Assault on California Power Station Raises Alarm on Potential for Terrorism

April Sniper Attack Knocked Out Substation, Raises Concern for Country’s Power Grid

By REBECCA SMITH WSJ
February 5, 2014

SAN JOSE, Calif.—The attack began just before 1 a.m. on April 16 last year, when someone slipped into an underground vault not far from a busy freeway and cut telephone cables.

Within half an hour, snipers opened fire on a nearby electrical substation. Shooting for 19 minutes, they surgically knocked out 17 giant transformers that funnel power to Silicon Valley. A minute before a police car arrived, the shooters disappeared into the night.

A sniper attack in April that knocked out an electrical substation near San Jose, Calif., has raised fears that the country’s power grid is vulnerable to terrorism. WSJ’s Rebecca Smith has the details. Photo: Talia Herman for The Wall Street Journal
With over 160,000 miles of transmission lines, the U.S. power grid is designed to handle natural and man-made disasters, as well as fluctuations in demand. How does the system work? WSJ’s Jason Bellini has #TheShortAnswer.
To avoid a blackout, electric-grid officials rerouted power around the site and asked power plants in Silicon Valley to produce more electricity. But it took utility workers 27 days to make repairs and bring the substation back to life.

Nobody has been arrested or charged in the attack at PG&E Corp.’s PCG -1.29% Metcalf transmission substation. It is an incident of which few Americans are aware. But one former federal regulator is calling it a terrorist act that, if it were widely replicated across the country, could take down the U.S. electric grid and black out much of the country.

The attack was “the most significant incident of domestic terrorism involving the grid that has ever occurred” in the U.S., said Jon Wellinghoff, who was chairman of the Federal Energy Regulatory Commission at the time.

The Wall Street Journal assembled a chronology of the Metcalf attack from filings PG&E made to state and federal regulators; from other documents including a video released by the Santa Clara County Sheriff’s Department; and from interviews, including with Mr. Wellinghoff.

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Q&A: What You Need to Know About Attacks on the U.S. Power Grid

The 64-year-old Nevadan, who was appointed to FERC in 2006 by President George W. Bush and stepped down in November, said he gave closed-door, high-level briefings to federal agencies, Congress and the White House last year. As months have passed without arrests, he said, he has grown increasingly concerned that an even larger attack could be in the works. He said he was going public about the incident out of concern that national security is at risk and critical electric-grid sites aren’t adequately protected.

The Federal Bureau of Investigation doesn’t think a terrorist organization caused the Metcalf attack, said a spokesman for the FBI in San Francisco. Investigators are “continuing to sift through the evidence,” he said.

Some people in the utility industry share Mr. Wellinghoff’s concerns, including a former official at PG&E, Metcalf’s owner, who told an industry gathering in November he feared the incident could have been a dress rehearsal for a larger event.

“This wasn’t an incident where Billy-Bob and Joe decided, after a few brewskis, to come in and shoot up a substation,” Mark Johnson, retired vice president of transmission for PG&E, told the utility security conference, according to a video of his presentation. “This was an event that was well thought out, well planned and they targeted certain components.” When reached, Mr. Johnson declined to comment further.

A spokesman for PG&E said the company takes all incidents seriously but declined to discuss the Metcalf event in detail for fear of giving information to potential copycats. “We won’t speculate about the motives” of the attackers, added the spokesman, Brian Swanson. He said PG&E has increased security measures.

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Utility executives and federal energy officials have long worried that the electric grid is vulnerable to sabotage. That is in part because the grid, which is really three systems serving different areas of the U.S., has failed when small problems such as trees hitting transmission lines created cascading blackouts. One in 2003 knocked out power to 50 million people in the Eastern U.S. and Canada for days.

Many of the system’s most important components sit out in the open, often in remote locations, protected by little more than cameras and chain-link fences.

Transmission substations are critical links in the grid. They make it possible for electricity to move long distances, and serve as hubs for intersecting power lines.

Within a substation, transformers raise the voltage of electricity so it can travel hundreds of miles on high-voltage lines, or reduce voltages when electricity approaches its destination. The Metcalf substation functions as an off-ramp from power lines for electricity heading to homes and businesses in Silicon Valley.

