Law Profs See $300 Million Electric Scheme

BUFFALO, N.Y. (CN) - Morgan Stanley and KeySpan Corp., New York City's largest electricity vendor, face an antitrust class action accusing them of withholding electricity from the market to goose prices to the tune of $300 million.

Plaintiffs Alfred Konefsky and Martha McCluskey, both professors at the University at Buffalo Law School, claim KeySpan and Morgan Stanley Capital Group cut an illegal deal to inflate prices.

According to the federal complaint, on Jan. 18, 2008, KeySpan and Morgan Stanley "executed an agreement (the 'Morgan/KeySpan Swap') that ensured that KeySpan would withhold substantial output from the New York City electricity generating capacity market, a market that was created to ensure the supply of sufficient generation capacity for New York City consumers of electricity, and in turn reduce capacity supply to be included in statewide capacity market demand curve auctions (the statewide area is referred to as the 'New York Control Area' or 'NYCA'). The likely effect of the Morgan/KeySpan Swap was increased capacity prices for retail electricity suppliers who purchased capacity, and, in turn, pass increase supply prices directly to consumers who pay for electricity in New York City and New York State. For its part, Morgan Stanley obtained a $21 million profit payment in connection with the Morgan/KeySpan Swap, while incurring no substantial expense, advancing no funds and taking no risk in such transaction."

Sellers of retail electricity in York City must purchase a product from generators known as "installed capacity," which was created by the New York Independent System Operator (NYISO) to ensure sufficient generation capacity to meet expected demand.

"Between 2003 and 2006, KeySpan, the largest seller of electricity generating capacity ('installed capacity') in the New York City market (the 'NYC Capacity Market') earned substantial revenues due to tight supply conditions. Because purchasers of capacity required almost all of KeySpan's output to meet expected demand, KeySpan's ability to set price levels was limited only by a regulatory ceiling (called a 'bid cap'). Indeed, the market price for capacity was consistently at or near KeySpan's bid cap," according to the complaint.

But market conditions were about to change, as two new large electricity generating plants came online in 2006, breaking the capacity shortage that had kept prices at the capped levels, the plaintiffs say.

The professor plaintiffs say KeySpan could prevent the new capacity from reducing prices by withholding a substantial amount of its own capacity from the market, which it weighed against the option of competitive bidding.

"KeySpan searched for a way to avoid the revenue decline from bidding its cap and the revenue risks of competitive bidding," the complaint states. "It decided to enter an agreement that gave it a financial interest in the capacity of Astoria Generating Company ('Astoria') - KeySpan's largest competitor. By providing KeySpan with revenues from a larger base of sales, such an agreement would make a 'bid the cap' strategy more profitable than a successful competitive bid strategy. Rather than directly approach its competitor, KeySpan turned to Morgan Stanley to act as the counterparty to the agreement - the Morgan/KeySpan Swap - recognizing that Morgan Stanley would, and in fact did, enter into an offsetting agreement with Astoria (the 'Morgan/Astoria Hedge).

"With KeySpan deriving revenues from both its own and Astoria's capacity, the Morgan/KeySpan Swap eliminated any incentive for KeySpan to bid competitively, enabling KeySpan to bid the cap on its capacity. Capacity prices remained as high as if no new capacity had entered into the New York City Market."

The plaintiffs estimate the defendants inflated electricity capacity prices in the New York City area by $200 million and in the rest of the state by $100 million, while reaping $63 million in illegal gains for themselves.

They seek disgorgement, penalties and treble damages for attempted monopoly violations of the Sherman Act, unjust enrichment, and violations of New York business law.

Their lead counsel is Lawrence Vilardo with Connors & Vilardo of Buffalo.

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