One Minor Act of a Larger, High-stakes Power Markets Drama

On April 1, the Public Utilities Commission of Ohio (PUCO) approved rate plans (for the supply and pricing of electric generation service) from regulated utilities American Electric Power Company (AEP) and FirstEnergy Corp. The plans, which are part of the regulatory process for the utilities, both include eight-year power purchase agreements (PPAs). In addition to the power purchase component of the agreement, the approved plans include provisions for AEP and FirstEnergy to reduce greenhouse gas emissions, fund low-income programs, support energy efficiency, and support wind and solar development. The utilities estimate that the approved plans will save customers almost $500 million over the lifetime of the contract, preserve $1 billion in annual statewide economic benefits, while also reducing price volatility, maintaining fuel diversity, and ensuring grid modernization.

The PPAs stipulate that AEP and FirstEnergy will purchase power at above-market, set rates from specific plants owned by their parent companies. The PPAs will effectively keep open the nuclear and coal power plants owned by AEP and FirstEnergy’s corporate affiliates. The regulated utilities will turn around and sell this power on the wholesale market, with Ohio ratepayers making up the difference between the wholesale price and the PPA set price (in the event that prices rise above the PPA price, customers would be credited the difference).

The Federal Energy Regulatory Commission (FERC), the federal agency charged with ensuring the integrity and competitiveness of wholesale electricity markets, generally restricts the ability of power companies to engage in transactions with their corporate affiliates because of the possibility for these transactions to result in anticompetitive behavior. However, PUCO, AEP, and FirstEnergy had secured “affiliate transaction waivers” from FERC in 2008 that allows them to undertake these transactions. Those waivers were granted on the basis of the fact that Ohio is a retail choice state, which means that power customers can switch power suppliers if prices rise too much; they are not “captive” to high prices, and this ability to switch power providers is assumed to be a check on affiliate transactions. While Ohio is still a retail choice state, the cost of the PPAs is “non-bypassable,” meaning that even customers who purchase power from other providers will still have to pay the cost of the PPAs.

The PPA components of the Ohio agreements are extremely controversial and sparked outrage among a diverse group of stakeholders ranging from independent power producers to consumer advocates to environmental groups (the Sierra Club dropped its opposition after the utilities included concessions related to renewable energy). Critics of the agreements argue that the PPAs circumvent and thereby undermine competitive power markets, will distort market prices, infringe on federal jurisdiction over wholesale markets, and are a bad deal for ratepayers, to the tune of $6–8 billion over the eight-year life of the contract.

In early 2016, critics of the plan asked FERC to step in on the Ohio issue. Several independent power producers, including NRG Energy, Dynegy, and others, filed formal complaints with FERC asking it to review the original affiliate transaction waiver in light of current circumstances. These companies charge that the power sales are an abuse of market power and undermine competitive markets. Ohio’s Consumers’ Counsel and PJM submitted comments to both PUCO and FERC on the matter, while the Pennsylvania Public Utility Commission also voiced concern. (AEP and FirstEnergy responded to these complaints in a formal response to FERC, asking the body to not intervene.) With or without FERC relief, opponents of the deal have stated that they intend to sue PUCO over the approval. The Environmental Defense Fund (EDF) and other parties have announced that they will ask PUCO for a rehearing, the first step in an appeals process; EDF has stated that if the decision is not in their favor, they will take the case to the Ohio Supreme Court.

While the plan approval is pursued in Ohio, the issue before FERC is about whether to review and potentially rescind the affiliate transaction waivers. FERC does have authority to review the PPAs, although whether it will decide to do so remains to be seen. AEP and FirstEnergy argue that FERC has stayed out of these transactions and should continue to do so—they have a waiver, the transactions are allowed, and there is no need for FERC to act. Complainants, however, allege that affiliate transaction waivers were granted under different circumstances than now prevail in Ohio, and the current situation threatens markets such that FERC has an obligation to step in, rescind the waivers and rereview them under a different standard. The primary argument is that the PPA fee will be “non-bypassable”: that customers will be forced to pay the cost of PPAs regardless of their electricity supplier—and therefore the terms of the original waiver (that retail choice would prevent affiliate abuse) are not relevant to the current situation (where ratepayers are captive). Complainants charge that this changed circumstance is akin to the fox being in the henhouse, with the farmer (FERC) looking the other way. The complainants want FERC to force AEP and FirstEnergy to file the PPAs for review under a standard that would force the transactions to be deemed reasonably priced compared to alternatives—a standard that critics charge the current deals baldly fail to meet. These complaints are still pending at FERC. All sides are waiting to see whether FERC will move to review the agreements as petitioners have requested, and if so, what the outcome of the review will be.

The PUCO’s decision and the dispute before FERC is extremely complicated, technical, and specific, but it is also only the latest act of a larger, high-stakes power markets drama. At the heart of this drama is whether wholesale electricity markets, as configured in the 1990s and continually tweaked since then, are meeting the disparate needs and interests of regulators, state lawmakers, consumers, and market participants.

