority nor the expertise to
ensure the reasonableness of rates or oversee reliability of energy
supplies. Shifting jurisdiction over energy markets from FERC to the
CFTC could impair FERC's ability to protect consumers from excessive
energy rates, an especially important consideration during a recession.
Similarly, expanding the CFTC's authority in FERC-regulated markets
could limit FERC's ability to police against market manipulation in
energy markets. [SIC]'' [FERC Testimony at 1]
This is nonsense and the Committee needs to look no further than to
what FERC has done in its handling of the 2000-1 western energy crisis
and the recovery of refunds (or lack thereof) for overcharges of
seventy one billion dollars to California energy ratepayers alone not
including those overcharged in the rest of the western United States to
see FERC does not serve consumers' interests.
On October 6, 2000 CARE filed its FERC Complaint in Docket EL01-2
et al. against Independent Energy Producers, Inc. and All Sellers of
Energy and Ancillary Services Into the Energy and Ancillary Services
Markets Operated by the California Independent System Operator
Corporation and the California Power Exchange; All Scheduling
Coordinators Acting On behalf of the Above Sellers; California
Independent System Operator Corporation; and California Power Exchange
Corporation wherein I asked the ``Commission to rectify unjust and
unreasonable prices stemming from the wholesale markets for energy and
ancillary services operated by the California Independent System
Operator (CAISO) and the California Power Exchange (CalPX). CARE
requests that the Commission find that wholesale markets in California
are not currently workably competitive. . .''
Essentially FERC told me to shut-up and go away and electricity
customers where not welcome at the FERC. But I didn't, because
initially FERC had listed my complaint EL01-2 along with the San Diego
Gas and Electric's (SDG&E's) complaint filed under Docket EL00-95 et
al. now called the Refund proceedings which are still pending before
the FERC and in which CARE is a Party.
The disdain for which FERC has shown ratepayers is legendary;
besides the fact that FERC failed to address the loss of ten lives as a
direct result of the rolling blackouts in the San Francisco Bay Area on
June 14th and 15th 2000 contrived by energy producers in concert with
the CAISO Board of Governors, the FERC issued its April 19, 2007 Order
Dismissing Complaint (119 FERC 61,058\1\) minimizing the impacts of
market manipulation as the cause of the energy crisis by stating it was
the result of a confluence of factors:
---------------------------------------------------------------------------
\1\ See http://elibrary.ferc.gov/idmws/common/
opennat.asp?fileID=11313181
First, it is now well accepted that the 2000-2001 energy
crisis in the West was the result of a confluence of factors.
These factors included: flawed market rules; inadequate
addition of generating facilities in the preceding years; a
drop in available hydropower due to drought conditions; a
rupture of a major pipeline supplying natural gas into
California; strong growth in the economy and in electricity
demand; unusually high temperatures; an increase in unplanned
outages of extremely old generating facilities; and market
manipulation.\2\ This was not a situation in which one or a few
factors stressed the market; rather, it was an unprecedented
situation in which numerous adverse events occurred
simultaneously to place California and the entire West in an
electricity crisis that had never before been experienced. [119
FERC 61,058 para 30 p. 9]
---------------------------------------------------------------------------
\2\ San Diego Gas & Electric Co. v. Sellers of Energy and Ancillary
Serv., 93 FERC 61,121(2000); San Diego Gas & Electric Co. v. Sellers
of Energy and Ancillary Serv., 102 FERC 61,317(2003).
In the seminal US Supreme Court Decision in Morgan Stanley Capital
Group v. Snohomish County Washington Public Utility District No. 1, 06-
1457\3\ the US Supreme Court focused on this minimalist ``confluence of
factors'' argument by the FERC by asking the federal courts and the
FERC to take another look at the terms of long-term wholesale energy
contracts several Western utilities signed during the 2000-1 energy
crisis. In the 5-2 opinion, the high court said FERC acted within its
authority to, in a balanced analysis, determine reasonable wholesale
power rates but made mistakes in its regulatory review. Under the
ruling both the Ninth Circuit and FERC must review how conclusions were
reached.
---------------------------------------------------------------------------
\3\ See http://www.supremecourtus.gov/opinions/07pdf/06-1457.pdf
---------------------------------------------------------------------------
The Court noted at page 11 FERC's diminutive Order 119 FERC
61,058:
That diminishment of the role of long-term contracts in the
California electricity market turned out to be one of the seeds
of an energy crisis. In the summer of 2000, the price of
electricity in the CalPX's spot market jumped dramatically--
more than fifteenfold. See ibid. The increase was the result of
a combination of natural, economic, and regulatory factors:
`flawed market rules; inadequate addition of generating
facilities in the preceding years; a drop in available
hydropower due to drought conditions; a rupture of a major
pipeline supplying natural gas into California; strong growth
in the economy and in electricity demand; unusually high
temperatures; an increase in unplanned outages of extremely old
generating facilities; and market manipulation.' CAlifornians
for Renewable Energy, Inc. v. Sellers of Energy and Ancillary
Servs., 119 FERC 61,058, pp. 61,243, 61,246 (2007).
