Mandatory National Reliability Standards

The passage last month of the Energy Policy Act of 2005 ("Act") marked the first step in a long road toward moving from voluntary to mandatory electricity reliability standards. Voluntary national reliability standards were created after a massive power outage in the Northeast during 1965 left millions in the dark. The organization that became the North American Electric Reliability Counsel ("NERC") was formed in 1968 to work with regional utilities to create a framework of voluntary electricity reliability standards and protocols for the continental U.S. Since the late 1990s, however, many have advocated the establishment of mandatory national reliability standards overseen by an organization that could impose sanctions for noncompliance.

Section 215 of the new Act establishes the framework for creation of an Electric Reliability Organization ("ERO") to oversee mandatory reliability standards. Before mid-February of 2006, the Act requires that the Federal Energy Regulatory Commission ("FERC") issue a final rule to enable entities to apply to become the national ERO. The FERC may then "certify one such ERO" if it meets certain specified standards, such as: (1) have the ability to develop and enforce reliability standards; (2) be independent of users and owners and operators of the bulk-power system; (3) equitably allocate reasonable dues, fees and other charges among end users of the bulkpower system; (4) provide fair and impartial procedures for the enforcement of reliability standards, including through the imposition of penalties; and (5) provide for reasonable notice and opportunity for public comment, due process, openness and balance of interests in developing reliability standards.

Two interesting features of Section 215 of the Act involve reliability standards for Regional Transmission Orgnaizations ("RTOs") that have developed competitive wholesale power markets. First, the Act only provides that there shall be a rebuttable presumption that reliability standards developed by a regional entity organized on an Interconnection-wide basis are "just, reasonable and not unduly discriminatory or preferential, and in the public interest." The only existing regional entities that would qualify for such deference are Electric Reliability Council of Texas, Inc. ("ERCOT") and the Western Electricity Coordinating Council ("WECC," located in the states west of the Rocky Mountains). On January 1, 2006, for example, a new reliability organization will be formed, ReliabilityFirst Corporation, to develop regional reliability standards for the Mid-Atlantic and Central United States. Reliability standards developed by ReliabilityFirst, however, would not necessarily receive any deference under the Act because this new organization will only represent a portion of the Eastern Interconnection (even though the peak load of ReliabilityFirst will exceed the combined peak loads of both ERCOT and WECC).

Second, the Act provides that the Commission will not defer to the expertise of the ERO or approved regional entities regarding the content of a proposed reliability standard "with respect to the effect of [the reliability] standard on competition." This section of the Act suggests that FERC apparently will not defer to ERCOT and WSCC regarding the effect of such reliability standards on competitive energy markets that they develop.

NERC has worked with its stakeholders for many months to assist FERC in drafting the requisite rulemaking to expedite the creation of the ERO. NERC forwarded a "strawman" set of language for the FERC to consider in establishing a rulemaking during the week of August 15. The Commission issued a Notice of Proposed Rulemaking (RM05-30-000) consistent with the new Act on September 1, 2005, with comments due on October 7, 2005.

The Energy Policy Act of 2005 repeals the Public Utilities Holding Company Act ("PUHCA"), effective as of February 8, 2006. PUCHA was a part of the New Deal legislation passed in 1935 in response to scandals in the energy industry. Corrupt holding companies were cross-dealing, using the steady stream of utility revenues to finance risky business activities. PUHCA was enacted to protect consumers against business dealings that could threaten the reliability of the energy utilities. Under PUHCA: (1) utility operations owned by a single holding company had to be contiguous or interconnected; (2) the U.S. Securities and Exchange Commission ("SEC") oversaw utility holding companies and reviewed utility mergers; and (3) utility holding companies could not own other businesses that were not reasonably incidental or functionally related to the utility business.

With the repeal of PUCHA, a utility holding company may again invest in unrelated businesses. Geographic limitations on utility operations will be gone. There will no longer be restrictions on who can buy public utilities. Utility investors might range from domestic industrial companies, financial institutions and foreign companies to non-profits and municipalities. In short, PUHCA’s repeal is expected to open the door to increased mergers and acquisitions, given the potential benefits that could arise from economies of scale. Although the SEC will no longer review such transactions, state agencies and the FERC will have increased authority to review utility mergers as well as the authority to review utilities’ books and records to ensure financial integrity and to protect against the abuse of market power. The pace of consolidation in the energy industry is likely to accelerate.

The Energy Policy Act of 2005 also includes a provision requiring states to consider demand response technologies to help reduce electricity usage at peak times. Such technologies include: (1) smart meters that allow ratepayers to be billed according to time-of-use rates; (2) smart appliances that can cycle on and off in response to signals from the grid; and (3) smart software that allows heating and cooling systems to shut down in response to signals from the grid. Customers could lower their electric bills by choosing to operate energy-consuming appliances during off-peak times, and customers could receive rebates for buying smart appliances and related software.

In response to the Energy Policy Act of 2005’s provision requiring FERC to seriously consider the concerns of New England relating to the plan to establish a locational installed capacity ("LICAP") market, FERC apparently has delayed issuing a final decision regarding this plan. LICAP, which uses the concept of a demand curve to meet capacity needs, provides for incentive payments to generators to encourage development in certain locations. FERC Chairman Kelliher has said, "There is a serious problem of insufficient capacity and transmission infrastructure in specifically defined New England load and supply pockets." Earlier this summer, an administrative law judge found that the LICAP proposal was just and reasonable and in the public interest by providing incentives to generators at the lowest possible costs to consumers. FERC, however, will hold an oral argument on September 20 to aid its decision-making. ISO New England supports the LICAP plan as the appropriate mechanism to address future electricity shortages, noting that interim measures to address reliability will be more costly.

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