Enforcement Insights - April 2011

    View Authors 11 April 2011

    EDITOR'S NOTE:

    Dear Friends and Colleagues,

    This is the April 2011 edition of Patton Boggs’ complementary newsletter reporting on regulatory enforcement activities affecting the electric and gas industries. This newsletter covers recent FERC activity, including its Inquiry into the widespread gas and electricity outages in the Southwest, the EnerNOC decision, FERC’s guidance on reviews of NERC penalties and AFUDC policy.

    FERC’s report on the gas and electricity outages in Texas, New Mexico and Arizona will likely become the authoritative work on the subject. FERC is the only governmental entity with the jurisdictional reach to require every utility affected by the outage to provide it with all the data necessary to ferret out what really happened. Its report will be on every Southwest regulator’s and utility’s must-read list. Even though this Inquiry is a massive undertaking, FERC is moving quickly to conclude its review.

    Sincerely,
    Suedeen Kelly, Editor

    For further information, please contact Suedeen at skelly@pattonboggs.com.


    FERC CONDUCTS HISTORIC INQUIRY INTO DISRUPTIONS OF ELECTRIC AND NATURAL GAS SERVICE
    by Debbie Swanstrom

    FERC’s Enforcement Staff is conducting a potentially precedent-setting Inquiry into the widespread outages of electric generating facilities and disruptions in electric and natural gas services that occurred the first week of February 2011 in Texas and other parts of the Southwest when unusually cold weather spread throughout the region.

    The Commission directed its Enforcement Staff to conduct the Inquiry with the objectives of identifying: (1) the causes of the disruptions; and (2) any appropriate actions for preventing a recurrence of the disruptions. The Commission’s priority is to gather relevant facts, identify the problems and fix them. Any decisions by FERC on whether to initiate formal enforcement investigations will be made later.

    While it is common for FERC to probe the causes of electric outages, this Inquiry is noteworthy for several reasons. First, it involves not only outages of electric generating facilities but also disruptions of natural gas deliveries. There are reliability standards in effect, pursuant to section 215 of the Federal Power Act (FPA), to maintain the reliability of the bulk-power system. But comparable statutory authority and reliability standards do not exist under the Natural Gas Act (NGA). Depending on the outcome of the Inquiry and any subsequent investigations, FERC may look for ways to increase or otherwise use its statutory authority over rates, terms and conditions of jurisdictional services provided in the natural gas industry for the purpose of improving reliability. Additionally, the results of FERC’s Inquiry will likely inform state commissions that are considering whether to impose new reliability-related requirements on local gas distribution companies or electric utilities. Considerations include whether electric utilities should have firm gas supply and transportation services rather than relying upon interruptible supply and transportation services.

    Second, the Inquiry includes service disruptions occurring within the Electric Reliability Council of Texas (ERCOT). In the past, FERC had no jurisdiction over utilities operating in ERCOT. However, the Energy Policy Act of 2005 gave FERC the responsibility to oversee and enforce electric reliability standards across the country, including Texas.

    Third, NERC and Regional Entities (to whom NERC delegated authority) also are conducting their own analyses of the disturbances. If, based on the results of FERC’s Inquiry, the Commission ultimately commences its own formal Part 1b investigation, it is possible that FERC may apply its Revised Policy Statement on Penalty Guidelines for the first time to violations of electric reliability standards also investigated by NERC. In its Revised Policy Statement, FERC stated that the Penalty Guidelines will apply to violations of reliability standards only in the Commission’s own Part 1b investigations and enforcement actions and that FERC did not intend to apply the Penalty Guidelines simply to its review of notices of penalties filed by NERC.

    For further information, please contact Debbie at dswanstrom@pattonboggs.com.


