Demand-Side Energy Economics: An evolving firm confronts an evolving market

Monday, June 1, 2015 - 10:24

MCC interviews David M. Kleppinger, chairman, McNees Wallace & Nurick LLC, and member of the firm’s Energy, Communications, and Utility Law Practice Group. He can be reached at dkleppinger@mwn.com.

David M. Kleppinger discusses the challenges of leading a firm expanding to meet client needs in the rapidly evolving energy sector.  

MCC: Can you give us an update on significant developments in the energy industry and their impact on the firm’s practice in this area?

Kleppinger: Restructuring and deregulation activity in the energy industry have added to the complexity of our practice, expanding it from strictly regulatory to a commercial, regulatory and politicized practice. Perhaps the most significant emerging issues relate to the Marcellus and Utica shale natural gas and oil finds and the infrastructure challenges in getting these low-cost energy sources to market.

I’m referring to pipelines, for the most part, such as the Keystone XL pipeline in the central part of the country and, more specifically to our practice, locations in Columbus, Ohio, and Harrisburg, Pennsylvania; the Mariner pipeline, which Sunoco is building; UGI Energy Services’ proposed Sunbury pipeline; and The Williams Companies’ Constitution pipeline. All of these were designed to transport the Marcellus and Utica natural gas closer to industrialized and population centers in Pennsylvania and Ohio, and to create a new energy hub in the southern Philadelphia port area for potential export of LNG converted natural gas.

That's a mouthful – but it represents major developments in the energy industry that directly affect our core clientele: large industrial and commercial consumers of electricity, natural gas and other energy sources. Clients are already benefiting from the price impacts but won’t realize the full price effects until the natural gas transmission infrastructure is in place.

MCC: How are you helping your large energy-consuming clients get through this transition period?

Kleppinger: Natural gas is being used not only as a feedstock fuel for industrial customers but also as a fuel source to fire electric generating stations. The PJM Interconnection is a regional transmission organization, or RTO, that coordinates the movement of wholesale electricity in all or parts of 13 states and the District of Columbia. Under PJM operations, those lower-cost natural gas prices at the margin are affecting electricity prices, so when our clients go out for RFPs on their electricity purchases, we work with them in analyzing the responses and then assist them in selecting the supplier that best meets their needs. It’s a complex process that didn’t exist in the energy-purchasing world 20 years ago, when the utility company was subject to a tariff that was regulated by the state’s public utility commission. You didn’t have nearly the negotiating power that you have today in being able to request proposals from multiple suppliers.

This is what I was referring to earlier about expanding from the firm’s purely regulatory practice to one that still has a regulatory and political component (e.g., the distribution and transmission of electricity is still under the control of the state and federal government, respectively) but that now adds in a whole new commercial practice involving contracting with multiple suppliers.

MCC: What type of advice or assistance do you provide your clients regarding the PJM Interconnection?

Kleppinger: We help them become more competitive by finding the lowest-cost, but still reliable, electricity and natural gas services. Many of our large commercial and industrial energy customers have some flexibility in terms of how and when they consume electricity and natural gas, so if our clients can voluntarily reduce consumption at peak demand periods – sometimes referred to as demand-side management – that’s of real value to both the RTO and local utilities. One thing we have been able to successfully accomplish at the Federal Energy Regulatory Commission (FERC) level is to have a demand side of the market that somewhat mirrors the supply side. While natural gas has had a salutary effect on the supply-side price of electricity, capacity or generation can be tight during very hot and humid summer periods or winter periods of extreme cold. If our customers can assist the local utility and RTO in reducing their loads, those energy-efficient entities deserve compensation, and the PJM tariffs and rules and regulations allow for that.

The Supreme Court just accepted a case, Electric Power Supply Association (EPSA) v. FERC, 753 F.2d 216 (DC Circuit 2014), on the jurisdictional question of whether the pricing of demand-side service should be determined at the federal level – as is currently the case for the PJM 13-state region, or at a more local level. We will be advocating that jurisdiction remain at the federal level because that’s where the wholesale market on the supply side is developed, and it would be disjointed if the demand-side components of the market were fractured among various states.

MCC: Would you please describe the contractual component of this whole process from a demand-side perspective?

Kleppinger: Within the demand-side market, there are actually two components, a capacity side and an energy side. The capacity side is a longer-term commitment. For example, in the PJM market, our clients have to commit to a load reduction three years out to receive a capacity payment. If a customer cannot commit to the capacity component that far out, they can make a shorter-term commitment with respect to just the energy component; in other words, they would be compensated for the energy value as opposed to the demand-and-energy value over a three-year-forward period.

MCC: What is the impact of such commitments on their businesses? Do they have to adjust their manufacturing schedules?

Kleppinger: Absolutely. But don’t forget that flexibility is the idea that enables a proactive response to a volatile market. It allows these large energy consumers to value their anticipated revenue stream as a result of the demand and energy reductions, and then compare that to the internal cost of sending people home for the day, shifting production schedules, or maybe enhancing production schedules later on. They have to make that economic calculation within their companies. On the shorter-term energy side, some will determine that the payment for the energy reduction on a hot July day is not sufficient to justify interrupting production lines and sending people home. There is no mandatory reduction in that instance. Conversely, when demand-side customers look three years out and lock in a long-term capacity commitment, they have already made the economic determination supporting it and must comply with a load reduction call.

