Energy Markets: Results of FERC Outage Study and Other Market	 
Power Studies (02-AUG-01, GAO-01-1019T).			 
								 
The importance of the role of the Federal Energy Regulatory	 
Commission (FERC) is illustrated by the situation in California. 
Wholesale electricity prices in California rose sharply in May	 
2000 and have remained high. California also saw disruptions in  
service this winter and spring. GAO reviewed FERC's outage study 
and two other studies that examined possible exercise of market  
power in California's electricity industry. GAO found that FERC's
study was not thorough enough to support its conclusion that	 
audited generators were not physically withholding electricity to
influence prices. FERC's study largely focused on determining	 
whether or not the outages were caused by actual physical	 
problems, such as leaks in cooling tubes that required		 
maintenance or repairs. Two other studies GAO examined found	 
evidence that electricity generators exercised market power to	 
boost electricity prices in California. These studies sought	 
broader evidence of the exercise of market power in the entire	 
market by comparing wholesale electricity prices to the estimated
costs of producing electricity. In doing so, they found that	 
prices were higher than would be expected if the generators were 
acting competitively. None of the studies was thorough enough to 
determine the precise extent to which market power versus other  
factors has caused high electricity prices in California since	 
May 2000. A thorough study of market power would combine the	 
market-wide approach of the other two studies with a		 
quantification of the extent to which outages, or other supply	 
disruptions, were caused by factors other than generators'	 
attempts to drive up prices. Such factors may include the	 
operating and maintenance history of existing power plants,	 
constraints on the number of hours certain plants can be run, and
financial problems of utilities, which led to suspension of	 
payments to some generators. This testimony summarized a June	 
report (GAO-01-857).						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-1019T					        
    ACCNO:   A01519						        
  TITLE:     Energy Markets: Results of FERC Outage Study and Other   
             Market Power Studies                                             
     DATE:   08/02/2001 
  SUBJECT:   Energy costs					 
	     Energy shortages					 
	     Prices and pricing 				 
	     Electric power generation				 
	     Electric utilities 				 
	     California 					 

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GAO-01-1019T
     
Testimony Before the Subcommittee on Energy Policy, Natural Resources and
Regulatory Affairs, Committee on Government Reform, House of Representatives

United States General Accounting Office

GAO For Release on Delivery Expected at 2: 00 p. m. Thursday, August 2, 2001
ENERGY MARKETS

Results of FERC Outage Study and Other Market Power Studies

Statement of Jim Wells, Director Natural Resources and Environment

GAO- 01- 1019T

Page 1 GAO- 01- 1019T Energy Markets

Mr. Chairman and Members of the Subcommittee: We are pleased to be here
today to discuss the role of the Federal Energy Regulatory Commission (FERC)
in monitoring electricity and other markets. As you know, the electricity
industry is in transition, from costof- service regulation to a less
regulated market in which competition plays a greater role in determining
the price of electricity. In FERC?s March 2000 report entitled ?State of the
Markets 2000,? FERC acknowledged that the rapid change in energy markets has
caused the commission to fundamentally alter its activities. Among its
evolving duties, FERC seeks to protect consumers from the exercise of market
power by individual energy suppliers seeking to affect the price of
electricity or natural gas. To protect consumers from the effects of market
power, FERC recognizes that it must continue to develop better tools and
procedures to understand markets and identify and address market power
issues.

The importance of FERC?s monitoring role is illustrated by the situation in
California. Wholesale electricity prices in California rose sharply in May
2000 and have remained high. In addition, there were disruptions in service-
blackouts- this winter and spring. A number of factors have likely
contributed to these high prices and service disruptions, including rapid
demand growth since 1995 accompanied by slow growth in supply, higher- than-
normal natural gas prices, and flaws in the design and structure of
California?s electricity market. In addition to these factors, state
officials and others have attributed the problems, at least in part, to
market power exercised by individual electricity- generating companies. In
response to concerns about high prices and short supplies of electricity in
California, FERC undertook a study, released in February 2001, to determine
whether generators were using plant outages to physically withhold power and
drive up prices of electricity in California. FERC?s overall conclusion to
this study was that the generators it audited had not physically withheld
electricity supplies to influence prices. One generating company concluded
that FERC?s study affirmed the company?s operating procedures in the face of
?incorrect and inflammatory allegations that we have somehow been
withholding power from our four plants in California.? Notwithstanding this
interpretation, officials of the state of California and other parties
insist that market power has indeed been used to drive up electricity prices
and have demanded that FERC require generators to pay refunds to the state.