    FERC TAKES NO ENFORCEMENT ACTION AGAINST DEMAND RESPONSE AGGREGATOR IN PJM
    by Meredith Jolivert

    On March 3, 2011, FERC addressed a petition for declaratory order filed by EnerNOC, Inc. (EnerNOC), which requested, among other things, that FERC find that EnerNOC could continue to register customers and settle under PJM’s Guaranteed Load Drop (GLD) baseline methodology without the threat of enforcement action. The GLD baseline methodology is a performance reporting method used to measure and verify demand response. Pursuant to PJM’s currently effective tariff and business rules, EnerNOC aggregates retail customers in the PJM market and is compensated for the aggregated capacity by netting over-performing resources against the underperformance of other resources.

    EnerNOC’s petition was prompted by a February 4, 2011 statement issued by PJM and its Independent Market Monitor (Joint Statement). The Joint Statement said that it was no longer appropriate for an aggregator of retail customers (ARC) to use over-compliance to offset underperforming resources. It further stated that future occurrences of such netting could result in referrals to FERC’s Office of Enforcement.

    In response to EnerNOC’s petition, FERC clarified that, until further notice, it would not institute any enforcement actions against EnerNOC (or other similarly situated ARCs) for registering customers in good faith and settling under the GLD baseline methodology. FERC also stated that it would operate as if the Joint Statement had not been issued and would not consider the Statement when considering any questions of market manipulation.

    For further information, please contact Meredith at mjolivert@pattonboggs.com.


    FERC PROVIDES GUIDANCE ON HOW IT WILL ACT ON NERC PENALTY NOTICES IN THE FUTURE
    by Debbie Swanstrom

    FERC recently provided important guidance to NERC, Regional Entities and the industry on how it will conduct future reviews of penalty notices in a proceeding involving load-shedding by the Turlock Irrigation District (Turlock) when a vegetation-related outage occurred on its transmission facilities. FERC’s March 17 order is noteworthy not only because it provides insight into its thinking on issues such as penalties when load is shed and mitigating factors, but also because FERC explicitly required that a Regional Entity conduct “spot checks” of a registered entity’s future compliance and report the results to FERC for the Commission to potentially take additional enforcement action.

    This controversial proceeding started in 2010 when FERC took the unusual step of initiating, on its own motion, a review of a NERC notice of penalty against Turlock. At issue was an $80,000 penalty, agreed to in a settlement between the Western Electricity Coordinating Council (WECC) and Turlock, for alleged violations of eight Reliability Standards, including Reliability Standard FAC-003-1 Requirement R2 pertaining to vegetation management. At the time FERC initiated its review, it was concerned that the penalty amount was too low, particularly in a situation in which a vegetation-caused outage led to load shedding in the service areas of Turlock and the Modesto Irrigation District (Modesto). Appearing inconsistent, NERC previously assessed higher penalty amounts against other entities for violations of the same vegetation management requirement when those entities did not shed load.

    Ultimately, FERC affirmed the Turlock penalty amount because the penalty related to a violation that occurred during the “initial period” in 2007 when mandatory Reliability Standards had only recently taken effect, and FERC had granted NERC greater enforcement discretion. FERC also directed WECC to conduct spot checks for the purpose of testing continued compliance by Turlock and, if appropriate, Modesto (which co-owned transmission lines with Turlock), with Reliability Standards relating to the events that led to the loss of load and to report the results to FERC Staff. Once WECC submits its report, FERC will determine whether to exercise its authority to issue an order, on its own motion, requiring compliance with the Reliability Standards.

    Although FERC affirmed the penalty amount, it nonetheless responded to issues raised in comments to provide notice of guiding principles applicable to future Commission actions on penalty notices. FERC addressed the adequacy of the record filed by NERC, the assessment of penalties when load is and is not shed, and factors that will and will not mitigate penalty amounts, such as self-reporting, cooperation, the nature and size of the registered entity and human error.

