http://www0.mercurycenter.com/local/center/ferc0604.htm

New market overwhelms U.S. agency

Posted at 10:18 p.m. PDT Sunday, June 3, 2001 Part 1: U.S. agency's actions invited power disaster

BY ERIC NALDER AND MARK GLADSTONE, Mercury News

Last August, more than two dozen employees at the Federal Energy Regulatory Commission were summoned to a conference room and told to find the cause of a dramatic run-up in electricity prices plaguing California and threatening other states.

For California, the stakes could not have been higher. Its utilities were amassing huge debts. Horrified consumers in San Diego saw their power bills triple. And in the Bay Area, a June scorcher brought the first blackouts.

Ron Rattey, a respected FERC economist, scanned the room skeptically. With a knot in his stomach, he realized he was one of just a few employees experienced at in-depth market analysis -- and the group was being given just three months. ``It was ludicrous,'' he said.

In the end, the group's Nov. 1 report largely detailed the well-known causes of the high prices -- a hot summer, more demand, less power available from other states -- without answering the most sensational question: Were energy traders manipulating the state's newly deregulated market?

And FERC's commissioners, reviewing the report, turned down California's plea for a cap on Western electricity prices.

The probe underscored the limitations of FERC, a little-known agency charged with regulating wholesale electricity prices. Through interviews with FERC employees and reviews of documents, the Mercury News found:

FERC lacks enough qualified employees to make sure that the savvy players in the nation's highly complex, new electricity markets are not artificially driving up prices.

The agency's collegial relationship with companies it regulates makes it reluctant to demand crucial market data. It shuns the use of subpoenas and did not back up California when the state issued subpoenas.

Energy companies have derailed probes with a phone call, but when one complained about a document leaked to the media, FERC interrogated 40 employees about it.

FERC's former chairman, James Hoecker, and its current chairman, Curtis Hébert Jr., both say FERC does a good job with the powers and resources it has. And Joe Bob Perkins, CEO of Reliant Energy Wholesale Group, said generators are ``absolutely not'' receiving favorable treatment from FERC. But Hoecker believes the agency needs more power. ``It can't be in a situation where it is begging the industry for information,'' he said.

Rattey, a 26-year veteran, argues that FERC is not taking advantage of the powers it has. At the request of senior FERC staff members, he wrote a postmortem report on the market investigation and concluded: ``The investigation was not well thought out, poorly designed and lacked a sense of urgency and direction until its last few weeks.''

Not until January, more than two years after warnings that the markets were vulnerable to manipulation, did FERC acquire the computers they needed to track energy trading. ``This is a difficult time,'' said Daniel Larcamp, the FERC official charged with watching the markets. ``It's not going to happen overnight. We are moving in the right direction.''

Order to investigate

The investigation began with a July 26 order from the commissioners to uncover what caused prices to leap to record levels in California and to look at problems nationwide. Last June, prices hit $750 per megawatt-hour for three days straight. The year before, electricity prices in the West averaged about $28 and had spiked higher than $100 only once.

FERC chose two people to lead the investigation: Andrea Wolfman, a longtime lawyer at the agency, and W. Scott Miller, a former industry executive. Each brought strengths to the probe, but each also illustrated some of FERC's vulnerabilities in its attempts to grapple with a complex market.

Wolfman is highly respected within the agency, but her expertise is not electricity markets. She has spent much of her career dealing with natural gas issues.Miller brought expertise. He had just left a $230,000-a-year job with one of the prime players in the electricity market, the power-generating subsidiary of PG&E Corp. ``Who better to look than someone who knows what is happening in the marketplace?'' asked Larcamp, Miller's boss. Miller heads a key FERC office when it comes to monitoring the market and investigating abuses.

But utility officials were suspicious that he would favor generating companies. Both Miller and Wolfman declined to comment on their investigation.

As the probe started, Miller and others met with utility representatives, including Southern California Edison's Gary Stern, who wrote an 11-page road map for how to investigate generators. He described ways to game the market, including: overloading transmission lines, filing false power schedules, shutting down plants and demanding top dollar for emergency power. And he advised FERC on how to track them.

But FERC did not follow this blueprint, according to Stern and Rattey. Stern said that when he talked to Miller about companies with sufficient market power to affect prices, Miller used a definition of market power that generators prefer, which limits it to companies that can affect prices for an extended period of time.

``That sort of gave me a clue as to where he is heading on this,'' Stern said. ``He's trying to find ways not to find market power.''

Team lacked key members

Market investigations cannot be done without a team of economists trained to understand the voluminous data that could reveal manipulation, unfair advantages and what economists call ``imperfect competition,'' said Paul Joscow, an economics professor at the Massachusetts Institute of Technology who is widely recognized as one of the top experts in the field.

But no such team was assembled for FERC's probe. ``The FERC staff is very well-intentioned and they work hard. But I think they are understaffed in the way of economic analysis,'' Joscow said.

Larcamp said FERC has a hard time competing for the talent it needs when energy companies pay much higher salaries. Traders can make up to $130,000. FERC salaries have gone up 21 percent since 1997, but they still average about $80,000.

In the closing weeks of the investigation, FERC did add three senior economists to the team. Recognizing that the report was thin on expert analysis, one of the new economists tried to keep his name off the report, and another was uncomfortable having his name on it, according to Rattey and another FERC source. All three economists declined to be interviewed.

Data requests fall short

Even if FERC had put together a team of crackerjack economists, it would have needed comprehensive market data and ample time to discover whether traders were exploiting the market. In his postmortem report, Rattey complained that the agency's requests for data were unclear. And he said FERC failed to collect data on specific transactions and detailed supply-and-demand data.