In the context of these high electricity prices and the surrounding
controversy, Congressmen Jay Inslee and Peter DeFazio asked us to review
FERC?s outage study and two other studies that examined possible

Page 2 GAO- 01- 1019T Energy Markets

exercise of market power in California?s electricity industry. 1 Our
testimony is based largely on the results of our review of these studies. 2

In summary, we found the following:  FERC?s study was not thorough enough
to support its overall

conclusion that audited generators were not physically withholding
electricity supply to influence prices. FERC?s study was largely focussed on
determining whether or not the outages that occurred were caused by actual
physical problems- such as leaks in cooling tubes- requiring maintenance or
repairs. However, it is practically impossible to accurately determine
whether such outages are orchestrated or not because plants frequently run
with physical problems and the timing of repairs and maintenance is often a
judgment call on the part of plant owners or operators.

 FERC?s overall conclusion differs from that of the other two studies we
examined, which found evidence that electricity generators exercised market
power to increase electricity prices in California. These studies looked for
broader evidence of the exercise of market power in the entire market by
comparing wholesale electricity prices to the estimated costs of producing
electricity. In doing so, they found that prices were higher than would be
expected if the generators were acting competitively.

 None of the studies was thorough enough to determine the precise extent to
which market power versus other factors caused the high electricity prices
in California since May 2000. A thorough study of market power would combine
the market- wide approach of the other two studies with a quantification of
the extent to which outages, or other supply disruptions, were caused by
factors other than generators? attempts to drive up prices. Such factors may
include the operating and

1 Report on Plant Outages in the State of California, prepared by the Office
of the General Counsel, Market Oversight & Enforcement and the Office of
Markets, Tariffs and Rates, Division of Energy Markets, Federal Energy
Regulatory Commission, February 1, 2001; Diagnosing Market Power in
California?s Restructured Wholesale Electricity Market,

Severin Borenstein, James Bushnell, and Frank Wolak, August 2000
[unpublished]; and A Quantitative Analysis of Pricing Behavior in
California?s Wholesale Electricity Market During Summer 2000, Paul Joskow
and Edward Kahn, January 2001 [unpublished]. 2 See Energy Markets: Results
of Studies Assessing High Electricity Prices in California, (GAO- 01- 857,
June 29, 2001).

Page 3 GAO- 01- 1019T Energy Markets

maintenance history of existing power plants; constraints on the number of
hours certain plants can be run; and financial problems of utilities, which
led to suspension of payments to some generators.

While FERC?s study was an initial step to more closely monitor generators?
activities, it was not thorough enough to support its overall conclusion
that the audited companies did not physically withhold electricity supplies
to influence prices. This study largely focused on determining whether or
not there were actual physical problems- such as leaks in cooling tubes- in
generating units experiencing outages. Under this approach, if FERC found
that there were physical problems with downed generating plants and that
repairs or maintenance was performed, it concluded that the outages were
legitimate and not orchestrated to reduce supply and push up prices. In this
context, FERC determined that most of one company?s generating plants were
old and suffered from mechanical problems. In addition, FERC found that many
of these plants had run at higher- thanusual rates in the summer and fall of
2000, prior to their shutting down for repairs or maintenance.

These facts could certainly offer a rationale for higher- than- normal
levels of outages later in the year. However, the industry experts we spoke
with generally agreed that it is practically impossible to accurately
determine whether outages are legitimate or not, because plants frequently
run with physical problems, and the timing of maintenance or repairs is
often a judgment call on the part of plant owners or operators. Another
weakness in the FERC study- or any study that seeks to determine whether
specific outages are legitimate- is the lack of data for past outages to use
as a benchmark with which to compare the number, type, and duration of
outages during the study period. In discussions with FERC, officials told us
that accurate outage data do not exist for the years prior to their study.
Without a baseline comparison, it is not possible to conclude that observed
outages are above normal in number, type, and duration. Finally, strategic
use of plant outages is not the only way that a generating company could
exercise market power, and FERC?s methodology did not look at other ways. As
FERC acknowledged in its report, the agency did not analyze whether
companies were using other techniques to influence prices, such as not
offering bids to sell some capacity, or bidding at prices high enough to
practically ensure exclusion from the market.

