Presented to:University of Virginia Law School

Charlottesville, VAMarch 25, 2004

Market Monitoring’s Key Role in Modern Economic Regulation

William F. Hederman, DirectorOffice of Market Oversight and Investigations

Federal Energy Regulatory Commission

WFH-3/25/04

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Outline

0.Ground Rules

1.FERC’s Strategy

2.Evolution of Energy Regulation

3.Market Monitoring

4.Key Initiatives

5.Next Steps

(Opinions: my own, not the Commission’s)

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FERC has a 3-pronged strategy.

Effective Rules

Infrastructure

Rules

Enforcement

CompetitiveMarkets

Just & ReasonableOutcomes

StrategicApproach

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Significant changes have taken place in energy regulation.

• Franchised Monopoly

- exclusive service (franchise) area

- obligation to serve

- cost-of-service regulation

-- price caps

-- return of rate base

• Transition to Competition

- trucks (ICC)

- airlines (FAA)

- oil

- natural gas (FPC/FERC)

- electricity (FERC/PUCs)

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Evolution

FERC Standard Market Design for Electric Markets

• Goal: one set of rules throughout the nation would reduce transaction costs and regulatory uncertainty

• NOPR: July 31, 2002

(Remedying undue discrimination through open access transmission service and standard electricity market design)

-- extensive outreach (pre- and post-NOPR)

-- explicit state role

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Evolution (continued)

• Key Elements of SMD:

-- independent transmission provider

-- new transmission tariff

-- transmission pricing reform

-- organized markets: day-ahead and real-time

-- mitigation of market power

-- resource adequacy

-- regional planning

-- market monitoring

• Extensive Controversy

-- state opposition (NW, South)

-- Congressional objections

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As SMD is transforming, a new consensus is developing.

• Regional differences are important

• Market transparency and integrity matter

• Market monitoring and FERC enforcement help whatever the policy

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Director

Office of Market Oversight and Investigations (OMOI) - Knowledge/Skillsets -

Division of Management & Communication

Division of Management & Communication

• Planning • Perf. Mgmt. • Budgeting • Facilitation • Speaking • Knowledge of industry • Partnering

• Career Dev. • HR • Recruiting • Contracting • Writing/Editing • Web design • Graphics • Presentation development

Deputy Director Market

Oversight & Assessment

Deputy Director Market

Oversight & Assessment

Deputy Director Investigations & Enforcement

Deputy Director Investigations & Enforcement

HotlineHotline

Division of Energy Market

Oversight

Division of Energy Market

Oversight

Division of Financial

Market Assessment

Division of Financial

Market Assessment

Division of Integrated

Market Assessment

Division of Integrated

Market Assessment

• Public Speaking • ADR • Phone answering

• Attorneys • Litigation • Investigation • Knowledge of financial markets • Enforcement • ADR Training • Paralegal

Division of EnforcementDivision of

Enforcement

Division of Operational

Investigations

Division of Operational

Investigations

Division of Technical

Investigations

Division of Technical

Investigations

• Forensic Auditors • Analytic ability • Statistical sampling • Documentation • Industry experience • Investigators • Examiners

• Gas Engineer • Electric Engineer • Mechanical Engineer • Quantitative Economist

• Electrical Engineers • Pipeline Engineers • Economists • Deep Industry Expertise • Information Analysis • Modeling • Operations Research • Market Design & Operation

• Engineers • Economists • Broad Industry Experience (Cross- Industry, Scenario, Regulatory Analysis; Market Microstructure Issues) • Operations Research • Writing/Presentation Skills • Policy Analysts

• Information Analysis • Energy Industry Expertise • Software Applications (Large databases, Data Analysis, Statistical, Presentations (including Mapping) • Web Experience • Questionnaire & Survey Design • Statistical Analysis

Market ScanningMarket

Scanning

• Strategic Analysts • Library Science

Division of Information Development

Division of Information Development

• Financial Analysts • Accountants • Understanding of Investment • Derivatives Markets • Energy Trading

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Natural Gas & Electric Market Space

Gas Supply

Trading Venues

Futures (NYMEX)

Electronic Platforms

Bilateral Trading

Voice Brokers

Pipelines&

Storage

Players

Delivered Market

Physical Nat Gas

Generation

Transmission&

Pumped Storage

Delivered Market

Phys Electric Power

Gas to fuel power generation

RTO’s & ISO’s

Price Contributors-Fixed price buyers & sellers-Speculators

Price Takers-Indexed price buyers & sellers

Source: FERC-OMTR&OMOI

Nat Gas & Electric Derivatives

Nat Gas & Electric Clearing

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Key Initiatives

• Behavioral Rules

• Standards of Conduct

• Audits

• Empowering Key Players

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New Market Behavior Rules Highlights (Electricity Markets)