FERC also chose to request data from just a dozen major firms, rather than the scores of companies Rattey hoped to review. The results, Rattey wrote, were ``superficial analyses.''

What little he did find, though, intrigued him. Prices in California were much higher -- 65 percent higher in June -- than expected under normal competitive conditions. The average cost of electricity on the spot market in June, $324 a megawatt-hour, was twice the cost to produce it.

``If we had the data and the staff to evaluate the data,'' Rattey said, ``I think we would have found that the players in the market -- the generators and power marketers -- were able to game the system. And we'd see the games they were playing.'' Generating companies have repeatedly denied that they manipulate the markets.

This wasn't the first time Rattey had run into this problem. The agency has a poor track record of demanding trading data-- the EKG of a commodities market -- from companies it regulates. When price spikes occurred in the Midwest in summer 1998 and in the Midwest and Northeast in summer 1999, Rattey investigated. In both cases, he lost battles to get the data he needed because energy companies bucked him, and his bosses were reluctant to press the issue.

Last June, before the California investigation, an exasperated Rattey e-mailed the entire FERC staff. ``The commission appears to have taken the tact (sic) (consciously or unconsciously) that industry should police itself,'' he wrote. ``If FERC staff has no ability to ferret out wrongdoing . . . how can FERC expect market participants to undertake the effort?''

Former FERC engineer Judy Cardell confirmed that there are at least five instances she knows of, or was involved in, where senior staff members derailed requests for data after company officials complained. An associate still at the agency confirmed her account. ``A number of people in FERC did not want to overburden the utilities or the people in the industry with these requests,'' Cardell said.

Hébert, the chairman, said he has started to negotiate with an industry organization, the North American Electric Reliability Council, to get detailed data on electricity transactions. But the talks -- recommended by FERC staff members for three years -- could take time. Gene Gorzelnik, the group's spokesman, said members want their names kept confidential. That could hamper FERC's ability to use the data for enforcement.

Getting information

The industry has resisted efforts to collect data, arguing that leaks of competitive information could hurt companies in a business based on thin differences in prices. FERC can subpoena data, but a spokesman said the last time it used a subpoena in a non-judicial investigation was 1985. In fact, FERC officials could recall only four investigations where subpoenas had been used since 1980.

Documents are regularly subpoenaed during the trials and hearings run by FERC's administrative law judges. Why not in other cases? ``I asked that question early on when I first came to the commission,'' said William L. Massey, who became a commissioner in 1993. ``I was basically told that it's a weapon that we keep in reserve, but that generally speaking we've got to deal with all these market participants in an ongoing basis. We'd rather persuade them to give us this information.''

The Securities and Exchange Commission, which oversees the nation's financial markets, subpoenas documents so frequently no one keeps track of the number. FERC General Counsel Kevin Madden said his agency might yet subpoena data in its investigations of alleged price-gouging in California, but only if companies don't cooperate.

FERC has sat on a request from California's Public Utilities Commission seeking help with its subpoenas. In August, the PUC subpoenaed pricing data from generators. It sent a second round of subpoenas a month later. In November, the PUC asked FERC to force six major generators to turn over the information. The matter is still pending.

In documents filed with FERC, the PUC said that without this data, ``there will be no way that the CPUC can present any evidence to the FERC that will `substantiate any charges of market power abuse.' '' Agency officials say the requests are overly broad. ``The CPUC was on a witch hunt and it was the commission's decision not to participate in it,'' Hoecker said.

Besides resorting to subpoenas, the commissioners can also ask the agency's Office of Administrative Law Judges to investigate market abuse, but they haven't done so in the past two decades, according to Chief Judge Curtis L. Wagner Jr., a 27-year veteran.

Steps approved by agency

The commissioners did recently order Wagner to launch a time-consuming probe. Wagner spent a month and took 40 sworn depositions trying to figure out which employee leaked documents about El Paso Merchant Energy's ability to influence natural gas markets. ``The El Paso folks were upset,'' he said. ``Any leak of protected material is of great concern to us. When something like that gets out, it hurts our procedures. It makes people reluctant to supply confidential business matters.''

FERC issued its report on the California investigation Nov. 1, along with a proposed order that found the market ``dysfunctional'' but included no regional price cap, disappointing California leaders. The commissioners finalized the order Dec. 15.

Since then, FERC has taken some steps to monitor the market more closely. Hébert just reassigned 150 employees. Some will go to a beefed-up enforcement division. The agency is seeking $125 million in refunds from generators and recently reached an $8 million settlement with one company. The state, however, has told FERC that it has found $6 billion in excess charges.

And on April 26, the commissioners emerged from closed-door negotiations to issue an order that set complex limits on wholesale power bids in California during power emergencies, a plan quickly rejected by state officials as inadequate.

Hébert, in an interview, defended FERC's actions so far under his reign, saying FERC's latest effort will reduce prices where others failed. ``I don't think the people of California are fooled by any of their leaders telling them that an agency is not doing anything, when the only thing they can point out that the agency has not done is a price cap,'' he said.

But two new FERC commissioners -- Patrick Wood and Nora Brownell -- could reshape how the agency handles enforcement. Both are free-market advocates who also say they want to do more to oversee the markets. Wood, who could become the next chairman, said he wants to see ``a vigilant market cop walking the beat.''

Contact Eric Nalder at enalder@sjmercury.com or (206) 729-5161 and Mark Gladstone at mgladstone@sjmercury.com or (916) 441-4601.

-- Swissrose (cellier3@mindspring.com), June 04, 2001