The purpose of this article is to explore what actions the Public Utility Commission of Texas (“Commission”) should take to help avoid potential market power abuse in the electric industry. Tex. Util. Code § 39.264(m) defines a specific abuse of market power and states:

A person possessing market power shall not withhold emissions allowances from the market in a manner that is unreasonably discriminatory or tends to unreasonably restrict, impair, or reduce the level of competition.

The section is best interpreted in conjunction with Tex. Util. Code § 39.157, which addresses matters related to market power and its abuses. In Tex. Util. Code § 39.157(a), the Legislature has charged the Commission with a broad responsibility to monitor market power “associated with the generation, transmission, distribution, and sale of electricity in this state.” The section defines “market power abuses” to include withholding production and precluding entry.

Section 39.264(m) makes it clear that it is an abuse of market power to withhold emissions allowances from the market where the effect is to restrict the production of electricity or preclude entry by potential competing generators (i.e., restrict, impair, or reduce the level of competition). Section 39.157(a) thus requires the Commission to monitor participants in the electric power industry to detect potential violations of Tex. Util. Code § 39.264(m). Upon finding a violation, the Commission must require mitigation of the abuses of market power by ordering the construction of transmission lines, by seeking an injunction or civil penalties, by imposing an administrative penalty, or by suspending, revoking, or amending a certificate or registration.

To avoid violating Tex. Util. Code § 39.264(m), participants in the electric power industry must clearly understand its key concepts. At a minimum, participants must know (1) how to determine whether a person possesses market power, and (2) whether such a person has a duty to market emissions allowances. As the agency responsible for enforcing Tex. Util. Code §§ 39.157(a) and 39.264(m), it falls upon the Commission to define the critical concepts so that participants in the industry know which actions are required and which are prohibited.

The Commission should adopt a market power test for the electric power industry. The Texas Utilities Code does not provide a definition of “market power” that is applicable to the electric power industry. The Legislature attempted to limit the market power of power generation companies by prohibiting them from owning or controlling more than 20 percent of the installed generation serving a power region (e.g., ERCOT).[1] Any power generator exceeding that limit is required to auction off its excess capacity pursuant to a market power mitigation plan approved by the Commission. Clearly, by enacting Tex. Util. Code § 39.154, the Legislature intended that there would be no persons owning or controlling more than 20 percent of the installed capacity serving a power region—without regard to an expressly defined concept of market power.

It is thus clear that the Legislature did not intend that owning less than 20 percent of the generation for a power region implies that a power generator lacks market power. If that were true, no power generator would ever be found to have market power because none are allowed to own more than that 20 percent cap. Accordingly, there would be no persons capable of violating Tex. Util. Code § 39.264(m) by withholding emission allowances from the market because that section applies only to persons possessing market power and, after unbundling, only power generating companies will hold emissions allowances. Nor would it have been necessary for the Legislature to separately require the Commission, in Tex. Util. Code § 39.157(a), to monitor market power associated with the generation of electricity in Texas. Similarly, there would be no power generators to whom the definition of market power abuses would ever apply, because the definition is applicable only to persons possessing market power. Finally and most importantly, an inference of no market power for power generators below the 20 percent cap would ignore obvious market realities: given the current constraints on the capacity of the transmission system and limits on emissions within non-attainment areas, there are consumers within the non-attainment area that will not be able to obtain sufficient power from distant generators to prevent the local dominant generator from profitably raising prices above competitive levels.

Without a definition in the Texas Utilities Code applicable to the electric power industry, the Commission must look elsewhere to define market power. In both economic theory and antitrust law, “market power” has been defined generally as “the ability of a firm to increase its profits by reducing output and charging more than a competitive price for its product.”[2] The United States Supreme Court has defined market power as “the power to control prices or exclude competition.”[3] In more technical, economic terms, market power is the ability of a firm to profitably charge prices above marginal cost.[4]

Since it is difficult to directly measure market power, courts have relied on the fact that there is direct relation between market share and market power. This reliance is reasonable because firms with a large share of a market are in a better position to profit from raising prices above competitive levels than are smaller firms. Typically, the means of achieving market power involve exclusionary practices that are effective only if a firm supplies a large portion of the market in question. Therefore, courts use market share as proxy for market power in antitrust cases.

To assess whether a firm possesses market power, therefore, courts generally determine whether there is some “relevant market” over which the firm exercises power (i.e., in which its market share is large enough to imply market power). For antitrust purposes, a relevant market has two aspects: the product market and the geographic market. For purposes of defining market power in Tex. Util. Code § 39.264(m), it should be fairly easy to agree that the relevant product market is electric power.

The relevant geographic market is the largest geographic area in which a firm can profitably increase its price without losing customers to sellers of substitute products, either within or outside the area.[5] As a respected authority on antitrust policy has put it, “[i]f sellers within the area are making price and output decisions protected from the need to take account of sellers outside the area, there is a distinct market.”[6]

Because buyers of electric power in an area are immobile, they depend on the electric power grid to transmit to them power from distant power generators. Accordingly, a key to determining whether an area is a relevant geographic market for purposes of Tex. Util. Code § 39.264(m) is the capacity of the transmission and distribution system to transmit power from outside the area. For example, if a power generator supplies a large portion of power to a non-attainment area that cannot easily receive power from distant power generators, it would be in a position to exercise power over the market for electricity in the area—i.e., profitably raise its price for electricity above competitive levels—without the prospect of losing sales to the distant suppliers.