The country’s roughly 2,000 very large transformers are expensive to build, often costing millions of dollars each, and hard to replace. Each is custom made and weighs up to 500,000 pounds, and “I can only build 10 units a month,” said Dennis Blake, general manager of Pennsylvania Transformer in Pittsburgh, one of seven U.S. manufacturers. The utility industry keeps some spares on hand.

A 2009 Energy Department report said that “physical damage of certain system components (e.g. extra-high-voltage transformers) on a large scale…could result in prolonged outages, as procurement cycles for these components range from months to years.”

Mr. Wellinghoff said a FERC analysis found that if a surprisingly small number of U.S. substations were knocked out at once, that could destabilize the system enough to cause a blackout that could encompass most of the U.S.

Not everyone is so pessimistic. Gerry Cauley, chief executive of the North America Electric Reliability Corp., a standards-setting group that reports to FERC, said he thinks the grid is more resilient than Mr. Wellinghoff fears.

“I don’t want to downplay the scenario he describes,” Mr. Cauley said. “I’ll agree it’s possible from a technical assessment.” But he said that even if several substations went down, the vast majority of people would have their power back in a few hours.

The utility industry has been focused on Internet attacks, worrying that hackers could take down the grid by disabling communications and important pieces of equipment. Companies have reported 13 cyber incidents in the past three years, according to a Wall Street Journal analysis of emergency reports utilities file with the federal government. There have been no reports of major outages linked to these events, although companies have generally declined to provide details.

“A lot of people in the electric industry have been distracted by cybersecurity threats,” said Stephen Berberich, chief executive of the California Independent System Operator, which runs much of the high-voltage transmission system for the utilities. He said that physical attacks pose a “big, if not bigger” menace.

There were 274 significant instances of vandalism or deliberate damage in the three years, and more than 700 weather-related problems, according to the Journal’s analysis.

Until the Metcalf incident, attacks on U.S. utility equipment were mostly linked to metal thieves, disgruntled employees or bored hunters, who sometimes took potshots at small transformers on utility poles to see what happens. (Answer: a small explosion followed by an outage.)

Last year, an Arkansas man was charged with multiple attacks on the power grid, including setting fire to a switching station. He has pleaded not guilty and is undergoing a psychiatric evaluation, according to federal court records.

Overseas, terrorist organizations were linked to 2,500 attacks on transmission lines or towers and at least 500 on substations from 1996 to 2006, according to a January report from the Electric Power Research Institute, an industry-funded research group, which cited State Department data.

An attack on a PG&E substation near San Jose, Calif., in April knocked out 17 transformers like this one. Talia Herman for The Wall Street Journal
To some, the Metcalf incident has lifted the discussion of serious U.S. grid attacks beyond the theoretical. “The breadth and depth of the attack was unprecedented” in the U.S., said Rich Lordan, senior technical executive for the Electric Power Research Institute. The motivation, he said, “appears to be preparation for an act of war.”

The attack lasted slightly less than an hour, according to the chronology assembled by the Journal.

At 12:58 a.m., AT&T fiber-optic telecommunications cables were cut—in a way that made them hard to repair—in an underground vault near the substation, not far from U.S. Highway 101 just outside south San Jose. It would have taken more than one person to lift the metal vault cover, said people who visited the site.

Nine minutes later, some customers of Level 3 Communications, an Internet service provider, lost service. Cables in its vault near the Metcalf substation were also cut.

At 1:31 a.m., a surveillance camera pointed along a chain-link fence around the substation recorded a streak of light that investigators from the Santa Clara County Sheriff’s office think was a signal from a waved flashlight. It was followed by the muzzle flash of rifles and sparks from bullets hitting the fence.

The substation’s cameras weren’t aimed outside its perimeter, where the attackers were. They shooters appear to have aimed at the transformers’ oil-filled cooling systems. These began to bleed oil, but didn’t explode, as the transformers probably would have done if hit in other areas.

About six minutes after the shooting started, PG&E confirms, it got an alarm from motion sensors at the substation, possibly from bullets grazing the fence, which is shown on video.

Four minutes later, at 1:41 a.m., the sheriff’s department received a 911 call about gunfire, sent by an engineer at a nearby power plant that still had phone service.

Riddled with bullet holes, the transformers leaked 52,000 gallons of oil, then overheated. The first bank of them crashed at 1:45 a.m., at which time PG&E’s control center about 90 miles north received an equipment-failure alarm.

