FTC Comment Before the Federal Energy Regulatory Commission Concerning Market-Based Rates for Public Utilities

Before the
United States of America
Federal Energy Regulatory Commission
Market-Based Rates for 	) 	Docket No. RM04-7-000
Public Utilities 	)
Comment of the
Federal Trade Commission
January 18, 2006

Before the
United States of America
Federal Energy Regulatory Commission
Market-Based Rates for 	) 	Docket No. RM04-7-000
Public Utilities 	)
Comment of the
Federal Trade Commission
I. 	Introduction
The Federal Trade Commission (“FTC”) offers this comment to identify and
explain the deficiencies in the “historical contestable load analysis” that the Federal
Energy Regulatory Commission (“FERC”) has been asked to use to evaluate horizontal
market power at the generation level.1 FERC currently uses a four-pronged test to
determine whether a generation supplier should be permitted to offer its supply at market
(rather than regulated) rates in wholesale electric power markets.2 The generation market
power prong uses two indicative screens to assess market power: one screen focused on
whether the applicant is a pivotal supplier, and the other focused on whether the
applicant’s market share is above a certain market share threshold.3 FERC should not
1 Edison Electric Institute (“EEI”), “Post Technical Conference Comments,” filed jointly with the Alliance
of Energy Suppliers on March 14, 2005, in the Matter of Market-Based Rates for Public Utilities, FERC
Docket No. RM04-7-000. The term “contestable load” signifies that suppliers can compete to serve these
customers, as opposed to “native load,” which consists of customers supplied by a franchised load-serving
entity. The use of the term “contestable load” in the current proposal is different from the term as used in
industrial organization economics, where contestability focuses on entry conditions. In the Matter of
Westar Energy, FERC Docket Nos. ER03-9-002 et al., for example, FERC agreed to consider the
contestable load analysis submitted by the applicant as part of a subsequent Section 206 proceeding. Order
on Updated Market Power Analysis, Instituting Section 206 Proceeding and Establishing Refund Effective
Date, ¶¶ 15-16 (issued Mar. 23, 2005).
2 FERC, Order on Rehearing and Modifying Interim Generation Market Power Analysis and Mitigation
Policy, In the Matter of AEP Power Marketing, Inc. et al., Docket Nos. ER96-2495-016 et al. (issued Apr.
14, 2004). See also FTC Comment before FERC, In the Matter of Market-Based Rates for Public Utilities,
FERC Docket No. RM04-7-000 (July 16, 2004), available at
http://www.ftc.gov/os/comments/ferc/v040021.pdf.
3 FERC, Order on Rehearing and Modifying Interim Generation Market Power Analysis and Mitigation
Policy, supra note 2, at ¶¶ 70-72. “[T]he pivotal supplier analysis focuses on the ability to exercise market
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switch to, or rely upon, an historical contestable load analysis, because it is not an
economically sound analysis of actual or potential generation market power in wholesale
electric power markets.4
This comment identifies substantial differences between historical contestable
load analysis and the economically sound method of analyzing horizontal market power
set forth in the Horizontal Merger Guidelines (“Merger Guidelines”) issued by the FTC
and the U.S. Department of Justice.5 On previous occasions, the FTC has urged FERC to
assess market power in a manner that is consistent with economic principles.6 In
assessing market power in connection with enforcement of the antitrust laws, the FTC
typically not only delineates relevant markets and computes market shares and
power unilaterally. Is essentially asks whether the market demand can be met absent the applicant during
peak times. . . . If demand cannot be met without some contribution of supply by the applicant, the
applicant is pivotal. In markets with very little demand elasticity, a pivotal supplier could extract
significant monopoly rents during peak periods because customers have few, in any, alternatives.” The
applicant’s market share “indicates whether a supplier has a dominant position in the market, which is
another indication of whether the supplier has unilateral market power and may indicate the presence of the
ability to facilitate coordinated interaction with other sellers.” Id. at ¶ 72.
4 Although FERC specifies analyses that applicants must provide, it invites applicants and interveners to
present additional historical evidence if that will provide a more accurate assessment of market power
issues. Id. at ¶ 66 & n.59.
