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Van Ness Feldman, P.C.www.vnf.com

Legal Framework for ElectricityAnd Gas Regulation:

A Quick 45-Minute Tour

Energy Markets and RegulationMarch 15, 2007

Washington, D.C.

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The Rise of State Regulation

− Early 1900’s, states began to take steps to regulate electric service.

− Franchise: Individual electric companies were granted the right tobe the exclusive provider of electric service in a designatedterritory

− Regulatory Compact: In exchange for monopoly franchise, utilitysubmitted to regulation by the state:

− Regulated rates established by the state− Service obligation

− State Regulatory Commissions: Established to oversee localutilities

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Gaps in State Regulation Lead toFederal Legislation

− In 1927, Supreme Court ruled that interstate sales of power are beyond theconstitutional reach of the states to regulate, under a Dormant Commerce Clauseanalysis. Public Utilities Commission of Rhode Island, et al. v. Attleboro Steam &Electric Company, 273 U.S. 83 (1927).

− In 1935, to address the “Attleboro gap” and the abuses of utility holding companies,Congress enacted the Public Utility Act:− Title I - the Public Utility Holding Company Act (PUHCA), regulating the

structure and activities of public utility holding companies.− Title II - added Parts II and III to the newly-renamed Federal Power Act,

regulating wholesale sales of electric energy and transmission of electricenergy in interstate commerce.

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Part II of the Federal Power Act

− Key FPA functions are:− Establishing and maintaining rates that are “just and reasonable,”− Policing against undue discrimination, and− Ensuring merger and acquisition activity is in the public interest

− Established the Federal Power Commission (now the Federal EnergyRegulatory Commission) as independent regulatory body

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Overview of FPA Jurisdiction

− Includes:− Transmission of electricity in interstate commerce− Wholesale sales of electricity in interstate commerce

− Excludes:− Distribution− Generation− Retail sales− Sales or transmission not in interstate commerce

− Also excludes, for some purposes:− Government-owned utilities− RUS-financed and small cooperatives

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“In Interstate Commerce”

− Doesn’t matter if sale or transmission is in a single state, if it is onthe interstate grid. FPC v. Florida Power & Light, 404 U.S. 453(1967); FPC v. Southern California Edison Co., 376 U.S. 205(1964).

− Excludes only Hawaii, Alaska and ERCOT.

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Dividing Line BetweenFERC and State Jurisdiction

− Key limitation on State regulation is now preemption by the Federal PowerAct, not dormant Commerce Clause limitation. Arkansas Electric Co-op. v.Arkansas Public Service Commission, 461 U.S. 375 (1983).

− FERC’s jurisdiction over transmission and sales at wholesale in interstatecommerce is plenary, preemptive, and non-discretionary. E.g., FPC v.Southern California Edison, 376 U.S. 205 (1964); Mississippi Power & LightCompany v. Mississippi ex rel. Moore, 487 U.S. 354 (1988) (prudentwholesale power costs must be passed through in retail rates).

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Rate Requirements UnderFPA § 205

− FERC has authority over rates, terms, and conditions ofjurisdictional service, as well as any rule, regulation, practice orcontract affecting such rates, terms, and conditions of service.

− Section 205 requires that rates, terms, and conditions ofjurisdictional service, as well as any rule, regulation, practice orcontract affecting such rates, terms, and conditions of service, be:

− Just and reasonable. FPA § 205(a).− Not unduly discriminatory or preferential. FPA § 205(b).− On file at FERC. FPA §§ 205(c) and (d).

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Rate Changes UnderFPA § 206

− Under FPA § 206(a), FERC may, on its own motion or uponcomplaint, investigate whether any rate, term, or condition isunjust, unreasonable, or unduly discriminatory.

− If FERC finds that any rate, term, or condition is unjust,unreasonable, or unduly discriminatory, then FERC mustdetermine and establish a just, reasonable, and non-discriminatoryrate, term, or condition.

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Rates Standards− Unjust and unreasonable rates and charges are unlawful. FPA § 205(a).

− No single formula determines when rates are unjust and unreasonable. FederalPower Commission v. Hope Natural Gas Co., 320 U.S. 591 (1944). Rather, ratesmust fall in a “zone of reasonableness.”− Not exploitive of consumers− Maintains financial integrity of utility

− Prudence review evaluates whether costs were prudently incurred, and thus can beincluded in cost-of-service rate calculations.

− Market-based rates are lawful where FERC finds that a seller cannot exercisemarket power.

− Undue discrimination is prohibited. FPA § 205(b).− Discrimination is unlawful when similarly situated customers are treated

differently.− Focus is often on whether utility is preferring affiliates over non-affiliates

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Filed-Rate and Mobile-SierraDoctrines

− Filed Rate Doctrine – A utility may collect only the rates, and may only enforcethe terms and conditions of service, reflected in its filed rate schedule. ArkansasLouisiana Gas Co. v. Hall, 453 U.S. 571 (1981).

− Preemptive effect of FERC filed rate limits state authority to second-guess justand reasonable finding

− Corollary - Rule against retroactive ratemaking prevents the Commission itselffrom imposing a rate increase or decrease for power already sold.

− Mobile-Sierra Doctrine – “Public interest” standard used in lieu of “just andreasonable” standard to evaluate proposals for unilateral changes to contractbetween utility and purchaser, unless contract provides otherwise. See United GasPipeline Co. v. Mobile Gas Service Corp., 350 U.S. 332 (1956); FPC v. SierraPacific Power Co., 350 U.S. 348 (1956).

