Academic journal article Energy Law Journal

Market-Based Ratemaking and the Western Energy Crisis of 2000 and 2001

Academic journal article Energy Law Journal

Market-Based Ratemaking and the Western Energy Crisis of 2000 and 2001

Article excerpt

I. INTRODUCTION

The Federal Energy Regulatory Commission (FERC) has recognized, at least in theory, the inescapable economic truth that competitive electricity markets, like other competitive markets, will experience high prices under conditions of relative scarcity and low prices under conditions of relative abundance. In practice, however, the FERC has not hesitated to impose restraints on sustained high wholesale electricity prices during periods of relative scarcity without considering, much less determining, whether such high prices are inconsistent with the outcome that a competitive market would produce or be expected to produce. There is perhaps no better example of the FERC's apparent cognitive dissonance of the realities of economic scarcity than the various market mitigation measures the FERC imposed as a consequence of the severe and sustained scarcity conditions experienced in and around California during 2000 and 2001.1 The legal rationale for the FERC's schizophrenic policy throughout the Western energy crisis appears to have been a concern that sustained high wholesale electricity prices, whatever the cause, somehow ran afoul of the FERC's statutory obligation under section 205 of the Federal Power Act (FPA) to ensure that rates are just and reasonable.

The FERC's willingness to modify market outcomes in the name of just and reasonable ratemaking, without regard to whether those outcomes are consistent with what a competitive market would produce, raises two fundamental and interrelated questions. First, as a matter of law, can the FERC rely on the market to set rates for the sale of electricity at wholesale? Second, to the extent that the FERC can lawfully rely on the market to set rates, are such market-based rates deemed to be just and reasonable if they are consistent with the outcomes a competitive market would produce or be expected to produce?

As we explain below, the answer to both of these questions is a resounding "yes." The FPA permits the FERC to institute a market-based rate regime for wholesale sales of electricity so long as two conditions are met: (1) the FERC makes a reasoned determination that the relevant market is likely to produce competitive market outcomes; and (2) market participants are provided a means to protect themselves in the future should the FERC's prediction about future market outcomes prove to be incorrect. Since the FERC authorizes an entity to make sales at market-based rates, those rates can and should be deemed to be just and reasonable to the extent that they are consistent with competitive market prices. To presume otherwise would defeat the very purpose of a market-based rate regime and invite the FERC to rely on a legally suspect, hybrid form of market-based and cost-of-service ratemaking that is worse than a retreat to pure cost-of-service ratemaking. As we argue below, that is precisely what the FERC appears to have done in response to the Western energy crisis of 2000 and 2001.

Section II of this article describes the legal basis for the FERC's ratemaking under section 205 of the FPA. In doing so, we describe the evolution of the judicial interpretation of "just and reasonable" rates from a narrowly conceived understanding based on the utility's cost-of-service to a broader view that encompasses rates determined by the market. In section III, we provide a description of the FERC's market-based rate regime, and explain the FERC's consistent defense of its market-oriented approach to ratemaking from both a legal and a policy perspective. In section IV(A), we provide the background of the Western energy crisis of 2000 and 2001, including the various market fundamentals that caused wholesale power prices to rise during this period. In sections IV(B) and (C), we explain how the FERC, through its words, continued to defend its market-based rate policies throughout the Western energy crisis but, in practice, abandoned these policies and imposed cost-based price mitigation. …

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