FERC Should Consider Structural Remedies in Cases That Present Vertical Competitive Problems, Urges AAI in Comments on Standards of Conduct for Transmission Providers

Dec 21 2001
Testimony and Interventions

Standards of Conduct for Transmission Providers) Docket No. RM01-10-000 COMMENTS OF THE AMERICAN ANTITRUST INSTITUTE

The American Antitrust Institute (AAI) appreciates the opportunity to comment on the Commission's notice of proposed rulemaking regarding standards of conduct for transmission providers, 96 FERC 61,334 (September 27, 2001). AAI is a non-profit organization whose mission is to advocate policies that increase the role of competition, assure that competition is fair, and challenge unduly concentrated power in the economy.

I. Overview: Deregulation Requires Careful Redefinition of the Regulatory Framework in Order to Create Competitive Energy Markets

The economy of the United States has been restructured over the past thirty years as a result of public policy decisions to deregulate key industries and thereby free up market forces previously constrained by regulatory frameworks. We now have sufficient experience with such industries as transportation and telecommunications to recognize that deregulation can indeed be beneficial in terms of promoting efficiency, reducing prices, and spurring innovation. But we have also learned that competitive industries are not easily arrived at where monopoly had previous reigned. In particular, if the competitive framework is to work, both antitrust and regulation should have integral roles from an early stage. For antitrust enforcement, this means continuing to identify and redress abuse. For regulation, this means a shift to market "oversight and enforcement" by developing policies to promote competitive outcomes; reviewing mergers in the context of the bigger picture of restructuring and changing industry landscape; and enforcing the rules of conduct.1

II. FERC's Proposed Rulemaking Takes an Important Step Toward Promoting Competitive Energy Markets

The FERC proposal would uniformly apply standards of conduct regulations to transmitting public utilities and natural gas pipelines that are currently subject to the electric standards of conduct in Part 37 of the Commission's regulations and the gas standards of conduct in Part 161 of the Commission's regulations, respectively. These standards are designed to prevent the anticompetitive sharing of information between the transmission company and its energy affiliates. Such information sharing, if unimpeded, could allow the transmission company to potentially frustrate or preclude its existing or prospective downstream rivals' access to the network. Electric transmission providers that do not control transmission facilities and participate in Commission-approved regional transmission organizations (RTOs) under Order No. 2000 would be able to request an exemption from the proposed standards of conduct.

The FERC proposal is the first generic initiative that addresses the core competitive issue associated with vertical integration. That issue is whether the firm has the ability and incentive to adversely affect electricity or gas prices by frustrating or precluding a rivals' access to electric transmission or gas transportation. Ability goes to whether the firm can affect market prices through control of or adverse impact on marginal resources (i.e., those with marginal costs close to the market-clearing price) or the ability to anticipate that others will also restrict supply. Incentive stems from control of enough infra-marginal resources (i.e., those with marginal costs less than or equal to the marginal resource) such that raising price is profitable.

As such, the proposal appropriately recognizes the potential competitive problems introduced by an increased level of vertical consolidation in the energy industries, particularly the convergence of electric and gas under single firm ownership. The proposal is a positive development, particularly as it recognizes the rapid development of new products in the electric industry, different uses of the transmission grid, and the important role of entry in the development of competitive markets.

III. FERC May Want to Consider a Cost/Benefit Assessment of Uniform Imposition of the Proposed Standards of Conduct

In light of the many positives that the FERC proposal prevents, the American Antitrust Institutes encourages the Commission to carefully consider the application of the proposed standards of conduct. Uniform application of standards of conduct assumes that the benefits of leveling the playing field for non-network-owning incumbents and new entrants outweigh the cost of lost vertical efficiencies. Those efficiencies stem from coordinating and enhancing operations through legitimate (non-anticompetitive) information sharing. While this calculus cannot possibly be true for every entity that would be subject to the standards of conduct, the Commission's operative assumption is that on the whole, it is.

Given the importance of efficiencies generated by vertical integration, AAI believes it is appropriate for FERC to make at least a cursory attempt to scope out the costs and benefits of uniform imposition of standards of conduct. FERC might consider ways to determine if the competitive problems the standards of conduct are designed to prevent are sufficiently large to warrant blanket imposition of the standards. FERC could do this through compliance filings in which respondents would evaluate the competitiveness of the upstream and downstream markets in which they participate and address directly the question of whether the firm has the ability and incentive to adversely affect prices. Once this is done, FERC should remedy identified competitive problems.

IV. FERC May Want to Consider Structural Remedies in Cases That Present Identified Vertical Competitive Problems

This brings us to a second important issue in the Commission's proposed rulemaking. The Commission raises, among other questions, the pivotal issue of whether behavioral remedies for transmission providers such as the proposed standards of conduct are sufficient to limit anticompetitive behavior or whether the Commission should consider imposing structural remedies. AAI urges the Commission to seriously consider imposing structural remedies, instead of the conduct-based approach embodied in the proposed standards of conduct.2 However, these remedies should be required when the Commission identifies vertical competitive problems involving transmission-controlling entities through a process like the one described above.

In this case, a structural approach should prevail over a conduct-based solution. Generally, a structural approach is one that: (1) acts to reduce market concentration (e.g., promoting entry, relieving transmission constraints to expand the scope of the market) or (2) severs vertical linkages that give rise to competitive concerns. Structural approaches are usually preferable because they are efficient-they involve a one-time fix. Divestiture, for example, permanently removes capacity from the firm's control and therefore reduces or eliminates the firm's ability and/or incentive to raise prices.

Conduct-based remedies fail to eliminate the incentive or ability of vertically integrated firms to adversely affect prices. Because of this, the incentive remains for firms to find loopholes to get around the rules. The Commission is therefore committed to ongoing monitoring and enforcement. At this transitional stage of deregulation, the Commission's resources are particularly taxed. Conduct-based remedies such as the standards of conduct would require a significant expenditure of valuable resources. Moreover, if the Commission addresses market structure first, then there is a greater likelihood that conduct will be more in line with competitive outcomes, thus minimizing the need for future monitoring and enforcement.

AAI also cautions that uniform imposition of the standards of conduct may have the effect of taking competitive issues involving future vertical mergers forever off the table. This could be problematic, particularly in cases where a proposed merger significantly increases the merging companies ability and incentive to adversely affect prices (e.g., through the consolidation of transmission and generation). Under those circumstances, the merging firm would have even more incentive to circumvent the standards of conduct, potentially decreasing their effectiveness and increasing the Commission's enforcement burden. In such problematic merger cases, the Commission should be open to structural remedies, but may have difficultly in seeking their imposition if the standards of conduct already apply.

Respectfully submitted,

/s/

Albert A. FoerPresidentThe American Antitrust Institute2919 Ellicott Street NWWashington, DC 20008Phone: 202-244-9800Fax: 202-966-8711e-mail: bfoer@antitrustinstitute.org

December 20, 2001

1 For more analysis and AAI policy recommendations on electricity restructuring, see "Promoting Competition in the U.S. Electricity Industry: Policy Issues and Recommendations" by Diana Moss, Senior Research Fellow. The paper is available on the AAI website.

2 In the merger of Dominion Resources, Inc. and Consolidated Natural Gas, (89 FERC 61,162, November 10, 1999) FERC imposed standards of conduct similar to those proposed by the Commission while the Federal Trade Commission went the structural route, requiring divestiture of a gas local distribution company to remedy vertical competitive problems raised by the proposed merger (Decision and Order, Docket No. C-3901, December 9, 1999).