Five minutes later, another apparent flashlight signal, caught on film, marked the end of the attack. More than 100 shell casings of the sort ejected by AK-47s were later found at the site.

At 1:51 a.m., law-enforcement officers arrived, but found everything quiet. Unable to get past the locked fence and seeing nothing suspicious, they left.

A PG&E worker, awakened by the utility’s control center at 2:03 a.m., arrived at 3:15 a.m. to survey the damage.

Grid officials routed some power around the substation to keep the system stable and asked customers in Silicon Valley to conserve electricity.

In a news release, PG&E said the substation had been hit by vandals. It has since confirmed 17 transformers were knocked out.

Mr. Wellinghoff, then chairman of FERC, said that after he heard about the scope of the attack, he flew to California, bringing with him experts from the Joint Warfare Analysis Center in Dahlgren, Va. After walking the site with PG&E officials and FBI agents, Mr. Wellinghoff said, the military experts told him it looked like a professional job.

In addition to fingerprint-free shell casings, they pointed out small piles of rocks, which they said could have been left by an advance scout to tell the attackers where to get the best shots.

“They said it was a targeting package just like they would put together for an attack,” Mr. Wellinghoff said.

Mr. Wellinghoff, now a law partner at Stoel Rives LLP in San Francisco, said he arranged a series of meetings in the following weeks to let other federal agencies, including the Department of Homeland Security, know what happened and to enlist their help. He held a closed-door meeting with utility executives in San Francisco in June and has distributed lists of things utilities should do to strengthen their defenses.

A spokesman for Homeland Security said it is up to utilities to protect the grid. The department’s role in an emergency is to connect federal agencies and local police and facilitate information sharing, the spokesman said.

As word of the attack spread through the utility industry, some companies moved swiftly to review their security efforts. “We’re looking at things differently now,” said Michelle Campanella, an FBI veteran who is director of security for Consolidated Edison Inc. ED -0.04% in New York. For example, she said, Con Ed changed the angles of some of its 1,200 security cameras “so we don’t have any blind spots.”

Some of the legislators Mr. Wellinghoff briefed are calling for action. Rep. Henry Waxman (D., Calif.) mentioned the incident at a FERC oversight hearing in December, saying he was concerned that no one in government can order utilities to improve grid protections or to take charge in an emergency.

As for Mr. Wellinghoff, he said he has made something of a hobby of visiting big substations to look over defenses and see whether he is questioned by security details or local police. He said he typically finds easy access to fence lines that are often close to important equipment.

“What keeps me awake at night is a physical attack that could take down the grid,” he said. “This is a huge problem.”

—Tom McGinty contributed to this article.

Write to Rebecca Smith at rebecca.smith@wsj.com

Corrections & Amplifications
Federal experts who examined a California substation after an attack last April were attached to the Joint Warfare Analysis Center at Dahlgren, Va. An earlier version of this article misidentified the men’s command as the Surface Warfare Center in Dahlgren, and incorrectly said it trains Navy SEALs.

U.S. Risks National Blackout From Small-Scale Attack

Federal Analysis Says Sabotage of Nine Key Substations Is Sufficient for Broad Outage

By REBECCA SMITH WSJ
March 12, 2014 7:03 p.m. ET

The U.S. could suffer a coast-to-coast blackout if saboteurs knocked out just nine of the country’s 55,000 electric-transmission substations on a scorching summer day, according to a previously unreported federal analysis.

The study by the Federal Energy Regulatory Commission concluded that coordinated attacks in each of the nation’s three separate electric systems could cause the entire power network to collapse, people familiar with the research said.

The U.S. could suffer a coast-to-coast blackout if saboteurs knocked out nine of the country’s electric-transmission substations on a summer day, according to a previously unreported federal analysis. National War College Professor Dr. Richard Andres discusses.
A small number of the country’s substations play an outsize role in keeping power flowing across large regions. The FERC analysis indicates that knocking out nine of those key substations could plunge the country into darkness for weeks, if not months.

Related
With over 160,000 miles of transmission lines, the U.S. power grid is designed to handle natural and man-made disasters, as well as fluctuations in demand. How does the system work? WSJ’s Jason Bellini has #TheShortAnswer.