The case involves the terms of numerous power contracts purchased
by utilities in California, Nevada and Washington State when energy
markets were in turmoil. At issue in the appeals were long-term
agreements that provided power at prices set during chaos in the spot
electricity markets. After the crisis subsided, the utilities decided
the contracts were set at unreasonably high prices that violated
federal law.
But the Commission, which oversees wholesale electricity prices,
declined to order changes in the contracts. Justice Antonin Scalia, in
the majority opinion, said FERC must engage in a thorough review when
it oversees wholesale power contracts.
`Balancing the short-term and long-term interests of
consumers entails difficult judgment calls, and to the extent
FERC actually engages in this balancing, its reasoned
determination is entitled to deference,' Justice Scalia wrote.
`But FERC cannot abdicate its statutory responsibility to
ensure just and reasonable rates through the expedient of a
heavy-handed presumption.'
According to FERC Chairman Wellinghoff ``Congress has recognized
FERC's role in ensuring that FTRs help protect utilities and their
customers from increases in the cost of transmission service. As noted
above, Congress in 2005 enacted Federal Power Act section 217,
requiring FERC to use its authority in a way that enables load-serving
entities to secure FTRs on a long-term basis for long-term power supply
arrangements made to meet their customer needs. . .Moreover, Congress
has indicated that RTOs and ISOs should be regulated exclusively by
FERC. When Congress enacted the Food, Conservation, and Energy Act of
2008 and addressed the regulatory gap known as the `Enron loophole,' by
giving the CFTC authority over ``significant price discovery contracts
[SPDCs],'' the Conference Report stated (on page 986) that `[i]t is the
Managers' intent that this provision [on SPDCs] not affect FERC
authority over the activities of regional transmission organizations or
independent system operators because such activities are not conducted
in reliance on section 2(h)(3) [of the Commodity Exchange Act].'''
[FERC Testimony at 6 to 7]
The Commission's current ISO/RTO governance processes effectively
disenfranchise customers by treating them as a second distinct class
while at the same time giving so-called ``stakeholders'' both
Commission jurisdictional and non-jurisdictional market participants'
control of the ISO/RTO in the very markets that are supposed to
regulate them. There exists a revolving door between the regulated and
the regulators\4\ under the current ISO/RTO governance structures,
since customers exercise no oversight over these markets to insure
their governing boards protect the customer's and publics' interests
before those of market participants' commercial interests they are
supposed to regulate. An example of this is the California Independent
System Operator Corporation's (CAISO) current Board of Governors who
are the appointees of the California Governor; not one who lists any
experience representing any California customers.\5\
---------------------------------------------------------------------------
\4\ An example of this regulatory revolving door comes from former
FERC Chairman Kelliher whose March 9, 2010 testimony before the
Committee states ``I am Executive Vice President--Federal Regulatory
Affairs for FPL, Group, Inc. . . .FPL Group is on of the Nation's
largest electricity companies. . .''that shows the revolving door
between the FERC and FERC regulated entities like FPL.
\5\ See Executive Biography: Mason Willrich, Chair http://
www.caiso.com/2449/2449cdbd3b9c0.pdf Executive Biography: Laura Doll
http://www.caiso.com/2449/2449cec946570.pdf Executive Biography: Robert
Foster http://www.caiso.com/2756/27568ae926390.pdf Executive Biography:
Tom Habashi http://www.caiso.com/2756/27568b8f2d830.pdf Executive
Biography: Kristine Hafner, Ph.D. http://www.caiso.com/2449/
2449ce1d3d5d0.pdf
---------------------------------------------------------------------------
CARE objects to the California ISO's current governance, which
disenfranchises its purported non-profit beneficiaries, who are
electricity consumers, and ratepayers within the state of California.
CARE proposes the CAISO board be composed of five directors elected
at large by its general membership, whom are California's electricity
consumers and ratepayers. The individual receiving the highest number
of votes in the annual corporate election is recommended be designated
by the title of Independent System Operator, who shall act of the
corporation's, President of the Board, Chief Executive Officer, and
shall act as the official representative of its California membership,
in the FERC's other Regional Transmission Organization (RTO)s who are
governed in the same manner as CARE proposes here for CAISO. Universal
ratepayer suffrage is the key to workably competitive wholesale markets
and providing open access to transmission services on a non-
discriminatory basis.