5 U.S. Dep’t of Justice and Fed. Trade Comm’n, Horizontal Merger Guidelines (Apr. 2, 1992; revised, Apr.
8, 1997), available at http://www.ftc.gov/bc/docs/horizmer.htm. In a related comment, the American
Public Power Association (“APPA”) and the Transmission Access Policy Study Group (“TAPS”) oppose
the use of historical contestable load analysis. Their opposition focuses in part on differences between the
proposal and the Merger Guidelines. The APPA/TAPS filing includes an affidavit prepared by Dr. Darren
Bush of the University of Houston Law Center (and formerly an economist and attorney in the Antitrust
Division of the U.S. Department of Justice). See
http://www.tapsgroup.org/sitebuildercontent/sitebuilderfiles/050314_appataps_comments.pdf (Mar. 14,
2005).
6 See, e.g., Comment of the Federal Trade Commission, FERC Docket No. RM04-7 (July 16, 2004),
available at http://www.ftc.gov/os/comments/ferc/v040021.pdf. The FTC stated repeatedly that consumers
benefit when markets operate unburdened by substantial and durable market power. See, e.g., Letter of the
Federal Trade Commission to Thomas E. Bliley, Chairman, House Committee on Commerce, on H.R.
2944, The Electricity Competition and Reliability Act (Jan. 14, 2000), available at
http://www.ftc.gov/be/v000002.htm. These comments do not take any position on whether and when rate
regulation might be desirable; rather, the comments discuss how to use economically sound principles to
implement Congress’ statutory directives to FERC.
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concentration but also evaluates whether market conditions are such that a seller, or
group of sellers, would be likely to exercise market power. In addition to assessing
market power, FERC may wish to take into account the potential costs, including
distortions in investment incentives that may result from price regulation in deciding
applications for market-based pricing authority.
* * * * *
The FTC is an independent agency of the federal government responsible for
maintaining competition and safeguarding the interests of consumers through
enforcement of the antitrust and consumer protection laws and through competition
policy research and advocacy. In the electric power industry, the FTC often analyzes
regulatory or legislative proposals that may affect competition or the efficiency of
resource allocation and reviews proposed mergers involving electric and gas utility
companies. In the course of this work, as well as in antitrust and consumer protection
research, investigation, and litigation, the FTC applies established legal and economic
principles and recent developments in economic theory and empirical analysis to
competition issues. As part of its competition advocacy program, the FTC has released
two staff reports on electric power industry restructuring issues at the wholesale and retail
levels.7 In addition, the FTC and its staff have filed numerous competition advocacy
7 FTC Staff Report: Competition and Consumer Protection Perspectives on Electric Power Regulatory
Reform (July 2000), available at http://www.ftc.gov/be/v000009.htm (compiling previous comments that
the FTC staff provided to various state and federal agencies); FTC Staff Report: Competition and
Consumer Protection Perspectives on Electric Power Regulatory Reform, Focus on Retail Competition
(Sept. 2001), available at http://www.ftc.gov/reports/elec/electricityreport.pdf.
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comments on electricity restructuring efforts with FERC and the states. The FTC staff
also contributes to competition filings with international competition organizations.8
II. 	Description of Historical Contestable Load Analysis
The historical contestable load analysis proposal compares total wholesale load
seeking competitive supply alternatives to the total competitive generation resources that
are available to serve those loads during the test period. For the wholesale supplier
seeking market-based rates, its available competitive generation consists of its total
generation minus its load obligations (which consist primarily of obligations to serve
native load).9 According to the proposal, if available competitive generation resources
are twice as large as the load seeking supply in the test period, and if the applicant can
demonstrate that competitive generation resources are not “unduly concentrated,” then
the applicant is deemed not to have supplier market power and the applicant should be
granted market-based rate authority. It is not clear why the proposal uses “twice as large”
as the standard, nor does the proposal specify what “unduly concentrated” means in terms
of the Herfindahl-Hirschman Index (“HHI”) or other market share concentration
measures.10
This proposal has some intuitive appeal because it includes elements that
wholesale customers are likely to consider when evaluating prospects to obtain wholesale
8 The FTC and the Department of Justice participate as delegates from the United States in a number of
international organizations, such as the Organization for Economic Cooperation and Development. As part
of this process, the FTC staff contributes to the United States’ “country reports” on competition topics.
When requested by the Department of State, the FTC staff also contributes to U.S. comments on proposed
regulatory reforms in other nations.
