On February 21, 2008, the Federal Energy Regulatory Commission ("FERC") issued two orders strengthening its cross-subsidization rules and granting certain limited blanket authorizations that will facilitate investment in the electric utility industry. These rules may affect the relationship between utilities and their affiliates, including affiliated service companies. They may also affect potential transactions, such as purchases and sales of utility securities.

Cross Subsidization

Order No. 707 amends FERC's regulations by restricting transactions between franchised public utilities that have captive customers or that own or provide transmission service over jurisdictional transmission facilities and their market-regulated power sales affiliates or non-utility affiliates. According to FERC, the purpose of the amended regulations is to ensure that affiliate restrictions cover transactions between all franchised public utilities with captive customers and their non-utility affiliates. Currently, the affiliate restrictions apply only if an entity has market-based rate authorization or is seeking FERC approval to merge. Order No. 707 concludes that limiting affiliate restrictions to these two contexts leaves a regulatory gap in cross-subsidization protection for a number of reasons: (1) affiliate restrictions on entities with market-based rate authorization do not cover transactions for non-power goods and services between a franchised public utility and a non-utility affiliate; (2) restrictions imposed on merger applicants only apply to those applicants; (3) FERC has not codified certain pricing policies governing sales of non-power goods and services among affiliates; and (4) not all states regulate these types of transactions.

FERC's regulations now make clear that franchised public utilities with captive customers may not sell power at wholesale to affiliates with market-based rates without first obtaining FERC approval pursuant to Section 205 of the Federal Power Act ("FPA"). Similarly, market-based rate affiliates may not sell power at wholesale to franchised public utilities without prior approval under Section 205. While these restrictions have been FERC policy for a number of years, the policy was never before codified in FERC's regulations.

In addition, FERC has adopted pricing restrictions on transactions for non-power goods and services among affiliates. Order No. 707 provides that a franchised public utility with captive customers that provides non-power goods and services to a market-regulated power sales affiliate or a non-utility affiliate will be required to sell at a price that is the higher of cost or market price. The order also prohibits a franchised public utility with captive customers from purchasing non-power goods or services from a market-regulated power sales affiliate or a non-utility affiliate at a price above market price, with the exception of transactions from centralized service companies. With regard to centralized service companies, Order No. 707 prohibits a franchised public utility with captive customers from purchasing or receiving non-power goods and services from a centralized service company at a price above cost. FERC notes that such "at-cost" pricing for transactions involving centralized service companies benefits ratepayers through economies of scale and eliminates the speculative task of defining a market price in these instances.

Blanket Authorizations

FERC has previously granted blanket authorization for certain types of transactions involving changes in control of jurisdictional facilities or corporate reorganizations that would have required approval under Section 203 of the FPA. Order No. 708 codifies five additional blanket authorizations under Section 203.

First, a public utility is pre-authorized to dispose of less than 10 percent of its voting securities to a public utility holding company if, after the disposition, the holding company and any associate or affiliate companies in aggregate will own less than 10 percent of the outstanding voting interests of that public utility. FERC notes that the "in aggregate" limitation will provide better protection against possible transfer of control of a public utility. For example, the limitation helps to prevent a public utility from transferring less than 10 percent of its voting securities in successive transfers to each of several affiliate or associate companies (or even the same entity), and thereby transferring control of the public utility's facilities and operations without first receiving FERC approval.

Second, a public utility is granted a blanket authorization under section 203(a)(1) to transfer its outstanding voting securities to a holding company that owns only exempt wholesale generators, foreign utility companies, or qualifying facilities if, after the transfer, the holding company and any of its associate or affiliate companies in aggregate will own less than 10 percent of the outstanding voting interests of such public utility (see 18 C.F.R. § 33.1(c)(8)).

Third, a public utility is in most instances granted a blanket authorization under section 203(a)(1) to transfer its outstanding voting securities to a holding company that is regulated under the Bank Holding Company Act (see 18 C.F.R. § 33.1(c)(9)).

Fourth, a public utility is granted a blanket authorization under section 203(a)(1) to transfer its outstanding voting securities to a holding company granted blanket authorization in 18 C.F.R. § 33.1(c)(10) to conduct underwriting or hedging activities.

Fifth, a public utility is granted a blanket authorization to acquire or dispose of a jurisdictional contract if neither the acquirer nor transferor has captive customers or owns or provides transmission service over jurisdictional transmission facilities; the contract does not convey control over the operation of a generation or transmission facility; the parties are not affiliated; and the acquirer is a public utility.

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