Testimony of Erik Saltmarsh

Senate Energy, Utilities and Communications Committee

Informational Hearing
February 11, 2003

Federal Energy Regulatory Commission Refund and Contract Reformation Cases

Erik Saltmarsh
Chief Counsel
Electricity Oversight Board

Refund Proceeding

• Refund claims for alleged overcharges in the range of $9 billion for the period May 2000 through June 2001.
• The FERC set a portion of the time period and transactions for hearing. These represented about $3 billion of our claims. The FERC directed the use of a price calculation formula that was anticipated to reduce actual refunds in this period by around $1 billion.
• Claims excluded by the FERC and flaws in their formula were appealed in the Courts.
• An extensive trial was conducted and briefed before a FERC judge. The Judge issued an initial order that found California wholesale buyers were entitled to $1.8 billion in refunds. This initial decision is now pending before the FERC for final action.
• The appeals are still pending.
• The California litigation team obtained an appellate court ruling granting allowing additional evidence of market manipulation to be placed into the record and that effort is proceeding.

In response to runaway prices in the summer of 2000, a series of complaints were filed at the Federal Energy Regulatory Commission (FERC). Among these was the State of California’s complaint, filed by the Electricity Oversight Board (CEOB). The FERC did not address the substance of these complaints until November 1, 2000 when it issued an order proposing market remedies. San Diego Gas & Electric Company, et al., "Order Proposing Remedies For California Wholesale Electric Markets," 93 FERC ¶ 61,121 (2000) (November 1 Order).

The FERC ultimately dismissed a number of the separate complaints, ruling that any claims would go forward under the earliest filed, that by San Diego Gas & Electric Company.

In late 2000 and early 2001, the FERC issued a series of orders in which it instituted a series of completely ineffective mitigation measures while waiting to decide what it would do with the complaint claims. In the interim, the FERC had put the market on notice that transactions might be subject to refund. The inadequate measures in these orders were all appealed by the CEOB and other parties.

In early 2001, the Department of Water Resources had become the predominant purchaser of power in California. On March 1, 2001, the CEOB made a filing to the FERC, seeking confirmation that CDWR purchases would be equally subject to refund as had been other purchases. The FERC did not immediately rule on this request.

The FERC finally dealt with claims for refunds in the summer of 2001, mostly in its July 25 Order, which established a methodology for calculating refunds for spot transactions from the refund effective date, October 2, 2000 through June 20, 2001. In setting the matter for hearing, the FERC excluded the first four months of runaway prices and also ruled that direct purchases by the CDWR would not be subject to refund. Additionally, the FERC chose a pricing formula that would lessen the remaining claims. In total, of approximately $9 billion in claimed refunds, the FERC excluded approximately 6$6 billion from review by a judge and then imposed a formula that would limit the remaining $3 billion claim to about $2 billion that could possibly be recovered. The CEOB and other parties appealed these decisions.

Through out late 2001 and 2002, the California trial team litigated the allowed claims before a FERC judge. These were highly contested proceedings with several hundred adversary parties.

On December 12, 2002, the Judge issued a preliminary decision finding that $1.8 billion in market refunds were due to California wholesale buyers. This finding has now been submitted and briefed to the FERC itself, where a final decision is pending. The FERC Chairman has stated that he intends to resolve all outstanding California issues in March 2003.

Numerous aspects of the FERC’s earlier decisions relating to price relief refunds remain in the Courts of Appeals. One matter that has been acted upon by the appellate court concerns the scope of record that the FERC has allowed. The FERC has systematically precluded California parties from introducing evidence of market manipulation into the refund proceedings. We have argued that this is a critical error because such evidence changes the legal standard for the FERC to act. Consequently, the Ninth Circuit granted a motion by the CEOB, the AG and Southern California Edison to be allowed adduce additional evidence on August 22, 2002. The FERC did not initiate the window for discovery until November 20, 2002. The November 20 Order allows California Parties 100 days to seek discovery of seller market manipulation from January 1, 2000 through June 20, 2001 and requires the California Parties to make its evidentiary submittal on February 28, 2003, the 100th day from the date of the Order and also requires the California Parties to comply with discovery requests of other parties. This process is actively underway and is consuming enormous effort by the California parties, including the CPUC who has joined in the effort.

