Inverting choice of law in the wired universe: thermodynamics, mass, and energy.

Author:Ferrey, Steven
Position:California electricity market restructuring

TABLE OF CONTENTS INTRODUCTION I. THE CALIFORNIA PARADIGM: MARKET RESTRUCTURING AND STRUCTURAL COLLAPSE A. Market Design and Response B. Wholesale Litigation C. New Rules: Legislative Recourse 1. No Exit 2. The Bankruptcies D. The "Solution" that Deepened the Hole II. TREATMENT OF ELECTRICITY UNDER THE COMMON LAW AND THE U.C.C. III. STATE PRECEDENT ON THE LEGAL NATURE OF ELECTRICITY A. Electricity Sales 1. Electricity as a Good Under the U.C.C. 2. Electricity as a Service B. Electricity and Tort 1. Electricity as a Good: The Product Inquiry 2. Public Policy Considerations 3. The Meter: When Is Electricity Transformed from a Service to a Good? IV. FEDERAL TANGO: FERC STEPS AROUND THE LEGAL NATURE OF ELECTRICITY A. General Principles and Conflict of Laws B. The Magnificent Seven: The Good, the Bad and the Ugly C. The Impossible Dream: FERC Applies the U.C.C. to Services V. THE REALITY OF MODERN ELECTRIC ENERGY VI. THE REAL DEAL: THE CURRENT LEX A. E=M[C.sup.2] B. Polar Opposites: Analogy to Gas and Telecommunications 1. Physical Realities 2. Tangibility C. Weights and Blends: Hybrid Good and Service CONCLUSION APPENDIX A. Formation, Content, and Modification of Contract 1. The Statute of Frauds 2. Parol Evidence Rule 3. Contract Formation 4. Option Contracts 5. Acceptance 6. Additional Terms 7. Modification B. Warranties, Breach, and Remedies 1. Course of Performance 2. Assurances 3. Standards of Performance 4. Impossibility 5. Warranties 6. Remedies INTRODUCTION

In 2001, the legally regulated world changed: The most essential and capital-intensive industry in the United States, in the largest state in the Union, which itself is one of the six largest energy economies in the world, (1) collapsed. The implosion of California's electric power restructuring, massive bankruptcies of some of the world's largest companies, and the demise of Enron and several other major providers of essential electricity, are of global dimension. (2) How we produce, distribute, and consume electric power has profound implications not only for social welfare, but also for the environment. (3)

The problems in California unleashed a flood of litigation and administrative proceedings of every conceivable claim and action, involving every party involved in any aspect of the electric market as the California system struggled to equilibrate. Part II of this Article deconstructs and analyzes how legal institutions and decision rules behaved during, and responded to, this regulatory crisis.

Below the radar screen is a fundamental issue profoundly shaping the litigation outcome: (4) With electric sector deregulation now a reality in twenty states, is electricity a "good," or a service? "Goods" are governed by the Uniform Commercial Code (U.C.C.), while services are governed by distinct common law precedent. Each jurisprudence imposes significantly different decision rules that alter the outcomes of legal disputes and the allocation of societal rights and obligations regarding electricity.

Part II of this Article evaluates and compares the differences between these decision rules as they affect electricity transactions. With a fundamental shift across the country from government-regulated, electric power monopolies to restructured, competitive markets, whether electricity is a good or service will determine both the legal rules by which the markets must operate and the outcome of the plethora of pending disputes. The multibillion dollar stakes of this choice of law are high.

Doctrine on this choice of law is emerging. Part III analyzes California and other state jurisprudence electing to characterize electricity as either a good or a service, evaluating both the legal bases and policy rationales for the evolving checkerboard--and often internally schizophrenic--choices of law made by the states. In Part IV, this Article dissects the decisions of the Federal Energy Regulatory Commission (FERC) applying the U.C.C. to electricity disputes, and demonstrates that the agency has done so haphazardly and uncritically, with no analysis as to whether electricity actually is a good. Moreover, FERC has even applied the U.C.C. incorrectly to adjudications where electricity transmission services rather than "goods" clearly were at issue.

