Bad Law: The legacy of California’s botched power market

by Dan Watkiss

Law school professors routinely assign judicial decisions for analysis that achieved notoriety before being decided, or surrounding which the competing equities seemed to clash with rote application of established law.

Frequently, the decisions in these cases depart from settled legal precedents and principles in order to achieve a specific result, a result seemingly suited to the case at hand, but difficult to digest into a legal system based on stare decisis, where precedents can control future outcomes in cases that are not notorious or equitably ambiguous.

More than a century ago, Supreme Court Justice Oliver Wendell Holmes described the object lesson of these law school assignments. “Great cases, like hard cases, make bad law. For great cases are called great not by reason of their real importance in shaping the law of the future, but because of some accident of immediate overwhelming interest which appeals to the feelings and distorts the judgment.”

Recent decisions from the United States Court of Appeals for the Ninth Circuit arising out of California’s notoriously bungled experiment in organized power markets-Public Utility District No. 1 of Snohomish County Washington v. FERC and Public Utilities Commission of California v. FERC-are preeminent contenders for this body of bad law, likely to be studied by future law students.

In the early 1990s, the structure and regulation of wholesale electric power and natural gas markets began a transition, when Congress and FERC began to open access to natural gas trunklines and storage and the high-voltage electric transmission grid. Open access induced competitive entry into the wholesale natural gas and power sectors by new suppliers. Competitive supply made possible the concurrent transition from cost-based rate regulation to market-based pricing.

Market pricing was premised on the presence of a sufficient number of natural gas and power wholesalers-price takers, incapable of exercising market power-whose negotiated rates would be just and reasonable as legally required. Most energy analysts view this decade-long transition from vertically integrated monopolies to competitive wholesale energy markets as a success that has diversified available energy products and lowered wholesale prices.

Central to that successful transition has been the grant to competitive suppliers of blanket-or advance-authority to make future wholesales at market prices pursuant to filed tariffs or rate schedules. Absent that authority, liquid spot and short-term markets for natural gas and power could not have arisen. Imagine running to the regulator for advance approval of the price and terms of every one of the many thousands of wholesales of natural gas or power that occur daily in today’s markets. But that is what the Ninth Circuit in two recent decisions ruled must occur if the seller is to enjoy the contract and price certainty that has traditionally been extended to wholesales under the Natural Gas and Federal Power Acts.

While purporting only to fault the FERC’s administration of blanket market pricing authority, the court in fact makes competitive wholesale natural gas and power markets untenable. It ruled that wholesalers operating pursuant to FERC’s market-based rate program enjoy no, or only limited, contract and price certainty following a unilateral challenge unless the contract has been presented in advance to FERC and FERC has had an opportunity for initial review of whether the rate is just and reasonable, meaningful substantive review of the circumstances of contract formation to determine “whether the original negotiations occurred in a functional marketplace,” and “timely reconsideration of the seller’s market-based pricing authorization if market conditions change. This type of advance and continuing regulatory review of competitive seller, which has never previously occurred in the history of either the Natural Gas or Federal Power Acts, is completely infeasible. As a consequence, buyers may still enjoy price certainty, but not market-based sellers.

Like most bad law, this ruling runs away from long-settled precedents in order to achieve the desired result: Permit a few buyers to escape wholesale power purchase contracts they entered when prices in Western power markets were high in 2000 and 2001. The court ruled that FERC should sanction unilateral abrogation or modification of these contracts simply upon the buyer’s demonstration that utility “bills are higher than they would otherwise have been had the challenged contracts called for rates within the just and reasonable range.” To achieve this desired result, the court jettisoned the Supreme Court’s 50-year-old Mobile Sierra doctrine that enforces the contract-based regulatory regime of the Natural Gas and Federal Power Acts by allowing unilateral changes to contracts only when required by the greater public interest, as opposed to mere seller’s or buyer’s remorse. The court’s decision also cast doubt on the applicability of the even older filed rate doctrine to market-priced natural gas and power wholesales.

And, like most bad law, the Ninth Circuit ruling is stunningly myopic. In order to accommodate a handful of cases of buyer’s remorse, the court has injected substantial price risk into all regulated wholesales of natural gas and power within the Western-state jurisdiction of the Ninth Circuit. That risk is a cost that sellers necessarily will factor into future natural gas and power prices.

Author

Dan Watkiss is a partner with Bracewell & Giuliani in Washington, D.C., representing power companies, exploration and production and mid-market companies, natural gas pipelines, power and liquefied natural gas project developers and lenders, as well as government agencies and regulators. You can contact Dan at Dan.Watkiss@bgllp.com

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