“This would be an event of unprecedented proportions,” said Ross Baldick, a professor of electrical engineering at the University of Texas at Austin.

No federal rules require utilities to protect vital substations except those at nuclear power plants. Regulators recently said they would consider imposing security standards.

FERC last year used software to model the electric system’s performance under the stress of losing important substations. The substations use large power transformers to boost the voltage of electricity so it can move long distances and then to reduce the voltage to a usable level as the electricity nears homes and businesses.

The agency’s so-called power-flow analysis found that different sets of nine big substations produced similar results. The Wall Street Journal isn’t publishing the list of 30 critical substations studied by FERC. The commission declined to discuss the analysis or to release its contents.

Some federal officials said the conclusions might overstate the grid’s vulnerability.

Electric systems are designed to be resilient and it would be difficult for attackers to disable many locations, said David Ortiz, an Energy Department deputy assistant secretary who was briefed on the FERC study. The agency’s findings nevertheless had value “as a way of starting a conversation on physical security,” he said.

The study’s results have been known for months by people at federal agencies, Congress and the White House, who were briefed by then-FERC Chairman Jon Wellinghoff and others at the commission. As reported by the Journal last month, Mr. Wellinghoff was concerned about a shooting attack on a California substation last April, which he said could be a dress rehearsal for additional assaults.

“There are probably less than 100 critical high voltage substations on our grid in this country that need to be protected from a physical attack,” he said by email this week. “It is neither a monumental task, nor is it an inordinate sum of money that would be required to do so.” Mr. Wellinghoff left FERC in November and is a partner at law firm Stoel Rives LLP in San Francisco.

FERC has given the industry until early June to propose new standards for the security of critical facilities, such as substations.

Executives at several big utilities declined to discuss the risks to substations but said they are increasing spending on security. Virginia-based Dominion Resources Inc., D -1.41% for example, said it planned to spend $300 million to $500 million within seven years to harden its facilities.

A memo prepared at FERC in late June for Mr. Wellinghoff before he briefed senior officials made several urgent points. “Destroy nine interconnection substations and a transformer manufacturer and the entire United States grid would be down for at least 18 months, probably longer,” said the memo, which was reviewed by the Journal. That lengthy outage is possible for several reasons, including that only a handful of U.S. factories build transformers.

The California attack “demonstrates that it does not require sophistication to do significant damage to the U.S. grid,” according to the memo, which was written by Leonard Tao, FERC’s director of external affairs. Mr. Tao said his function was to help Mr. Wellinghoff simplify his report on the analysis.

The memo reflected a belief by some people at the agency that an attack-related blackout could be extraordinarily long, in part because big transformers and other equipment are hard to replace. Also, each of the three regional electric systems—the West, the East and Texas—have limited interconnections, making it hard for them to help each other in an emergency.

Some experts said other simulations that are widely used in the electricity industry produced similar results as the FERC analysis.

“This study used a relatively simplified model, but other models come to the same conclusion,” said A.P. “Sakis” Meliopoulos, professor of electrical and computer engineering at the Georgia Institute of Technology in Atlanta. He estimated it would take “a slightly larger number” of substation attacks to cause a U.S.-wide blackout.

In its modeling, FERC studied what would happen if various combinations of substations were crippled in the three electrical systems that serve the contiguous U.S. The agency concluded the systems could go dark if as few as nine locations were knocked out: four in the East, three in the West and two in Texas, people with knowledge of the analysis said.

The actual number of locations that would have to be knocked out to spawn a massive blackout would vary depending on available generation resources, energy demand, which is highest on hot days, and other factors, experts said. Because it is difficult to build new transmission routes, existing big substations are becoming more crucial to handling electricity.

In last April’s attack at PG&E Corp.’s PCG -1.29% Metcalf substation, gunmen shot 17 large transformers over 19 minutes before fleeing in advance of police. The state grid operator was able to avoid any blackouts.

The Metcalf substation sits near a freeway outside San Jose, Calif. Some experts worry that substations farther from cities could face longer attacks because of their distance from police. Many sites aren’t staffed and are protected by little more than chain-link fences and cameras.

While the prospect of a nationwide blackout because of sabotage might seem remote, small equipment failures have led to widespread power outages. In September 2011, for example, a failed transmission line in Arizona set off a chain reaction that created an outage affecting millions of people in the state and Southern California.