CARE proposes that any ratepayer/consumer member of the ISO/RTO
receiving fifty qualified member signatures on a nomination petition
not less than ninety days prior to the corporate election be qualified
as a nominee for election to the ISO/RTO board of directors. Such
candidate shall be entitled to a statement of not more than 500 words,
free of charge, which shall be delivered along with the official mail
ballot. CARE proposes that such election take place by mail ballot
delivered as part of the ratepayer/consumer electric utility bill, with
a thirty-day polling period for return of ballots in a self addressed
postage-paid envelope. Such ballots are recommended be addressed to the
appropriate Secretary of State, who is statutorily entrusted to insure
the fairness and impartiality of the corporate election process. The
tallying of the ballots must be open to the members and their corporate
director candidates to insure such impartiality.
CARE views the transmission system as one big integrated
transportation service that provides services locally, statewide, on
the national and international basis much like Greyhound's passenger
bus service. But unlike Greyhound this transportation service is for
electricity instead of passengers. Like Greyhound's passenger bus
service transmission services must be provided on a non-discriminatory
basis, and in so doing insure that the regulation adopted protects the
public's interest over the commercial interests of the provider of
services. The Congress for example wouldn't want to put the KKK in
charge of the seating arrangement for Greyhound buses. Likewise the
Congress shouldn't put market participants in charge of the regulated
markets under the FERC's jurisdiction if they ever want to eliminate
discrimination in those markets.
the ferc gives too great a deference to state utility commissions
Also according to FERC Chairman Wellinghoff; ``State regulators
support FERC's jurisdiction in wholesale energy markets instead of a
shift of jurisdiction to the CFTC. Last month, the National Association
of Regulatory Utility Commissioners (NARUC) adopted a resolution
stating that FERC (and, within ERCOT, the state commission) ``should
continue to be the exclusive Federal regulator with authority to
oversee any agreement, contract, transaction, product, market mechanism
or service offered or provided pursuant to a tariff or rate schedule
filed and accepted by the FERC. . . .'' [FERC Testimony at 7]
The Commission also gives too great a deference to State utility
Commissions\6\ even when there is a clear conflict of interest between
their duty to protect the ratepayers from unjust and unreasonable rates
with their interests representing the state as a wholesale market
participant.
---------------------------------------------------------------------------
\6\ State regulatory authority
---------------------------------------------------------------------------
In the Order on rehearing, motion for conditions and compliance
filing re Duke Energy Trading and Marketing, L.L.C. et al under EL03-
152 et al., 126 FERC 61,234 (March 19, 2009), the Commission stated:
CARE cites to 16 U.S.C. Sec. 2602(5), which is a PURPA
provision, but our action here is pursuant to the FPA and not
PURPA. In any event, even if CARE's citation were relevant,
CARE is not the only ratepayer advocate. For example, the
California Public Utilities Commission (CPUC), which is one of
the California Parties, represents California ratepayers.[] We
find that the CPUC's participation in these proceedings belies
CARE's claim that ratepayers were excluded.[] [Footnotes not
provided]
CARE is currently challenging this finding before the US Court of
Appeals for the Ninth Circuit, Docket No. 09-71515. This finding
conflicts with the ``factual basis'' for the Commission's prior rulings
on this issue--viz, that the CPUC and CDWR are both agents and
representatives of the State of California--were not at issue or
disputed. See Pub. Utils. Comm'n of Cal. v. Sellers of Long Term
Contracts, 105 FERC 61,182 at 51 (2003) (``Complainants, like CDWR, are
agents of the State of California'').
Nor can it be disputed that the CPUC did not negotiate or sign
these DWR contracts. What remains at issue, in the remanded cases, is
the Commission's determination that the legal effect of these facts
under California law, is that the CPUC somehow ``stepped into the
shoes'' of CDWR and therefore must be considered a contracting party.
These facts have created the irreconcilable conflict between the
CPUC's roles as a ``State regulatory authority''\7\ to protect the
interests of ``electric consumer[s]'' with the California Energy
Resources Scheduling division of the California Department of Water
Resources (CERS) as an ``electric utility''. The terms ``electric
consumer'' and ``electric utility'' have the meanings given those terms
in section 2602 of title 16.\8\ Therefore, CARE's efforts are the only
direct ratepayer participation without the influence of their
conflicting role as a market participant.
---------------------------------------------------------------------------
\7\ Within the meaning given that term in section 796 (21) of title
16.
\8\ TITLE 42 CHAPTER 149 SUBCHAPTER XII Part E Sec. 16471 Sec.
