FERC decision

This looks important at first glance though I'm not sure what to make of it exactly. It has little to do with proxy fights or the other usual subjects of this blog, but hey -- it's my blog -- and I'll allow myself some topic drift.

The subject today then, electricity generation, contracted-for rates, and regulatory interference therewith.

I looked into this a bit last fall, when the International Swaps & Derivatives Association filed an amicus brief on the case. ISDA was unhappy about the circuit court's opinion because it had essentially told the Federal Energy Regulatory Commission to reconsider its approval of certain rate-setting contracts.

As necessary backgroud: the Federal Power Act requires that FERC ensure that all rates, terms, and conditions for the sale of power be "just and reasonable." In 1956the US Supreme Court created what is known as the "Mobile-Sierra doctrine," which makes it very difficult for FERC to intercede and invalidate a market contract between two commercial entities: between, say, the owner of a power plant and the owner of the transmission wires. There must be an "unequivocal public necessity" to justify such abrogation.

In effect, this limits FERC's unilateral rate setting ability to the retail market, where commercial entities deal not with each other but with unsophisticated normal folk.

Yet FERC has played a larger role than you might think, because the practice has developed (and the courts have blessed it) among some commercial parties of contracting out of Mobile-Sierra, creating agreements that specifically allow the FERC to change rates. In such a case, the transmission and the generation company are essentially stipulating that the FERC shall be their mediator if either side comes to believe that the contracted-for rate has become unfair by virtue of subsequent developments.

Nowadays power contracts are often themselves traded by financial institutions in much the same way that stocks and bonds are traded. This was one of Enron's innovations, and a practice that has survived that company's demise. Thus, the appellant in the case the Supreme Court decided Thursday is the Morgan Stanley Capital Group.

FERC had refused to modify the long-term contracts that parties entered into in 2000-2001, a period of tremendous price spikes and blackouts on the west coast. The 9th circuit had remanded, indicated that it did think there ought to be modification, because the unlawful activities of various parties in the spot market may have also affected the forward contract market.

This is what ticked off ISDA, leading to the amicus brief that first drew my attention to the matter. ISDA's amicus brief maintained, in the spirit of Mobile-Sierra, that contract rates negotiated at arms length are presumptively fair and reasonable, and that "buyers should not be permitted to escape contractual commitments because the contract was negotiated during a period of market dysfunction."

Now SCOTUS has spoken. But, as it sometimes does, SCOTUS has spoken with a stutter. It has said on the one hand that the 9th circuit was right to remand the case to FERC, but that it did so on the wrong rationale. If I understand it, the decision re-affirms Mobile-Sierra, but nonetheless says that this might (for all it can tell on the record) be one of those "unequivocal public necessities" that justify abrogation of contracts. Accordingly, it has remanded the case to FERC to build a better record. I think.

I don't know whether ISDA is happy with this outcome or not. I could ask them but, hey, that's too much work. My guess is that their chief interest isn't in who wins or how long it takes, but in re-affirming the principles, and that accordingly they are content with this decision. The folks over at Morgan Stanley may not be thrilled, though. This means further rounds of hearings and at least some continued uncertainty about their contracts. They're interested in the outcome more than the "principle of the thing"!