Sabotage could wreak worse havoc, experts said.

“The power grid, built over many decades in a benign environment, now faces a range of threats it was never designed to survive,” said Paul Stockton, a former assistant secretary of defense and president of risk-assessment firm Cloud Peak Analytics. “That’s got to be the focus going forward.”

Write to Rebecca Smith at rebecca.smith@wsj.com

Companies Unplug From the Electric Grid, Delivering a Jolt to Utilities

BUSINESSSeptember 17, 2013, 11:05 p.m. ET

Companies Unplug From the Electric Grid, Delivering a Jolt to Utilities

By REBECCA SMITH and CASSANDRA SWEET CONNECT

Michal Czerwonka for The Wall Street Journal

At Kroger’s food-distribution center in Compton, Calif., a tank system converts organic waste into biogas to produce electricity used by the facility

On a hill overlooking the Susquehanna River, two big wind turbines crank out electricity for Kroger Co.’s Turkey Hill Dairy in rural Lancaster County, Pa., allowing it to save 25% on its power bill for the past two years.

Across the country, at a big food-distribution center Kroger also owns in Compton, Calif., a tank system installed this year uses bacteria to convert 150 tons a day of damaged produce, bread and other organic waste into a biogas that is burned on site to produce 20% of the electricity the facility uses.

These two projects, plus the electric output of solar panels at four Kroger grocery stores, and some energy-conservation efforts are saving the Cincinnati-based grocery chain $160 million a year on electricity, said Denis George, its energy manager. That is a lot of money that isn’t going into the pockets of utilities.

From big-box retailers to high-tech manufacturers, more companies across the country are producing their own power. Since 2006, the number of electricity-generation units at commercial and industrial sites has more than quadrupled to roughly 40,000 from about 10,000, according to federal statistics.

Experts say the trend is gaining momentum, spurred by falling prices for solar panels and natural gas, as well as a fear that power outages caused by major storms will become more common.

Michal Czerwonka for The Wall Street Journal

Organic waste

“The battle cry is Hurricane Sandy,” said Rick Fioravanti, vice president of energy-storage technology at DNV Kema, a Netherlands-based consulting company.

The growing number of companies that are at least partly energy self-sufficient is sending a shudder through the utility industry, threatening its revenues and growth prospects, according to a report earlier this year by the Edison Electric Institute, a trade association for investor-owned electric companies.

State and federal regulators say they are worried that utilities could end up with fewer customers to pay for costly transmission lines and power plants.

Utility executives, meanwhile, are asking themselves a disquieting question: “Am I going to just sit here and take it and ultimately be a caretaker of a museum, or am I going to be part of that business” that’s emerging, said Nick Akins, chief executive of American Electric Power Co., a big Ohio-based utility. AEP is considering helping its customers install their own generating facilities.

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On-site generation still accounts for less than 5% of U.S. electricity production. But it is peeling off some of the bulk sales that utilities find especially profitable. And some of the companies getting into the business think it is approaching a tipping point called “grid parity,” at which point power would be as cheap to make as to buy from a utility.

Since 2007, when the first solar arrays went up on its store roofs in California, the installed costs of Wal-Mart Stores Inc.’s solar systems have dropped from $6 or $8 per watt of capacity to about $3.50 per watt, said David Ozment, the company’s senior director of energy management. He said he expects the retailer to be paying as little for solar power as utility power “in less than three years,” opening the floodgates to solar expansion.

Wal-Mart produces about 4% of the electricity it uses but intends to make 20% by 2020, taking advantage of idle acreage on thousands of store rooftops.

On-site generation isn’t a new idea. It existed before the electric grid—the interconnected system of power plants, substations and transmission lines that ferry power thousands of miles—was stitched together beginning in the 1920s.

But for most of the past 50 years, the practice was associated mostly with remote locations like Alaska fish canneries or industrial facilities like oil refineries that generated lots of waste heat that could be harnessed for power production.

Almost overnight, that niche market has gone decidedly mainstream. Six years ago, Google Inc. attracted attention by installing big solar arrays atop its Silicon Valley complex in California. Other tech companies followed suit, worried about ensuring power supplies for energy-hungry server farms and achieving sustainability objectives.