16471. Consumer privacy and unfair trade practices (f) Definitions For
purposes of this section: (1) State regulatory authority The term
``State regulatory authority'' has the meaning given that term in
section 796 (21) of title 16. (2) Electric consumer and electric
utility The terms ``electric consumer'' and ``electric utility'' have
the meanings given those terms in section 2602 of title 16. TITLE 16
CHAPTER 46 Sec. 2602 Sec. 2602. Definitions As used in this Act,
except as otherwise specifically provided--(1) The term ``antitrust
laws'' includes the Sherman Antitrust Act (15 U.S.C. 1 and following),
the Clayton Act (15 U.S.C. 12 and following), the Federal Trade
Commission Act (15 U.S.C. 14[41] and following), the Wilson Tariff Act
(15 U.S.C. 8 and 9), and the Act of June 19, 1936, chapter 592 (15
U.S.C. 13, 13a, 13b, and 21A). (2) The term ``class'' means, with
respect to electric consumers, any group of such consumers who have
similar characteristics of electric energy use. (3) The term
``Commission'' means the Federal Energy Regulatory Commission. (4) The
term ``electric utility'' means any person, State agency, or Federal
agency, which sells electric energy. (5) The term ``electric consumer''
means any person, State agency, or Federal agency, to which electric
energy is sold other than for purposes of resale.
---------------------------------------------------------------------------
michael\9\ and the bottomless pit
---------------------------------------------------------------------------
\9\ Michael (the fifth angel) Michael (Hebrew, Greek, Latin,
Arabic) is an archangel, one of the principal 50 angels in Christian
and Islamic tradition. Tradition gives to St. Michael four offices: 1.
To fight against Satan. 2. To rescue the souls of the faithful from the
power of the enemy, especially at the hour of death. 3. To be the
champion of God's people, the Jews in the Old Law, the Christians in
the New Testament, the Islamic tradition in the Torah; therefore he was
the patron of the Church, and of the orders of knights during the
Middle Ages. 4. To call away from earth and bring men's souls to
judgment
---------------------------------------------------------------------------
A ``bottomless pit'' of unsecured debt was opened up worldwide when
the Congress allowed unregulated banks to be created in 2000 in the
Enron loophole. The ``Enron loophole'' exempted most over-the-counter
energy trades and trading on electronic energy commodity markets from
government regulation. The ``loophole'' is so-called as it was drafted
by Enron Corporation lobbyists working with U.S. Senator Phil Gramm (R-
TX) to create a deregulated market for their experimental ``Enron On-
line'' initiative.\10\The ``loophole'' was enacted in sections Sec.
2(h)(3) and (g) of the Commodity Exchange Act, 7 U.S.C. as a result of
the Commodity Futures Modernization Act of 2000, signed by U.S.
president Bill Clinton on December 21, 2000. It allowed for the
creation, for U.S. exchanges, of a new kind of derivative security, the
single-stock future, which had been prohibited since 1982 under the
Shad-Johnson Accord, a jurisdictional pact between John S. R. Shad,
then chairman of the U.S. Securities and Exchange Commission, and Phil
Johnson, then chairman of the Commodity Futures Trading Commission. On
June 22, 2008, then U.S. Senator Barack Obama proposed the repeal of
the ``Enron loophole'' as a means to curb speculation on skyrocketing
oil prices.\11\
---------------------------------------------------------------------------
\10\ Mother Jones, http://www.motherjones.com/politics/2008/05/
foreclosure-phil
\11\ ``Obama vows crackdown on energy speculators: McCain fires
back after Democrat tries to tie rival to 'Enron loophole'' Associated
Press 2008-06-22. http://www.msnbc.msn.com/id/25318274/
---------------------------------------------------------------------------
The bottomless pit opened up when these unregulated banks selling
over-the-counter (OTC) derivatives where created in the US by the
government enacting the Enron loophole. The ``Enron loophole'' exempted
most over-the-counter energy trades and trading on electronic energy
commodity markets from government regulation.\12\ The ``loophole'' is
so-called as it was drafted by Enron Corporation lobbyists working with
U.S. Senator Phil Gramm (R-TX) to create a deregulated market for their
experimental ``Enron On-line'' initiative.\13\ I've attached the check
I got from Enron to show you we are battling the Devil.
---------------------------------------------------------------------------
\12\ Jickling, Mark (2008-07-07). http://assets.opencrs.com/rpts/
RS22912_20080707.pdf
\13\ Davis, Trey (2005-01-07). http://
www.universityofcalifornia.edu/news/2005/jan07.html
---------------------------------------------------------------------------
My theory is that this bank in Switzerland holding all the futures
(derivatives) is the bottomless pit referred to in Revelations Chapter
9\14\ and 20\15\ and that it is the modern day equivalent of the Oracle
at Delphi that went away in 394 AD. It existed at the time of Jesus
Christ was born. I got this link from my buddy who is working for the
UN bank in Switzerland. If we could take these boys out we could change
the world. Will you help me to seal up the bottomless pit?
