Using electricity on a day-to-day basis seems simple — flip a switch, turn a dial, press a button and what we want to start, slow down, speed up or stop does just that. If we can save some money or obtain the watts more efficiently, even better.
But, like many deals, the devil is in the details. There are derivatives markets; carbon offset formulas; a snarl of local, regional and national regulations. There are end- millionusers and regional transmission commissions and electricity brokers. And as many ways as there are to transmit, regulate and make money on energy, there are ways to game the system. The poster child for energy market manipulation? Enron, which stifled supply and drove up prices so drastically in California that it caused rolling blackouts in 2000 and 2001.
In 2005, Congress expanded the Federal Energy Regulatory Commission's mission beyond the interstate regulation of oil, natural gas and electricity to include more than a dozen new tasks, from regulating oil pipelines to licensing hydroelectric plants to monitoring and investigating energy markets. In February, FERC Chairman Jon Wellinghoff announced the creation of an Office of Enforcement within the agency to monitor infractions, and in April it required regional transmission organizations (RTOs) and independent system operators (ISOs) to submit more regular data on pricing and other market indicators. Both efforts are designed to catch trading manipulation.
This summer, allegations that J.P. Morgan manipulated California's electricity market in 2010 and 2011 and cost ratepayers upwards of $200 million have further motivated FERC to clamp down. The commission recently shined its market manipulation spotlight on Maine, for a different type of alleged market infraction, in a popular program designed to conserve electricity.
FERC charged in January that three Maine companies — Lincoln Paper & Tissue, the Rumford Paper Co., and Competitive Energy Services — and energy consultant Richard Silkman, a managing partner of Competitive Energy Services, defrauded a regional program intended to encourage energy conservation and consequently bilked Maine's ratepayers out of $3.4 million.
The companies and Silkman face a total of $26.4 million in civil penalties and "disgorgement," or returning of money paid to them by ISO-New England that they didn't deserve. All of the accused vigorously deny that they intentionally defrauded ISO. The parties have until mid-September to reply to the allegations, or "show cause" that the discrepancy noted by FERC was not, in fact, fraudulent. If the responses are rejected by the commission, representatives for Silkman, Competitive Energy Services, Lincoln Paper & Tissue and the Rumford Paper Co. told Mainebiz they intend to fight the charges in court.
A showdown in court is rare for FERC, which reports that of the 118 investigations it conducted from 2007 through 2011, roughly half ended in settlements. The remaining cases were either closed without findings of violation, or closed with findings of violations but without penalties, which FERC spokesman Craig Cano says usually means the infraction was minor, one-time or unintentional.
FERC claims the Maine violations were chronic and deliberate. But Lincoln Paper, Rumford Paper, Competitive Energy Services and Silkman all have filed reams of counterarguments insisting that flaws in the program were at fault for any mistakes.
"First of all, their allegations are so over-the-top and incorrect we've got to fight it," says Lincoln Paper & Tissue President and CEO Keith Van Scotter, who is mentioned in the FERC filings as an alleged fraud conspirator along with his senior management. "What they claim is our ill-gotten gain, they didn't calculate correctly, and what they want to fine us on top of it is ridiculous. And we have our good name to defend, too."
What does FERC claim Van Scotter and the rest did wrong? The simple answer —and, fair warning, there are no simple answers in energy policy — is that the mills pretended to reduce electricity consumption to cash in on an incentive program run by ISO-New England, which manages the electric power grid for the region's six states.
Lincoln Paper and Rumford Paper were members of the now-defunct Day-Ahead Load Reduction Program that ISO-New England ran from 2005 through May 2012. DALRP was part of a national effort to encourage an energy-saving maneuver called demand response. And here's where the explanation gets complicated.
Demand response is designed to address grid overload, those points in the day when too many people are using too much juice and the grid doesn't have enough supply to handle it. When this happens, the ISO calls certain end-users — usually commercial or industrial entities — that have said they would be willing to reduce their energy use in exchange for a fee. These are called "demand-response" participants. When the demand goes up, these companies respond by shutting their lights off, powering down part of their operations, basically doing whatever it takes to reduce the number of megawatts they're draining from the grid. In the case of DALRP, the demand-response participants would pledge a day ahead to reduce wattage.
For example, Company A in Maine joins DALRP, telling ISO that in a pinch, it could downgrade its energy use by 30-40 MW during certain hours of the day. In demand response vernacular, the megawatts Company A agrees to reduce are "negawatts," or watts-that-never-were. Every participant attaches a value to their negawatts in an auction, and when ISO needs electricity it calls on the lowest negawatt bidder and goes up from there. So participants are incentivized to bid low; bids range from $50 to $475, but usually come in at $100 or less per negawatt.
