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Hone~ I Shrunk the Franchise!

Detroit Edison's suit to halt the Michigan Commission's

limited retail wheeling experiment could result in two

ironies:(1) Edisonmay still berequiredtowheelpowertoretail customers, but at rates less likely to befully

compensatory, and (2) its generation will be more devaluedthan it would have been without the suit.

Ashley C. Brown

Ashley Brown is executive director

of the Electricity Policy Group at

Harvard University's John F.

Kennedy School of Government, and

is principal consultant to

RCGIHagler, Bailly, Inc. Mr. Brown

is a former commissioner of the Public

Utilities Commission of Ohio. Mr.

Brown gratefully acknowledges the

assistance of Andrew Young, astudent at Harvard Law School, in

preparing this article.

Last April, a week before theCalifornia Public Utilities

Commission announced its plansto have a comprehensive retailwheeling program by 2002,1Michigan declared its intention to

implement an experimental five-

year retail wheeling plan2 whichaddressed 60 MW of ConsumersPower Co.'s load and 90 MW of

Detroit Edison's. In AssociationofBusinessesAdvocatingTariffEquityv. DetroitEdison,Jthe MichiganPublic Service Commission as-

serted explicitly that it possessedjurisdiction to order retail wheel-

ing. Detroit Edison challenged the

Michigan Commission's action byfiling suit in the local U.S. District

Court claiming that the Michigan

commission is "federally preemp-

ted"4 from mandating retail trans-mission service by the Energy Pol-iey Act of 1992.5Michigan'sAttorney General then filed a mo-tion to dismiss the suit on various

grounds, including ripeness and

abstention, while appeals of theCommission's decision proceed.

The purpose of this article is to

examine a very likely scenario ifDetroit Edison succeeds in its suit.

Ignoring the legal merits of the

suit, what are the logical conse-quences of federal preemption?Based on the current state of the

la\v, plus likely actions of state

and federal regulators and marketparticipants, I believe the follow-

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ing scenario is a likely result of aholding for Edison.

State Regulatory Background

For decades, state utility regula-tors have exercised jurisdictionover retail transmission facilities

and services, defacto and dejure,by including their costs in retailrate-base proceedings. DetroitEdison, like all other investor-

owned utilities in the U.S., ac-

cepted state jurisdiction over re-tail transmission by allowinginclusion of these transmission fa-

cilities in its retail rate base and

seeking recovery of all transmis-

sion-related expenses in its overallrevenue requirements. Now, how-ever, it is clear that Detroit Edison

believes that Michigan's choice tobundle transmission costs with

other utility costs6 for the purposeof establishing retail rates is thebasis for the commission's juris-diction-that the decision to bun-dle or unbundle retail rates is not

merely a policy determination bythe state, to which jurisdiction is aprecondition. Thus the MichiganCommission's past policy of al-lowing utilities to bundle utilityassets in rates did not created ju-risdiction where none existed.That view would come as a sur-

prise to the Michigan Public Serv-ice Commission, which believes

that bundling or unbundling ratesis merely the exercise of policy

making pursuant to jurisdiction

that it already possessed.However, most importantly

from the commission's perspec-

tive, without that jurisdiction De-troit Edison and other Michigan

utilities may not lawfully include

the costs of transmission service

in utility retail rates. Thus a fed-eral court decision that the Michi-

ganCo~ronmdGauthorityover the provision of retail trans-mission services would necessi-tate the removalof Detroit

Edison's transmission costs fromits retail rates: The commission

would mck jurisdiction to dealwith them in the first place.

The dispute over transmis-sion jurisdiction is compli-

cated by two very different per-spectives over the source of statejurisdiction. State commissionssee their jurisdiction as flowing

from the asset itself, the prudenceand valuation of which was ana-

lyzed by the state regulatoryagency and then included in retail

rate base. Those who argue forpreemption often see jurisdictionas being service based rather thanasset based. State jurisdiction, De-troit Edison will presumably ar-gue, exists only as long as theservice regulated is fully bundledand the service is provided to an

end user on a single delivered-price basis. State regulators will,of course, argue that the decision

to bundle or not bundle is a pol-icy call which can only be made ifthe agency has jurisdiction in thefirst place.

But the question of whether ju-

risdiction follows bundling orwhether bundling follows juris-

diction is largely irrelevant to thescenario mid out in this article. Inthe event the court were to find

that jurisdiction was asset based,

but that the asset was FERCjuris-dictional, the likely results are aslaid out below. In the event that

The Michigan Com-mission's past policyof allowing utilities tobundle utility assetsin rates did not created

jurisdiction'luherenone existed.

March 1995 73

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Nothing in theFederal POlverAct

preempts statejurisdiction over

retail sales ofelectricity.

