Testimony

Before the Subcommittee on Energy Policy, Natural

Resources and Regulatory Affairs, Committee on

Government Reform, House of Representatives

United States General Accounting Office

GAO

For Release on Delivery

Expected at 2:00 p.m.

Thursday, August 2, 2001 ENERGY MARKETS

Results of FERC Outage

Study and Other Market

Power Studies

Statement of Jim Wells, Director

Natural Resources and Environment

GAO-01-1019T
Page 1 GAO-01-1019T Energy Markets

Mr. Chairman and Members of the Subcommittee:

We are pleased to be here today to discuss the role of the Federal Energy

Regulatory Commission (FERC) in monitoring electricity and other

markets. As you know, the electricity industry is in transition, from costof-service regulation to a less regulated market in which competition plays

a greater role in determining the price of electricity. In FERC’s March 2000

report entitled “State of the Markets 2000,” FERC acknowledged that the

rapid change in energy markets has caused the commission to

fundamentally alter its activities. Among its evolving duties, FERC seeks to

protect consumers from the exercise of market power by individual

energy suppliers seeking to affect the price of electricity or natural gas. To

protect consumers from the effects of market power, FERC recognizes

that it must continue to develop better tools and procedures to understand

markets and identify and address market power issues.

The importance of FERC’s monitoring role is illustrated by the situation in

California. Wholesale electricity prices in California rose sharply in May

2000 and have remained high. In addition, there were disruptions in

service—blackouts—this winter and spring. A number of factors have

likely contributed to these high prices and service disruptions, including

rapid demand growth since 1995 accompanied by slow growth in supply,

higher-than-normal natural gas prices, and flaws in the design and

structure of California’s electricity market. In addition to these factors,

state officials and others have attributed the problems, at least in part, to

market power exercised by individual electricity-generating companies. In

response to concerns about high prices and short supplies of electricity in

California, FERC undertook a study, released in February 2001, to

determine whether generators were using plant outages to physically

withhold power and drive up prices of electricity in California. FERC’s

overall conclusion to this study was that the generators it audited had not

physically withheld electricity supplies to influence prices. One generating

company concluded that FERC’s study affirmed the company’s operating

procedures in the face of “incorrect and inflammatory allegations that we

have somehow been withholding power from our four plants in

California.” Notwithstanding this interpretation, officials of the state of

California and other parties insist that market power has indeed been used

to drive up electricity prices and have demanded that FERC require

generators to pay refunds to the state.

In the context of these high electricity prices and the surrounding

controversy, Congressmen Jay Inslee and Peter DeFazio asked us to

review FERC’s outage study and two other studies that examined possible
Page 2 GAO-01-1019T Energy Markets

exercise of market power in California’s electricity industry.1 Our

testimony is based largely on the results of our review of these studies.2

In summary, we found the following:

• FERC’s study was not thorough enough to support its overall

conclusion that audited generators were not physically withholding

electricity supply to influence prices. FERC’s study was largely

focussed on determining whether or not the outages that occurred

were caused by actual physical problems—such as leaks in cooling

tubes—requiring maintenance or repairs. However, it is practically

impossible to accurately determine whether such outages are

orchestrated or not because plants frequently run with physical

problems and the timing of repairs and maintenance is often a

judgment call on the part of plant owners or operators.

• FERC’s overall conclusion differs from that of the other two studies we

examined, which found evidence that electricity generators exercised

market power to increase electricity prices in California. These studies

looked for broader evidence of the exercise of market power in the

entire market by comparing wholesale electricity prices to the

estimated costs of producing electricity. In doing so, they found that

prices were higher than would be expected if the generators were

acting competitively.

• None of the studies was thorough enough to determine the precise

extent to which market power versus other factors caused the high

electricity prices in California since May 2000. A thorough study of

market power would combine the market-wide approach of the other

two studies with a quantification of the extent to which outages, or

other supply disruptions, were caused by factors other than generators’

attempts to drive up prices. Such factors may include the operating and

 1 Report on Plant Outages in the State of California, prepared by the Office of the General

Counsel, Market Oversight & Enforcement and the Office of Markets, Tariffs and Rates,

Division of Energy Markets, Federal Energy Regulatory Commission, February 1, 2001;

Diagnosing Market Power in California’s Restructured Wholesale Electricity Market,

Severin Borenstein, James Bushnell, and Frank Wolak, August 2000 [unpublished]; and A

Quantitative Analysis of Pricing Behavior in California’s Wholesale Electricity Market

During Summer 2000, Paul Joskow and Edward Kahn, January 2001 [unpublished].

2

 See Energy Markets: Results of Studies Assessing High Electricity Prices in California,

(GAO-01-857, June 29, 2001).
Page 3 GAO-01-1019T Energy Markets

maintenance history of existing power plants; constraints on the

number of hours certain plants can be run; and financial problems of

utilities, which led to suspension of payments to some generators.

While FERC’s study was an initial step to more closely monitor generators’

activities, it was not thorough enough to support its overall conclusion

that the audited companies did not physically withhold electricity supplies

to influence prices. This study largely focused on determining whether or

not there were actual physical problems—such as leaks in cooling tubes—

in generating units experiencing outages. Under this approach, if FERC

found that there were physical problems with downed generating plants

and that repairs or maintenance was performed, it concluded that the

outages were legitimate and not orchestrated to reduce supply and push

up prices. In this context, FERC determined that most of one company’s

generating plants were old and suffered from mechanical problems. In

addition, FERC found that many of these plants had run at higher-thanusual rates in the summer and fall of 2000, prior to their shutting down for

repairs or maintenance.