 

Long-term Energy Contract FERC Litigation

• Complaints were filed against 34 contracts with 24 suppliers.
• The CEOB alleged approximately $11 billion in excess charges based on the original prices and terms.
• 21 Contracts have been renegotiated, resulting in direct reductions of $5.2 billion, and other major improvements in the value of the products reflected in the contracts.
• Hearings have been conducted on the remaining contracts. The matter has been briefed to the FERC and a decision is expected in coming weeks.

The CDWR became the buyer of last resort for the "net short" position of California’s three main investor-owned utilities ("IOUs") upon enactment of AB1X 1 in January of 2001. The net short is the difference between the amount of power needed to meet customer demand and the energy the IOUs provide from their own resources. The CDWR responded to this challenge by entering into a variety of short and long term purchase arrangements, including the long-term contracts being discussed here. These contracts initially had durations ranging from 18 months to 20 years with an aggregate cost of purchased power of approximately $42 to $45 billion.

On February 25, 2002, the CEOB filed a complaint at the FERC, pursuant to Section 206 of the Federal Power Act, against 24 suppliers of energy and capacity under 34 long-term contracts with the CDWR. The CPUC simultaneously filed a separate complaint and these were consolidated into a single proceeding.

The complaints seek reformation of price and non-price terms of the CDWR long-term contracts. The CEOB asserted in its complaint that the dysfunctional spot markets, i.e., short-term market, adversely affected the long-term bilateral market by raising forward prices during the winter and spring of 2001 for power delivered during 2001 through 2003 to levels significantly above what they would have been but for the dysfunctional spot market. The CEOB evaluated the contracts and calculated that approximately $11 billion of excess charges in the 34 challenged contracts. The CPUC made substantially the same claims and used a different comparison benchmark to allege a somewhat larger overcharge.

On April 25, 2002, the FERC consolidated the complaints, dismissed fifteen (mostly smaller) contracts from the proceeding and set the remainder for hearing on the narrow question of whether the dysfunctional California spot markets adversely affected the long-term bilateral markets, and, if so, whether modification of any individual contract at issue is warranted. (99 FERC ¶ 61,087 ["April 25 Order"].)

A central premise of the complaints was that the exercise of market power constituted a substantial factor in driving up spot market prices amid tight supply conditions in 2000 and 2001 and that the expectations of continued and future opportunities to exercise market power substantially inflated the prices offered for long-term bilateral transactions. The FERC expressly excluded the subject of market manipulation from this hearing.

The FERC made an initial determination in the April 25 Order that certain of the contracts that contained what is called a "Mobile-Sierra" clause, would be considered under a higher burden of proof than simply whether the prices and terms were "just and reasonable" under the law. Instead, the State would have to show that the public interest compelled modification of the contracts for reasons other than simply high prices. That parties whose contracts were subject to this standard included: Allegheny Energy Supply Company, Mirant Americas Energy Marketing, and Coral Power, Williams, Soledad Energy, and GWF Energy. The judge would recommend the standard to be applied to the remaining contracts. These included El Paso Merchant Energy, Dynegy, Morgan Stanley Capital Group, Sempra Energy Resources, Alliance Colton, and PG&E Energy Trading. Following intense, concentrated pretrial discovery, the hearing was held at the FERC from December 2 – 13, 2002 and briefing was concluded on January 27, 2003..

Prior to and during the hearing, many of the original 24 suppliers, including some dismissed by the April 25 Order, successfully renegotiated their contracts with the State and as a consequence, the complaints were withdrawn as to those sellers. In total, the State has successfully renegotiated 21 contracts resulting in direct contract savings to the State of approximately $5.2 billion. Suppliers that remained in the action through the conclusion of the hearing included Dynegy, Mirant Americas Energy Marketing, Sempra Energy Resources, El Paso Merchant, Morgan Stanley Capital Group, Allegheny Energy Supply Company and Coral Power.

On January 16, 2003, the ALJ found that all contracts are to be considered under the public interest standard with its higher burden to the State. The record of the hearing and the briefs are currently before the FERC awaiting a decision. No date has been explicitly set for a ruling by the FERC. However, FERC Chairman Patrick Wood III has publicly stated that the FERC anticipates resolving all outstanding California dockets, including this proceeding, by the end of March 2003.