Don’t Get Shocked by Electricity Costs: Inside and outside counsel can play a vital role in managing this indispensable commodity

Tuesday, October 4, 2016 - 15:25

Electricity is the lifeblood of many companies. Whether electricity is being used to power secure databanks, melt steel, split air into its constituent parts, run paper machines, or operate compressors and blowers on HVAC equipment, no company can operate without electricity. For many companies, electricity costs are a significant component of variable operating expense. The management of electricity within most companies typically resides with procurement, or plant management, or engineering, or even information technology. However, there are critical roles that corporate counsel, often working with outside counsel who focus on electricity issues, must play with respect to electricity issues. Here, we explore the legal and regulatory aspects of electricity, and explain why and how corporate counsel should position their companies to optimize electricity consumption and cost management.

Dynamic Markets

As a threshold matter, it is important to understand that electricity is unlike most other commodities and services. Electricity is considered to be essential. Electricity has implications for health and safety. Electricity cannot be stored. Large systems operate 24/7/365 to ensure that the supply of electricity is precisely balanced with the demand for electricity at any given time. Electricity production and delivery remain highly capital-intensive. The delivery of electricity, with few exceptions, remains a monopoly function, performed by electric utilities, municipalities and rural cooperatives operating within designated franchise areas. Electricity pricing is subject to a constantly changing mix of regulatory oversight and market forces.

The supply, transmission and distribution of electricity are subject to a combination of federal and state regulations. The Federal Energy Regulatory Commission (FERC) regulates wholesale power sales and the transmission of electricity in interstate commerce, under the Federal Power Act, the Public Utility Regulatory Policies Act and other federal statutes. State commissions – which are variably called public service commissions, public utility commissions, commerce commissions, corporation commissions or boards of public utilities – regulate retail power sales and the distribution of electricity, under state statutes. The “takings” clause of the U.S. Constitution, as interpreted by the U.S. Supreme Court in cases such as Hope and Bluefield, establishes overarching standards about permissible rate levels. The line of demarcation between transmission and distribution and, thus, the line of demarcation between federal and state jurisdiction over delivery services is nominally addressed under principles of cooperative federalism, but it has in practice been quite contentious. Likewise, the line of demarcation between “wholesale sales” and “retail sales” has been quite contentious, with two U.S. Supreme Court opinions being issued during this most recent term on that very subject.

All companies pay for electricity supply (i.e., the actual electrons that are consumed at various facilities). All companies pay for electricity transmission service. All companies pay for electricity distribution service. What your company pays and how your company pays for this critical commodity and the associated delivery service are determined by a combination of regulated and market-based outcomes.

Wholesale electricity prices are determined in most areas of the country by wholesale market dynamics. And, unbeknownst to many, electricity supply is comprised of several components, each subject to its own form of pricing. What many think of simply as “electricity” is, from both a regulatory and pricing perspective, actually a combination of energy, capacity and various forms of “ancillary services,” such as operating reserves and reactive power. The price for each of these components is determined differently and can vary widely over time and based on geographical location. In the Mid-Atlantic area, for example, the wholesale price of energy changes every five minutes. On a hot summer day, the price can go, and has gone, from as low as $50 per megawatt-hour to as high as $1,000 per megawatt-hour and then back down to $50 per megawatt-hour, all in as few as 12 hours. To put that into perspective, imagine the drama that would ensue if the price of gasoline at all gas stations in the Mid-Atlantic area were to go from $3 per gallon at 9:00 in the morning to $60 per gallon at 4:00 in the afternoon, then back down to $3 per gallon at 9:00 in the evening. And then imagine if that occurred three or four days in a row, every few weeks. Yet, that is exactly what can happen, and has happened in the past, with energy prices in certain parts of the country when a heatwave occurs.

