Financial Institutions Warn FERC Order May Unnecessarily Restrict Physical Forward Transactions

A single paragraph in a FERC order regarding a complaint by DC Energy against PJM may, "unnecessarily restrict the ability of market participants to engage in physical forward transactions," the Financial Institutions Energy Group (FIEG) warned in a request for clarification concerning the requirements for internal bilateral transactions (EL12-8).

Although the DC Energy proceeding originated from certain specific transactions, FIEG is concerned that FERC's order has resulted in unintended confusion on what types of transactions can legitimately be reported as internal bilateral transactions (IBTs) to PJM, and resulted in new interpretations of how physical bilateral transactions should be conducted within RTO markets.

Specifically, FIEG said that FERC's order, "seems to announce a new interpretation of the requirement for physical transfer [for IBTs to be legitimate] -- and one that may unnecessarily restrict the ability of market participants to engage in physical forward transactions in RTO markets throughout the U.S."

Section 1.7.10 of the PJM Tariff requires that bilateral contracts reported as IBTs must contemplate the physical transfer of energy.

"Despite longstanding market practices, the DC Energy Order interprets this physicality requirement to mean that the PJM Interchange Energy market cannot be used as the source for power in a bilateral transaction," FIEG said.

More specifically, FERC stated that, "[T]he source of energy cannot be the PJM Interchange Energy Market and it is irrelevant that a buyer is not withdrawing power nor is a seller injecting power at a hub."

"The Commission's discussion seems to ignore the basics of how LMP-based RTO markets operate," FIEG said.

"If a generator sells power to a load in an RTO and it is more economic to meet the supply obligation from the market, then that is precisely what economic dispatch would result in. Once again, the fundamental purpose of an LMP market is to decouple dispatch from contractual arrangements and ensure that regardless of the private contractual arrangements made by market participants, the most efficient set of resources will nonetheless be dispatched. If so, then even a generator that submits an IBT should be able to continue to use the PJM market to source the power for its contractual obligation. Indeed, the markets in PJM, CAISO, ISO-NE, MISO and NYISO have operated on this basis for some time and, as further discussed below, any contrary conclusion would jeopardize these well-established market design features," FIEG noted.

"Precluding the submission of an IBT within an RTO market is, in effect, restricting the ability of market participants to transact bilaterally for physical energy," FIEG said.

"It should not be the case that a single paragraph in a complaint involving the trading activity of one group of affiliated market participants in one market could be intended to eviscerate a well established practice nationwide," FIEG said in asking for clarification, and safe harbor regarding the use of IBTs until clarification is granted.

FIEG noted that PJM issued guidance as a result of the FERC order that appears to be less restrictive than the Commission's language. PJM concluded that an IBT can be legitimately reported to PJM only if the underlying transaction results in the physical delivery of energy by having a physical generator or physical load at one end of the transaction. As interpreted by FIEG, PJM's position is that, in order to qualify as an IBT, the PJM market can be used as a source or a sink for the power to be purchased and sold in the applicable transaction, but cannot be used as both a source and sink for such power.

FIEG said that PJM's position is likewise, "contrary to the fundamental assumptions underlying an LMP-based market, as it precludes bilateral counterparties from entering into physical forward transactions in PJM unless they can identify the source and sink of the transaction chain at the time of contracting."

"This is nearly impossible because the chain of transactions evolves over time and varies for any given day. Rather, if both parties to the transaction contemplate and acknowledge that they are obligated to physically perform under the transaction if required, this fulfills the function of the LMP market and should qualify as an IBT regardless of the source or sink," FIEG said.