74

the court were to find that the ju-risdiction is service based, and

that unbundling handed jurisdic-tion over to the FERC, the Michi-

gan Commission could well

choose to unbundle rates anyway,the result of which would be pre-cisely the same as if the courtfound the jurisdiction to be assetbased. A state could, of course,

make such a policy detenninationwith or without jurisdiction overany transmission. Even withoutexercising any jurisdiction overthe wires, the state may in fact de-tennine from whom an end user

can purchase power. Nothing inthe Federal Power Act preemptsstate jurisdiction over retail salesof electricity. In short, regardlessof the basis for detennining juris-diction, Detroit Edison would be

compelled to go to the FERC toobtain a retail transmission tariff

unless it determined to forgo itstransmission requirements.

If either of these situations

proves to be the case, thenevery inclusion of transmission fa-cilities in rate base throughout theU.S.,at least since the passage ofthe Federal Power Act,7waseither ultravires8-and, therefore

null and void-or is subject toautomatic disallowance from rate

base should a state opt for retailwheeling.

If state jurisdiction were found

lacking then it is likely that atleast some retail consumers will

demand refunds to compensate

them for the implied overcharges.Setting aside the question of re-funds, however, the immediate re-

sult of a finding of federal pre-

emption would be the removal of

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transmission costs from retailrates.

li'ansmission Cost RecoveryIssues

In order to remedy this loss,which might amount to more

than 10 percent of its rate base, De-troit Edison would likely seek toestablish a retail transmission tar-

iff with the Federal Energy Regu-latory Commission. FERCwouldpossess exclusive jurisdictionalauthority over transmission serv-ices as a result of the assumedU.S. District Court decision. Estab-

lishment of such a tariff at FERCwould be all but certain to result

in contentious and complicatedlitigation lasting for quite sometime,9though in the end FERCwould likely approve a transmis-sion tariff for the company. Thisassumes, of course, that even

though FERC could not order re-tail wheeling, it couldapprove atariff for the needed transmission

service, a power which FERCit-self opined that it possessed in its1994 Ktznsas City Pawer & Light de-

cision.1oIn that case FERCupheld

a voluntary tariff barring retailwheeling, but went on to say that

just as it has the power to do that,it also possessed jurisdiction to ap-

prove a tariff allowing retailwheeling. If this proves incorrect,then Detroit Edison faces the

equivalent of trapped costs, a fateto which it would have commit-ted itself.

It is important to note that this

jurisdictional scenario is far more

like hop-scotch betweo..n t.~estate

and federalagenciesthan it is asimple caseof preemption.Both

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non-utility generators operating

in Michigan and generators

owned by Michiganutilitiesother .than Detroit Edison, which had

theretofore sold power into thewholesale market, now maychoose to sell to an end userwithin Detroit Edison's service ter-

ritory. Such a transaction wouldnow fall within the MichiganCommission's exclusive authoritybecause the transaction, as a retailsale, would not be a sale for re-sale-a criterion on which FERC

service jurisdiction depends.

The only jurisdictionalauthority which would be

altered if the District Court de-cides in favor of Detroit Edison is

the jurisdiction over the actualtransmission wires which wouldnow fall under FERC's exclusive

jurisdiction. The Michigan Com-mission would retain jurisdictionover even an intersta te gener-ator's sale to an end-user becausethis transaction would be a retailsale and would remain under

state jurisdiction. FERC's jurisdic-tion over the transmission would

alter nothing in the transaction be-tween a generator and an end-user. This remains a retail sale

within jurisdiction of the Michi-gan Commission.

Significantly, the retail transmis-sion tariffs filed at the FERCun-

der the Federal Power Act cannot

be discriminatory. Once a tariff is

approved-and there is nothingin the Federal Power Act to pre-

clude approval-Detroit Edison isbarred from discriminating

against end-users which may seek

to buy generation from power

generators other than Edison.ll If

the companytries to conditionac-cessto its monopolycontroloftransmissionupon the purchaseof generationonly fromitself,itwould be likelyto run afoulof thenon-discriminationrequirementsof the FederalPowerActand the

antitrust lawson "tying arrange-ments."12

Consequences of the Edison Suit

The irony of this hypotheticalscenario-one that Edison seeksto make real-is to make it more

likely that retail wheeling will oc-cur, and occur sooner, as a result

of the company's successful prose-cution of the case, since the buyer

and seller need simply invoke theFERC-approved retail transmis-sion rate and seek approval for

the power sale rate from theMichigan Commission.

Some could well raise the argu-ment that the FERClacks jurisdic-tion to approve a retail transmis-sion tariff, although nothing in theAct appears to preclude the com-mission from doing so. While theEnergy Policy Act of 1992prohib-its the commission from orderingretail wheeling, nothing suggeststhat it cannot approve a retailtransmission service tariff "volun-

tarily" filed by a utility. One

would suspect that Edison wouldbe loath to raise the argument that

the FERCsomehow lacked juris-

diction to approve such a tariff,given that such a holding wouldinevitably result in transmissioncosts being trapped in a jurisdic-tion hole it would have dug on itsown.

Another significant and highly

ironic outcome of an Edison legal

The irony of thishypothetical scenario-one that Edison seeks

to make real-is that

retail1.vheeling 1.villoccur, and occur sooner.