FERC officials acknowledge that simply looking at outages and maintenance
records of generators is not sufficient to determine whether generating
companies are exercising market power. Accordingly, they told us that FERC
has recently implemented a more comprehensive plan for FERC?s Study Not

Thorough Enough to Support Its Conclusion

Page 4 GAO- 01- 1019T Energy Markets

monitoring the exercise of market power. Under this plan, FERC will continue
to look at outages to determine if the number, type, and duration are
warranted. In addition, FERC will monitor generators? bids and try to detect
bidding behavior that is designed to exclude generating capacity from the
market. FERC officials also said they have notified electricity generators
that their ability to earn unregulated market prices for electricity will be
in jeopardy if they are found to be withholding power in order to drive up
prices.

In contrast to FERC?s study, the other two studies found evidence that
market power had been used to raise prices. The authors reached this
conclusion after looking for evidence of the existence and exercise of
market power in the entire market, rather than focusing on particular
instances of generator outages. The first of these two studies, dated August
2000, concluded that from June 1998 to September 1999, prices were 16
percent higher than they would have been had generators behaved
competitively. One of the study?s authors told us that while their study
provides strong evidence of market power, it does not necessarily suggest
any illegal activity on the part of electricity- generating companies. He
believes that individual companies are sometimes able to exercise unilateral
market power to raise prices without violating antitrust laws.

The second study, dated January 2001, also concluded that there was strong
evidence that market power was exercised to raise prices in summer 2000.
While the authors found that higher electricity prices were caused in part
by higher natural gas prices and other factors, they also found that prices
in summer 2000 were greater than they would have been had the market behaved
competitively. In addition, they concluded that the level of outages
experienced during June 2000 cannot be explained by reasonable expectations
about repairs or maintenance requirements, or by the need to hold power in
reserve to ensure the reliability of the power system.

Niether FERC?s study nor the other two studies covered the entire period of
high prices, nor did they evaluate all the factors that could have led to
greater- than- normal levels of generator outages. Therefore, their results
are inconclusive about the precise extent to which market power versus these
other factors explains high electricity prices in California since May 2000.
We believe that a thorough and conclusive study of market power in
California since May 2000 must combine the market- wide approach of the two
market- power studies, with a quantification of the extent to which Two
Other Studies

Reached Different Conclusions From FERC?s

A More Thorough Study Still Needed

Page 5 GAO- 01- 1019T Energy Markets

outages or other supply disruptions were caused by factors other than
companies? attempts to drive up prices. In its study, FERC pointed out two
such factors that could lead to higher- than- normal levels of outages: (1)
some plants had been run at above- normal rates prior to being shut down for
repairs or maintenance, and (2) many plants that were shut down were older.
A third factor, suggested by other industry sources, is that a number of
companies were simply refusing to operate their generators at various times
during 2000 because they had not been paid for electricity they had
previously sold to California?s utilities. While the precise extent to which
high prices were the result of market power has not been conclusively
determined, the authors of the August 2000 and January 2001 studies believe
that there is enough evidence that market power exists to warrant a policy
response from FERC and the state of California.

In conclusion, we believe that, as the federal government?s marketmonitoring
entity, FERC has an important responsibility to fully investigate the
potential exercise of market power and clearly report the results of its
investigations. In light of changes in the electricity industry, we
recognize that FERC?s role in overseeing this industry is evolving and that
FERC?s outage report was simply one part of its ongoing effort. We encourage
FERC to continue to improve its market- monitoring capabilities. In this
regard, we are currently conducting an analysis of the electricity market in
California to determine whether the design of the market has facilitated the
exercise of market power. In addition, we have begun work on a review of
FERC?s monitoring and oversight roles and responsibilities with respect to
energy markets. This work will include a broad- based review of FERC?s
management practices and internal organization. We will report to Congress
with the results of these studies in early 2002.

I would be happy to respond to any questions that you or other Members of
the Subcommittee may have at this time.

Contact and Acknowledgements

For further information, please contact Jim Wells on (202) 512- 3841.
Individuals making key contributions to this testimony were Dan Haas and
Frank Rusco.

(360125)
*** End of document. ***