---------------------------------------------------------------------------
\14\ Rev 9:1 And the fifth angel sounded, and I saw a star fall
from heaven unto the earth: and to him was given the key of the
bottomless pit. Rev 9:11 And they had a king over them, which is the
angel of the bottomless pit, whose name in the Hebrew tongue is
Abaddon, but in the Greek tongue hath his name Apollyon.
\15\ Rev. 20:1-3 And I saw an angel come down from heaven, having
the key of the bottomless pit and a great chain in his hand. And he
laid hold on the dragon, that old serpent, which is the Devil, and
Satan, and bound him a thousand years, and cast him into the bottomless
pit, and shut him up, and set a seal upon him, that he should deceive
the nations no more.
---------------------------------------------------------------------------
I. Market developments in the first half of 2008
The notional amounts outstanding of over-the-counter (OTC)
derivatives continued to expand in the first half of 2008.
Notional amounts of all types of OTC contracts stood at $683.7
trillion at the end of June, 15% higher than six months before
(Table 1). Multilateral terminations of outstanding contracts
resulted in the first ever decline of 1% in the volume of
outstanding credit default swaps (CDS) since the first
publication of CDS statistics in December 2004. The average
growth rate for outstanding CDS contracts over the last three
years has been 45%. In contrast to CDS markets, markets for
interest rate derivatives and FX derivatives both recorded
significant growth. Open positions in interest rate derivatives
contracts rose by 17%, while those in FX contracts expanded by
12%. Gross market values, which measure the cost of replacing
all existing contracts and are thus a better gauge of market
risk than notional amounts, increased by 29% to $20.4 trillion
at the end of June 2008.
good job
In order for Satan to be bound by Michael's great chain all the
futures (derivatives) must be unwound and all the underlying assets
they are derived from must be revalued to eliminate this false debt so
Satan that he should deceive the nations no more.
I e-mailed you and faxed each member of Congress, the Senate, and
the President in the middle of February 2009 about the presence of the
bottomless pit which when I sounded the pit was at $683.7 trillion at
the end of June 2008. See http://www.bis.org/publ/
otc_hy0811.pdf?noframes=1 at page 5
The Bottomless Pit has declined around 90 trillion dollars at the
end of June 2009 now it is at $592 trillion, see http://www.bis.org/
publ/qtrpdf/r_qt0909.pdf at page 45. This decline is attributed to a
fear of further regulation of futures (derivatives). You have a duty to
America and the world economies to seal the pit.
Here is an explanation of what a credit default swap is (***note
the Revelations chain is a Ponzi scheme). http://en.wikipedia.org/wiki/
Credit_default_swap
Essentially these unregulated banks own the world's economies and
there are no real assets backing any of this debt, so therefore; the
bottomless pit. Everyone on the planet could work for the rest of their
lives for the next 100 years and we still wouldn't pay off this debt--
clearly this is the bottomless pit referred to in Revelations.
An unregulated futures market is nothing new however; for around
one thousand eight hundred years it was called the Oracle at Delphi.
Around 1400 BCE a goat herder noticed his sheep acted strange after
peering into a particular chasm on Mount Parnassus. He looked in and
found himself ``agitated like one frantic''. At least that is how the
legend goes on the humble beginnings of the Oracle at Delphi.
The effects of the brain altering vapors, Ruins were ultimately
attributed to a divine source. Other people began inhaling the vapors
so that they could prophesy. But the gas was so disorienting some fell
into the cavern and were lost. So a tripod was built and an individual
was appointed to sit over the chasm and prophesy. Originally, the
perfect candidate was considered to be a young virgin girl. But after
one of the virgins escaped with a young Thessalian it was decreed no
prophetess (also called the Pythoness or the Pythia) would be appointed
under 50 years of age. A booming industry grew up around the Oracle.
Temples were built and rebuilt, priests were trained, rituals evolved
and sacrifices were performed. Priests interpreted the incoherent
utterances of the Pythia. Presents were brought to both placate the
deity and in the hope of influencing a positive prophesy. The Delphic
temple itself became one of the largest ``banks'' in the world. Delphi
became a center for banking and commerce.
The divine nature and associated deity changed a few times over the
course of several centuries. When the profits of the Oracle began to
decline it was declared that Poseidon was speaking through her. Later
this changed to the goddess Themis and, finally, Apollo was determined
to be presiding over Delphi. For over a millennia people traveled to
the hill to consult the Oracle. Farmers consulted the Oracle on matters
as simple as planting and harvest. Famous world leaders consulted on
matters of conquest. Sophocles, Alexander the Great, and Croesus of
Lydia all consulted the Oracle at one time or another.