Electricity transmission and distribution rates are not afflicted by the same level of volatility that accompanies energy pricing, but these rates do comprise significant components of electricity bills. Electricity transmission service rates, terms and conditions are regulated by FERC. All transmission service rates are reflected in tariffs on file with FERC. Some tariffs have rate mechanisms where the allowed return on the equity component of a rate formula is fixed unless and until FERC changes it, pursuant to either a utility request or a customer complaint. Most other components of formula rates are automatically updated each year based on the utility’s actual costs and customers’ actual consumption. Other transmission tariffs have “stated transmission rates,” which do not fluctuate each year. Those rates change only if FERC accepts a rate change, again pursuant to either a utility request or a customer complaint. Electricity distribution rates are regulated by the states. Unlike the formula rate structures that are increasingly prevalent at FERC for transmission rates, most distribution rates are “stated rates” that do not change unless a state commission or state board allows them to change pursuant to either a utility filing or customer complaint. Rural cooperatives and municipal utilities are generally beholden to member-elected boards and city councils, respectively, in the setting of their rates. Certain federal entities, such as the Tennessee Valley Authority and Bonneville Power Administration, are subject to unique federal statutes and to board oversight pursuant to those statutes. In all states, most aspects of electricity pricing remain subject to regulatory oversight.

Getting Proactive

So, what is a company to do? And what is the role of in-house counsel?

Companies, with the input and assistance of their in-house counsel, and with buy-in from their energy managers, building and plant managers, and procurement specialists, should take several proactive and reactive steps to managing their electricity costs.

Companies with substantial electricity consumption should engage at the national, regional and state levels to influence electricity policies and prices. National associations representing large energy consumers – such as the Industrial Energy Consumers of America (IECA) and the Electricity Consumers Resource Council (ELCON) – are active before Congress, FERC, the Department of Energy and other federal institutions to represent the voice of large energy consumers. Regionally, ad hoc associations such as the Coalition of MISO Transmission Customers (CMTC) and the PJM Industrial Customer Coalition (PJMICC) have, for close to 20 years, been active in stakeholder processes, FERC proceedings, and appellate court proceedings on behalf of large electricity consumers in the Midwest and Mid-Atlantic, respectively. At the state level, large consumer groups exist in nearly every state. For example, Industrial Energy Users-Ohio (IEU-Ohio) represents corporate electricity consumers in Ohio Industrial Energy Consumers of Pennsylvania (IECPA) represents corporate electricity consumers in Pennsylvania; and Texas Industrial Energy Consumers (TIEC) represents corporate electricity consumers in Texas. In some states, groups of large electricity consumers  are also active with respect to specific electric utilities. Generally speaking, ample opportunities exist at the national, regional and state levels for large corporate consumers of electricity to engage in regulatory processes to influence the rates, terms, and conditions of electricity supply and service.

Guidance Required

Every company also experiences at least some company-specific issues with respect to electricity. Most electric utilities require service agreements. Electric utility rates and bills, if in error or if excessive, may be contested before state or federal regulatory commissions. Companies should engage in rate cases before state commissions, whether the state still regulates all aspects of electricity service or has narrowed its regulatory focus to the non-generation components of electricity service. Companies in states where electricity supply is deregulated should undertake requests for proposals, contract comparisons, and contract negotiations with competing electricity suppliers. Many companies are exploring renewable energy projects, such as solar photovoltaic arrangements, as a key component of their corporate sustainability initiatives. Long-term power purchase agreements are often a prerequisite to the financing and construction of these projects. Companies are also exploring opportunities to offset purchases from “the grid,” by deploying on-site generation, establishing microgrids, and engaging in peak load management and demand response. All of these initiatives have legal components.

The current electricity landscape is highly dynamic. The market structures that existed three years ago do not exist today. Electric companies are constantly changing via mergers, acquisitions and divestitures. Environmental policies are effecting dramatic changes in how electricity is produced, delivered and consumed. Regulatory paradigms that have guided electricity service ratemaking for decades are rapidly evolving to accommodate changes in electricity consumption patterns and system configuration. Against this backdrop, companies are well advised to develop and maintain, through some combination of internal and external resources, the capability to guide the company through electricity issues.

Robert A. Weishaar chairs the Energy and Environmental Group and is member-in-charge of the Washington, D.C., office of McNees Wallace & Nurick.

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