Energy Update July 2008

July 2008

From the editors of Wolters Kluwer Law & Business, this update describes important developments from CCH energy publications.

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FERC

FERC Examines Causes of Rising Electricity Costs
Higher fuel prices, increased capital costs and continued uncertainty about climate policy are helping fuel the rising costs of electricity faced by consumers across the country, the Commission (FERC) has announced. The rising cost trends are likely to continue for years, according to a report presented to the Commission by analysts from FERC’s Office of Enforcement. The report pegs current futures prices for natural gas at $2.50 to $5 above the average 2007 spot price for natural gas, with costs for everything from iron and steel to cement and copper wire rising significantly over the past several years. Those have contributed to increases in the cost of new generation for every type of power plant, from nuclear power to combustion turbine and wind generators. “We must confront three realities: FERC is regulating in a high-cost environment; the United States needs massive investments in new electricity generation, transmission and distribution facilities; and we are beginning to confront the climate change challenge, which puts us in a period of uncertainty regarding policy,” according to FERC Chairman Joseph Kelliher. “There is tension among these three realities, and they work at cross purposes. The United States cannot simultaneously make the massive investments necessary to assure security of our electricity supply, make additional large investments to confront climate change, and lower electricity prices. Doing so would likely result in failure.” The report says that consumers and the market likely will respond with demand response measures that help reduce energy consumption during times of peak prices, energy efficiency and conservation measures, and technological innovations that could usher in changes that help reduce costs and improve value, as they did in other competitive industries such as telecommunications. The FERC staff report, “Increasing Costs in Electric Markets,” is available on the FERC web site, www.ferc.gov. (FERC Statutes and Regulations, No. 498, July 21, 2008)

Nuclear Power

NRC’s Annual Security Inspection Report to Congress Released
An unclassified version of an annual report to Congress outlining last year’s security inspection program has been released by the Nuclear Regulatory Commission. The report covers the security inspection program, including force-on-force-exercises, for commercial power reactors and certain fuel cycle facilities for calendar year 2007. According to the report, required under the Energy Policy Act of 2005, the NRC conducted 199 security inspections at commercial power reactors, of which 22 were force-on-force inspections. These force-on-force inspections use a well-trained mock adversary force to test a facility’s ability to respond to the level of threat the facility is required to defend against. Virtually all of these inspections yielded findings that were or very low security significance. Under the security inspection program, licensees are expected to promptly fix, or compensate for, any potentially significant deficiencies which are identified in the protective strategy of the plant. (CCH Nuclear Regulation Reporter, No. 1396, July 15, 2008)

Posting of All Documents Not Required for Repository License
In a proceeding that involves the Department of Energy’s (DOE) license application for a high-level nuclear waste repository at Yucca Mountain, Nevada, DOE’s certification of the availability of its documentary material on the Licensing Support Network (LSN) has been affirmed by the Nuclear Regulatory Commission. Documentary material is (1) information upon which a party intends to rely; (2) any information which is known which does not support the party’s position; and (3) reports and studies prepared by the parties. This material had to be posted at least six months before DOE submitted its license application for the repository. The State of Nevada argued that DOE could not certify compliance until it had created and finalized all documents that it will rely on for its license application and had placed them on the LSN. NRC regulations, however, do not require DOE to attest that all of the supporting documentary material for its license application is complete. Rather, certification could occur when DOE affirmed that it placed the documentation it had at the time on the LSN and that it will also place newly created or identified documentary material on the LSN in the future as it is generated or identified. (CCH Nuclear Regulation Reporter ¶31,563)

