FERC Rejects Application to Sell Generating Facility in Arizona, Finding Mitigation Plan Fails to Alleviate Horizontal Market Power Concerns

Earlier this month, the Federal Energy Regulatory Commission (FERC) in Docket No. EC13-11-000 denied the application of MACH Gen, LLC (MACH Gen), New Harquahala Generating Company, LLC (New Harquahala), and Saddle Mountain Power, LLC (Saddle Mountain) to sell outstanding membership interests in New Harquahala to Saddle Mountain, finding that the applicants failed to demonstrate that the proposed transaction would not have an adverse effect on competition. Specifically, FERC found that the market power concerns raised by Saddle Mountain’s affiliation with another large electric generation facility in the Arizona Public Service (APS) balancing authority area (BAA) through a common fund manager were not mitigated by an Energy Management Agreement (EMA) with a third party, where the common fund manager retained indirect control over the facility’s operating limits, dispatch curves, operating costs, and ability to enter into long-term contracts.

New Harquahala owns the Harquahala Facility, a 1,054 MW natural gas-fired, combined-cycle electric generating plant in the APS BAA. Saddle Mountain is a wholly-owned subsidiary of Wayzata Opportunities Fund II, L.P. (WOF II). WOF II and Wayzata Opportunities Fund I, L.P. (WOF I) are both private investment vehicles managed by Wayzata Investment Partners, LLC (Wayzata). Through Wayzata as a common fund manager, Saddle Mountain is affiliated with various energy projects. In particular, WOF I and WOF II each own a 50 percent interest in Sundevil Power Holdings, LLC (Sundevil), which owns two of the four generating units that comprise the Gila River facility in Gila Bend, Arizona (in the APS BAA). The two units Sundevil owns have a combined capacity of approximately 1,167 MW.

Because of Saddle Mountain’s affiliation with Sundevil, the applicants conceded that the proposed transaction would fail FERC’s horizontal market power screen. When the applicants performed a delivered price test for the APS BAA, they found that absent mitigation, the market would be both highly concentrated and the changes in the Herfindahl-Hirschman Index would be above FERC’s threshold for seven of ten seasons/load periods. The applicants therefore proposed a mitigation plan whereby New Harquahala would transfer control over the Harquahala Facility to an independent third party at closing by entering into an EMA with Twin Eagle Resource Management, LLC (Twin Eagle).

In the March order, FERC found that the EMA was inadequate to address the potential adverse competitive effects of the proposed transaction. Under the proposed EMA, New Harquahala established the parameters for Twin Eagle’s operation of the Harquahala Facility, including the operating limits, dispatch and efficiency curves to be used by Twin Eagle. In addition, the applicants proposed that New Harquahala would retain responsibility for the Harquahala Facility’s O&M, and would therefore be cognizant of the Harquahala Facility’s operating costs. New Harquahala also proposed to retain the right to market the output of the Harquahala Facility for long-term contracts.

According to FERC, these aspects of the mitigation plan undermined the applicants’ argument that New Harquahala should not be considered to have control over the Harquahala Facility for purposes of the competition analysis. Since New Harquahala would dictate the Harquahala Facility’s dispatch model through the EMA, New Harquahala would have access to market information that would allow Sundevil (under common control with New Harquahala) to make anticompetitive sales sourced from the Gila River Facility by either withholding output or raising prices in the APS BAA.

FERC’s decision in this case sheds further light on how FERC will assess the “totality of circumstances” when considering whether an EMA provides adequate mitigation for an acquisition that otherwise fails FERC’s horizontal market power screen. Under FERC’s current view, it appears that any EMA that does not approximate a firm, long-term sale will face a high level of scrutiny. Reaching this bar could be especially problematic in areas with limited liquidity or no organized energy markets.

The order is available here.