HOARDERS: CLARIFYING FERC'S POLICY, AS ARTICULATED IN ORDER NO. 888, AGAINST WITHHOLDING ELECTRIC TRANSMISSION CAPACITY.

• Author: Kugbei, Sandy

INTRODUCTION

Adopted in 1998 with the express goal of curbing undue discrimination (1) in the interstate market for electric transmission, Order No. 888 (2) has been referred to as the single largest step taken by the Federal Energy Regulatory Commission (FERC or the Commission) (3) to foster competition in the market for wholesale electric transmission. (4) Among its key features, Order No. 888 requires a utility (5) within FERC's jurisdiction (6) to separate its transmission function (7) from its wholesale merchant function (8) and to charge separate rates for each of the services. (9) The Order also requires any public utility that "own[s], controls] or operate[s] transmission facilities which transmit electricity in interstate commerce to fde with the FERC open access transmission tariffs." (10) These open access tariffs cannot be discriminatory or anticompetitive. (11) Rather, the tariffs must "offer third parties access on the same or comparable basis, and under the same or comparable terms and conditions, as the transmission provider's use of its system." (12)

As such, Order No. 888 reflects a marked departure from the regulatory approach FERC has traditionally taken. (13) Its successors, Orders No. 888-A, (14) B, (15) C, (16) and Orders No. 889 (17) and 890, (18) clarify and expand upon many of the policies articulated in Order No. 888. Among the articulated policies of Order No. 888, the FERC outlaws capacity hoarding. (19)

There are two issues associated with FERC's treatment of capacity hoarding under Order No. 888. The first is that the Commission never explicitly defines the concept. The second issue rests on the Commission's failure to identify a clear and transparent approach to policing hoarding (in the context of transmission capacity reservations). (20) In Order No. 888, FERC summarily refused to adopt a use-it-or-lose-it approach to regulating transmission customers who reserve capacity. (21) This decision needs to be expressly revisited in light of changes to the electric utility landscape.

Part I provides a brief historical background of the electric utility industry, with an emphasis on significant changes that occurred prior to the adoption of Order No. 888. It segues through the traditional vertically integrated utility model and the concept of natural monopolies to reach the Commission's fight against what FERC considers the foremost barrier to competition, undue discrimination. In doing so, Part I contextualizes many of the issues raised by this Note. Part II addresses the current need for reform. It begins by arguing that FERC's hoarding policy, as described in Order No. 888, lacks both clarity and transparency. It contends that with rising mergers and acquisitions activity within the utility industry, FERC should expressly revisit its treatment of hoarding. Part III is concerned with establishing a comprehensive definition for capacity hoarding. Ultimately it defines capacity hoarding as "an electric utility's retention of transmission capacity when such utility possesses market power or otherwise has an intention to exert market power through its retention of such capacity." After establishing the definition, Part III concludes by suggesting that FERC adopt a modified use-it-or-lose-it approach to address hoarding.

1. BACKGROUND

   1. Impetus Towards Increasing Competition/Decreasing Discrimination

      Energy law's main objective has consistently been "to provide an abundant, stable energy supply at a low price." (22) The traditional utility model in the United States was the vertically integrated monopoly (23) that provided a bundled (24) service and charged its customers "a single price for generation, transmission, and distribution of electricity." (25) This system of nationwide vertically integrated utilities "began to unravel" in the latter half of the 20th century, as "electricity prices precipitously climbed, and the massive capital investments that utilities had been sinking into their systems came under heightened political scrutiny." (26) Simultaneously, numerous academic studies began encouraging reform. (27) The Commission considered the apparent lack of competition (under the traditional system) (28) to be an underlying cause of a growing problem: pervasive discrimination within the industry. (29)

   2. The Importance of Competition and the Natural Monopoly

      Competition is a relatively new addition to the electric utility landscape. (30) Historically, electric utilities have been considered natural monopolies. (31) A natural monopoly "is not like other businesses subject to the steady, constant pressure of competition." (32) In his article, Natural Monopoly and Its Regulation, Richard Posner explains the concept of a natural monopoly.

