By Rich Heidorn Jr.
Are RTO market rules too clumsy and complicated to prevent gaming and protect consumers?
That’s the question on the minds of many observers following federal regulators’ $410 million-dollar settlement with JPMorgan Chase last week.
The settlement between the Federal Energy Regulatory Commission and JP Morgan Ventures Energy Corp. resulted from schemes that turned money-losing natural gas-fired generators in California and Michigan into profit centers.
It was the fourth major enforcement action over manipulation of the electric markets in the last two years, following earlier FERC cases against Deutsche Bank AG, Barclays PLC and Constellation Energy Group Inc. and a Justice Department antitrust settlement with Morgan Stanley and KeySpan.
Regulators said the JP Morgan settlement, which included a $285 million fine and disgorgement of $125 million in unjust profits, showed FERC has dramatically improved enforcement since Congress gave the agency tougher penalties in the wake of the Enron scandal.
But consumer advocates and other critics say regulators’ enforcement actions have neither provided sufficient deterrent nor made consumers and honest market participants whole. Moreover, some say regulators will never be able to catch up with clever traders looking to exploit the rules.
Traders Smarter than Regulators?
“You have to wonder whether bureaucrats constructing byzantine regulatory systems that attempt to create a market within a government-controlled sector ever ask themselves: Are we simply developing arbitrage opportunities for Wall Streeters twice as smart as we are?” asked CNBC columnists John Carney and Jeff Cox.
“FERC and the ISOs built a dumb system that rewarded a modicum of perfectly transparent gamesmanship,” wrote financial industry blogger Matt Levine. “JPMorgan gamed them in the obvious and perfectly transparent way,”
Tyson Slocum, director of Public Citizen’s Energy Program, said the repeated instances of market manipulation are an indictment of FERC’s philosophy of regulation through competitive markets. By replacing its review of individual wholesale electric tariffs with market-based rates, Slocum said, “FERC outsourced federal law enforcement to the mall cops of the industry, so-called Independent System Operators (ISOs), private organizations with internal voting structures dominated by power sellers and utilities.”
If FERC won’t return to the prior regulatory regime, Slocum said, “People representing the interests of household consumers must serve on the [RTO boards] and hold a majority of voting shares. The organizations should be subject to Freedom of Information Act requests, and all meetings must be held before the public.”
FERC found that JP Morgan used 12 bidding strategies to profit from uneconomic power plants, all designed to exploit market rules intended to make generators whole when market prices don’t cover operating costs. At times, JP Morgan was paid $999 per MWh when the market price was $12.
`Historic’ Settlement
FERC Commissioner Tony Clark said that last week’s “historic [settlement] … sends a strong signal that market manipulation is being taken seriously” while allowing immediate refunds to consumers “rather than after a long multi-year court proceeding.”
California ISO General Counsel Nancy Saracino said the fact that the scheme was uncovered by the ISO proves the effectiveness of enforcement mechanisms created to ensure competitive markets result in just and reasonable prices.
FERC Chairman Jon Wellinghoff emphasized in an interview on CNBC that the $125 million JP Morgan scheme was “only about 1%” as large as the 2000-1 Enron scandal, which cost West Coast consumers an estimated $10 billion.
“Activities in organized, competitive wholesale electricity markets are subject to scrutiny by multiple parties. They are carefully monitored by the ISOs/RTOs themselves, by the respective market monitors and by the FERC,” PJM spokesman Ray Dotter said issued this statement. “Detecting and correcting uncompetitive behavior in the PJM region has been successful.”
PJM Market Monitor Joe Bowring rejected suggestions that the repeated instances of fraud by electric traders was an argument for a return to cost-of-service regulation.
“All markets have complex rules. Look at the financial markets,” he told RTO Insider in an interview yesterday. There’s nothing uncompetitive or bureaucratic about it.”
“Competition has, in my view, been very effective in reducing prices,” he added. “But there will always be people trying to exploit the rules.”
No Deterrent
Critics said the JP Morgan case and its predecessors showed that regulators are unable or unwilling to provide real deterrence.
JP Morgan’s $285 million fine was little more than twice the profits FERC estimated the company made in the scheme and little more than a day’s worth of revenues for the banking giant, which generated nearly $94 billion in revenues and $21 billion in profits last year. The settlement also allowed the traders and executives involved to keep their jobs, including head of Global Commodities Blythe Masters, who gained notoriety for helping develop credit default swaps, a derivative that figured largely in the 2008 financial crisis. A JP Morgan spokesman confirmed to RTO Insider that the employees remain with the company.
“The incentive remains for outfits like JPMorgan to stretch the rules to the breaking point — if they get caught, the cost is tolerable; if not, the returns are fabulous,” wrote Los Angeles Times columnist Michael Hiltzik. “It will have no more deterrent effect on white-collar wrongdoing at JPMorgan or anywhere else than telling its traders they’ve got to take the Ferrari to work instead of the Lamborghini, though they can still take the Lambo to the beach house.”
Public Citizen called on JP Morgan to fire Masters and on FERC to revoke the company’s market-based rates. “The most powerful sanction FERC can invoke is to no longer allow JP Morgan to engage in the charade of deregulated energy markets,” Slocum said. In November, FERC announced it was suspending JP Morgan’s right to sell power at market-based rates for six months because it had lied to California and FERC staffers investigating the scheme.
Consumers Made Whole?
Others, including Massachusetts Sens. Elizabeth Warren and Ed Markey, said they were not convinced the settlement would make consumers whole.
In a paper published in the Energy Law Journal in November, attorney Paul B. Mohler concluded that consumers are less likely to be made whole when rates are found to be unjust and unreasonable under market-based rates than under traditional cost-based regulation.
The disgorgement also doesn’t compensate generators whose legitimate bids were rejected by CAISO and MISO. And in the case of California, it resulted in the dispatch of 1950s and 1960s vintage steam boilers which are less efficient and produce more emissions than more modern plants.
Regulators Playing Catch-up
Still others say the case and those involving other large banks and utilities are proof that — more than a decade after the Enron scandal, and eight years since Congress gave FERC the power to levy heavier fines — regulators are powerless to stop gaming of market rules.
JP Morgan’s scheme ran for more than two years between September 2010 and November 2012. The company’s traders gamed CAISO’s software, alternating high bids and low bids in a way that took advantage of the ISO’s make whole rules but maximized the company’s revenues. MISO, which can manually reject bids it considered suspicious, caught the scam more quickly. While FERC estimates JP Morgan made $124 million in unjust profits in California, the agency estimated only $1 million in improper payments in MISO.
“ISO market overseers seemed always to be behind the curve,” said Hiltzik. “The ISO had to submit new market rates and regulations for FERC approval five times … in its effort to wipe out Morgan’s scheming.”
JP Morgan thought so little of the risk of getting caught that, remarkably, 10 of the 12 schemes identified by FERC were launched after regulators began investigating the company.
“The record thus far indicates that manipulative schemes can go on for months, even years, before they’re uncovered by regulators,” said Hiltzik. “When will we finally learn about the ones that may be taking place today?”
The Enron scandal stopped many states from transitioning to competition from traditional ratemaking. The criticisms raised by the recent cases aren’t yet widespread enough to cause Congress to turn back the clock on competitive markets. But if traders continue to see gaming the rules as a path to easy profits, RTOs won’t be able to take public support for granted.