The global energy landscape is experiencing a seismic shift as the world transitions toward environmentally sustainable energy sources. This transition, driven by the demand to decarbonize, is reshaping the energy industry and prompting companies to adapt and innovate.
While critical for achieving grid stability in the face of extreme weather events, this shift introduces a complex array of legal and financial challenges.
Bringing these challenges to life are the recent PJM Interconnection LLC settlement negotiations taking place at the Federal Energy Regulatory Commission, following the aftermath of Winter Storm Elliot in December 2022, which covered the majority of the U.S.
The disputes and outcomes associated with these negotiations have brought to the fore a potential legal minefield arising out of extreme weather events that could lead to an existential threat — or, at minimum, commercial risks — for power generating companies.
Financial Shocks and Rewards After the Storm
A series of winter storms, wildfires and other extreme weather events have exposed vulnerabilities in energy infrastructure, and led to a critical assessment of the performance of power generators.
Some companies have managed to navigate these events' challenges successfully, ensuring uninterrupted energy supply to consumers. Others have faltered, causing disruptions and raising concerns about the resiliency of the grid.
As a response, regional transmission operators have imposed penalties on the companies that failed to deliver during extreme weather events. For example, PJM assessed a nearly $40 million fee on Lincoln Power LLC for failure to run during Elliott in 2022 — a penalty that constituted a multiple of Lincoln Power's annual revenue.
As a protective tool, Lincoln Power resorted to filing for bankruptcy to insulate itself from further consequences, as it was in no position to pay the penalty and was unable to find an alternative. In fact, after Elliott, PJM levied about $1.8 billion in nonperformance penalties, with private equity firms being among those on the hook.
Conversely, power generators that performed during extreme weather events came out ahead and received monetary bonuses from regional transmission operators to reward successful operations. In accordance with PJM's tariff at the time of Elliott, the penalties levied on underperforming companies actually funded the bonuses granted — creating a zero-sum scenario.
For context, the winter storms in 2021 and 2022 caused widespread power outages across the U.S., including in the PJM region, which covers 13 states in the mid-Atlantic and Midwest. The storms caused PJM to declare an emergency, which resulted in the imposition of emergency pricing mechanisms that led to higher electricity prices.
In response to the penalties levied against the underperforming power generating companies, FERC is facilitating settlement negotiations between these companies and PJM, pursuant to its convening and quasi-judicial authority. All those who were assessed a penalty and received a bonus are parties to the settlement negotiations.
On Sept. 19, it was announced in court that settlements had been reached in principle with a majority of the power plant owners. However, the announcement did not include details on which power plant owners have agreed to a resolution.
The dynamics of the FERC-PJM settlement negotiations in creating a zero-sum game — where the penalties imposed on certain companies directly fund the bonuses awarded to others — is an approach designed to incentivize resilient performance. But it also introduces a delicate balance that can have profound consequences on the financial health of power companies.
Penalties assessed for the inability to perform during extreme weather events raise legal questions about procedural fairness, reasonableness and even potential disputes over regulatory authority. These tensions will amplify if we continue to see record weather events, as we have over the course of 2023.
And this is all against a backdrop of a credit crunch, an impending recession, rising interest rates and commodity price volatility. We are also seeing aging carbon-based plants run by coal or gas that are not dependable, and regulatory reluctance to build pipelines and traditional energy infrastructure.
Meanwhile, financing sources that are considering a project now understand that nonperformance will be costly — potentially prompting them to raise financing costs for new gas-fired projects.
Still further, there is a regulatory and competitive environment that makes competing simply a losing proposition for some of these companies. And even though PJM is changing its capacity market rules — partly in response to Elliott — companies with dark clouds on the horizon should be planning now for the future.
Bankruptcy Risk and Restructuring
Substantial penalties like those being discussed in the PJM settlement negotiations at FERC might cause power companies to come face-to-face with insolvency risk, requiring financial and operational restructurings or bankruptcy.
