Energy Industry Updates for January 2009

Energy Stimulus: The Transformation Begins

The energy provisions of the U.S. House Democrats’ version of the stimulus legislation reflect President Barack H. Obama’s vision of a transformed economy led in large part through an energy revolution. Mr. Obama intends to put scientists to work on the next great scientific breakthroughs, which may lead to additional jobs in cutting-edge technologies and smart investments that will help businesses in every community succeed in a global economy. Mr. Obama envisions the process will provide returns of multiple dollars in value to the American economy for every dollar invested, as has been the case in the investment in broadband technology.

Designed to put people back to work today and reduce our dependence on foreign oil tomorrow, the stimulus package will double renewable energy production and renovate public buildings to make them more energy efficient. The specifics of the House Democratic stimulus package lay out Mr. Obama’s vision of a national energy transformation through green technologies and infrastructure upgrades, including:

• Creating a new reliable efficient electricity grid through a $32-billion investment to transform the nation’s energy transmission, distribution, and production systems. Through research and demonstration projects and focusing investment in renewable technology, a smarter and better grid will be created. ($11 billion).
• Making buildings more energy efficient through the U.S. General Services Administration (GSA) programs ($6.7 billion), local government building programs ($6.9 billion), housing retrofits ($2.5 billion), energy-efficiency grants for institutions ($1.5 billion), and home weatherization ($6.2 billion).
• Implementing fleet initiatives to help federal, state, and municipal governments replace older vehicles with more fuel-efficient vehicles ($1 billion)
• Providing electric transportation initiatives ($300 million in grants).
• Developing clean fossil fuel energy initiatives ($2.4 billion).
• Providing research and development initiatives for universities, companies, and national laboratories ($2 billion).
• Transforming the U.S. Department of Defense’s energy use through initiatives designed to make military bases more energy efficient ($350 million).
• Creating industrial energy efficiency initiatives through demonstration projects ($500 million).

Some bills will follow the passage of the stimulus package and will authorize and appropriate programs in the stimulus bill. Other programs will be self-enacted, and will go into effect with the passage of the stimulus bill. Much of the steering of stimulus funds into actual projects will occur through the states, where decisions are expected to be made quickly. Some states are looking at creating expedited processes for proposals and bids for projects that will meet the criteria of being both a good long-term investment in our infrastructure and capable of being up and running quickly. “Shovel ready” is the new buzz word. Companies with projects that fit the criteria or who are uniquely qualified to get the job done should consider becoming involved now.

Investment Adviser Warning: You Could Be a FERC-Regulated Company Without Knowing It

Investment advisers and other holders of securities in public utilities have been put on notice by the Federal Energy Regulatory Commission (FERC) that they have until February 23, 2009 to submit all filings to FERC that are required under the Federal Power Act (FPA). The case that gave rise to this warning involved Horizon Asset Management, Inc. (Horizon), an investment adviser that acquired and managed securities on behalf of account holders. In the course of its normal investment activities for the account holders, Horizon acquired the securities of certain public utilities regulated by FERC under the FPA. Horizon managed the accounts that apparently could be aggregated at various times to involve holdings of more than 10 percent of Reliant Energy, Sierra Pacific Industries, and Aquila, Inc., all FERC-regulated entities. In a recent order, FERC held that Horizon should have obtained prior approval for its purchase of these securities and was in violation of the FPA because it did not.

Under the FPA, holding companies must obtain prior FERC authorization before they can “purchase, acquire, or take any security” worth $10 million or more from any transmitting utility, electric utility company, or electric holding company. Although Horizon acquired securities in excess of $10 million, it argued that FERC should disclaim jurisdiction over it because the acquisition of securities was on behalf of account holders, and that account holders merely delegated to Horizon the responsibility for supervising and managing the securities portfolio, including the purchase and sale of securities. Horizon also received voting rights proxies, and although they were delegated to another entity, Horizon did retain the right to override the recommendations of that entity.

FERC denied Horizon’s request for a disclaimer of jurisdiction and found that Horizon was a holding company subject to its FPA jurisdiction because, “in its capacity as investment adviser to certain accounts it has power to vote more than ten percent of the outstanding voting securities” of a jurisdictional utility. FERC did, however, grant Horizon a blanket authorization for acquisitions of voting securities of jurisdictional utilities as long as (1) no individual investor held more than 10 percent of a jurisdictional company, and (2) the cumulative total in Horizon investor accounts remained under 20 percent. (In a separate case, FERC recently clarified that companies which previously received exemptions or waivers must notify FERC each time they obtain the power to vote 10 percent or more of the voting securities of any additional public utility companies or holding companies, even if the underlying basis for their exemption or waiver did not change.)