The priests' interpretations may have been more coherent than the
Pythoness but they generally remained cryptic and ambiguous. Croesus
for example donated a fortune to the oracle to find out if he should
invade a neighboring country. He was told ``If you go to war you will
cause the destruction of a great empire''. He went to war and not only
was defeated but was captured. He sent word to the Oracle asking why he
was misled. The word came back that he wasn't misled, he had been told
that there would be the destruction of a great empire and there was--
his. The world famous Oracle of Delphi played an influential role in
ancient history. For fourteen centuries it helped determine the course
of empires. The prophesying was abolished in the 4th century as it
conflicted with Christian beliefs that were at that time being embraced
by Rome.
Fast forward sixteen hundred and sixteen years to March 9, 2010
Commodity Futures Trading Commission Chairman Gary Gensler testimony:
``Nearly 60 years after the futures markets were regulated, the first
OTC swap was transacted in 1981. During its early years, the OTC
marketplace was highly tailored to meet specific risk management needs.
Contracts were negotiated between dealers and their corporate customers
seeking to hedge specific financial risks. In contrast to the regulated
futures markets, these early OTC derivatives were not traded on
exchanges. Instead, OTC derivatives were transacted bilaterally, with
dealers standing between their various customers. In this market
structure, dealers keep transactions on their books, leaving the
financial institutions more interconnected with all of their customers
and limiting the amount of relevant pricing information available to
the public.
In the last three decades, the over-the-counter derivatives
marketplace has grown up, but it remains largely unregulated. Since the
1980s, the notional value of the market has ballooned from less than $1
trillion to approximately $300 trillion in the United States--that's
$20 in derivatives for every dollar of goods and services produced in
the American economy. The contracts have become much more standardized,
and rapid advances in technology--particularly in the last ten years--
now can facilitate transparent trading of much of this market on
electronic platforms. While so much of this marketplace has changed
significantly, the constant that remains is that it is largely
unregulated and still dealer dominated.
It is now time to bring comprehensive regulation to this large and
economically significant market. In well functioning markets,
derivatives are meant to mitigate and help manage risk in the economy.
Even if not for the 2008 financial crisis, this market should be
regulated to achieve these goals. The financial crisis only highlights
this in dramatically revealing how unregulated OTC derivatives and
their dealers actually can heighten and concentrate risk to the great
detriment of the American public. The need for broad based reform is
the ultimate lesson of AIG and the broader risks brought about by the
unregulated OTC derivatives market.''
conclusion
Please help me to seal the bottomless pit by giving CFTC authority
to regulate energy futures (derivatives) and their clearing houses like
ISOs and RTOs. Universal ratepayer suffrage is the key to workably
competitive wholesale markets and providing open access to transmission
services on a non-discriminatory basis.
______
Statement of the American Public Power Association (APPA)
The American Public Power Association (APPA) appreciates the
opportunity to provide the following statement for the record for the
Senate Energy and Natural Resources Committee's hearing on financial
transmission rights (FTRs) and we would like to endorse the testimony
given by Mr. Michael Henderson, representing the Arkansas rural
electric cooperatives.
APPA represents the interests of more than 2,000 publicly-owned
electric utility systems across the country, serving approximately 45
million Americans. APPA member utilities include not-for-profit state
public power agencies and municipal electric utilities that serve some
of the nation's largest cities. However, the vast majority of these
publicly-owned electric utilities serve small and medium-sized
communities in 49 states, all but Hawaii. In fact, 70 percent of our
member systems serve communities with populations of 10,000 people or
less.
Overall, public power systems' primary purpose is to provide
reliable, efficient service to their local customers at the lowest
possible cost, consistent with good environmental stewardship. Like
hospitals, public schools, police and fire departments, and publicly-
owned water and waste-water utilities, public power systems are locally
created governmental institutions that address a basic community need:
they operate on a not-for-profit basis to provide an essential public
service, reliably and efficiently, at a reasonable price.
As the Senate continues its work in drafting legislation to
regulate over-the-counter derivatives markets, we urge Congress to use
caution to avoid creating duplicative authorities between the Commodity
Futures Trading Commission (CFTC) and the Federal Energy Regulatory
Commission (FERC) over the aspects of power supply and transmission
markets that are run by Regional Transmission Organizations (RTOs) or
Independent System Operators (ISOs).
There are currently six RTOs/ISOs in several regions of the country
under the jurisdiction of FERC. In these regions, market participants
buy and sell a variety of electricity products and services in the
centralized markets these RTOs/ISOs administer. These power supply-
related products and services are typically not furnished by the RTO
itself; instead they are sold by market participants through
centralized, auction-type market structures that the RTO administers.
For example, most RTOs/ISOs operate ``day-ahead'' and ``real-time''
markets through which market participants buy and sell wholesale
electric power. RTOs also administer markets for the purchase and sale
of financial transmission rights (FTRs), which APPA members and other
Load Serving Entities (LSEs) use to hedge the costs of transmission
congestion associated with the transmission service they purchase from
the RTOs/ISOs to move their power supplies to their retail customers
(loads).