Apple Inc. now gets 16% of its electricity from solar panels and fuel cells that run on biogas. Apple’s data center in Maiden, N.C., makes all the power it consumes, a company spokeswoman said.

BMW AG’s assembly plant in South Carolina, which made 300,000 vehicles last year, gets half its electricity from an on-site energy center that burns methane piped to it from a nearby garbage dump. Drugstore chain Walgreen Co., which has solar panels at 155 stores, plans to install them at 200 more.

Falling equipment prices make on-site generation increasingly attractive. From 2002 to 2012, the cost of installed solar systems fell by half, according to an August report from the Lawrence Berkeley National Lab. Companies also have the option of leasing big solar systems, rather than incurring the capital cost of buying them.

Many “clean energy” projects also qualify for federal and state subsidies. In the case of solar installations, there is a 30% federal tax credit, which is set to drop to 10% in 2017. Government officials say a shift to greener energy resources is good since it reduces the output from coal-fueled power plants, which produce about 40% of the nation’s electricity and are the most polluting.

But analysts say the importance of subsidies has been waning, overshadowed by steep declines in the cost of power-generating equipment. For example, the cost of solar modules—the biggest single component in a rooftop solar system—has dropped about 80% in the past four years, to about 65 cents a watt from about $4 a watt, said Galen Barbose, a senior researcher at the lab.

Companies also are turning to wind turbines and technologies like fuel cells, batteries, small natural-gas turbines and reciprocating engines, which are natural-gas-fueled cousins of the auto’s internal combustion engine.

Engineering and technology company SAIC Inc. is installing enough generating capacity at a data center outside New York to meet the center’s core needs, with batteries for backup power. The system uses reciprocating engines burning natural gas, an option considered reliable in storms because gas pipelines are buried.

A report released by the White House in August estimated that power outages caused by bad weather cost the U.S. economy $18 billion to $52 billion a year in lost productivity from 2003 to 2012.

Demand for fuel cells in the U.S. is coming primarily from telecom companies, hotels and universities, said David Wright, CEO of ClearEdge Power Inc., a manufacturer in Hillsboro, Ore. Many buyers want reliable on-site generation as a hedge against storm-related outages.

By next year, Verizon Communications Inc. plans to install $100 million worth of fuel cells from ClearEdge and Bloom Energy, as well as solar panels, at 19 data centers and other facilities in seven states, including New York and New Jersey.

Some traditional utility companies are edging into the on-site generation business.

Edison International, which owns big utility Southern California Edison, recently bought a Chicago-based developer of rooftop solar projects, SoCore Energy LLC, and it is an investor in solar-finance company Clean Power Finance.

As power production becomes more decentralized, “I want to make sure the company is deeply involved,” said Edison CEO Ted Craver.

Write to Rebecca Smith at rebecca.smith@wsj.com and Cassandra Sweet at cassandra.sweet@dowjones.com

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Banks Replacing Enron in Energy Incite Congress as Abuses Abound

 

Banks Replacing Enron in Energy Incite Congress as Abuses Abound

 

The U.S. government permitted Wall Street firms to expand in the energy industry a decade ago, when the collapse of Enron Corp. and its army of traders left a void in the market. The results aren’t pretty.

 

JPMorgan Chase & Co. (JPM) settled Federal Energy Regulatory Commission claims this week that employees engaged in 12 bidding schemes to wrest tens of millions of dollars from power-grid operators. A Barclays Plc (BARC) trader stands accused of bragging he “totally fukked” with a Southwest energy market. Deutsche Bank AG workers, faced with losses on a contract, allegedly altered electricity flows to make it profitable instead.

 

The FERC’s investigations are fueling a debate among lawmakers and the Federal Reserve over whether to reverse more than a decade of policy decisions that let Wall Street banks keep or build units handling commodities and energy. Senators examining the firms’ roles have said they may call bankers and watchdogs to a September hearing amid concern traders are abusing their ability to buy and sell physical products while betting on related financial instruments.

Banks have been seen as “sources of capital investment and market liquidity,” said Marc Spitzer, a partner at law firm Steptoe & Johnson LLP in Washington and a former FERC commissioner. “But the tradition and culture of large banks is different than the conservative and risk-averse culture of regulated utilities.”