In the course of its decision, FERC observed that other investment advisor holding companies may have purchased securities without prior approval, thus violating the FPA. To ensure compliance, FERC required similarly situated companies to comply by making all required filings and seeking all required authorizations no later than February 23, 2009. FERC cautioned that investment industry companies “may face possible monetary or other sanctions if they fail to obtain advance approval under [the FPA] of similar acquisitions of securities. Thus, if investment companies participate or have a role in other types of acquisitions of securities of public utility companies or public utility holding companies and it is not clear to them whether [FPA] approval is needed for those types of transactions, they have the option of seeking a jurisdictional determination from the Commission through a request for declaratory order or other appropriate procedural mechanism prior to engaging in the transactions.”

Patent Trends Are Greatly Impacting Public Utility Companies

Public utility companies have generally operated independently of the world of patents, at least as it pertains to their regulated operations. It appears that this may now be ending as patents have begun to affect the regulated businesses of utility companies. In particular, the specter of patent infringement also hangs over the industry much as it has the telecommunication and finance industries for years.

Some of the most well known patent licensing entities have begun to assert their communications and business method patents against utility companies. For example, the Ronald A. Katz Technology Licensing, L.P. juggernaut has asserted its portfolio against some of the largest investor-owned utilities in the country.

In addition, other entities are beginning to assert patents specific to the utility industry. For example, IPCO, LLC has a patent portfolio relating to automated meter reading, specifically for systems and methods applicable to communication with smart meters. While IPCO, LLC has previously enforced its patents against meter equipment vendors, they also have now sued a utility company for patent infringement.

Adding to the turmoil, at least one investor-owned utility, Southern California Edison, has responded by filing a patent of its own. While utility companies have been issued hundreds of patents in the past, this patent filing is among the first to be directed to the business methods used in operating a utility company, specifically those utilized in automated meter reading. An entire program has been developed by Southern California Edison to allow other entities to license the patent and surrounding knowledge as part of an “open source” strategy for combating the threat of patent trolls.

These developments raise many issues for utilities, particularly large investor-owned utilities. The public nature of the details of their operations as described in tariffs and public utility commission filings may make them an attractive target of patent trolls. This may be particularly true where the patent holder believes the utility company will take a license to avoid the risk of litigation. Another unknown issue that is somewhat unique to regulated utilities is the question of how state public utility commissions will judge the prudence of utilities actions, both in protecting potentially patentable inventions paid for with ratepayer funds and managing the risk of infringement of third-party patent rights.

It remains to be seen what direction the utility industry will take regarding patents, but it is clear that it is no longer going to be able to ignore the patent trends affecting the rest of the world.

For the First Time, FERC Directs a Regional Entity to Separate Its Market and Reliability Functions

On January 15, 2009, FERC found in an audit of the Southwest Power Pool, Inc. (SPP) that SPP had not sufficiently separated its market and reliability functions in compliance with FERC Order No. 672 and, thus, had not adequately prevented conflicts of interest. This order, which reflects the first time that FERC has made such a finding in an audit report, requires the separation of a regional entity’s market and reliability functions. FERC expects all regional entities that have not yet been subjected to an audit to observe this order. FERC’s action provides advanced notice to these entities of FERC’s commitment to ensuring the reliability of the nation’s electricity grid, which continues to be stressed by unprecedented demands for power.

To rectify this deficiency, FERC held that SPP must improve its implementation of its Compliance Monitoring and Enforcement Plan and outlined 20 specific recommendations that SPP should implement. Among the recommendations are that SPP hire a full-time reliability manager to oversee all reliability functions and to serve as a primary representative to the North American Electric Reliability Corporation (NERC). FERC also suggested that SPP eliminate the reporting relationships between employees serving its reliability functions and employees serving its market functions. FERC further suggested that SPP implement procedures to ensure that its reliability personnel have full authority over reliability expenses. To comply with FERC’s order, SPP must submit a compliance plan by March 17, 2009 to implement FERC’s recommendations contained in the audit report and must submit quarterly reports detailing its progress on implementing such recommendations.

FERC Instructs NERC on Audit Procedures to Ensure Compliance With FERC’s Reliability Standards

On January 15, 2009, FERC issued an order instructing NERC on improving its audits of registered entities to ensure their compliance with FERC’s reliability standards. FERC set forth instructions on two different phases of the audit process: pre-audit procedures and procedures used during an audit. In terms of pre-audit procedures, FERC suggested that NERC and the regional entities ensure that auditors receive training in interviewing, choosing samples of matters to be audited, and evaluating evidence. FERC added that auditors’ requests for information should be consistent across all regional entities and that audit teams should allow ample time to review responses to such requests for information prior to visiting a site.

In terms of the procedures to be used during an audit, FERC emphasized that auditors should not consider whether sanctions or monetary penalties should be imposed on a registered entity that has been found to have violated a requirement. Similarly, FERC held that auditors should not decide whether a registered entity has violated a requirement based on the resources needed to pursue litigation against the entity or needed to settle a notice of an alleged violation. Finally, FERC advised that an audit should always include an assessment of a registered entity’s reliability standards compliance program. 

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