While these FTRs are financial contracts, their terms, conditions
and rates are comprehensively regulated by FERC and they should remain
under FERC jurisdiction. These FTRs took the place of the physical
transmission rights that LSEs had used to serve their loads prior to
the implementation of RTO/ISO power supply markets. The ability of LSEs
to have continued access to FTRs on reasonable terms and conditions is
absolutely essential to their ability to serve their retail loads at
reasonable rates and with less price volatility.
RTO market rules are fully regulated by FERC and are set out in
FERC-approved tariffs. The rates, terms and conditions applicable to
any RTO product under a FERC tariff should not be subject to concurrent
jurisdiction by CFTC. Concurrent jurisdiction could result in
inconsistent regulations and uncertainty over enforceability of
transactions. Because of this concern, if concurrent jurisdiction is
found, CFTC should be required to consult with FERC regarding these
markets and should be given statutory authority to cede jurisdiction to
FERC.
However, APPA is strongly concerned with market manipulation in
electricity markets, and because of that we recognize that CFTC can
play a beneficial role in policing and preventing such manipulation.
CFTC and FERC could be most effective when working together to prevent
manipulation in energy markets run by RTOs. APPA would therefore
support concurrent FERC and CFTC jurisdiction only over market
manipulation in RTO-administered markets. APPA would urge the two
agencies to pool their resources and expertise to provide more
comprehensive oversight in this specific area.
In conclusion, while APPA fully supports legislation to curb
manipulation in the OTC derivatives market, we urge Congress to use
caution when drafting legislation in this area to ensure it does not
have an unintended, adverse effect on retail electric and natural gas
customers. From APPA's perspective, a well drafted bill will include
the provisions necessary to curb market manipulation while preserving
FERC's primary jurisdiction over RTO/ISO markets, including the FTR
markets to hedge against energy price volatility.
______
FPL Group,
Federal Regulatory Affairs,
Washington, DC, March 26, 2010.
Hon. Jeff Bingaman,
Chairman, Committee on Energy and Natural Resources, U.S. Senate, 304
Dirksen Senate Office Building, Washington, DC.
Dear Chairman Bingaman: I am writing to supply additional
information for the record of the hearing held by the Committee on
``Financial Transmission Rights and Other Electricity Market
Mechanisms'' on March 9, 2010. Specifically, I am writing in response
to questions raised by Commodity Futures Trading Commission Chairman
Gary Gensler about the accuracy of an example I used in my testimony
involving financial hedges of wholesale power sales into the New Jersey
Basic Generation Service (NJ BGS) auction.
The question is whether these financial hedges were standard
products that would be forced to trade on exchanges under various
legislative proposals, requiring the posting of significant collateral
and creating liquidity risk exposure, or custom products that would not
be forced to trade on exchanges. In my testimony, I asserted these
financial hedges were standard products. Following is an excerpt from
my written testimony:
It is critical that these companies continue to have access
to the OTC market for these hedges. Requiring suppliers to
hedge on an exchange would expose them to significant liquidity
risk for cash margining. The cost of this risk would ultimately
be borne by the utilities' customers via higher prices charged
for the full requirements service. For example, in February
utilities in New Jersey purchased approximately 2,500 MW for a
three-year term. If this entire volume were hedged on an
exchange, suppliers would have had to post about $1 billion in
cash to cover initial margin and variation margin. This $1
billion would have been added to bids accepted for the auction
and ultimately would have been borne by consumers in New
Jersey. There are a number of other states that conduct similar
auctions. They would face a similar cost premium to reflect the
additional working capital costs that suppliers would have to
bear if the OTC markets are not available for the hedging
needed to provide these types of products. Competition would
also decline as the liquidity risk would simply be unacceptable
to many suppliers. It is a basic tenet of markets that fewer
participants would result in higher prices to customers.
At the hearing, Chairman Gensler suggested the NJ BGS example in my
testimony was a ``red herring'', maintaining that the transactions
involved were physical sales of wholesale power outside CFTC
jurisdiction or financial hedges that were custom products rather than
standard products.\1\ I write to provide additional information
demonstrating these financial hedges are indeed standard products, and
stand by the accuracy of my testimony.
---------------------------------------------------------------------------
\1\ CHAIRMAN B1NGAMAN: ``Let me ask on this specific that Joseph
Kelliher talked about there, the auction that occurred ... in New
Jersey last month, What is your thinking about the role the CFTC would
play on that kind of a--''
MR. GENSLER: ``I am glad you asked it. I understand the facts on
that, probably none. I think it is a red herring, with all respect to
Chairman Kelliher. I think it is probably a cash transaction that is
excluded under the Commodity Exchange Act. We do not cover cash or
physical spot or forward contracts. If Congress were to move forward
and actually suggest that we cover broad, over-the-counter derivatives,
it would only be the standard transactions that would be recommended to
be brought to central clearing, and I think the transaction he was
describing, if it were an over-the-counter derivative, would actually
be customized or tailored,''
Financial Transmission Rights and Other Electricity Market
Mechanisms, Hearing Before the Senate Comm. On Energy and Nat.