1. Unit operation must comply with Commission-approved rules of applicable market power.

2. Actions/transactions without a legitimate business purpose and that are intended to or foreseeably could manipulate prices are prohibited; no wash trades/false information/artificial congestion relief/collusion

3. Provide accurate information to FERC/ISO/RTOs and MMUs.

4. Voluntary price reporting must follow Price Index Policy Statement and sellers must tell Commission whether they report.

5. Retain relevant pricing records for 3 years.

6. Do not violate code of conduct or Order 889 Standards of Conduct.

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Highlights (continued)(Natural Gas Markets)

1. Actions/transactions without a legitimate business purpose and that are intended to or foreseeably could manipulate prices are prohibited; no wash trades/collusion.

2. Voluntary price reporting must follow Price Index Policy Statement and sellers must tell Commission whether they report.

3. Retain relevant pricing records for 3 years.

See 18 CFR 284.288 (pipelines)

18 CFR 284.403 (blanket marketing certificates)

For first time: sellers relying on blanket market certificates must ID themselves.

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Highlights (continued)Remedies

• Disgorgement of illegal profits

• Suspension or revocation of authority

• Other civil penalties await Congressional action

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Highlights (continued)Other Provisions

• 90-day limit on complaints (from end of quarter in which transacted or when party knew/should have known)

• FERC limiting self (action within 90 days of learning of violation)

• Compliance with approved RTO/ISO rules = compliance with behavior rules (absent broad scheme)

• OMOI to review effects annually

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Highlights (continued)Market Monitoring Units

• MMUs: an extension of Commission staff• MMUs can enforce matters

- expressly set forth in tariff

- involve objectively identifiable behavior

- subject seller to consequences expressly approved by Commission and set forth in tariff

• Commission responsible to enforce other matters• MMUs – OMOI to forge close working relationships• Clear RTO/ISO rules to assist compliance with

behavior rules• MMUs: a work in progress

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Standards of Conduct

GOAL: One set of standards of conduct to apply uniformly to natural gas pipelines and electric utilities or “transmission providers”

PRINCIPLES:

• The transmission function must operate independently from its marketing and sales functions and energy affiliates; and,

• Transmission providers must treat all transmission customers, affiliated and non-affiliated, in a non-discriminatory manner, and cannot operate their transmission system to preferentially benefit an energy affiliate.

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Standards of Conduct (continued)

Key Elements:

• Independent functioning requirement• Emergency exception w/reporting to FERC• Affiliates identified on OASIS• Organization charts and job descriptions posted on OASIS• Employee transfers posted on OASIS• Codes of Conduct submitted to FERC• Non-discrimination requirement• Information sharing prohibitions• Discounts posted on OASIS

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Standards of Conduct (continued)

Important definitions

- transmission provider (TP) (not including RTO)

- energy affiliate (EA)

- marketing affiliate (MA)

Independent functioning

- of TP and MA/EA

- exceptions (e.g., certain personnel, emergencies)

Important postings (on OASIS/Internet)

- names, titles, job descriptions

- certain employee transfers

- potential merger partners

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Standards of Conduct (continued)

Restrictions on information disclosure- TP cannot share with MA/EA- e.g., transmission, price, curtailment, storage, balancing,

ancillary services, ATC, maintenance or expansion information

Tariffs- non-discriminatory application- must post discounts

Chief Compliance Officer

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Audits

• Targeted

- Complaint-based (informal/formal)

- Company-specific

- Issue-specific

• Random

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Key Initiatives

OMOI is working to empower key market participants to

contribute to market integrity.

• State commissions

• State consumer advocates

• Energy engineers

• Members of energy company boards

• Compliance officers

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OMOI Next Steps

• Continuous improvement

- market surveillance reports

- oversight meetings

- seasonal look-aheads

- definitions of market power, abuse, etc.• Enhanced auditing

- targeted

- random• Empowering key market participants• Rapid response to observed anomalies• More intense scrutiny of less transparent markets• Expanded teaming

- MMUs

- states

- other federal agencies

- North American colleagues

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Market Integrity is Everyone’s Business

FERC Hotline:

1-888-889-8030