    First, FERC expressed concern about the adequacy of the record filed by NERC. FERC noted that in the absence of its review, FERC would not have discovered several critical facts, including the fact that a transmission protection system was incorrectly toggled off due to an alleged “human error.” FERC also criticized NERC’s initial filing for failing to include sufficient information about system conditions on the date the vegetation contact and loss of load occurred, including conditions within the California Independent System Operator footprint.

    Going forward, FERC directed NERC to file a complete and accurate record for each notice of penalty, whether it reflects an adjudicated determination or a settlement with the registered entity. FERC expects that when a loss of load results from a violation, the Regional Entity and NERC will clearly describe relevant system conditions and whether (and, if so, how) the unnecessary loss of load led to or required changes in these conditions. FERC believes this description will help determine harm resulting from the loss of load.

    Second, FERC addressed the imposition of penalties when load is shed. Many commenters urged the Commission to refrain from penalizing entities for shedding load because it would discourage system operators from taking this action when necessary to prevent a problem from spreading. In response, FERC stated that load shedding alone is not a violation and that it may be necessary to comply with a Reliability Standard as a last resort to contain system emergencies and prevent cascading. FERC further stated that, if the Reliability Standards require load shedding, system operators should shed load and FERC will not approve or assess a penalty for such conduct. If, however, load shedding results from a violation of a Reliability Standard, FERC stated that the penalty for the violation should take into account the lost load because the violation creates a more serious risk, due to the actual harm than results, than a similar violation that did not necessitate load shedding. FERC also stated that the failure to shed load when required could lead to greater load loss, damage to assets and an increase in the penalty.

    Turlock asserted that there was no actual harm from the loss of load because no customers suffered damages, injuries or fatalities. FERC, however, determined that a loss of load caused by a violation of a Reliability Standard results in harm that is unnecessary and avoidable. Accordingly, the Commission will consider the quantity of load lost from a Reliability Standard violation in its analysis of harm when determining appropriate penalty levels.

    Turlock also argued that NERC’s Sanction Guidelines do not allow load shedding to be considered in a penalty determination. FERC disagreed. While harm resulting from a violation is not specifically included in the Sanction Guidelines’ list of “adjustment factors” that may lower or increase a base penalty amount, FERC found that a Regional Entity and NERC may consider other appropriate factors. FERC concluded that actual harm resulting from a violation of a Reliability Standard is an appropriate penalty adjustment factor if a Regional Entity or NERC does not consider such harm in setting a base penalty amount.

    Third, FERC addressed other factors that can potentially lower penalty amounts. FERC recognized that Turlock took some actions after the load shed event to remedy the problem, but FERC did not appear to be persuaded that those actions warranted a reduction in the penalty amount. FERC generally stated that an entity’s efforts to achieve or maintain compliance with Reliability Standards should not be the basis for a reduction in the penalty amount for a violation; rather, only an entity’s significantly enhanced efforts that go beyond what is required to attain compliance may be considered in the penalty determination.

    FERC also disagreed with Turlock’s contention that it self-reported the alleged FAC-003-1 R2 violation. Distinguishing self-reporting from cooperation, FERC found that Turlock fulfilled the notification requirements under EOP-004-1 R3 by informing WECC that it experienced a loss of firm load as a result of a vegetation contact and later cooperated with WECC by providing additional information about the disturbance on its system. FERC observed that “Reliability Standard EOP-004-1 R3 and Attachment 1-EOP-004 require a registered entity to report certain disturbances including, among others, those that result in firm load shedding of 100 MW or more to maintain the reliability of the bulk electric system.” The record showed that Turlock submitted a notification to WECC pursuant to EOP-004-1 R3 using a NERC Preliminary Disturbance Report Form that instructs the submitter, among other things, to identify the cause of the disturbance. Thereafter, Turlock promptly provided additional information to WECC. Because Turlock was required to report the event, FERC concluded that it was not entitled to a self-reporting credit. FERC stated that when a registered entity informs a Regional Entity of a potential violation through a report required more quickly by another standard than by the one that the registered entity may have violated, it will expect the Regional Entity and NERC to remove self-reporting as a mitigating factor when assessing a penalty amount. However, the Regional Entity and NERC may recognize the registered entity’s cooperation after reporting as a separate mitigating factor in the notice of penalty determination, if justified.

