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WASHINGTON � Consumer groups and state utility regulators are waging a multibillion-dollar battle with energy suppliers and federal regulators in a U.S. Supreme Court case with major ramifications for the nation’s volatile energy market. “This case probably will affect people’s lives more than most anything on the court’s agenda,” said Lynn Hargis of Public Citizen, amicus counsel for the National Consumer Law Center, the New Mexico attorney general and others in the case. The backdrop to the high-stakes challenge in Morgan Stanley v. Public Utility District No. 1, nos. 06-1457 and 06-1462, is the Western energy crisis of several years ago. From 2000 to 2001, West Coast consumers endured skyrocketing energy costs, spot energy shortages, rolling blackouts and brownouts. The crisis was so dire that some leading proponents of energy deregulation urged the imposition of price caps and other regulatory measures. After the Federal Energy Regulatory Commission (FERC) stepped in with pricing and structural reforms, the crisis subsided. Government investigations later blamed “an unprecedented confluence” of factors, including market manipulation and “gaming” of the regulatory system by energy suppliers, such as Enron, and their “rampant” noncompliance with federal rate reporting requirements under FERC’s so-called market-based rate program. During the crisis � and what is now at the heart of the Supreme Court challenge � Western utilities, such as Public Utility District No. 1 of Snohomish County, Wash., entered into long-term contracts with energy suppliers, such as the Morgan Stanley Capital Group, to ensure supplies. When the crisis ended, energy prices dropped but the utilities were bound by the long-term contract prices. The utilities filed complaints with FERC, asking it to review whether the contract rates and terms, from inception, were “just and reasonable,” a standard of review under the Federal Power Act. But FERC declined to apply that standard and upheld the contracts. The 9th U.S. Circuit Court of Appeals disagreed and remanded the cases to FERC with authority to reform the contracts. The high court will hear the case on Feb. 19. So just how sacred are these long-term, “forward” energy contracts? Riding on the Supreme Court’s answer for the Snohomish utility district is about $153 million over the life of its contracts, said its high court counsel, Christopher J. Wright, a partner at Washington’s Harris, Wiltshire & Grannis. It is a significant amount for the district, but pales next to the $1.4 billion at stake in California’s contracts. “These contracts are not sacrosanct,” said Wright. “It’s in unusual circumstances where the markets aren’t competitive that there’s reason for FERC to revisit them.” But this type of contract is the very best response to the problem of volatile energy prices, said Mark S. Davies, a counsel to the Washington office of O’Melveny & Myers who is working on the case with Morgan Stanley’s lead counsel, O’Melveny’s Walter Dellinger. “If you say a contract entered into a crisis can be undone, which at first has some appeal to it, there is always going to be an argument out there to undo a contract based on prices, particularly in a time like we’re in now with high oil prices,” he said. And if contracts mean less than what the parties agreed to, Davies predicted, then the market forces believed to be the best way to get the energy the nation needs won’t be able to operate. Buyers’ remorse? In this modern energy battle, the combatants face off over two not-so-modern Supreme Court precedents: United Gas Pipe Line Co. v. Mobile Gas Service Corp. (Mobile), 350 U.S. 332 (1956), and Federal Power Commission v. Sierra Pacific Power Co. (Sierra), 350 U.S. 348 (1956). FERC, Morgan Stanley and the energy suppliers contend that those precedents, known as the Mobile-Sierra doctrine, established that the terms of a negotiated wholesale energy agreement are “just and reasonable” for purposes of the Federal Power Act except in instances of unequivocal “public necessity.” “Not only is that standard plainly unsatisfied here, but the parties specifically set forth in their agreement that the contract rates were binding for the full duration of the contract and were not subject to adjustment through unilateral application to FERC,” Dellinger argues. But the 9th Circuit held, and the utilities agreed, that when the market is dysfunctional and manipulation is widespread, a contract formed under those circumstances can no longer be presumed “just and reasonable.” A party seeking reformation of the contracts, the 9th Circuit held, may not have to meet the much more contract-protective standard of “public interest” or “public necessity” under Mobile-Sierra. FERC should look at whether the rates are “just and reasonable.” “Morgan Stanley’s position is not as extreme as some of its amici, who say, ‘If it’s in the contract, it can’t be changed,’ ” said the utilities’ counsel, Wright. “ That’s not even a remotely plausible view of the statute. It requires rates to be just and reasonable and contracts have to be filed with FERC so it can see if they’re just and reasonable. Nobody disputes that in some circumstances there will be fraud and that rates can be revised.” FERC “presumed” these contract rates were just and reasonable because the energy suppliers were part of a FERC-created program known as the market-based rate program. FERC sometimes grants market-based rate authority to certain energy suppliers that do not have market power. Their contracts typically are not individually reviewed by FERC. Public Citizen’s Hargis and others believe the program itself is illegal because it flies in the face of the Federal Power Act’s command to FERC to ensure rates are filed and reviewed. Since these contracts were never filed, they argue to the court, the Mobile-Sierra doctrine does not even apply since those cases dealt with filed rates. FERC initially opposed Supreme Court review of the 9th Circuit decision, saying it has made changes in the program. “I don’t really know if the program works but it is certainly a lot different,” said Wright. “From our perspective, that all goes to show how it was a very badly operating system during the Western energy crisis.” But once the high court granted review, FERC understood what was at stake � the proper functioning of the nation’s energy market, countered O’Melveny’s Davies. “FERC’s been very clear about the need for regulatory certainty,” he said. “And, to get the investments from private industry, investors need to be able to count on the rules.” FERC argues if there were problems in its scheme, he added, the solution is to fix problems in its scheme, not to undo deals entered into by sophisticated parties, in which there was no fraud nor manipulation of an agreement. But Wright said there is no basis to Morgan Stanley’s “parade of horribles” if the justices rule for the utilities. Reform of tainted contracts, he said, can improve market performance, reduce risk premiums, increase market liquidity and provide for stable, long-term markets. Public Citizen’s Hargis predicted the outcome will have a “huge impact.” Morgan Stanley, she said, warns that affirming the 9th Circuit will be the end of the energy market as it is known. But if industry wins, “something even worse could happen,” she said, noting the financial disaster involving utility holding companies in the 1930s. “If you don’t regulate this carefully, there’s a lot more at stake than Morgan Stanley’s profits,” she added. “In our view, the electric utility system is basic to the whole economy � important to business, but also to individuals. Clearly, if we win this case, industry will head straight for Congress.”

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