In Part V, I step back to examine the thermodynamic physics of electricity and to determine what electricity truly is. Doctrinally and physically, I compare electricity to other fossil fuels, to phone service, and to cable television transmission, and their respective regulation. From this comparison I draw conclusions about the true physical and derivative legal character of electricity, and how its physical thermodynamics create a legal continental divide in application of the law. I analyze and chart that divide to the legal fictions that are embedded in current case precedent.

As a result of this analysis, I challenge the conventional legal constructions. As the various state common laws of contracts replace traditional regulation for interpretation of electricity transactions, legal rights and obligations, as well as the ultimate judicial outcome of major disputes, will depend on how individual states regard and treat the ephemeral thing known as electricity. How we adjudicate rights in the inevitable move to a partially deregulated, restructured electric environment is of critical economic, environmental, and strategic importance in the United States. First, I examine the massive collapse of legal and economic foundations of the California electric market and its implications for the energy future of the United States.


    1. Market Design and Response

      In late 2000, California's restructured electric power market imploded. (5) In 1998, California became the third state in the nation, after Massachusetts and Rhode Island, to restructure its electric sector, allow retail competition, and force or incentivize its investor-owned utilities to sell their generating assets. (6) When California eventually enacted Assembly Bill 1890 in September 1996, it passed the state's deeply divided legislature by an unusual, unanimous vote. (7) The retail value of the California electric market was approximately $20 billion annually, with peak load of 53 GW and consumption of 264,000 GWh. (8)

      Assembly Bill 1890 adopted almost verbatim the state Public Utility Commission's restructuring plan. (9) The legislation was subsequently approved by FERC (10) and capped the retail utility rate for each class of customer at 90% of its current level for a period of approximately six years. (11) Because California's concept of deregulation contained a 10% price cut to pacify consumers, (12) consumers were discouraged from shifting to alternative retail suppliers. (13) Accordingly, a vibrant retail market and significant customer shift to alternative suppliers did not become a reality. Because of the recession in California, demand for electricity between 1991 and 1996 only progressed at a rate of about 1% per year. (14) After deregulation was set in motion, and the economy improved, between 1997 and 2000 the increase in demand for electricity was 3.5-4% per year. (15) Between 1993 and 1999, cumulative electric power demand increased 18%. (16)

      While retail rates under the restructuring system were frozen, average demand for electricity in California increased almost 13% from June 1999 to June 2000. (17) Because of the 10% price cut, only about 3% of customers, representing about 12% of electricity sales, switched to new suppliers, leaving 88% of electricity sales subject to default service by the regulated electric utilities. (18)

      These default service obligations were unhedged. (19) Regulatory authorities required the utilities to buy a substantial amount of their power requirements on the spot market (day-to-day) rather than through forward-hedged contracts. (20) The utilities asked permission to hedge their short positions in power supply not covered by the approximately 12,000 MW of retained coal, nuclear, and hydroelectric assets they had not yet divested, which retained assets meeting only a minority of daily default service load. (21) Petitions of Southern California Edison Co. hoping to purchase some of its power in the forward market were denied in July 1999 and again in January and May 2000. (22) Consumer representatives feared that this would undermine the health of the Power Exchange. (23) When the California Public Utilities Commission (CPUC) later approved these requests as the crisis loomed, the specific Commission approval of forward contracts was slow. (24) Responding to political pressure to keep rates low, CPUC denied utilities' requests to increase the retail cost of default service during 2000. (25)

      The conventional utilities, therefore, continued to supply more than 90% of the power being sold in the state. (26) The California system worked well enough from its beginning in April 1998 through approximately May 2000. At that point, wholesale prices jumped dramatically. (27)

      Power shortages began in the summer of 2000. (28) During the first four months of 2000, prices in the wholesale market on an hourly basis averaged about $30/MWh. (29) In June, July, and August 2000, however, average prices on the spot market quadrupled to about $125/MWh, and at times exceeded $200/MWh. (30) By the end of 2000, moreover, spot market values had doubled from this new plateau, (31) creating an increase of approximately 1000%, or ten times the price of what they had been in 1998. (32)

      What was unusual about these price levels was that they "were not confined to a few peak hours per day, but frequently lasted all day long." (33) In May 2000, due to hot weather, out-of-service generation, and increasing demand, the ISO declared a Stage II emergency which resulted in power curtailment to certain nonfirm, large, retail customers. (34) Still more unusual was the fact that...

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