PJM addresses FERC credit concerns with new entity

PJM Settlement’s upcoming launch represents one US RTO’s attempt to address regulatory credit risk concerns, but others want a more diverse approach. Pauline McCallion reports

The decision by the US Federal Energy Regulatory Commission (FERC) on September 3, 2010 to conditionally approve the creation of PJM Settlement ties in with the regulator's initiative to reform credit risk management in organised wholesale electric markets. The new entity will operate separately from PJM Interconnection, the regional transmission operator (RTO) for 13 states and the District of Columbia, acting as the contractual counterparty to all PJM pool transactions from January 1, 2011.

FERC published a notice of proposed rulemaking (NOPR) on the issue of credit reforms on January 21, 2010 (see the May issue of Energy Risk or log on to risk.net for more details). One of several points it raised in the NOPR was the need to clarify the status of RTOs and Independent System Operators (ISOs) as a party to each transaction that occurs in their respective markets. FERC is concerned about how defaults will be managed and market obligations offset in the face of a market participant's bankruptcy.

FERC uses the example of the bankruptcy of energy producer Mirant in 2003. When the company defaulted, its market administrator California ISO (CAISO) had not "taken title" of the transactions and so could not net payments owed to Mirant against those owed by the company. As a result, Mirant's creditors had a claim to revenues owed to Mirant by CAISO market participants, but those participants could not recover the money owed to them by Mirant.

While in this case, prior establishment of mutuality would have been beneficial to those involved, many have argued that this solution should not be blindly applied across all RTOs/ISOs. Given the significant differences between the tariffs and structures of these entities, the risk may not be felt equally within each region.

"A number of people have questioned whether this solution is going to solve the problem that has been identified by FERC or even if that problem is so significant that it needs to be addressed immediately," says John Lilyestrom, a partner in Hogan Lovells' energy practice who focuses on electric utility regulation.

Both the Midwest ISO (MISO) and CAISO filed comments with FERC in March calling for further examination of the issue and urging interested parties to "examine whether the proposed rule would materially reduce market credit risk for RTOs/ISOs and their customers and whether less costly alternatives are available", such as shorter settlement cycles.

"PJM has jumped the gun to some extent in proposing to establish PJM Settlement and a number of power market participants have argued that this is something that should be PJM-specific; that perhaps PJM has a unique set of circumstances that permit it to undertake this restructuring," says Lilyestrom.

PJM stakeholders decided after two years of discussion that establishing PJM Settlement would be the best solution for its markets. But speaking at a technical conference about FERC's credit NOPR held on May 11, 2010, Daniel Shonkwiler, senior counsel for CAISO, said mandating counterparty status for all "would involve a fundamental restructuring of all ISOs and RTOs at significant expense".

While it did not oppose the restructuring itself, PJM market participant Shell Energy voiced concerns in comments to FERC about the related costs and said the regulator should require estimates. Shell and another PJM-market player PSEG, also pointed to unintended consequences, such as the increased likelihood that the US Commodity Futures Trading Commission might attempt to assert jurisdiction over PJM Settlement. PJM rejected their comments as "vague and unsupported" and pointed out these companies filed two of only four protests about PJM Settlement from market participants.

However, the fact remains that many in the market feel more information is required, not only from PJM about the creation of PJM Settlement, but also from FERC about its credit risk concerns in this area. In comments filed with the regulator in June, the Electric Power Supply Association, a trade body for competitive power suppliers, said: "The record in this proceeding is simply not sufficient to support a national mandate that RTOs/ISOs function as central counterparties." Instead, it says FERC should ask each RTO /ISO to propose stakeholder-driven solutions.

Even PJM seems to hint at this point in its May 5 FERC filing that outlines the pros of PJM Settlement and notes a 95% approval rating for the new entity from the PJM Markets and Reliability Committee. Highlighting the two-year development of this approach to managing credit risk, PJM said its "stakeholders have fully vetted these matters [and] made adjustments to address unique concerns in the PJM region... There may be alternative ways to address these matters in other regions, but as evidenced by the strong support of the PJM members, for PJM this proposal is ready for implementation".