Natural Gas

Capacity Release Rule Expands Gas Supply Market Options
A final rule (Order No. 712) designed to enhance competition in secondary natural gas capacity release markets has been approved by FERC. Competition will be expanded primarily by removing price caps on short-term releases of capacity and increasing flexibility afforded asset management agreements under FERC’s capacity release rules. The final rule adopts and clarifies provisions of the rule proposed in November 2007 to remove permanently the rate cap on capacity release transactions of one year or less. This will enable shippers to offer competitively priced alternatives to pipelines’ negotiated rate offerings and permit short-term capacity release prices to rise to market clearing levels, thereby allocating capacity to those who value it the most. The rule declines to lift the rate cap on long term capacity releases of more than one year and on primary sales of capacity by pipelines. Order No. 712 also modifies FERC policies and regulations to facilitate and accommodate the use of asset management arrangements under which a capacity holder releases some or all of its pipeline capacity to an asset manager who agrees either to purchase from or manage the natural gas needs of the capacity holder. To promote asset management arrangements, the final rule exempts capacity releases made as part of such arrangements from the prohibition on tying capacity releases to any extraneous conditions. The final rule also exempts asset management arrangements from the bidding requirements of FERC’s rules governing the release of firm capacity on interstate pipelines. The rule will take effect July 30, 2008. (FERC Statutes and Regulations ¶31,271 (ip access user))

More Accurate Financial Reporting Requirements for Gas Companies Affirmed
The Commission’s decision to require gas companies to report their financial transactions more accurately has been largely affirmed by the agency. In Order No 710, the Commission revised the financial forms, statements and reports required of interstate natural gas companies to better reflect the current market and cost information needed for regulatory oversight of their rates and terms of service. In affirming the earlier order, the Commission denied a request for rehearing filed by the American Gas Association (AGA) which argued that the Commission should have broken down the newly required information further. It argued that gas companies should include, by function, the amount of fuel that has been waived, discounted or reduced as part of a negotiated rate agreement. The Commission found this request unnecessary and burdensome—it is unlikely that all pipelines would have this type of information readily available and it is not apparent that the level of fuel associated with these types of transactions was significant enough to warrant additional reporting requirements.

Nor will the Commission reinstate a periodic rate filing requirement as a condition for the issuance of a blanket certificate for open access transportation service. It is well settled that the Commission may not compromise the limits set by the Natural Gas Act restraining the Commission’s power to revise rates. The reinstatement proposal, filed by the Kansas Corporation Commission, is inconsistent with that limitation on the Commission’s powers. In today’s natural gas market, the Commission continued, open access transportation is so fundamental to the manner in which pipelines conduct business that there is no realistic option for a pipeline not to retain its blanket certificate. The alternative would require a return to the pre-open access past when pipelines provided only individually certificated service requiring abandonment procedures under the Natural Gas Act and would deprive the pipelines’ customers of the benefits of open access transportation service. (Revisions to Forms, Statements, and Reporting Requirements for Natural Gas Pipelines, 123 FERC ¶61,278)

Electric Utilities

High Court Requires FERC To Review California Power Contracts
The Commission must presume that the rates for electricity set in a freely negotiated wholesale-energy contract met the just and reasonable requirement of the Federal Power Act and that presumption, known as the Mobile-Sierra doctrine, could be overcome only if FERC concluded that the contract seriously harmed the public interest, the U.S. Supreme Court has ruled in Morgan Stanley Capital Group, Inc. v. Public Utility District No. 1 of Snohomish County (Dkt. No. 06-1457). The Supreme Court’s decision reversed a Ninth Circuit finding that contract rates were presumptively reasonable only when FERC has had an opportunity to review the contracts without applying the Mobile-Sierra presumption, and, therefore, that the presumption should not apply to contracts entered into under market-based tariffs. FERC had initially determined that the presumption applied and that the contracts did not seriously harm the public interest. However, the Supreme Court did affirm the Ninth Circuit’s decision on alternate grounds, finding two defects in FERC’s analysis. First, the analysis was flawed to the extent that FERC looked simply to whether consumers’ rates increased immediately upon the conclusion of the relevant contracts, rather than determining whether the contracts imposed an excessive burden down the line relative to the rates consumers could have obtained (but for the contracts) after the dysfunctional market that existed in 2000-2001 in the western United States ended. Second, the Supreme Court determined that it was unclear from FERC’s orders whether it found adequate evidence to support the claim that the petitioners engaged in unlawful market manipulation that altered the playing field for contract negotiations. Under these circumstances, the high court found that FERC should not presume that a contract was just and reasonable. (CCH Utilities Law Reporter ¶14,699)