MCC: Do disputes ever arise over these changes in demand? What other kinds of issues do you help your client with?

Kleppinger: There will always be disputes, and we have assisted clients in those matters. For example, these reductions don’t happen automatically; they have to occur within a certain time period after the PJM’s notification. Sometimes, as a result of notification glitches, our clients don’t reduce their loads as the PJM expected. In cases like this, we have gone to PJM and explained that it was a notification problem and not our client’s fault. So the process is not as simple as flipping a switch.

But what has really burnished our reputation in the energy area is the assistance we’ve provided clients in navigating this complex market. Even among large manufacturing companies, it’s rare to have an employee whose sole job is energy management; typically, these folks wear many hats, and when faced with PJM rules and regulations that are several feet thick, they are grateful for our ability to step in and provide comprehensive regulatory, commercial and operational assistance.

In fact, the area has become so complex that the firm has brought in energy management specialists, including engineers and CPAs, to support the client service teams we’ve created for our large commercial and industrial customers. While our lawyers are developing RFPs and negotiating supply contracts, the specialists will provide assistance in analyzing RFP responses and complying with demand-side reduction programs.

MCC: And by relieving your clients of the need to maintain internal resources, you’re helping them manage costs and redeploy resources to more strategic priorities.

Kleppinger: Correct again. The largest of the companies may have a full-time energy manager or maybe even a vice president of energy management. But those are the exceptions. And in energy-intensive industries like foundries, pulp-and-paper producers and pharmaceutical manufacturers, even if the company’s full-time energy manager is a C-suite executive, it is unlikely to have a person at each plant who is dedicated to energy management. So our role has been to assist the corporate-level energy manager in interfacing with the local plant managers to ensure compliance with all of the demand- and supply-side market rules.

MCC: Returning to the infrastructure projects that are underway to exploit the Marcellus and Utica shale finds, are there any related legislative or regulatory issues or developments that could have an impact on your clients?

Kleppinger: We represent several companies that are either constructing pipelines or interested in doing so, and an unresolved issue with direct impact on them is whether such projects are interstate or intrastate in nature (i.e., fall under the jurisdiction of FERC or state commissions). Dealing with siting issues is a big part of our work because pipelines run through so many counties, townships and municipalities, each of which has its own zoning rules and thoughts on the use of eminent domain. Our energy team works closely with our real estate, litigation and environmental lawyers in handling these matters, which involve pure energy utility issues to a lesser degree than they involve local land use considerations, environmental protections, eminent domain and litigation related to development activity and the construction process.

MCC: What are your thoughts on renewable portfolio standards (RPS)?

Kleppinger: Thirty states plus D.C. have renewable portfolio standards, also referred to as renewable electricity standards (RES), designed to increase generation of electricity from renewable resources by mandating increased production of energy from wind, solar, biomass and geothermal. In addition, seven states have voluntary goals for renewable generation. In a number of the states that have set a minimum requirement for the percentage of electricity to be supplied from designated renewable energy resources by a certain date/year, we have been engaged in legislative and regulatory advocacy to repeal or roll back these mandates, as our clients generally view them as untoward government intrusion in the free market. If those renewable sources of energy can be competitive, companies will build them, but mandating their construction – when the associated costs would cause clients to be less competitive in the global marketplace – does not sit well.

MCC: For readers who are not familiar with McNees Wallace, can you provide a basic overview of your firm?

Kleppinger: Sure. We are celebrating our 80th birthday this year, having grown from a 3-person partnership in 1935 with an office in Harrisburg, Pennsylvania, to a 130-lawyer firm with additional offices in Columbus, Ohio, and Washington, D.C. While we established these offices to better serve our energy and utility clients, they have become very important to our growing labor and employment and intellectual property practices. Our other Pennsylvania offices in State College, Lancaster and Scranton either have each of our practice areas represented or are supported by our other offices.

So our footprint has allowed many practices to become regional and/or national in scope, and a few international as well. Over the past decade, we have established a significant public sector practice, including in the areas of public financing, labor and employment and asset optimization for public entities with underfunded pension problems or severe debt. We’ve completed a couple of transactions for municipalities involving the long-term leasing of their water and sewer utility systems, which not only helped them avoid bankruptcy but fully funded their outstanding pension obligations and debts.

MCC: I understand you have a unique customer service model.

Kleppinger: Like many firms, we have a strategic plan and primary excellence goals. First and foremost is “Clients First.” We are dedicated to maintaining intensely loyal client relationships through the provision of highly accessible, highly predictable and highly valued services. While different clients value our services in different ways, predictability, responsiveness and, obviously, quality lawyering are high on most lists. Recognizing that there are a lot of great lawyers out there, we have differentiated ourselves by focusing on the individual client relationship. As a result, clients remain loyal to us for many, many years.