FERC & DOJ Address KeySpan & the New York City Capacity Market - What's a swap between friends?

FERC & DOJ Address
KeySpan & the New York
   City Capacity Market
 What's a swap between friends?

                             David M. Perlman, Partner
                              Bracewell & Giuliani LLP
                            Washington, DC 20006-1872
                                   202-828-5804
                             david.perlman@bgllp.com

The Market

   New York City Capacity Market
    
   Highly Concentrated
    
   Created by Con-Ed Divestitures
        
   Three "Bundles"
    
   Subject to Market Rules and Bid/Price Caps
    
   Supply/Demand Resulted in Prices at Cap until
        2006
    
   1,000 MW of New Supply Enters Market in 2006

KeySpan
 
   Reviews Options to Optimize Revenue
     
   Acquire Astoria
     
   Bid the Cap (Economically Withhold Capacity)
     
   Enter Into Swap Transferring Risk
 
   Swap Terms
     
   If Clearing Price Exceeds $7.57 MS pays KeySpan to
         amount over X 1800 MW; if under $7.57 KeySpan
         pays MS the amount under X 1,800 MW
     
   Per DOJ – Deal Contingent Upon On Offsetting
         MS/Astoria Swap

KeySpan

   KeySpan Action
    
   Enter Into Swap
    
   Bid the Cap
    
   Collect on Swap
        
   Per FERC – KeySpan's exposure for 1,000 MWs of
            new capacity -- $80 million lost revenue; Swap
            revenue $35 Million

FERC

   FERC Directs Its Enforcement Staff To
    Review For Tariff Violations and Market
    Manipulation Rule Violations
    
   No Tariff Violations Found
    
   No Market Manipulation Rule Violations Found

FERC

   Tariff Findings
    
   In 1998, In Approving the Mitigation Regime,
        FERC Had Contemplated Generators Bidding the
        Cap
        
   KeySpan and Astoria Never Bid Above the Cap
        
   KeySpan and Astoria Offered All Of Their Available
            Capacity
    
   Generators Complied With the NYISO Services
        Tariff and Mitigation Rules

FERC

   Market Manipulation Rule
    
   KeySpan "Legitimate Business Purpose" –
        "maximizing a relatively predictable revenue level
        and minimizing risk consistent with its assessment
        of its risk/reward ratio"
        
   Offer Below Cap
        
   Offer At Cap
               Offer At Cap – Always Economically Superior When
                Modeled

FERC

   Astoria
    
   Bid As Price Taker
    
   "Legitimate Business Purpose" "Because Its
        Bidding Maximized Its Revenue and Ensured that
        All of Its Capacity Cleared."

FERC

   SWAP

   KeySpan Had a "Legitimate Business Purpose" "To
    Offset Expected Revenue Reductions Due to the
    2006 additions of Capacity

   Astoria Had a "Legitimate Business Purpose (1)
    Help Facilitate USPowerGen Acquisition Financing
    &(2) hedge physical risk

    Morgan Stanley was a "Broker" & Did "not have an
    incentive to encourage market prices to increase

   Swaps Did Not Involve Collusion

FERC

   Enforcement Staff Concludes:
    
   (1) KeySpan’s offering behavior was anticipated by the
        Commission’s 1998 Order;
    
   (2) KeySpan’s offering behavior did not constitute a fraud
        or fraudulent practice;
    
   (3) the capacity additions in 2006 to the in-city ICAP market
        were insufficient to cause KeySpan, based on its analysis
        of its risk/reward ratio, to change its offering strategy;
    
   (4) KeySpan’s and Astoria’s offering behaviors in the in-city
        ICAP market were not affected by the fact that they had
        entered into swaps; and
    
   (5) KeySpan, Astoria, and Morgan Stanley did not engage
        in collusion to impair, obstruct, or defeat the functioning of
        the in-city ICAP market in violation of section 1c.2.

DOJ

   DOJ files a Complaint in Federal District Court on
    February 22, 2010
      
   KeySpan undertook a plan to avoid competition
      
   The "clear tendency of the KeySpan swap was to alter
          KeySpan's bidding in the NYC Capacity Market auctions"
      
   "But for the KeySpan swap, installed capacity likely would
          have been procured at a lower price in NYC from 5/06-2/08
      
   KeySpan entered into an agreement the likely effect of
          which was to increase prices in the NYC Capacity Market in
          violation of the Sherman Act, Section 1
      
   The KeySpan swap agreement constitutes an illegal
          restraint of trade in the sale of installed capacity in the NYC
          market in violation of Section 1 of the Sherman Act

DOJ

   DOJ and KeySpan settle for $12 million.
    
   Consent judgment entered
    
   Does not constitute "any evidence against or an
        admission by KeySpan with respect to any
        allegation"

   No further DOJ action taken

Manipulation Standard

   FERC Standard
    
   It shall be unlawful for any entity, directly or indirectly, in
        connection with the purchase or sale of electric energy or
        the purchase or sale of transmission services subject to the
        jurisdiction of the Commission
        
 to use or employ any devise, scheme, or artifice to defraud
        
 to make any untrue statement of a material fact or to omit to
           state a material fact necessary in order to make the
           statements made, in the light of the circumstances under
           which they were made, not misleading, or
        
 to engage in any act, practice, or course of business that
           operates or would operate as a fraud or deceit upon any
           entity.

Statutory Standards

   Sherman Act, Section 1
    
   Every contract, combination in the form of trust or otherwise, or
        conspiracy, in restraint of trade or commerce among the several
        States, or with foreign nations, is declared to be illegal.
    
   Every person who shall make any contract or engage in any
        combination or conspiracy hereby declared to be illegal shall be
        deemed guilty of a felony, and, on conviction thereof, shall be
        punished, in the discretion of the court, by
        
   fine not exceeding $100,000,000 if a corporation or, if any other
            person, $1,000,000,
        
   or by imprisonment not exceeding 10 years, or by both said
            punishments.

What Next?

   More DOJ Action?

   Private action?

   FERC Section 306 Proceeding?

   Other?