On November 20, 2008, the Federal Energy Regulatory Commission (“FERC”) addressed whether the terms of a power contract or the functions performed under the contract could cause a party to the contract to be categorized as Generator Operator (“GOP”) with responsibility for complying with the mandatory and enforceable reliability standards established by the North American Electric Reliability Corporation (“NERC”). Specifically, FERC addressed NERC’s decision from earlier this year to uphold a Texas Regional Entity (“TRE”) decision to treat Constellation Energy Commodities Group (“Constellation”) as a GOP with regard to its functions as a Level 4 Qualified Scheduling Entity (“QSE”) under its Tolling Agreement with Power Resources, Ltd. (“PRL”), with respect to PRL’s generating plant. Constellation appealed NERC’s decision. FERC has remanded the matter to NERC for further consideration and has directed NERC to supply it with additional information regarding Constellation’s role as QSE, the manner in which NERC and TRE approach the registration of QSEs, and the relationship between the QSE levels (ranging from Level 1 to Level 4) and the NERC Registry designations.

This matter highlights the importance of expressly allocating NERC registration and compliance responsibilities in a contract, especially in tolling arrangements and energy management agreements that could be construed as giving a non-plant owner operational responsibilities. Possible provisions include whether the scope of services includes any NERC responsibilities, whether the non-plant owner will be listed in the NERC Registry as having any role related to the plant, who is responsible for NERC violations and penalties, and in what circumstances. It also highlights the need to monitor the NERC Registries to ensure that market participants are registered in the correct categories. In view of NERC’s penalty authority (with authority to assess penalties as high as $1 million per violation per day) and pressure from FERC to avoid undue leniency, it would be prudent for market participants to make NERC-related contract issues a compliance priority.

Background

In January 2007, PRL and Constellation executed a Tolling Agreement that governs PRL’s sales and Constellation’s purchases of generation capacity, thermal energy and electric energy, including all ancillary products and services marketable in the Electric Reliability Council of Texas (“ERCOT”) for a 212-MW PRL generation facility in Howard County, Texas. Under the Tolling Agreement, Constellation also agreed to act as a Level 4 QSE. At issue in the FERC case is TRE’s decision to designate Constellation as a GOP on the NERC Compliance Registry (“Registry”) and NERC’s decision to uphold that designation.

Constellation is a FERC-authorized power marketer. TRE initially determined that Constellation was the sole GOP of the PRL facility. As a result of discussions following Constellation’s appeal to NERC of TRE’s designation, TRE found that PRL was the GOP of the PRL facility. However, TRE never removed Constellation from the Registry. Both Constellation and PRL supported a Joint Registration Organization (“JRO”) agreement in lieu of concurrent registration as GOP. Consistent with NERC’s Rules of Procedure (§§ 501 and 507) that allow parties to determine by written contract which party is responsible for compliance with the Reliability Standards, a JRO would have delineated and divided compliance responsibilities and liabilities between the parties and resolved the registration dispute. However, Constellation and PRL were unable to develop a mutually agreeable JRO, and TRE’s original registration of Constellation as GOP for the PRL generating facility remained in place.

In May 2008, after considering the appeals and responses filed individually by Constellation, PRL and TRE, the NERC Board of Trustees Compliance Committee declined to remove Constellation and PRL from the Registry, thus upholding TRE’s initial registration decision. Constellation appealed the NERC decision to FERC. PRL did not appeal.

NERC’s Arguments in Favor of Listing Constellation as a GOP

In its May 2008 decision, NERC argued that certain communications services that Constellation performs as QSE for the PRL facility make it a GOP under the NERC GOP Reliability Standards. According to NERC, these QSE communications services made Constellation the communications intermediary between PRL and ERCOT regarding market operations, including on: daily plans indicating the forecast state of Generation Resources; the availability, limits, and forecast generation or load of each Resource; and coordinating activities between the general resource and ERCOT. NERC contended that this is the case regardless of the fact that Constellation performs these communications services under ERCOT protocols, not under the NERC GOP Reliability Standards. In other words, the mere fact that a party agreed to perform certain QSE services is sufficient. Consequently, NERC found that concurrent registration of Constellation as GOP for the PRL facility is required.

