Decision brings more clarity to jurisdictional boundaries between state public utility regulatory commissions and FERC set forth by the Federal Power Act.

On January 25, the US Supreme Court, in a 6-2 decision, ruled in favor of the Federal Energy Regulatory Commission’s (FERC’s or the Commission’s) demand response rule. The rule requires FERC-regulated market operators to compensate customers at the same prices as other wholesale market generators (also referred to as the “locational marginal price” or LMP) for curtailing power consumption during high-demand periods of energy usage.[1] Reversing the US Court of Appeals for the DC Circuit (DC Circuit), the Court supported both the Commission’s statutory authority to implement the demand response rule and the mandatory compensation scheme to which wholesale market operators must now adhere. The decision brings more clarity to the murky jurisdictional boundaries between state public utility regulatory commissions and FERC set forth by the Federal Power Act (FPA).

Background

FERC’s demand response rule was announced in 2011 in Order No. 745 (the Rule). The Rule was challenged by the Electric Power Supply Association (EPSA) and other energy market participants. The Rule requires market operators to pay the same price to demand response providers for conserving energy as to generators for producing it, so long as a “net benefits test” (which ensures that accepted bids actually save consumers money) is met. The issue reached the Court by way of the DC Circuit, which vacated the Rule and held that FERC lacked authority to issue the order because it directly regulates the retail electricity market, and held in the alternative that the Rule’s compensation scheme was arbitrary and capricious under the Administrative Procedure Act.

The Demand Response Rule Falls within FERC’s Statutory Authority

Reversing the DC Circuit’s decision, the Supreme Court determined that the FPA provides FERC with the authority to regulate wholesale market operators’ compensation of demand response bids in a multipronged analysis—concluding that the Rule affects wholesale electricity market rates and does not inappropriately regulate retail electricity sales in violation of the FPA’s jurisdictional limitations. Ultimately, all FERC-regulated wholesale power sales (sales for resale) become or affect retail power sales (sales to final, end-use purchasers of power); the Supreme Court’s ruling declined to strip FERC of the ability to exercise its FPA jurisdiction solely because FERC’s administration of the FPA could have some effect on retail pricing.

The Demand Response Rule Affects Wholesale Rates

In the first part of its analysis, the Court determined that FERC’s Rule falls squarely within FERC’s statutory authority under the FPA because the Rule’s formula for compensating demand response regulates wholesale electric sales that are within FERC’s FPA jurisdiction—the Rule necessarily lowers wholesale electricity prices by causing demand response to displace higher-priced generation bids, thereby directly affecting wholesale rates.

The Court reasoned that because the Rule allows participants to be compensated at LMP rather than at some lesser amount, more demand response providers would enter more bids capable of displacing generation. Moreover, the Court agreed that heightened demand response participation would put downward pressure on generators’ own bids, encouraging power plants to offer their product at reduced prices to remain a part of the bidding process. In reaching this conclusion, the Court adopted a “common sense” construction of the FPA’s jurisdictional limiting language, stating that FERC’s ability to regulate rules or practices “affecting” wholesale rates was meant to be limited to rules or practices that “directly affect” wholesale rates. This forecloses an alternative interpretation that the US Congress intended for FERC to be allowed to regulate all industries with tangential impacts on wholesale electricity rates.

The Rule Does Not Regulate Retail Electricity Sales in Violation of the FPA’s Jurisdictional Limitations

The Court also determined that although FERC’s Rule has consequences at the retail level, it did not run afoul of the FPA’s jurisdictional proscription from regulating retail electricity sales because any affect the Rule had on retail sales did not amount to FERC setting retail rates. The Court stated that the Rule’s effect on retail sales is of no legal consequence because virtually any action FERC takes with respect to wholesale transactions will have some effect on retail rates. The Court buttressed its position by highlighting that FERC’s justifications for regulating demand response were only about improving the wholesale market, stating that compensation paid for a successful demand response bid is priced at levels that provide an economic benefit to the wholesale market and that FERC presented several ways in which the Rule would help improve competition in wholesale energy markets.

The Court rejected EPSA’s arguments that FERC usurped the power of individual US states by effectively regulating retail prices, and that FERC purposely intruded into the states’ regulatory sphere by luring retail customers into wholesale markets with benefits provided by the Rule. The Court determined that the Rule, at best, alters consumers’ incentives to purchase retail products, but does not set retail rates under any conventional understanding of the concept. Additionally, the Court determined that rather than FERC intentionally seeking to usurp powers reserved to the states, FERC adhered to its FPA role to improve competition in the wholesale markets; this was evidenced by the Rule allowing states to deny customer participation in FERC’s demand response program.

The Court also rejected a position that EPSA implicitly supported that FERC does not have jurisdiction to regulate any programs related to demand response. The Court found this position problematic because states cannot regulate demand response programs due to demand response programs’ wholesale characteristics. EPSA’s position would leave demand response in a regulatory “no man’s land” where neither the states nor the federal government would have regulatory authority. Instead, the Court took the position that the FPA was created to eliminate such regulatory vacuums and rejected EPSA’s position that would, in the Court’s view, completely extinguish wholesale demand response programs.

FERC’s Decision to Compensate Demand Response Providers at the Same Price Paid to Other Wholesale Generators Was Adequately Reasoned

The Court also rejected EPSA’s argument that the mandatory compensation scheme employed by FERC’s Rule was arbitrary and capricious, and held that FERC’s decision to compensate demand response providers at the same price paid to other wholesale generators was adequately reasoned. EPSA contended that FERC erroneously rejected an alternative proposal that would prevent demand response providers from obtaining a windfall for curtailing power usage. Under the alternative compensation scheme, demand response providers would be compensated at the LMP (i.e. the same price as other bidders) minus the retail rate for electricity. The Court found the rationale FERC used to support its compensation scheme satisfied the reasoned decision-making requirements of the Administrative Procedure Act. This rationale relied on

  1. an eminent regulatory economist’s views that demand response bids provide the same value to the wholesale market as generator bids and thus should be compensated similarly,
  2. the Rule’s “net benefits test,” which filters out bids that do not benefit wholesale purchasers, and
  3. that paying LMP would help demand response providers overcome certain barriers to participation in the wholesale market, such as costs associated with significant start-up expenses, including the cost of installing necessary metering technology and energy management systems.