 

Rolling Blackouts

 

JPMorgan, the largest U.S. lender, announced last week that it’s considering ways to exit the physical commodities business, which includes energy trading. The New York-based company, led by Chief Executive Officer Jamie Dimon, 57, will pay a $285 million fine and disgorge $125 million in gains to settle the FERC’s case without admitting or denying wrongdoing.

 

“We’re pleased to have this matter behind us,” Brian Marchiony, a spokesman for the firm, said as the accord was announced.

 

“It is up to Congress, and not FERC, to decide if banks should continue to be allowed to participate,” FERC Chairman Jon Wellinghoff said in an e-mailed statement. “We welcome anybody in the markets who wants to play in those markets fairly, whether it be banks, traditional utilities or other traders. We just want to make sure that they play by the rules.”

 

Details of Enron’s market abuses surfaced in the years after the world’s biggest power trader collapsed in an accounting fraud in 2001. The company, whose actions led to rolling blackouts in California, eventually reached a $1.5 billion settlement with state authorities, while employees pleaded guilty to criminal charges.

 

Enron’s Void

 

To prevent future misconduct, a congressional overhaul of U.S. energy policies gave the FERC additional enforcement powers in 2005, setting the stage for the current jump in cases.

 

Enron’s fall left a hole in the market. Utilities and companies needed more stable and dependable power brokers for their transactions. Banks, with relatively strong balance sheets and credit ratings, were among companies that saw an opportunity. Congress already had loosened energy-market restrictions in the 1990s, as well as a ban on banks’ involvement in commercial businesses in 1999. Regulators let firms proceed.

 

UBS AG (UBSN), Switzerland’s largest lender, bought Enron’s energy-trading business in 2002, later shrinking the unit. That same year, Bank of America Corp. also won the FERC’s approval to make electricity transactions. Altogether, more than 50 firms including banks filed applications with the FERC from December 2001 through February 2003 to make trades in that market.

 

Edison’s Backer

 

“Banks have assumed a prominent role in energy trading since the collapse of Enron and other energy marketers, in part, because financial institutions generally have significant financial assets to back their trades,” said Richard Drom, a partner at law firm Andrews Kurth LLP who focuses on energy regulation. “Such trading can improve energy markets by promoting market liquidity and energy price transparency.”

JPMorgan’s website credits a predecessor of the bank with helping bring about the advent of electricity by financing Thomas Edison’s research. In 2005, a unit of the company won FERC approval to provide power in wholesale electricity markets, according to the agency. Three years later, the firm inherited U.S. energy holdings and sales arrangements, including power plants in Southern California and Michigan, through its acquisition of failing investment bank Bear Stearns Cos.

 

The FERC found that J.P. Morgan Ventures Energy Corp., a unit overseen by commodities chief Blythe Masters, engaged in 12 separate bidding strategies from 2010 to 2012. Ten allegedly began while the agency’s probe was in progress.

 

Profits Predicted

 

The bank controlled older power plants that had marginal costs that were typically higher than the market prices of electricity, according to its consent agreement with the FERC. To ensure their profitability, the firm sought to exploit pricing rules, the agency wrote.

JPMorgan used strategies such as offering below-market rates for some hours of energy production, then charging exorbitantly high rates for hours that state bidders agreed to pay for the plants to “ramp” production, according to the FERC.

 

Masters, 44, was told in an October 2010 document that the firm’s bidding strategies would enable it to produce $1.5 billion to $2 billion in gains through 2018, according to the FERC. She wasn’t accused of wrongdoing. The company’s settlement releases her from any future FERC enforcement actions in the case.

 

Enron Worse

 

Some JPMorgan bidding tactics were similar to abuses that occurred in the Enron era, FERC Chairman Wellinghoff said in an interview this week.

“That doesn’t mean that they are as widespread or that they are resulting in the level of consumer losses that we saw during that period,” he said.

A recent jump in the watchdog’s cases targeting a variety of companies stems from the additional authority Congress granted its investigators in 2005. Wellinghoff has said that the agency isn’t seeking to single out Wall Street firms.

“We now have a very sophisticated and very deep enforcement team” able to identify and stop market manipulation swiftly, he said in the interview.

 

The FERC’s case against Barclays and Frankfurt-based Deutsche Bank centered on their alleged abuse of power-market influence to benefit related positions on financial instruments.