March 1995 75

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The result which

Detroit Edison fearsthe most would almost

inevitably become theresult of successful

prosecution of itsfederal suit.

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victory would be a boost for gen-erators which seek to sell electric-

ity directly to end users inEdison's franchise territory. Witha FERC-approved wheeling rate

in place, they could then competeagainst Detroit Edison's own high-

cost generators. That competitionwould inevitably lead to calls for

removing Edison's high-cost gen-erating units from rate base. Itwould also cause severe financial

strain on the ability and desirabil-ity of Detroit Edison to continueto operate as a vertically inte-grated utility.

At a minimum, Edison would

be compelled to sell its generationat market prices well below bookvalue. The result which Detroit

Edison fears the most-beingstuck with stranded assets by vir-tue of competitive market forces,forcing the devaluation of its high-cost nuclear generation from bookto market value-would almost

inevitably become the result ofsuccessful prosecution of its fed-eral suit, and it would become re-

ality far more quickly and com-

pletely than the Michigan Com-mission's original order would

have permitted.

If these ironies were not

enough, for better or forworse, the traditional method

used by state regulators to priceretail transmission services-theinclusion of transmission assets inthe retail rate base-has had the

effect of guaranteeingDetroitEdison's full recovery of its invest-ment in transmission assets, a

guarantee FERC has never pro-vided. If FERC continues to em-

ploy average embedded-cost pric-

ing of transmission services,Detroit Edison might run agreater risk of under-recovery onits transmission investment be-

cause under the current regimethe Michigan Commission guar-antees 100 percent recovery ofsunk cost for transmission.

In summary, a successful prose-cution of the federal suit by De-troit Edison is very likely to resultin two delicious ironies: (1)De-

With tIreresults of tIresuit clear, Edisonslzarelwlders became disgruntLed.

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troit Edison will stillbe requiredto wheel power to retailcustom-ers,but thiswould now be attransmissionrates lesslikelyto befullycompensatory,and (2)De-troit Edison's high-<:ostgenera-tion will be more quicklyand cer-tainly devalued frombook tomarket value than would be the

case if the MichiganCommissionorder were not challenged.

One further irony worth not-ing-indeed a critical legal

point on the merits of the case-isthat the franchise upon which De-troit Edison relies for maintaining

itself as an integrated monopolyis a creation of state, not federal,

law. Yet Detroit Edison is trying toenforce this same franchise byseeking federal preemption underthe Federal Power Act, a use ofthe 1935 act its authors-who be-

lieved they were merely filling injurisdictional gaps created by theinherent limits on the reach of

state regulation-would have

found quite curious.Although I believe this analysis

is essentially correct, if elementsof it are shown by subsequent ad-

judicatory decisions to be flawed,it is extraordinary that any com-pany would be willing to bet vir-tually its very existence on the out-come of a case where a triumph

could give new meaning to theterm "Pyrrhic victory."

Perhaps the next time DetroitEdison files a suit it should ask its

lawyers an important question:

"What happens if we win?" Oth-erwise, senior management will

have to go home at night and an-nounce to their spouses: "Honey, Ishrunk the franchise!" .

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Endnotes:

1. Order Instituting Rulemaking onthe Conunission's Proposed PoliciesGoverning Restructuring California'sElectricServices Industry and Reform-ing Regulation, Case No. R.94-04-031,1.94-04-032(Cal. Pub. Uti!. Commis-sion, April 20, 1994).

2. By this I mean the offering of unbun-dled transmission service needed for adirect sale to an end user.

3. Association of Businesses AdvocatingTariff Equity v. The Detroit Edison Co.,Case No. U-10143 and U-10176 (Mich.

Pub. Service Comm'n, April 11, 1994).

4. "This Constitution and the Laws ofthe United States which shall be made

in pursuance thereof ... under theauthority of the United States ...shallbe made the Supreme Law of theLand." U.S. Const., art. IV, cl. 3.

5. Pub. L. No. 102-486, 106 Stat. 2776(1992).

6. Including, but not limited to, the costof generation and distribution facilities.

7.16 U.S.c. 791a-825u.

8. I.e.,"an act performed without anyauthority to act on the subject,"Black's Law Dictionary (6th ed.).

9. The complexity would result fromthe fact that the FERChas had no ex-

perience setting retail transmissionrates, or any rates at all, for facilitieswhose residual revenue needs were

not assumed by state commissioners'actions to include the entire facility inretail rate base. There would also be

many first impression questions re-garding equities, priorities, and otherterms and conditions.

10.67 FERC 61,183(1994).

11.Such a result is not prohibited bythe provision of the EPActof 1992thatprecludes FERCfrom ordering retailwheeling, since FERCwould not bemandating any transactions. It ismerely approving a tariff which par-ties can choose to invoke if they wish.

12. See,e.g.,Cajun Electric v.FERC,28F.3d 173 (D.C.Cir., 1994).

Edison'shigh-costgenerationwill bemorequickly andcertainly devaluedfrom bookto marketvalue than iftheorderwerenot challenged.

March 1995 77

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