Continuing the example, the grid gets overwhelmed, ISO asks Company A to dial down, it does so and in exchange for the negawatts saved, ISO pays Company A. Maine's average demand-response client receives about $38,000 per negawatt annually, according to the Maine Public Utilities Commission. This money comes from the total collected regionally from all electricity ratepayers, and the thinking is it's cheaper to conserve with programs like these than it is to generate more energy.
With its emphasis on conservation, demand response is touted by some as the smart grid of the future. In Maine, it's a popular way for factories and mills to make extra money. According to the PUC, Maine is second in the region in negawatts pledged to ISO's various demand response programs, after only Connecticut. (Maine has pledged a total of 487 negawatts, to Connecticut's 996. All other states in the region have pledged fewer than 200 negawatts.) In total, Maine's demand-response participants collect $18 million annually to not use energy. Why is demand-response so hot here? According to the PUC, it's because we have far more industrial capacity than we do electricity users.
New England ratepayers support this demand-response system that, when it works, makes sure users that don't need power free up the grid for those that do. It's a way to keep the grid alive without generating wasted energy. But for ISO to tell if demand-response members are in fact lowering their energy consumption when asked, ISO needs to know how much energy the businesses typically use.
This baseline is established during a given period of the year, when ISO checks in and records energy use over the course of a work week. According to FERC, the parties named in its action defrauded demand-response by making it look like their baseline use during this period was much higher than it really was. For example, say Company A's actual baseline is 10 MW per hour, but it intentionally burns extra wattage during the monitoring period to beef up its average to 14 MW. It then goes back to operating at its actual baseline — 10 MW — after ISO leaves, and when ISO calls it to dial down from its baseline of 14 MW, it agrees and changes nothing, since 10 MW business-as-usual appears to be a reduction according to ISO records. No energy is saved for the grid, and ratepayers reward Company A for a reduction that never happened. This is what FERC claims the mills did.
Competitive Energy Services' Silkman allegedly came up with the baseline plan and pitched it hard to Rumford Paper Co.'s senior management, which according to FERC filings was initially suspicious about getting paid for doing nothing. In exchange, Competitive Energy Services received 5% of the DALRP revenue.
According to FERC, Rumford Paper supplemented grid energy with an internal generator, but during the baseline period it turned its generator down to suck more energy from the public grid than it usually would. The mill then allegedly "resumed normal use of its behind-the-meter generation after establishing its baseline, creating the false appearance that Rumford was reducing demand from the grid when it was actually returning to normal operations and normal levels of demand." The final alleged step was to set its negawatt bid at the minimum price and, bingo, it was called upon to contribute to DALRP nearly every day for seven months.
FERC says this practice went on at the Rumford mill during 2007 and 2008, and cost ratepayers $2.8 million in fraudulent demand-response payments, the largest alleged fraud among the entities charged. Rumford Paper Co. is adamant that its practices were above-board and that any mistakes happened because the program is confusing or direction was unclear from ISO, Competitive Energy Services and its energy broker, Constellation NewEnergy of Baltimore.
Lincoln Paper is accused of similar baseline inflation during the same period, to the tune of $379,000 in alleged fraudulent DALRP payments. Lincoln Paper's Van Scotter, who referred to an unnamed expert consultant in his public response to the accusations, would not tell Mainebiz whether Silkman was that consultant, but the representative for Silkman and Competitive Energy Services, Dustin Brooks at Preti Flaherty in Portland, told Mainebiz that "neither Silkman nor Competitive Energy Services had any relationship with Lincoln Paper either about this or about anything else."
Though Competitive Energy Services was apparently not a common link between the targeted paper mills, regional energy broker Constellation NewEnergy was. Constellation acted as middle-man between both Maine mills and ISO-New England during the alleged period of fraud, but FERC filings suggest the company knew nothing about the alleged baseline inflation.
Still, Constellation is quite familiar with market manipulation elsewhere. In March, FERC settled its largest violation to date when Constellation Energy, Constellation NewEnergy's parent company, agreed to pay $245 million in a case involving manipulation of New York wholesale energy markets by trading to influence the price of energy shares, according to the Baltimore Sun. The company agreed to pay a $135 million civil penalty and to disgorge, or return, $110 million in "unjust profits." Those profits will be distributed to the six mid-Atlantic states in the regional grid and to a fund established for the "benefit of electric energy consumers," according to the paper.
Should the Maine cases result in a settlement or fines, FERC says civil penalty money will go to the federal Treasury and disgorged money will be returned to ISO-New England. ISO will then decide how to distribute that money to ratepayers. As for the Day-Ahead Load Response Program, it was allowed to expire earlier this summer, though ISO says day-ahead bidding remains a part of other demand-response offerings.