9 As noted in note 1, supra, native load is the quantity required to provide electric power to the utility’s
retail customers.
10 The elements of the proposed analysis are described in the historic contestable load analysis “Preparation
Guidelines.”
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supply. These considerations – all of which are relevant – include the amount of
available generation in an area, the amount of demand in the area not covered by native
load obligations, and the amount of transmission transfer capability available to bring in
electric power from other areas.
The basic problem with the proposal, however, is that historical contestable load
analysis is not a reliable test of market power. The historical contestable load proposal
fails to include a number of potentially important considerations in its framework for
assessing horizontal market power, and the elements that it does include are not
considered in an economically sound manner.11 In sum, the proposal does not represent
an analytical advance over existing techniques to evaluate horizontal market power, and
it falls far short of the economically sound framework for market power analysis
presented in the Merger Guidelines.
III. 	Evaluation of Historical Contestable Load Analysis as a Method to Assess
Generation Horizontal Market Power
This section discusses four problems with the historical contestable load proposal
and contrasts it with a market power analysis conducted under the Merger Guidelines
framework.12
1. The Role of Price in Market Delineation. The proposed historical contestable
load analysis ignores the critical role of price to delineate economically meaningful
product and geographic markets to assess market power.13 For example, market
11 In addition, the proposal does not provide for any sensitivity analysis that would establish the robustness
of the results of historic contestable load analysis.
12 Aspects of these points are raised in the affidavit of Dr. Darren Bush that was filed as an attachment to
the comment of the APPA and TAPS, supra note 5.
13 Comments of the American Antitrust Institute, FERC Docket No. RM04-7-000 (filed Mar. 14, 2005),
available at http://www.antitrustinstitute.org/recent2/392.pdf.
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delineation under the Merger Guidelines examines whether it would be profitable for a
hypothetical monopolist in the proposed market to “impose at least a small but significant
and nontransitory increase in price.”14 A chief reason why a price increase might not be
profitable is that buyers could turn to suppliers outside of this proposed market who could
undercut the price increase. In such a case, these close substitute products would be
added to broaden the initial proposed market. One would continue to add the closest
substitute products or services to the market until a hypothetical monopolist could
profitably impose a small but significant nontransitory price increase.
Because the historical contestable load proposal does not include a price threshold
in the assessment of available supply, it erroneously treats all suppliers as though they
would be willing to operate their generators at capacity even if their variable costs for
relevant outputs exceeded prevailing prices.15 It also disregards the fact that product and
14 Merger Guidelines, § 1.0. Customers’ responses to price changes are a key determinant of the
profitability of restricting supply (raising prices above the competitive level). Also, differences in
generation capacity portfolios give rise to different incentives to raise prices above competitive levels in
organized spot markets. Suppliers often have a range of generating units: base-load, mid-merit, and
peaking units. Base-load generators usually are dispatched any time that they are operable, either because
they have the lowest variable costs or because they cannot be turned on and off quickly and thus are left
online (e.g., nuclear plants). In contrast, peaking generators usually operate only during peak demand
periods and can be brought online very quickly, although their variable costs are too high to warrant
operation during off-peak periods.
A supplier with inframarginal units, such as base-load or mid-merit, may have strong incentives to
withhold its peaking units from the market during periods of increased demand so as to raise the market-
clearing price that all of its inframarginal units receive. A utility is more likely than any other suppliers in
the market to have inframarginal units, and thus is likely to have greater incentives than other suppliers to
withhold capacity. If independent generation firms are not as large and do not have individual generators at
the margin, the utility may also have a greater ability to exercise market power by reducing its output.
The United Kingdom electricity regulator examined these incentives when it investigated whether
the two dominant generators in the U.K. were exercising market power in the early 1990s. The regulator
determined that divestiture of some mid-merit generators – rather than divestiture of a portion of generation
capacity of all types – would be sufficient and more effective because the localized competitive problems
centered on the generators owned by the dominant suppliers in the mid-merit segment of the generation
supply curve. FTC Staff Report, Competition and Consumer Protection Perspectives on Electric Power
Regulatory Reform, supra note 7, Ch. I.