Approval of Grid Charge, Fee Pass-Through Upheld
The Federal Energy Regulatory Commission (FERC) did not act arbitrarily or capriciously in its approval of the California Independent System Operator's (CAISO) administrative fees or in the pass-through of those fees by Pacific Gas and Electric Company (PG&E) to its customers, the U.S. Court of Appeals for the District of Columbia Circuit held. PG&E's customers argued that the ISO's grid management charge and the pass-through tariff from PG&E violated the Mobile-Sierra doctrine because they amounted to a change of the existing contract the customers had with PG&E. However, where a new rate is intended to recover the costs of new benefits and services, the doctrine does not apply. The court said that FERC made factual findings that: CAISO would generate significant new services for PG&E's existing customers upon CAISO's takeover of the state's transmission grid from the control of privately-owned utilities; CAISO had brought about “fundamental changes” in the manner in which electricity was sold and distributed in the region; and new market opportunities were created. Further evidence showed that the costs of the grid management charge pass-through were for the CAISO's service, and not the service that PG&E had provided under the existing contracts. Also, the court said that PG&E and CAISO performed new and better services for customers, and the pass-through tariff was “dollar-for-dollar” based on the grid management charge, which was the cost of starting up and operating the ISO. The customers received the benefit of the new system and paid exactly the cost of the new system, according to the court. Finally, the court ruled that FERC's finding that the market operations charge did not result in charging the customers twice for the same service was based on substantial evidence and was not arbitrary or capricious. (Western Area Power Admin. v. FERC (DCCir) CCH Utilities Law Reporter ¶14,697)

“Contract Demand” Rate Method for Standby Customers OK'd
The Federal Energy Regulatory Commission's (FERC) approval of the proposed rate for an electric utility's standby customers based on the “probabilistic method” (under which rates are based on the percentage of “contract demand” the class is likely to use) was just and reasonable because substantial evidence in the record showed that the unpredictability of standby customer demand imposed costs not captured by measuring that class's contribution to system peak, the U.S. Court of Appeals for the District of Columbia Circuit ruled. Two unincorporated associations comprised of Pacific Gas and Electric Company's (PG&E) standby customers (customers) argued that FERC's approval violated the cost-causation principle under the Federal Power Act (FPA). However, the court upheld FERC's conclusion, which was based on the testimony of a rate expert who explained that the standby class is different from other classes because the demand it places on the system is both variable and unpredictable and on the fact that under the contract PG&E must provide service to the standby customers on demand. In contrast, PG&E's “12-coincident peak method” did not sufficiently allocate costs to the standby class because the probability of that class's maximum demand coinciding with system peak was statistically low. The court also ruled that FERC's approval of a weighted cost allocation factor produced by PG&E's proposed rate methodology for the electric utility's standby customers was just and reasonable, and was supported by substantial evidence in the record. Data in the record showed that a regional allocation reflected the standby customers' actual usage. (Cogeneration Ass'n of California, et al. v. FERC (DCCir) CCH Utilities Law Reporter ¶14,698)

Oil Pipelines

TAPS Carriers Ordered to Make Compliance Filing, Limited Refunds
An administrative law judge’s (ALJ) finding that the Trans Alaska Pipeline System (TAPS) Carriers’ proposed 2005 and 2006 interstate rates were not just and reasonable was affirmed by the Federal Energy Regulatory Commission. The Commission also affirmed the ALJ’s determination of the components for establishing the rates for 2005 and 2006, as well as the ALJ’s order of limited refunds. The TAPS Carriers were directed by the ALJ to make a compliance filing after the Commission issued its final order establishing rates in conformance with the initial decision’s (ID) findings, of which there were several. The ALJ found that although the TAPS Carriers had the burden of proof with respect to showing their filed rates and settlement methodology were just and reasonable, they failed to carry that burden of proof. The ALJ concluded that the TAPS Settlement Methodology (TSM) did not establish reasonable rates, and that the TAPS Carriers failed to prove that each component of the TSM-based rates was cost-based and just and reasonable. In spite of the TAPS Carriers’ exception urging that no refunds should be required and that any change in rates must be prospective only, the Commission affirmed the ID’s ruling that the newly determined just and reasonable rates would be effective January 1, 2005, but the refund would be limited to the amount of the increase in the filed 2005 and 2006 rates over the existing rate in the 2004 filing, which was not protested.( BP Pipelines (Alaska) Inc., et al., Opinion No. 502, 123 FERC ¶61,287)