Two issues at the heart of dispute over the Ohio PPA reflect the broader questions swirling around power markets. The first is how to interpret the PPAs: are they a massive, unfair ratepayer-funded bailout for utilities looking to shield their unprofitable plants from the vagaries of the market, or are the agreements a way to limit bill increases and strike “ a highly challenging balance between consumers’ interest…and the vested interests of other diverse stakeholders ”? The answer to the question hinges on whether you believe that wholesale electricity markets, in which Ohio is a participant, are able to deliver affordable energy and long-term reliability at a level of risk that is acceptable to states. PUCO’s decision can be justifiably interpreted as a deeply unfair shifting of economic risk from market participants onto consumers, as alleged by the Ohio consumer advocate and others. Consumer advocates and market participants argued that it was a simple bailout of uncompetitive power plants that would distort prices in wholesale markets, undermining competition in the entire mid-Atlantic region. But PUCO’s decision can also be reasonably interpreted as a recognition of the failure of markets to ensure the kinds of outcomes that states would like to see, primarily ensuring the long-term availability of low-cost power. AEP, FirstEnergy, and PUCO believe that the risks to the system are from low and volatile energy prices that do not reflect the true cost of a robust, diverse, and reliable energy system. Undoubtedly, the proponents and opponents are aligned with their business interests, but it does not change the fact that both interpretations have merits. The PPA payments are ratepayer subsidies for power plants that are not competitive in wholesale markets, but that fact is also concealing a more complicated reality that markets are simply responding to supply and demand in the short term and that FERC and market operators have struggled to find a way to properly incentivize capacity build-out, while states have the obligation to ensure a robust system in the long term. While some have faith that markets are capable of providing this absent intervention, in the long term, others are less confident.

Those unsympathetic to Ohio (and Maryland and New Jersey, the petitioners in a current case before the Supreme Court, see below) will argue that states are simply trying to undo the decisions they made two decades ago when they restructured their power markets and ordered their utilities to divest themselves of generation. Opponents of Ohio’s recent action also argue that Ohio was aware of the trade-off between control and efficiency when it signed up to participate in wholesale markets (and in fact, many states, for those reasons and others, not wanting to make the same trade-off, chose not to participate in organized wholesale markets). Wholesale market proponents point to low electricity prices and projections of adequate supply well into the future. Markets are working, they say, and states are nakedly acting on parochial interests to protect local jobs and economic activity. Ohio’s decision to cherry-pick the best aspects of markets while disregarding the rest undermines the entire market structure, imperiling the integrity of the markets for all participants (which is why Pennsylvania and PJM felt the need to intercede). These proponents point out that there is no option to only sort of participate—you’re either in or out, and being half-way in—what Ohio is trying to do—distorts the market in profound and unfair ways. It is a fair point but also cold comfort to many states looking around now, unhappy with the status quo and grappling with a way forward that maximizes ratepayer interest while not compromising long-term goals of reliability and decarbonization.

A more sympathetic reading is to ask what states can do if they have legitimate concerns about the inability of wholesale markets to address the long-term consequences of price volatility in wholesale markets. If a large generator closes, and market prices are too low to incentivize new generation, states have little recourse to ensure the long-term availability of power.

Which brings us to the second issue: legal jurisdiction. In two cases before the Supreme Court this term, the Court is grappling with how to preserve some recourse for states, while also maintaining the distinction in the Federal Power Act between wholesale transactions (the prerogative of the federal government) and retail transactions (the prerogative of the states). The difficulty, as we noted in a previous post, is that the neat division of jurisdiction over electricity markets between retail and wholesale transactions, embodied in the 1935 law (called the “bright line”), does not align with the realities of either the physical grid or its institutional architecture.

Although they are not directly about affiliate transactions (the issue that will be the basis of any future lawsuit in Ohio), the current Supreme Court cases this term try to strike a balance on the jurisdictional issues at play in electricity markets. The first case, EPSA v. FERC, was decided earlier this year and clarified that FERC has jurisdiction over anything that “directly” affects wholesale power rates. Another case argued in February, Hughes v. Talen Energy Marketing, is expected to rule on what exactly states in wholesale power markets can do with respect to ensuring stability in their power markets. Energy policy watchers will be keen to see whether Hughes sets a new standard for how to understand the jurisdiction of the states and federal government over electricity markets. Alternatively, the Court may hand down a relatively narrow decision, declining to engage in, as SCOTUSblog writes, an “extended exploration of where, as a more general matter, federal law places the dividing line between federal and state authority over this industry, a line that always seems elusive.” In other words, it is unlikely that the Court can or will simply draw a new bright line. Whatever the Supreme Court eventually decides in Hughes will be far from the last word on the fraught question of jurisdiction and, at the broader level, whether electricity markets are capable of delivering the diverse range of goals and objectives sought by state policymakers.

Coming back to Ohio: It is not clear whether FERC will move to rescind the waivers and rereview an application for a new waiver using a new standard. But regardless of any decision on the waivers, the curtain is not close to falling on the broader drama. Ohio is not the only state that is now looking at its options for how to take advantage of the benefits of markets while also trying to retain room to maneuver on energy policy.

Michelle Melton is an associate fellow with the Energy and National Security Program at the Center for Strategic and International Studies in Washington, D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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