15 The historical contestable load proposal generally leaves market delineation up to the discretion of the
applicant rather than specifying a sound economic method for such analysis. The proposal calls for the
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geographic markets vary by time of day – thus, each generating unit is not in each
relevant market. For example, an evaluation of the relevant market based on the Merger
Guidelines would not include peaking units with high marginal costs of generating
energy in the relevant market for energy during off-peak hours, when the competitive
price of energy would be below the marginal cost of these peaking units.16
2. Contractual and Legal Restrictions. 	The historical contestable load proposal
disregards important contractual and legal restrictions on available generators and on the
generators from which electricity customers are allowed to buy if faced with an
anticompetitive price increase. This disregard can result in the improper inclusion within
the relevant markets of generating units that customers could not turn to in the face of a
small but significant and nontransitory price increase by an applicant for market-based
rates. Including firms in the market that are not actually available to customers may
result in a downward bias in market concentration calculations17 and can lead to
underestimation of market power concerns. In contrast, the market delineation approach
applicant to select whatever geographic and product markets it prefers. Given an applicant’s incentives to
show that it does not possess market power, the proposal’s discretionary approach to market definition is
unreliable.
16 FERC’s market share screen suffers from a similar weakness by including all available generators in all
periods of time in calculating available capacity.
17 FERC’s market share screen also may yield inaccurate market share calculations. The delineation of
product and geographic markets has to be accurate in order for market share calculations to be meaningful.
By designating control areas as relevant geographic markets, the market delineation approach used in
FERC’s market share screen emphasizes administrative convenience over economic accuracy. For
example, FERC may define the geographic market as a control area even though the market would include
additional control areas or parts of control areas if one conducted the analysis pursuant to the methodology
of the Merger Guidelines. Conversely, FERC may define the geographic market as an entire regional
transmission organization (“RTO”) footprint despite the fact that transmission constraints within the RTO
are likely to result in smaller, separate geographic markets during some periods of time – i.e., temporal
product markets – under a Merger Guidelines approach. As a result, the market shares of applicants as
measured by FERC may be biased or arbitrary. As a remedy for this problem, we recommend that FERC
improve the accuracy of market delineation by using a Merger Guidelines approach or, failing that, accept
share calculations based on administratively convenient market delineations only if the market shares are
not sensitive to a range of alternative geographic market definitions.
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prescribed by the Merger Guidelines18 takes into account contractual and legal
restrictions. For example, the PJM RTO19 restricts exports of power when reserve
margins within PJM are low. If the PJM RTO declares a supply emergency within PJM,
generators within PJM are obligated to curtail wholesale power sales to customers outside
of PJM.20 During peak demand periods in PJM, the proposal would assume that exports
from PJM are available, when in fact they would not be.
Another example of relevant legal restrictions is state renewable fuel generation
(“green power”) requirements. Wholesale customers subject to state renewable resource
generation requirements are legally obligated to procure a portion of their electricity
supply from renewable generation sources. If this requirement is a binding constraint on
18 Electric demand and supply conditions at any one point in time are largely independent of those in other
periods. Hence, “[i]n the current wholesale electricity market, short periods of time (e.g., hour or one-half
hour periods) often represent distinct product markets because electricity demand cannot easily be shifted
from one time period to another and because electricity cannot easily be stored in large quantities.” FTC,
Analysis of Proposed Consent Order to Aid Public Comment, PacifiCorp et al., FTC File No. 971 0091
(Feb. 18, 1998), available at http://www.ftc.gov/os/1998/02/9710091.ana.htm. This means that an
assessment of market shares based on uncommitted capacity at the peak demand period will entail reducing
the applicant’s total capacity in the period by its native load obligation in that same period. See Section IV
of FTC comment to FERC in the Matter of Information Requirements for Available Transfer Capability,
FERC Docket No. RM05-17-000 (Aug. 22, 2005), available at
http://www.ftc.gov/os/2005/08/050823availtranscapab.pdf. The view that native load obligations should be
averaged over a longer period for this calculation is therefore misplaced.
19 PJM is the regional transmission organization that originally included Pennsylvania, New Jersey,
Maryland, Delaware, and the District of Columbia. PJM subsequently expanded to the South and West to
approximately three times its original size in terms of generation capacity and geographic scope.
20 “The [PJM] Office of the Interconnection shall curtail deliveries to an External Market Buyer if
necessary to maintain appropriate reserve levels for a Control Zone as defined in the PJM Manuals, or to
avoid shedding load in such Control Zone.” PJM Interconnection, Third Revised Rate Schedule FERC No.