NERC also found that, from an operational standpoint, while PRL physically operates the PRL facility, it does so pursuant to Constellation’s directives. Specifically, under the Tolling Agreement, Constellation has authority over certain power purchase rights, fuel supply obligations, and scheduling rights. NERC found that Constellation’s authority to direct these decisions makes it an entity engaged in “operations” of the PRL facility and, thus, supports Constellation’s designation as a GOP.

Constellation’s Arguments Against its Listing as a GOP

In its appeal, Constellation argued that, to avoid duplication of responsibilities and overlap of decision-making functions, concurrent GOP registration should be adopted only in extraordinary circumstances. Neither the contract nor the relationship between Constellation and PRL warrant such concurrent registration here.

Constellation also argued that it does not meet the criteria to be listed in the GOP Registry. Specifically, Constellation pointed out that the definition of a GOP covers only entities responsible for directing and controlling physical operations of a generation facility. Constellation is merely the contractual purchaser of output from, and scheduler of, the PRL facility. This contractual arrangement, Constellation argued, does not support the transfer of GOP responsibility because PRL retains operational authority over the PRL facility.

Constellation claimed that the NERC decision was arbitrary and capricious because NERC provided no analysis of the commercial contract to support its decision that Constellation was a GOP. Constellation argued that, as QSE for the PRL facility, it did not have the type of control that would warrant GOP designation. Furthermore, Constellation did not assume GOP obligations or agree to be registered as GOP for the PRL facility in its contract with PRL. Finally, Constellation alleged that the decision to uphold its characterization as a GOP was inconsistent with NERC registrations in other regions.

November 20, 2008 FERC Ruling

In its November 20 order, FERC agreed with NERC that an entity cannot opt out of compliance with the NERC Reliability Standards when it actually performs and assumes responsibility for activities governed by those standards. If a party to a contract is responsible for performing certain functions that are required by the NERC Reliability Standards, that party can be registered with NERC for those functions, regardless of whether the contract expressly mentions NERC registration or responsibility. Thus, in this case, FERC took a functional approach to determining whether a contract allocates NERC responsibilities.

Although FERC agreed with NERC on the general approach to the Constellation-PRL Tolling Agreement, FERC directed NERC to provide it with additional information regarding the specific tasks that Constellation performs as QSE. FERC observed that it may be willing to hold Constellation responsible as a GOP for a certain discrete set of communications-related requirements, but required NERC to provide it with information showing a correlation between Constellation’s activities as a QSE and specific requirements of the Reliability Standards. FERC also noted that the GOP designation in this case would not raise concerns of inconsistencies with the NERC registration of entities in other regions because the ERCOT QSE status and related requirements are unique to that region.

In addition, FERC directed NERC to supply it with more detailed information regarding the manner in which NERC and TRE have approached the registration of QSEs. FERC seeks to determine whether Constellation is an “outlier” or whether numerous other entities will be impacted by NERC’s registration decision. Furthermore, FERC directed NERC to clarify whether and how a specific QSE level (Level 1 to Level 4, with a Level 4 entity having the greatest responsibilities) impacts TRE’s decision to register an entity as a GOP. NERC is required to supplement the record accordingly within 60 days.

FERC’s decision in this case should serve as a reminder to parties to tolling agreements, energy asset or management agreements, and similar agreements to review their contracts to determine whether the parties have allocated NERC registration and compliance responsibilities among themselves. It is important to review the actual functions being performed and the contractual allocation of responsibility for those functions, not just whether the parties have expressly mentioned NERC in their contract. By clearly allocating responsibility for NERC Reliability Standard requirements, contractual counterparties will be able to more readily determine what they must do to ensure that they are in compliance with the Reliability Standards. Doing so will thus help avoid violations of the Reliability Standards—and the potentially hefty penalties and other burdensome sanctions associated with violations.