    Fourth, FERC rejected Turlock’s argument that a smaller penalty than was assessed against other entities for violations of the same requirement was warranted because Turlock is a smaller, public entity. The Commission acknowledged that, in Order No. 672, it stated that “the relative size of an entity or its financial ability [to pay a penalty] is a factor that the ERO or a Regional Entity may consider when developing penalty guidelines or determining an appropriate penalty in a particular case.” But, in Turlock’s case, FERC found that a lower penalty than assessed to other violators of the same requirement (which did not shed load) was not warranted simply because Turlock is a public entity or smaller in size. FERC specifically disagreed with Turlock’s position that the Commission should measure the size of an entity by the number of miles of transmission lines it operates and its interconnections with the bulk-power system. Rather, FERC stated that it intends to determine size by looking at factors such as the number of employees; the annual revenue, profits and budget of the organization; the number of separate operating divisions or units within the organization; and the corporate structure of the organization. While an entity’s financial status could reflect its ability to pay, FERC generally will not consider the size and nature of the registered entity as the most important factor in reviewing penalty notices.

    Finally, FERC rejected an argument that a smaller penalty should apply to Turlock because the violation allegedly resulted from human error. FERC found that violations resulting from “human error” can lead to significant adverse effects to the bulk-power system, including massive load shedding. FERC therefore would not decrease the penalty amount, reasoning that the possibility of a significant monetary penalty for a violation of a Reliability Standard resulting from human error provides an incentive for registered entities to create and implement robust training and compliance programs and procedures to make human errors less likely.

    For further information, please contact Debbie at dswanstrom@pattonboggs.com.


    FERC INITIATES AUDIT INTO PERFORMANCE OF PJM
    by Scott Binnings

    On March 11, 2011, the FERC Division of Audits in the Office of Enforcement, in conjunction with the Divisions of Compliance and Logistics and Security in the Office of Electric Reliability, initiated an audit into the performance of PJM Interconnection, L.L.C. (PJM) as: (1) a Transmission Operator and Transmission Planner; and (2) a Balancing Authority responsible for certain Critical Infrastructure Protection (CIP) Reliability Standards. FERC’s audit of PJM is being conducted under the Commission’s electric reliability authority under section 215 of the Federal Power Act and will cover the period from June 18, 2007 to the present.

    For further information, please contact Scott at sbinnings@pattonboggs.com.


    FERC’S OFFICE OF ENFORCEMENT CLARIFIES AFUDC POLICY
    by Debbie Swanstrom

    With the aim of harmonizing its policy on the allowance for funds used in construction (AFUDC) and applying that policy uniformly not only to natural gas pipelines, but also to public utilities and hydropower licensees, FERC’s Office of Enforcement issued a revised Accounting Release No. 5. The Release, authored by the Director and Chief Accountant in the Division of Audits, provides guidance on the capitalization of AFUDC.

    It recites that the capitalization period for AFUDC shall begin when two conditions are present: (1) capital expenditures for the project have been incurred; and
    (2) activities that are necessary to get the construction project ready for its intended use are in progress. AFUDC capitalization shall continue as long as these two conditions are present.

    The term “activities” is to be construed broadly and includes “all the actions required to prepare the construction project for its intended use, including activities prior to physical construction, such as the development of plans or the process of obtaining permits from governmental authorities.” Notably, however, the term “activities” does not include “preliminary survey and investigation” activities. These types of activities, occurring prior to the above two conditions being met, would be considered preliminary in nature for the purpose of determining feasibility of projects under contemplation. The preliminary activities would not be subject to AFUDC accruals until such a time as the two conditions are met.

    For further information, please contact Debbie at dswanstrom@pattonboggs.com.