      The term does not refer to the actual number of sellers in a market but to the relationship between demand and the technology of supply. If the entire demand within a relevant market can be satisfied at the lowest cost by one firm rather than by two or more, the market is a natural monopoly, whatever the actual number of firms in it. If such a market contains more than one firm, either the firms will quickly shake down to one through mergers or failures, or production will continue to consume more resources than necessary. (33) Essentially, "[a] natural monopoly exists when a single firm can produce a desired level of output at lower total cost than any output combination of more than one firm." (34) Under such conditions, a government might grant a single firm a monopoly franchise to provide the particular service to customers. (35) Granting a monopoly franchise within an industry that is inherently monopolistic (36) typically results from a finding that the service sought to be provided is essential to the public. (37) Governmental entities then regulate the franchised monopoly to prevent it "from earning excess profits at the expense of the consumer." (38)

      Electric utility companies were long considered natural monopolies for three main reasons. First, it was understood that the most economical way to transmit and distribute electricity was typically over "a single line or a single network of lines." (39) Second, such generation of electricity had to be "centrally dispatched (usually by computer programs) to meet both predictable changes and unforeseen contingencies." (40) This requirement resulted due to the infeasibility of storing electricity. (41) Third, the service rendered by electric utilities was inextricably linked to the public interest. (42)

      The characteristics above led to a system of vertically integrated utilities (43) whose rates were heavily regulated by both the states (44) and the federal government. (45) The aim of such regulation was to set utility rates just "high enough to ensure that utility investors had the opportunity to earn 'a fair rate of return' on their investments." (46) In doing so, regulators protected the public from potential abuses by monopoly owners. (47) By the 1980s, "there [was] a developing recognition that economic regulation accomplishes little in the public interest when it is directed at limiting competition." (48) Furthermore, with technological advancements making electric generation more and more efficient, Congress passed the Energy Policy Act of 1992. (49) The Act gave FERC "a clear signal that [Congress] would like to see more competition in wholesale electric power markets." (50)

      In theory, the principal benefits that are realized from injecting competition into the electric industry come from a reallocation of risks. (51) When a utility is heavily regulated, its customers bear the risks of increased rates due to the utility's technology becoming obsolete and/or the utility's capacity exceeding the utility's anticipated demand. (52) In contrast, "[u]nder competition, these risks are initially with the owners of the plants--they will pay for mistakes or profit from good decisions and management." (53)

      Testifying before the Committee on Energy and Natural Resources of the United States Senate in 1995, the Commission's Chair (54) accordingly highlighted FERC's desire to "ensure a fair and orderly transition from regulation to competition." (55) She recognized that consumers should be able to enjoy "competitively priced generation" but emphasized that the Commission was "not comfortable entirely with promoting competition by eliminating regulation" when there was "still a substantial potential ... [for] discriminatory practices in the industry." (56)

      The Commissioner indicated that FERC learns of most discriminatory practices through industry participants. (57) She asserted that although the electric generation segment of the industry had become more competitive organically, the transmission sector still sometimes prevented customers from realizing the benefits of this newfound competition. (58) Put differently, she claimed that "[w]ith the entry of significant, new third party power suppliers, [FERC had] heard an increasing number of complaints that those who own[ed] transmission facilities [were] discriminating against these third party suppliers." (59) She noted that this development was hardly surprising; one could expect utilities that had long enjoyed monopoly power to resist competitions and perhaps be "simply unwilling to give up their monopoly control over the transmission facilities." (60)

   3. Order No. 888's Shift to Competition

      In a Notice of Proposed Rulemaking that preceded Order No. 888, FERC echoed many of the concerns that its Commissioner had voiced in the previous year. (61) At times, FERC went further and found that "discriminatory transmission service [was] the foremost barrier to fair competition." (62) The Commission's view was precipitated by "evidence of pervasive discrimination" in the interstate transmission of electricity (63) and changes that had emerged in the market as a result of several technological advancements. (64) While those advancements had...