− Recent Ninth Circuit cases limit applicability of Mobile-Sierra in electricitymarkets that are not “well-functioning”

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Public Utility Mergers− FERC’s approval is required for public utility mergers, consolidations, and

dispositions of jurisdictional facilities. FPA § 203.

− Transactions evaluated under a public interest test. Market powerassessment dominates merger evaluation.

− FERC jurisdiction over mergers under § 203 are not exclusive; reviewsunder Federal antitrust laws and state utility statutes also apply.

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Open Access Transmission

− Mandatory wheeling orders under FPA §§ 211–212 may be granted on a case-by-case basis against “electric utilities”− Authority granted in Energy Policy Act of 1992

− FERC’s Order No. 888, issued in 1996− Requires transmission-owning public utilities to offer transmission services

under an Open Access Transmission Tariff (OATT)− OATT recently modified in Order No. 890− Order No. 888 was issued under FPA § 206, not FPA §§ 211 and 212

− FERC Order No. 2000 encouraged the formation of regional transmissionorganizations (RTOs)− Designed to provide for independent, region-wide operation and planning of

transmission grid

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Power Market Oversight

− Market-Based Power Rates− Expansion of MBR through the 1990s− Reined-in after California crisis

− Market Behavior Rules− EPAct/05 - Market Manipulation Provisions− Ongoing reforms of market power test

− Mergers and Acquisitions− Market power test is key to public interest evaluation

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Electricity Title of EPAct/05

− Reliability− Backup siting authority for transmission facilities− Incentives for transmission investment− Extension of open access transmission requirements (“FERC

Lite”)− Native load protection− Expansion of FERC merger authority− PUHCA repeal− PURPA reform− Prohibitions on market manipulation and false statements− Expansion of FERC civil penalty authority

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Natural Gas Act

− Many parallels to FPA in statutory framework

− Longer history of deregulated wholesale sales marketand open access transportation

− Sales price deregulation implemented because regulatoryfailures were causing supply problems

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Comparison of Key FeaturesFederal Power Act− Initially Enacted: 1935− Regulatory Functions:

− Regulate rates for wholesale salesand transmission (FPA §205,206)

− Regulate mergers and acquisitions(FPA §203)

− ----

− Jurisdiction:− No generation, distribution or retail

sales− Only activity in interstate commerce− Excludes governmental entities

Natural Gas Act− Initially Enacted: 1938− Regulatory Functions:

− Regulate rates for wholesale andtransportation (NGA §§ 4,5)

− ----

− Require certificates of publicconvenience and necessity forfacilities and services (NGA §7)

− Jurisdiction:− No production, gathering, or local

distribution− Only activity in interstate

commerce− Excludes governmental entities

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FERC Jurisdiction Under NGA

FERC regulates:− The transportation of natural gas in interstate

commerce;− Sales of natural gas for resale (wholesale sales) in

interstate commerce; and− Natural gas companies engaged in these activities

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Key Regulatory Concepts

− Transportation rates, terms and conditions must be “justand reasonable” and not unduly discriminatory.

− Cost-of-Service Ratemaking: Pipelines charge “cost-basedrates” that recover from customers the costs the pipelineincurs to provide service.

− No Undue Preference: Pipelines are prohibited fromgranting any customer an undue preference in providingservice, either with respect to rates charged or the termsand conditions of service.

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NGA Section 4

− Parallel to FPA § 205.

− A pipeline seeking to change rates, terms orconditions of service must obtain approval fromFERC under NGA section 4.

− The pipeline bears burden of proving that its rateproposal is just and reasonable and not undulydiscriminatory or preferential.

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NGA Section 5

− Analogous to FPA § 206.

− FERC or third party may seek to modify existingpipeline rates or tariff under NGA § 5.

− FERC or complainant bears burden of showingthat existing rate or tariff is no longer just andreasonable.

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Pipeline Construction:Section 7

− FERC authorizes the construction and operation ofinterstate natural gas pipelines and gas storagefacilities under § 7.

− FERC issues “certificates of public convenienceand necessity” which contain environmental andoperating conditions.

− No analog in FPA

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Open Access Policies

− Unbundled Service: In the 1980s and 1990s, FERCrequired pipelines to “unbundle” gas sales fromtransportation services, so that customers could buygas supply and transportation services separately

− Pipelines required to provide customers “open access”to their transportation systems

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Current Issues

− Adequate natural gas supplies

− Building adequate infrastructure to get supplies fromproduction areas to markets− Alaska pipeline− LNG terminals− Pipeline infrastructure− Natural gas storage capacity

− High natural gas prices− Policing market manipulation

− Pipeline safety and infrastructure security

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Resources− EPAct/05:

− CCH, Energy Policy Act of 2005; Law and Explanation (2005)− CCH, Energy Tax Incentives Act of 2005 and Safe, Accountable, Flexible

Efficient Transportation Equity Act of 2005: Law, Explanation andAnalysis (2005)

− Redline/Strikeout version of FPA-http://www.vnf.com/content/articles/fparedline.doc

− Redline/Strikeout version of NGA-http://www.vnf.com/content/articles/ngaredline.doc

− FERC Activity:− FERC website - http://www.ferc.gov− VNF website - “Alerts” on key FERC actions:

http:/www/vnf.com/articles.htm

− Energy Law Overview:− Tomain and Cudahy, Energy Law in a Nut Shell (2004).