Although the Texas Utilities Code does not provide a market power test for electric power markets, it does provide such a test for determining whether an independent local exchange company dominates the market for a telephone service in a geographic market.[7] Fortunately, this test is readily modified for application to electric power generators:

To determine whether a power generator has market power in the market for electric power in a relevant geographic area, the Commission shall consider:

(1) the number and size of other power generators who provide the same, equivalent, or substitutable electric power in the area;

(3) the ability of customers in the area to obtain the same, equivalent, or substitutable electric service at comparable rates and on comparable terms;

(4) the ability of other power generators to make the same, equivalent, or substitutable electric service readily available in the area at comparable rates and on comparable terms;

(5) the proportion of electric service in the area that is being provided by power generators other than the person in question; and

The fifth consideration raises the issue of a power generator’s market share in the relevant geographic market. In this regard, courts in antitrust cases have developed guidelines for deciding whether a defendant’s market share indicates enough market power that it may be guilty of illegal monopolization. Herbert Hovenkamp, a leading authority on antitrust policy, has summarized the court holdings as follows:

They [i.e., the courts] fairly consistently hold that a 90% market share is enough to support the necessary inference of market power. Several courts have found a market share on the order of 75% to be sufficient, but if the share is lower than 70% courts become much more reluctant to find monopoly power. Some courts hold as a matter of law that a share of less than 50% is insufficient, even if the defendant clearly had the power to raise its price by reducing output.[8]

Professor Hovenkamp notes that if a court has a high degree of confidence in the market definition and the barriers to entry are strong, it should find market power along the minima of the foregoing ranges.[9] With respect to the electric power industry, the product market is as clearly defined as one is likely to find. According to the court precedents and Prof. Hovenkamp’s analysis, therefore, in cases where the relevant geographic market can be defined with a reasonable degree of precision, the Commission can confidently infer market power for power generators with market shares in the range of 70 to 75 percent in the relevant geographic market.

Under the appropriate circumstances, market power should be considered for power generators with market shares lower than 70 percent. Market power nearly always rests on an ability to exclude competitors. If, by leveraging control over an essential facility, a power generator can effectively prevent entry by new firms into a particular geographic market, then a power generator may well be able to extract monopoly profits from consumers in the area—especially during peak load seasons—even though its share of the electric power market may be as little as 50 or 60 percent.

Here is an example. This instance involves how the Commission could adopt a test for determining whether a person with market power has a duty to market emissions allowances. To say that a person has improperly withheld emissions allowances from the market is to say that the person has violated a duty to market the allowances.[10] The first question therefore is what circumstances give rise to such a duty. The second question is how to determine the price at which the emissions allowances should be traded.

The same questions have arisen in antitrust cases involving a monopolist that has refused to share an “essential facility” with others. “Such a refusal may be unlawful because a monopolist’s control of an essential facility can extend monopoly power from one stage of production to another.”[11] To resolve these questions, courts have developed the “essential facilities doctrine,” according to which the owner of an essential facility may have a duty to share it with others.[12] Courts have applied the essential facilities doctrine to cases involving the connection of communications equipment to telephone networks, interconnections with railway lines, and interconnections with electric transmission lines.[13]

Even though emissions allowances are not the sort of tangible assets normally considered facilities, they have become an input that is crucial to the production of electric power and thus qualify for treatment as an essential facility.[14] Control over emissions allowances can be used to limit the entry of competitors into a relevant geographic power market—as the Legislature implicitly recognized when it enacted Tex. Util. Code § 39.264(m). And since the most meaningful measure of market power is generally the ability to exclude competitors, a power generator could use a state-awarded monopoly over emissions allowances to monopolize a relevant geographic market for electric power.

In antitrust cases, forcing a firm to deal with competitors over an essential facility can compel a court to set the terms and conditions of a sale or lease of the facility, turning the court into a quasi-regulatory agency. On the one hand, unless constrained by the court, the monopolist will simply collect its monopoly profits through its charges for the essential facilities and thereby deny customers the benefits of competition. On the other hand, courts are constrained by the fact that the essential facilities in question are normally the property of the defendant, and in some antitrust cases they have therefore declined to force the owner of an essential facility to compromise or impair its own business to accommodate others.

This last consideration, however, is not applicable to emissions allowances. Pursuant to Tex. Util. Code § 39.264, the Texas Natural Resources Conservation Commission, now the Texas Commission on Environmental Quality (“TCEQ”) has allocated annual emissions allowances to each qualifying electric generating facility in the state. Pursuant to the TCEQ’s regulations under which the allocations were made, “[a]n emissions allowance does not constitute a security or a property right.” 30 Tex. Admin. Code §101.322(f). Moreover, the original power generator/integrated utility recipients of emissions allowances have not paid for allowances; their cost basis and net book values are zero.[15] The emissions allowances are permits, awarded by the state, which retain the power to rescind them and reallocate them in the public interest—without violating the property rights of the affected power generators.

