With several key regulatory areas facing uncertainty—including derivatives oversight, renewable energy tax credits and environmental protection—the outlook for the energy industry’s regulatory landscape remains in flux, according to a new report entitled, “Energy Regulatory Outlook.”
Taking these factors into account, below are the regulatory trends that may have the biggest impact on energy companies in 2017:
—Regulatory developments for commodity derivatives: There have been a number of important regulatory developments that center on commodity derivatives. Two that are likely to have the biggest impact are the de minimis threshold and position limits.
- De minimis threshold: As part of the Dodd-Frank Act (Dodd-Frank), the US Commodity Futures Trading Commission (CFTC) was required to implement a portfolio value threshold for trading activity in swaps (commonly referred to as the de minimis threshold). An entity that remained below the threshold wouldn’t have to register as a swap dealer. At this point, the market still isn’t sure if the de minimis level will actually drop to $3 billion in December 2018, as currently planned, or if it will remain at the $8 billion level. This is causing a great deal of uncertainty for market participants.
- Position limits: In December 2016, the CFTC issued a re-proposed rule on position limits for derivatives. In response to comments on its December 2013 proposal and a supplemental proposal issued in June 2016, the CFTC re-proposed limits on speculative positions in 25 core physical commodity futures contracts and their “economically equivalent” futures, options, and swaps, and deferred action on three cash-settled commodities. The CFTC is also re-proposing the definition of bona fide hedging position and the exemptions for such hedging in physical commodities to hold that, among other things, exemptions for positions established in “good faith” prior to the effective date of the initial limits would be established by final regulations. In conjunction with the re-proposal, the CFTC issued a final rule governing aggregation under the position limits regime for futures and option contracts on nine agricultural commodities. Acting Chairman Christopher Giancarlo noted that the proposal “provides the basis for the implementation of a final position limits rule that [he] could support,” adding that he expects the Commission to finalize a “workable” version of the rule in 2017.
—Price reporting: With lower commodity prices and fewer trading firms in the market, the value of many traded markets isn’t currently being discovered since most firms don’t contribute prices. But the need for settlement data remains. Firms that are still trading understand it may be in their best interest to now report trades in order to gain price discovery and proper settlement of markets. Also, there have been technological advances that, to some extent, make price reporting easier and safer, leading some firms to start rethinking their position on price reporting as long as the proper controls are in place.
—Market surveillance data collection expands: Energy regulators are continuing to strengthen and expand their market surveillance capabilities, stepping up their approach to monitoring market behavior using increased amounts and types of data. “There’s no mistaking the Federal Energy Regulatory Commission’s (FERC) desire and continued focus on refining and enhancing its enforcement capabilities around energy market regulation,” says Christopher Spoth, Deloitte Risk and Financial Advisory managing director, Deloitte & Touche LLP and head of the Center for Regulatory Strategy, Americas Deloitte U.S. Additionally, since the two key regulators in this space (FERC and the CFTC) share information and routinely borrow from each other’s approaches, this trend is likely to continue. The expected outcome is increased scrutiny of market transactions and data. The big question is whether this will also lead to increased inquiries and investigations—and what that might mean for market participants.
—Risk-based approaches for capital investments: Key stakeholders—primarily regulators and customers—are demanding greater accountability in safety and reliability decisions. A risk-based approach to value investments and operational expenses can help energy companies meet or exceed compliance requirements. In addition to strict compliance with the rules, companies are under increased pressure to use enhanced analytics to proactively identify business risks and to better assess and measure the risks associated with compliance failures. Although companies are striving to remain compliant, many often face the challenges of restricted budgets and rising rates of enforcement investigations. As regulatory authorities increase the rigor with which they evaluate and enforce compliance, the potential consequences of non-compliance go far beyond monetary penalties to include reputational risk, as well as impacts on internal ethics programs and organizational culture.
—Pipeline integrity and safety: In March 2016, the U.S. Department of Transportation’s Pipeline and Hazardous Materials Safety Administration (PHMSA) announced proposed regulations to update critical safety requirements for natural gas transmission pipelines. The proposed rule would broaden the scope of safety coverage by adding new assessment and repair criteria for gas transmission pipelines and by expanding existing protocols to include pipelines located in areas of medium population density, where a pipeline safety incident would pose risks to human life.
—Leadership in flux at CFTC and FERC: The CFTC and FERC both have empty seats that need to be filled. Each of the commissions consists of five commissioners appointed by the president with the advice and consent of the Senate. No more than three commissioners can be from the same political party. The president designates one of the commissioners as chairman, again with the advice and consent of the Senate.
—NERC trends: NERC regulations for entities that operate assets related to the bulk power system (BPS) are some of the most comprehensive and heavily enforced rules in the energy industry. NERC uses several enforcement mechanisms that essentially add up to continuous and detailed compliance monitoring. Entities subject to NERC regulation should closely monitor the agency’s direction and any new requirements that may be imposed. Preparation of the controls required to ensure compliance can require substantial time, making it challenging to meet the regulatory deadlines. Key focus areas in 2017 included supply chain rulemaking; FERC involvement in day-to-day NERC enforcement; and growth of renewable generation and smaller utilities.
—Cybersecurity regulations: Cybersecurity remains a key focus for regulators in the energy industry. “Today, we are seeing initial regulation at the distribution level, along with more aggressive approaches to promoting the implementation of voluntary cybersecurity frameworks in non-regulated industries,” says David Strachan, a Risk Advisory partner and head of the Centre for Regulatory Strategy, EMEA, Deloitte UK. State regulators continue to focus on cybersecurity and its implications for distribution utility operations and infrastructure, especially in terms of reliability and customer impact in the event of failures. New regulations are being developed; special task forces and committees are being formed to assess risks; and regulators continually monitor technology shifts (e.g., smart grid) that could increase risk and potentially trigger the need for increased regulation.
—Trade surveillance: Trade surveillance continues to be a hot topic both for regulators and the companies they regulate. It involves electronically monitoring trading activities, compliance with internal controls, and trade communications—including phone calls, instant messages and chat room participation. It may also include surveillance of how bids and offers are placed in the market, whether or not proper entities are trading with each other, and whether there are signs of a trader trying to manipulate a market in a number of other ways. Inadequate trade surveillance capabilities can expose a firm to regulatory scrutiny as well as portfolio risk from a bad actor. But trade surveillance that’s done correctly continues to be expensive. Inadequate capabilities can be worse than nothing because they may provide a false sense of security and compliance that leads to even bigger problems down the road.
—Convergence of risk and compliance: In the face of rising regulatory obligations and compliance costs, many companies are thinking about the discipline and value associated with their risk and compliance analyses—and looking for ways to bring those analyses closer together. This trend is important because it raises questions about the value of the analysis and how the outputs from the two processes are used by the organization. Moving forward, companies should rationalize their existing operating models for risk and compliance, looking for ways to maximize commercial value while protecting the organization against controllable and uncontrollable risks.
—Utility commodity hedging and risk management: State regulators are starting to take a closer look at utility commodity hedging and risk management programs. A shift in regulatory thinking might push utilities to take a more risk-based approach to developing hedging strategies. This would require more sophisticated risk measurement and monitoring capabilities, as well as the development of a strategy based on risk indicators that are tied to market movements—whether up or down—rather than simply locking in a percentage of expected commodity purchases or sales. “Done well, such a strategy could allow utilities—and by extension, their customers—to limit downside commodity price risk while not completely eliminating their ability to benefit from advantageous market movements,” says Kevin Nixon, a Risk Advisory partner and head of the Centre for Regulatory Strategy, APAC, Deloitte Australia.