Meanwhile, the next storm looms, and power companies are wondering whether they could be saddled with a financial albatross of their own. Given the magnitude of these penalties, cutting corners in a budget will be insufficient.
Instead, the industry is compelled to reassess the bigger picture — including operations, strategies and even ownership structures. In this context, restructuring can serve as a shield from externalities, rather than a symbol of commercial defeat.
For instance, strategically filing for bankruptcy may be a prudent course of action for power generating companies grappling with substantial penalty fees, and could involve shedding assets, workforce reductions and divestitures, all within the protection of the bankruptcy regime.
In cases where these penalty fees pose a severe financial burden, bankruptcy offers a chance to reorganize operations and negotiate with creditors, potentially leading to the reduction or even the discharge of these penalties.
By using bankruptcy as a tool, companies can temporarily halt aggressive collection actions, allowing themselves to stabilize operations and devise a feasible plan for repayment. This approach not only safeguards vital power infrastructure but also provides an opportunity to restructure debt and improve financial health over the long term.
Nonetheless, careful consideration of the potential consequences remains imperative, and we see companies already leveraging energy regulatory expertise to advance corporate restructuring objectives in this area.
Collaboration across these sectors involves considerations like debtor-in-possession financing, treatment of regulated contracts, asset sales, and even potential disputes over the assessment and collection of penalties.
Implications and Future Dilemmas
The outcome of the FERC-PJM settlement negotiations has far-reaching implications for the energy industry's ongoing transition.
Depending on how these settlement negotiations play out at FERC, we might witness a polarization of the sector — some companies with previous performance success during extreme weather events will thrive, while others will potentially collapse under the weight of penalties.
There may be a third category: those leveraging bankruptcy as a strategy to protect against externalities. And this split is on top of the already bright divide between companies pivoting toward decarbonization and adopting cleaner sources, and those doubling down on fossil fuels.
The industry is transforming in terms of its corporate structures, as well as the menu of energy sources being offered. Additionally, the repercussions of potential bankruptcies extend beyond individual companies.
For example, forced bankruptcy or restructuring can trigger a domino effect that disrupts supply chains, affects contractual relationships and poses challenges to regulatory compliance. This chain reaction has legal implications that span contract law, environmental regulations and even labor law, as companies realign their operations to address financial distress.
Ultimately, proactively managing bankruptcy in light of new market disruptions that either heighten the risk of actual bankruptcy, or make the bankruptcy option more appealing, lessen the impact of these types of disruptions.
The ongoing energy transition itself adds a layer of complexity to this situation. Many companies are already grappling with the need to adapt to new technologies, regulatory changes and shifting consumer preferences. And rather than one-time fixes, these endeavors are trending.
Generally, we are seeing a number of oil and gas companies pursue renewable energy partnerships to decarbonize operations. We are also seeing large-scale utilities bid in auctions to acquire nuclear energy assets, as well as the conversion of coal plants slated for retirement to become sites for new, clean energy technologies.
The added pressure of penalties or bonuses can exacerbate challenges associated with these initiatives — particularly in the face of unpredictable weather events — potentially pushing companies to the brink.
Conclusion
The FERC-PJM settlement negotiations provide a snapshot of the broader challenges that energy companies face in the evolving legal landscape. Proactive legal strategies that encompass compliance, risk mitigation and contingency planning all play a crucial role in averting a crisis.
Alternatively, while daunting, a restructuring may actually provide a safe space for accelerated change, giving companies the time and ability to right-size their balance sheets to be better poised to explore new opportunities.
As the world moves inexorably toward a more sustainable energy future, the risks and challenges emerging from this transition should not be underestimated.
Those who are prepared to formulate and implement a strategic plan will be best positioned to capitalize on new opportunities that inevitably arise from continued technological, financial and climate disruptions.
Authored by Neil Chatterjee, Christopher Donoho, and Megan Ridley-Kaye
Originally published by Law360