These facts could certainly offer a rationale for higher-than-normal levels

of outages later in the year. However, the industry experts we spoke with

generally agreed that it is practically impossible to accurately determine

whether outages are legitimate or not, because plants frequently run with

physical problems, and the timing of maintenance or repairs is often a

judgment call on the part of plant owners or operators. Another weakness

in the FERC study—or any study that seeks to determine whether specific

outages are legitimate—is the lack of data for past outages to use as a

benchmark with which to compare the number, type, and duration of

outages during the study period. In discussions with FERC, officials told

us that accurate outage data do not exist for the years prior to their study.

Without a baseline comparison, it is not possible to conclude that

observed outages are above normal in number, type, and duration. Finally,

strategic use of plant outages is not the only way that a generating

company could exercise market power, and FERC’s methodology did not

look at other ways. As FERC acknowledged in its report, the agency did

not analyze whether companies were using other techniques to influence

prices, such as not offering bids to sell some capacity, or bidding at prices

high enough to practically ensure exclusion from the market.

FERC officials acknowledge that simply looking at outages and

maintenance records of generators is not sufficient to determine whether

generating companies are exercising market power. Accordingly, they told

us that FERC has recently implemented a more comprehensive plan for

FERC’s Study Not

Thorough Enough to

Support Its

Conclusion
Page 4 GAO-01-1019T Energy Markets

monitoring the exercise of market power. Under this plan, FERC will

continue to look at outages to determine if the number, type, and duration

are warranted. In addition, FERC will monitor generators’ bids and try to

detect bidding behavior that is designed to exclude generating capacity

from the market. FERC officials also said they have notified electricity

generators that their ability to earn unregulated market prices for

electricity will be in jeopardy if they are found to be withholding power in

order to drive up prices.

In contrast to FERC’s study, the other two studies found evidence that

market power had been used to raise prices. The authors reached this

conclusion after looking for evidence of the existence and exercise of

market power in the entire market, rather than focusing on particular

instances of generator outages. The first of these two studies, dated

August 2000, concluded that from June 1998 to September 1999, prices

were 16 percent higher than they would have been had generators behaved

competitively. One of the study’s authors told us that while their study

provides strong evidence of market power, it does not necessarily suggest

any illegal activity on the part of electricity-generating companies. He

believes that individual companies are sometimes able to exercise

unilateral market power to raise prices without violating antitrust laws.

The second study, dated January 2001, also concluded that there was

strong evidence that market power was exercised to raise prices in

summer 2000. While the authors found that higher electricity prices were

caused in part by higher natural gas prices and other factors, they also

found that prices in summer 2000 were greater than they would have been

had the market behaved competitively. In addition, they concluded that

the level of outages experienced during June 2000 cannot be explained by

reasonable expectations about repairs or maintenance requirements, or by

the need to hold power in reserve to ensure the reliability of the power

system.

Niether FERC’s study nor the other two studies covered the entire period

of high prices, nor did they evaluate all the factors that could have led to

greater-than-normal levels of generator outages. Therefore, their results

are inconclusive about the precise extent to which market power versus

these other factors explains high electricity prices in California since May

2000. We believe that a thorough and conclusive study of market power in

California since May 2000 must combine the market-wide approach of the

two market-power studies, with a quantification of the extent to which

Two Other Studies

Reached Different

Conclusions From

FERC’s

A More Thorough

Study Still Needed
Page 5 GAO-01-1019T Energy Markets

outages or other supply disruptions were caused by factors other than

companies’ attempts to drive up prices. In its study, FERC pointed out two

such factors that could lead to higher-than-normal levels of outages: (1)

some plants had been run at above-normal rates prior to being shut down

for repairs or maintenance, and (2) many plants that were shut down were

older. A third factor, suggested by other industry sources, is that a number

of companies were simply refusing to operate their generators at various

times during 2000 because they had not been paid for electricity they had

previously sold to California’s utilities. While the precise extent to which

high prices were the result of market power has not been conclusively

determined, the authors of the August 2000 and January 2001 studies

believe that there is enough evidence that market power exists to warrant

a policy response from FERC and the state of California.

In conclusion, we believe that, as the federal government’s marketmonitoring entity, FERC has an important responsibility to fully

investigate the potential exercise of market power and clearly report the

results of its investigations. In light of changes in the electricity industry,

we recognize that FERC’s role in overseeing this industry is evolving and

that FERC’s outage report was simply one part of its ongoing effort. We

encourage FERC to continue to improve its market-monitoring

capabilities. In this regard, we are currently conducting an analysis of the

electricity market in California to determine whether the design of the

market has facilitated the exercise of market power. In addition, we have

begun work on a review of FERC’s monitoring and oversight roles and

responsibilities with respect to energy markets. This work will include a

broad-based review of FERC’s management practices and internal

organization. We will report to Congress with the results of these studies

in early 2002.

I would be happy to respond to any questions that you or other Members

of the Subcommittee may have at this time.

Contact and Acknowledgements

For further information, please contact Jim Wells on (202) 512-3841.

Individuals making key contributions to this testimony were Dan Haas and

Frank Rusco.

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