Resources, 111th Cong. 44-45 (March 9, 2010) (unofficial transcript).
---------------------------------------------------------------------------
The example in my testimony described a typical full requirements
product that many utilities procure to provide retail electric service.
The NJ BGS auction is one of the most competitive and highly regarded
wholesale power procurement auctions in the country. The product
procured in the NJ BGS auction includes electricity delivered in
quantities that match the utilities' load, or a percentage thereof, in
each hour of the day, ancillary services and other products, hence they
are called full requirements products. The Federal Energy Regulatory
Commission (FERC) has jurisdiction over these wholesale power sales. A
supplier of the full requirements product to serve one block of firm
load in the Public Service Electric and Gas (PSE&G) service territory
would have the obligation to serve 1.18% of PSE&G's firm load at any
given hour for three years. The load obligation varies by season and
time of day, but has a peak load of 99 megawatts and an average load of
45 megawatts.
Given the uncertainty regarding future wholesale power prices,
sellers often hedge their positions with standardized products. These
standardized hedges consist of one of, or a combination of (i) physical
wholesale power purchases subject to FERC regulation and (ii) financial
products purchased from over-the-counter (OTC) markets. The supplier
would also enter into financial swaps to hedge the price risk between
the liquid trading point and the utility's delivery point, commonly
referred to as basis swap transactions. If the transaction is hedged
with a combination of financial products, the physical delivery of
power to meet the utility's load obligations would be purchased in the
physical spot market.
In the example used in my testimony, a supplier of one block of
PSE&G firm load would procure standard on and off peak block power
products of seasonal, yearly or multi-year terms at PJM West, the
closest liquid trading hub to the PSE&G delivery zone. The block power
purchases would be made in such a fashion to as closely as possible
replicate the expected load obligation by month. However, due to the
nature of the standardized products that are traded at the PJM West
Hub, quantities that exactly match PSE&G's expected load are not
typically available. The same process of buying on and off peak block
volumes in seasonal, yearly or multi-year terms would be followed for
the basis swap transactions. The supplier of the full requirements
product then manages the exposure resulting from variations between the
actual load volume and the procured hedge products.
None of the financial products used to hedge the risk associated
with these forward wholesale power sales into the NJ BGS are custom
products. These are standard OTC products with fixed volumes and terms
associated with liquid pricing points\2\. NYMEX and ICE trade multiple
products associated with the PJM West Hub, some of which could be used
to hedge the price risk associated with buying the PJM West Hub block
power referenced in the example above. The NYMEX and ICE purchases
would likely be considered standardized under the pending legislation.
Similarly, both the NYMEX and Nodal Exchange trade multiple basis swap
products, including the basis swap between the PJM West Hub and the
PSE&G service territory, and such products would likely be considered
standardized products. Legislative proposals that would force trading
and clearing of standard products would indeed mandate the trade of
these products on exchanges.
---------------------------------------------------------------------------
\2\ A customized product utilized to hedge a supplier's firm load
obligation to PSE&G would contain non-standard terms to the transaction
such as a shaped hourly volume rather than fixed block volumes of
energy, or would have other terms that would not be readily tradable in
the market by multiple parties. It should be noted, however, that the
supplier of such non-standard products would most likely have to hedge
its exposure using a combination of standard products and then manage
the exposure resulting from the variations between the non-standard
product and the standard hedges.
---------------------------------------------------------------------------
Requiring suppliers to hedge on an exchange would expose them to
significant liquidity risk for cash margining. The cost of this risk
would ultimately be borne by the utility's customers via higher prices
charged for the full requirements service. In this particular instance,
financially hedging one block of PSE&G firm load with a standard 50
megawatt block of PJM West energy on an exchange versus OTC would have
resulted in an initial cash margin posting of $6.6 million and a peak
cash margin posting to the exchange of $21 million. Extrapolating this
exposure to cover the entire auction volume would have required
suppliers to post over $1 billion in cash to cover the exchange
requirements.
I continue to maintain that requiring energy companies and end
users to conduct all of their transactions of standard products on
exchanges and subjecting those transactions to costly central clearing
requirements would result in significant price increases and reduced
participation in the market, without any commensurate reduction in
risk. This is why I support an end-user exemption for both wholesale
and retail market participants
Sincerely,
Joseph T. Kelliher,
Executive Vice President.