24, Section1.10.6 (Apr. 30, 2004), available at
http://www.pjm.com/documents/downloads/agreements/oa.pdf. In June 1998, PJM repeatedly declared
generation emergencies and cut off exports (5,300 mw on one day). The Staff Report to the Federal Energy
Regulatory Commission on the Causes of Wholesale Electric Pricing Abnormalities in the Midwest During
June 1998 (Sept. 22, 1998), available at http://www.ferc.gov/legal/maj-ord-reg/land-docs/mastback.pdf,
discusses these declarations and the likely effects on wholesale pricing in other areas.
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customers (that is, customers buy only as much green power as is required), then “green
power” is likely to be a separate relevant product market.21
3. Transmission Discrimination Affects Market Delineation. The historical
contestable load proposal ignores the potential for the transmission operator to prevent
customers from switching away from the generation units it owns. It assumes that
transmission discrimination is absent despite potential incentives to use transmission
discrimination to reduce competition.22
Further, the transmission operator has incentives to select periods for historical
contestable load analysis in which it did not discriminate and had no incentives to do so.
There may be other periods, however, in which it did discriminate, and therefore was able
to exercise market power. Consequently, the historical contestable load analysis could
disregard important and common changes in market conditions. Interactions between
generation market power and transmission market power that follow changes in supply23
21 For example, Maine has a requirement that 30 percent of each utility’s supply come from renewable
energy sources. Other states have adopted renewable requirements or are considering doing so. The FTC
staff previously observed that Maine’s renewable requirement could raise market power concerns regarding
the subset of generators that qualify as renewable energy generators. Comment of the Staff of the Bureau
of Economics before the Maine Department of the Attorney General and the Maine Public Utilities
Commission regarding “The Interim Report on Market Power in Electricity” (May 29, 1998), available at
http://www.ftc.gov/be/v980011.htm.
22 FERC has described in detail how transmission discrimination disrupts the operation of wholesale
electricity markets. See Regional Transmission Organizations, Order No. 2000 (Dec. 20, 1999), available
at http://www.ferc.gov/industries/electric/indus-act/rto/iss-2000/order-2000/2000.pdf.
23 Supply conditions are part of the analysis in the Merger Guidelines’ assessment of (a) suppliers in the
market and (b) entry conditions. Merger Guidelines §§ 1.3 and 3, respectively. The proposal does not
address entry conditions. Additional demand conditions are taken into account in the analysis of potential
adverse competitive effects in § 2 of the Merger Guidelines.
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and demand conditions are potentially important and are not considered by the historic
contestable load analysis.24
4. Transmission Constraints Affect Market Delineation. The proposal’s treatment
of transmission constraints is inconsistent with economically sound market delineation.
The proposal identifies the relevant geographic market independent of the location of
some of the suppliers to which customers likely would turn in the event of a price
increase. By contrast, a properly delineated market contains all of the sources of supply
to which customers likely would turn to in order to undermine an anticompetitive price
increase imposed by one or more suppliers. Whether a customer is likely to turn to a
particular alternative supplier depends on the risk that such supplier will not be able to
deliver the product. This analysis is not – as the proposal suggests – a separate step to be
completed after the geographic market has been delineated. Rather, it is an integral
component of defining an appropriate geographic market.
IV. 	Conclusion
The historical contestable load proposal suffers from substantial defects. These
defects involve conceptual and measurement techniques that are at odds with the sound
economic framework for horizontal market power analysis set forth in the Merger
Guidelines. Accordingly, the FTC recommends that FERC reject use of a contestable
load in assessing generation market power.
24 FERC Order No. 2004 consists of behavioral rules seeking to address concerns about strategic use of
transmission discrimination by vertically integrated utilities to reduce wholesale competition facing
affiliated generators. See Comment of the Federal Trade Commission before FERC in the Matter of
Market-Based Rates for Public Utilities, supra note 2, § II.B; Comment of the Electric Power Supply
Association before FERC in the Matter of Standards of Conduct for Transmission Providers, Docket No.
RM01-10-000 (2002), available at http://www.epsa.org/forms/uploadFiles/afflconductcomments6-28.pdf.
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