FERC's Standards of Conduct NOPR: Back to the Future?

Implications: The Federal Energy Regulatory Commission's recently issued Notice of Proposed Rulemaking on the Standards of Conduct applicable to natural gas and electric transmission providers would establish revised standards for preventing anti-competitive information sharing between those trasmission providers and their marketing affiliates. FERC’s rulemaking bluntly acknowledges that the standards of conduct adopted with much fanfare in Order No. 2004 have proven too difficult for both industry and regulators to interpret and enforce, and seeks a return to the "functional separation" regulatory approach that prevailed prior to Order No. 2004.

Analysis:  On March 21, 2008, the Federal Energy Regulatory Commission (“FERC”) issued a Notice of Proposed Rulemaking (“NOPR”) that would establish revised standards of conduct for natural gas pipelines and electric transmission providers.  FERC’s rulemaking bluntly acknowledges that the standards of conduct adopted with much fanfare in Order No. 2004 have proven too difficult for both industry and regulators to interpret and enforce, and seeks a return to the more straightforward regulatory approach that prevailed prior to Order No. 2004.  

Standards of conduct have been part of FERC’s regulatory framework for about twenty years.  Originally adopted for natural gas pipelines in 1998 (Order No. 497), and then for electric transmission providers in 1996 (Order No. 888), standards of conduct were intended to prevent anticompetitive practices between gas and electric transmission providers on the one hand, and their marketing affiliates on the other.  In particular, these standards sought to prevent the improper sharing of competitively sensitive, non-public market information through a  “functional separation” of transmission and merchant personnel. 

Responding to perceived changes in the energy industry, particularly with regard to the flow of information to affiliates other than traditional marketing functions, FERC’s Order No. 2004 replaced these separate gas and electric standards with one comprehensive set.  In so doing, FERC broadened the standards of conduct to reach a new type of market participant, a transmission provider’s “ Energy Affiliate,” not just traditional “marketing affiliates.”  Order No. 2004 also replaced FERC’s earlier reliance on functional separation to police transmission providers and their marketing affiliates with a “corporate separation” approach.
 
FERC’s revised standards of conduct did not survive judicial review.  The D.C. Circuit’s decision in National Fuel Gas Supply Corp. v. FERC, 469 F.3d 831 (D.C. Cir. 2006)(“National Fuel”), rejected Order No. 2004 as applied to natural gas pipelines.  The Court found FERC’s new rules, and particularly its attempt to regulate Energy Affiliates, arbitrary and capricious in the context of natural gas pipelines.  According to the Court, the record developed before FERC did not demonstrate that the problem supposedly addressed by the new standards of conduct actually existed in the natural gas industry.  

In response to National Fuel, FERC first initiated a rulemaking proceeding in January, 2007.  Based on the comments received, FERC concluded that a more sweeping review of its standards of conduct was required.  According to FERC, the corporate separation approach that characterized its Order No. 2004 regime had proven unworkable for all concerned.  The approach had become too difficult for industry to comply with in practice, a problem made worse by FERC’s recently expanded civil penalty authority.  Furthermore, FERC admitted that the corporate separation concept had proven too difficult to enforce, as evidenced by the mushrooming number of waivers from the standards of conduct requested and granted since the advent of Order No. 2004.  Finally, the Order No. 2004 standards had significantly impinged on transmission management, creating inefficiencies and impeding legitimate integrated resource planning and competitive solicitations.
 
In its March 21 NOPR, FERC attempts to bring greater clarity to the standards of conduct by refocusing them on the most likely areas for affiliate abuse.  In so doing, FERC seeks to facilitate better compliance and enforcement, and to respond adequately to the National Fuel decision.  While the NOPR retains a single set of standards for both the electric and natural gas industries, it discards Order No. 2004’s corporate separation approach and eliminates the concepts of “shared employees” and “Energy Affiliates.” In their place, the NOPR proposes a return to the “functional separation” approach previously used by Order Nos. 497 and 889.  

The revamped standards of conduct have three “core elements:”  an “Independent Functioning Rule,” a “No Conduit Rule,” and a “Transparency Rule.”  Under the Independent Functioning Rule, individuals qualifying as “transmission function employees” must function independently from those acting as “marketing function employees.”  The NOPR defines a transmission function employee as an employee, contractor, consultant or agent of a transmission provider who engages in the conduct of transmission system operations, or the planning, directing, organizing or carrying out of  transmission operations, including the granting or denying of transmission service requests.  A marketing function employee is defined as an employee, contractor, consultant or agent of a transmission provider or a transmission provider’s affiliate engaged in the sale for resale in interstate commerce, or the submission of offers or bids to buy or sell natural gas or electric energy or capacity, demand response, virtual electric or gas supply or demand, or financial transmission rights in interstate commerce.  

After establishing these parameters, the NOPR then carves out a variety of exceptions to them.  Five existing exemptions to the definition of “marketing” are retained, while transmission providers acting as Providers of Last Resort in serving retail customers also would be exempted. In addition, a supervisor, officer or director not “actively and personally engaged” in transmission or marketing functions would not qualify as a transmission function employee or a marketing function employee.  Where generations sales and operations overlap, an exemption is created to permit communications with a transmission provider regarding plant operational status.  An exemption is also created for communications needed to maintain or restore transmission system operation.  In all instances, the transmission provider can have such information exchanges only to the same extent that it would with a non-affiliated entity, and such information exchanges must be documented.  

Under the No Conduit Rule, the current prohibition against transmission function employees disclosing non-public transmission function information to marketing function employees would be expanded to prohibit marketing function employees from receiving non-public transmission function information from any source.  The NOPR similarly would expand the current prohibition against transmission providers using anyone as a conduit for the improper disclosure of non-public transmission function information to to prohibit employees of either a transmission provider or an affiliate engaged in marketing functions from disclosing non-public transmission function information to marketing function employees.  

The NOPR’s Transparency Rule would permit a transmission provider to comply with the prohibition on passing transmission function information to marketing function employees by making such information publicly available.  If, however, an unauthorized disclosure includes non-public transmission customer information, the public posting need only provide notice that such information has been disclosed.  The current requirement for a log reflecting any exercise of discretion or waivers by transmission providers would be retained, as would current exemptions for a marketing employee’s specific requests for transmission service and instances in which a transmission customer consents to the release of its information.
 
Finally, RTOs and ISOs would remain exempt from the revised standards of conduct.    New transmission providers would not need to observe the standards until the earlier of the date on which they have a rate on file with FERC or commence transportation transactions.