This article, from law firm McGuireWoods LLP, is authored by Christopher McEachran.
In recent years the Federal Energy Regulatory Commission (FERC or the Commission) has greatly increased its scrutiny of the energy markets. In 2005 Congress amended the Federal Power Act (FPA), specifying that it would be “unlawful for any entity . . . to use or employ, in connection with the purchase or sale of electric energy or the purchase or sale of transmission services subject to the jurisdiction of the Commission, any manipulative device or contrivance . . . .” Section 222, Federal Power Act (2005); 16 U.S.C. § 824v. FERC, pursuant to this statutory authority, crafted its own Anti-Manipulation Rule, 18 C.F.R. § 1c (2006), which essentially tracks the same language included in the statute, as well as the anti-manipulation provision relevant to securities law, Section 10(b) of the Securities Exchange Act. The language of the rule is broadly written — so to many market participants who come under regulatory scrutiny and to legal observers, “market manipulation” seems to be somewhat of a “we know it when we see it” sort of violation — which can make compliance difficult for even the most well-intentioned market participants.
This year alone, FERC has brought actions against several energy firms, using several theories of market manipulation. The targeted firms range from producers of energy (J.P. Morgan) to financial traders that trade only in products designed to increase the liquidity of the energy market (Oceanside). All who participate in the energy markets should be aware that FERC is stepping up its efforts, and broadened its understanding, of market manipulation enforcement.
In 2008, J.P. Morgan acquired Bear Stearns’ assets, including the rights to gas-fired power plants in California and Michigan. These particular plants are steam boiler plants, built in the 1950s and 1960s, and are less efficient than modern power plants. Because of that, the cost of running the units was often higher than the day-ahead market price in the California markets, which meant that the plants often were not picked up to produce energy, and thus finished “out of the money.” The Commission accused J.P. Morgan Ventures Energy Corporation (JPMVEC) of using various, traditionally “uneconomic,” bidding strategies that enabled it to profit from its inefficient power plants. JPMVEC admitted to setting up bidding strategies that in part were aimed at capturing various make-whole payments, those payments set up in the tariff to compensate generators when market revenues were insufficient to cover the bid cost, available in the California ISO (CAISO) and Midcontinent ISO (MISO). JPMVEC admitted to the facts but, importantly, neither admitted nor denied violating the Anti-Manipulation Rule, even though it paid a civil penalty of $285 million and disgorged allegedly unjust profits of $125 million. 144 FERC ¶ 61,068 (2013).
The Commission concluded that JPMVEC had violated the Anti-Manipulation Rule by devising bids to trigger the make-whole payments, in particular making bids that “falsely appeared economic to CAISO and MISO’s automated market software,” and by submitting bids that were intended to lose money at market rates, but would realize a net profit once the make-whole payments were distributed. In other words, JPMVEC was accused of incorporating the tariff-sponsored rebates into its profitability calculus and bidding strategy — which was notably not prohibited at the time, by either the CAISO or MISO tariff.
Rumford Paper Co.
Rumford Paper Co., a New England paper manufacturer, operated its own generator to meet almost all its electricity needs. Rumford was also authorized to sell power at market-based rates. As a generator of power in ISO-New England (ISO-NE), Rumford participated in the day-ahead load response program (DALRP), which encouraged end-use consumers to alter their normal consumption patterns during peak demand hours. ISO-NE incentivized participation in the program by compensating the participants for their load reduction.
The Commission accused Rumford of intentionally adopting a scheme aimed at establishing an inflated baseline to receive additional payments from the DALRP without actually reducing its energy consumption. Rumford achieved this by allegedly reducing its internal generation and purchasing replacement energy during the baseline period to establish a false and inflated baseline, which later allowed it to claim load reductions without actually reducing any load. The Commission alleges that by using this scheme, Rumford caused consumers to pay $3,336,964.63 for demand response that never occurred, of which Rumford received $2,836,419.08. 142 FERC 61,218 (2013). Rumford admitted to the facts but neither admitted to nor denied violating the Anti-Manipulation Rule. Rumford paid a civil penalty of $10 million and disgorged the profits it received from the DALRP.
Like J.P. Morgan, Rumford was not accused of violating any tariff provision, only of violating the Commission’s Anti-Manipulation Rule. This theory of manipulation is similar to J.P. Morgan in that it accuses a generator of seeking “rebate” payments through manipulative means, but differs considerably in that JPMVEC was accused of making uneconomic bids to generate power, and to collect loss-related rebates, whereas Rumford was accused of establishing a false baseline to earn reduction payments without actually reducing consumption.
Oceanside is a financial trader that placed Up-To Congestion (UTC) transactions in the PJM Interconnection (PJM) during the summer of 2010. According to the Commission, a UTC transaction is “a PJM product that enables a trader to profit if the congestion price spread between two nodes changes favorably between the Day Ahead Market (DAM) and the Real Time Market (RTM).” To profit from a UTC trade, the spread change in the nodes must exceed the cost of engaging in the trade, which includes various charges. Some of these charges were rebated in part to some market participants.
According to the Commission, Oceanside engaged in certain trades that were not designed to profit in the traditional sense, as the specific nodes targeted always allegedly had a spread of $0 — which meant that the service charges would always exceed the potential spread. However, the Commission alleged that Oceanside, by engaging in these allegedly zero-risk, “uneconomic” transactions, used the UTC transactions as a “pretext” to reserve a large volume of transmission and thereby earn a larger share of some of the charge rebates, which, it concluded, violated the Commission’s Anti-Manipulation Rule, even though it did not find that the behavior violated any portion of the tariff then in effect.
Oceanside admitted to the facts of the consent agreement, but neither admitted nor denied the violations. It paid a disgorgement of $29,563, including interest, and a civil penalty of $51,000. The theory here — that Oceanside made uneconomic trades for the purpose of collecting a rebate — is most similar to the J.P. Morgan case and, like J.P. Morgan, was settled before the Commission and never heard by a court. And like all others mentioned, Oceanside was not accused of violating any provisions in the applicable tariff.
What do we learn from these cases?
It seems FERC is aggressively pursuing firms it views as market manipulators, even for relatively small sums of money, as in Oceanside’s case. Also, FERC has targeted energy producers and financial traders alike. While the theories used in each case have their differences, the theme appears to be: market manipulation involves activity that either involves what FERC considers outright misrepresentation or appears to FERC to be traditionally “uneconomic” but that still ends up resulting in profits for your firm, which in some way is viewed by the Commission as manipulative or false — whether or not such activity is permitted by the governing tariff. There also seems to be a lot of emphasis on the connections and convergences between physical and financial commodity trading and positions.
Thus far, the Commission’s theories of market manipulation have been validated only by the Commission itself — making any potential review by a court all the more important. As stated above, FERC procedure for some types of cases provides that a party that elects to receive an immediate penalty assessment may refuse to pay it, triggering de novo review by a district court. Other types of violations may require Commission action that would then be reviewed by a court of appeals. As the FERC enforcement program evolves and the stakes rise, some cases will eventually be litigated rather than settled, possibly providing some further clarity on the legal boundaries in this area.
At a minimum, firms trading or producing energy should be aware that FERC has brought actions against producers and traders alike, utilizing several newly minted theories of market manipulation that did not violate the relevant tariff or other express proscriptions or specific requirements in effect at the time. Traders and firms should be aware of the fact patterns involved in those cases because they shed light on how FERC might apply its rule in other cases. Though the question of whether this approach by FERC will be affirmed by the courts remains to be seen, you would probably prefer not to be a part of the processes that may resolve that question.
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