Oil & Gas

House Votes on “Use It or Lose it” Oil Lease, Oil Speculation Bills
A Democratic-sponsored bill in the House of Representatives that would have forced oil companies to use or lose their existing federal oil and gas leases failed on July 17 to achieve the two-thirds majority needed for passage. The bill, H.R. 6515, faced a veto threat from President Bush. A similar bill--H.R. 6251, the Responsible Federal Oil and Gas Lease Act, also known as the ``Use it or Lose It'' legislation--also failed to pass on June 26. However, the House voted 402 to 19 on June 26 to pass the Energy Markets Emergency Act of 2008 (H.R. 6377), which allows the Commodity Futures Trading Commission (CFTC) to utilize its authority, including its emergency powers, to curb the role of excessive speculation in energy futures markets. (CCH Energy Management, No. 1278, July 24, 2008)

President Lifts Executive Order Banning Offshore Drilling
President Bush said on July 14 that he will lift the executive prohibition on oil exploration in the Outer Continental Shelf (OCS) through 2012, and again urged Congress to lift the legislative ban in order for exploration to proceed. ``I've taken every step within my power to allow offshore exploration of the OCS. All that remains is for the Democratic leaders in Congress to allow a vote,'' Bush said at a White House ceremony. The White House pointed to estimates that OCS areas under leasing prohibitions could produce about 18 billion barrels of oil. (CCH Energy Management, No. 1278, July 24, 2008)

Discriminatory Access Complaints Process Established
Regulations establishing a complaint process for shippers transporting oil or gas production from federal leases in the Outer Continental Shelf (OCS) who believe they have been denied open and nondiscriminatory access to OCS pipelines have been issued by the Minerals Management Service. The regulations implement complaint procedures and informal or alternative dispute resolution (ADR) processes that are similar those used for other appeals to the Interior Board of Land Appeals (IBLA). Complaints regarding Outer Continental Shelf Lands Act (OSCLA) pipelines will be filed with the MMS Director, along with a nonrefundable processing fee of $7,500. Complaints must be filed within 2 years of the alleged violation. If MMS finds that there has been a violation, it will be authorized to ordering grantees and transporters to provide open and nondiscriminatory access and assess civil penalties of up to $10,000 per day, as well as to request the Department of Justice institute civil actions for a temporary restraining order, injunction, or other remedy. Parties adversely affected by the decision would be allowed to appeal to the IBLA. MMS will also establish a toll-free hotline that will receive allegations of violations, including anonymous allegations if desired, and to allow shippers and transporters to request ADR. (CCH Energy Management ¶9535)

Rules Allocating Funds from Certain Gulf of Mexico Leases Proposed
The regulations that govern the distribution and disbursement of royalties, rentals, and bonuses would be amended to include the allocation and disbursement of revenues from certain leases on the Gulf of Mexico (GOM) Outer Continental Shelf (OCS), under a proposal from the Minerals Management Service. This would implement portions of the requirements of the Gulf of Mexico Energy Security Act of 2006 (GOMESA) that address GOMESA provisions relating to the distribution of OCS revenues to Gulf producing states and their coastal political subdivisions. GOMESA lifted the moratorium on oil and gas leasing in a part of the Central Gulf of Mexico and mandated lease sales in 181 Area and 182 South Area, both in the GOM. For fiscal years 2007 through 2016, 50 percent of qualified OCS revenues from these two Areas would be divided as follows: 25 percent would be disbursed to the Land and Water Conservation Fund and 75 percent allocated among the states of Alabama, Louisiana, Mississippi, and Texas, with 20 percent of the funds allocated to the states disbursed to political subdivisions along the coasts. (CCH Energy Management ¶9319)