There are several considerations essential to determining whether a power generator has a duty to market emissions allowances pursuant to Tex. Util. Code § 39.264(m). First, and most obviously, does the power generator possess market power (i.e., the ability to profitably charge supra-competitive prices) in a relevant geographic market for electric power? Second, does withholding the allowances unreasonably restrict, impair, or reduce the level of competition in the relevant market? Third, would the sale or transfer of the allowances harm consumers? That is, would selling or transferring the allowances to some other power generator(s) produce more or less electricity for customers at a higher or lower unit cost to customers with the same amount of emissions? Finally, what is the reasonable price for an emissions allowance?

When the relevant geographic market lies within a non-attainment area, the second consideration above collapses into the first: if the power generator has market power, any withholding of emissions allowances precludes entry by competitors, perpetuates the market power, and is therefore unreasonable. The Commission may thus conclude that power generators possessing market power have an inherent duty to market their emissions allowances unless they can demonstrate that selling the allowances would raise the price of wholesale electric power in the relevant geographic market. Absent such a demonstration, it will be in the public interest to reallocate the allowances so that society can more effectively utilize its scarce resources—including clean air.

This article does not address how the Commission should determine whether a compelled sale of emissions allowances would raise or lower the price of wholesale electric power in a relevant market. The goal is to prevent power generators from using state-awarded emissions allowances to monopolize relevant geographic electric power markets. The selling price of the emissions allowance would therefore have to be sufficiently low to prevent the selling power generator from realizing monopoly profits, and allow the third-party generator to obtain financing and board approval (or its equivalent) to construct the new generating facility.

The Legislature has designated the Public Utility Commission as the agency responsible for monitoring market power associated with the generation, transmission, distribution, and sale of electricity in this state. One part of that responsibility involves monitoring market participants to detect potential violations of Tex. Util. Code § 39.264(m). In order to effectively discharge its responsibilities, the Commission should adopt a market power test applicable to the electric industry. It is only when standards are developed that the Commission will have the necessary tools to consider the activities and behavior of persons potentially subject to Tex. Util. Code § 39.264(m).

[1] Tex. Util. Code § 39.154.

[2] Hovenkamp, H., Federal Antitrust Policy: The Law of Competition and Its Practice 78 (2d ed. 1999) (hereinafter Hovenkamp).

[3] United States v. E.I. du Pont de Nemours & Co., 351 U.S. 377, 391-92 (1956).

[4] See Hovenkamp at 78-82.

[5] Id. at 113.

[6] Sullivan, L.A., Handbook of the Law of Antitrust 68 (1977).

[7] Tex. Util. Code § 52.203(b).

[8] Hovenkamp at 270; see, United States v. Grinnell Corp., 384 U.S. 563, 570-71 (1966) (holding that an 87% share of the relevant market would leave “no doubt” that the defendants had monopoly power).

[9] Id. at 271.

[10] Emission allowances are a creature of SB 7. Grandfathered generating facilities were allocated emission allowances for each grandfathered generating facility operating during a base period (1997). The emission allowances are based on an emissions rate that reflects reduced emissions from the 1997 level. Emission allowances are tradeable. If a third party generator were able to obtain emission allowances from an electric utility, municipal corporation, or a river authority, then the generator would advise the TNRCC, now the TCEQ, that it held the emission allowances and the TNRCC would convert the emission allowances held by the generator to emission reduction credits that can be used to offset the emissions of a new generation facility. See Tex. Util. Code § 39.264. Emission reduction credits, or ERCs, are generally associated with emission reductions below that otherwise required by local, state or federal law.

[11] MCI Communications Corp. v. AT&T, 708 F.2d 1081, 1132-1133 (7th Cir.), cert denied, 464 U.S. 891 (1983).

[12] There are four elements necessary to establish antitrust liability under the essential facilities doctrine: (1) control of the essential facility by a monopolist, (2) a competitor’s inability practically or reasonably to duplicate the essential facility, (3) the denial of the use of the facility to a competitor, and (4) the feasibility of providing the facility. MCI Communications Corp, 708 F.2d at 1132-1133.

[13] See, e.g., City of Malden, Mo. v. Union Elec. Co., 887 F.2d 157 (8th Cir. 1989); MCI Communications Corp., 708 F.2d at 1132-1133; United States v. Western Elec. Co., 673 F.Supp. 525 (D.D.C. 1987). See also, Otter Tail Power Co. v. United States, 410 U.S. 366 (1972); United States v. Terminal R.R. Assn., 224 U.S. 383 (1912).

[14] Courts have held that intangible assets such as customer lists can be an essential facility. Bellsouth Advertising v. Donnelley Inf. Pub., 719 F.Supp. 1551 (S.D. Fla. 1988), rev. on other grounds, 999 F.2d 1436 (11th Cir. 1993). In economic terms, an essential facility is an input that is crucial to the production of the relevant product. Hovenkamp at 307.

[15] Emission allowances are normally viewed as intangibles and no specific value is recorded in the books and records of a corporation.