 

Barclays Fighting

 

At Barclays, the FERC’s investigators found traders made transactions in fixed-price electricity products — often at a loss — with the intent of moving an index to benefit the London-based bank’s other bets on swaps. The regulator’s staff estimated that the abuses, spanning 2006 to 2008, caused $139 million “in harm to the market.”

Barclays has said the FERC’s accusations are without basis. The firm has vowed to fight an order that it pay $469.9 million in penalties and forfeited profits. Swaps allow investors to hedge or speculate on changes in underlying assets such as interest rates, currencies or the ability of a borrower to repay debt.

 

Deutsche Bank agreed to pay the FERC more than $1.6 million in January without admitting or denying wrongdoing. The bank was accused of moving electricity to benefit its position on financial instruments known as congestion revenue rights.

Enron employees targeted by prosecutors took a direct approach: They sought to drive up electricity prices to squeeze more money out of power-starved utilities, businesses and consumers. Wholesale power prices soared and electricity supplies dwindled, leaving millions of Californians to suffer blackouts in 2001. The state’s two largest utilities became insolvent.

 

Enron Testimony

 

The focus on derivatives in some of the bank probes echoes at least one Enron case. In 2004, Enron settled claims brought by the Commodity Futures Trading Commission that employees rapidly bought up natural gas in the spot market, creating “artificial” prices for natural gas futures contracts.

That behavior helped make Enron a repeat topic during a Senate Banking Committee subcommittee hearing on July 23 to examine whether banks are abusing their roles in commodities markets.

 

“There is at least a very plausible argument that Enron was the pioneer in discovering a business model” that combined the handling of physical commodities and derivatives bets, Saule T. Omarova, a law professor at the University of North Carolina at Chapel Hill, told the Senate panel. “Once that model was discovered, that model was up for the taking.”

The notion that some firms are emulating Enron “suggests that this movie does not end well,” Senator Elizabeth Warren, a Massachusetts Democrat, said at the hearing. It shows “we are now putting more and more risk into this system.”

 

‘Grandma Millie’

 

The cases against banks in the past year have resurrected concerns that traders are disregarding markets and consumers.

Enron workers were caught on audiotapes as they discussed tactics with code names like “Death Star” and “Fat Boy” that could be used to take advantage of consumers, whom they termed “Grandma Millie.” In that case, prosecutors said employees used a variety of strategies, such as creating artificial congestion on transmission lines so that Enron could earn additional fees for relieving the crunch.

One Barclays trader accused of manipulating prices in the U.S. Southwest wrote in an internal message that he had “totally fukked with the Palo mrkt today,” the FERC said in an order this month. Another trader wrote that he was “trying to drive price in fin direction,” referring to transactions he made to benefit derivatives positions, the agency said.

At Odds

 

The claims against banks are fueling a regulatory debate that may push those firms back out of certain markets. The Fed said July 19 that it’s reviewing a 2003 decision that physical commodities are “complementary” to banking, allowing lenders such as JPMorgan to operate in both industries. Such a reversal would demonstrate authorities’ growing discomfort with allowing complex trading strategies into markets that ultimately heat people’s homes.

 

Banks’ and utilities’ interests are fundamentally at odds, with financial firms earning more from volatility and consumers needing stability, said Miki Kolobara, a Phoenix-based attorney who specializes in energy-trading cases. Banks’ hunt for gains will gravitate to derivatives, where profits are theoretically unlimited, rather than in power lines and physical infrastructure, where returns are capped by regulators, he said.

 

Electricity and natural gas — the two main commodities under the FERC’s oversight — are areas in which banks should tread carefully, because the government is wary of practices that hurt people’s ability to meet basic needs.

“Trading in energy requires not just expertise, but also an awareness of a highly complex regulatory structure,” said Harvey Pitt, the SEC chairman during Enron’s collapse. “If traders view energy as just another commodity, then they will find themselves on the wrong side of FERC.’”

 

To contact the reporters on this story: Keri Geiger in New York at kgeiger4@bloomberg.net; Brian Wingfield in Washington at bwingfield3@bloomberg.net

 

To contact the editors responsible for this story: David Scheer at dscheer@bloomberg.net; Christine Harper atcharper@bloomberg.net; Jon Morgan at jmorgan97@bloomberg.net