On January 25, 2016, the U.S. Supreme Court upheld the authority of the Federal Energy Regulatory Commission (FERC or Commission) to regulate demand response in the case Federal Energy Regulatory Commission v. Electric Power Supply Association et al. (“EPSA”).[1] This opinion is significant not only for upholding FERC’s right to regulate demand response, but also more broadly in clarifying the scope of FERC’s jurisdiction as the regulator of wholesale energy markets.

Two issues were before the Court. The first asked whether demand response regulation is within the Commission’s purview. The second assumed the Commission has such authority, but examined whether the Commission’s rulemaking on demand response compensation is arbitrary and capricious. At the root of this controversy is a rulemaking issued by the Commission in March 2011, designated Order No. 745. That Order requires demand response resources participating in wholesale energy markets to be compensated at the same price paid to generation resources (the locational marginal price) in the energy market when dispatch of the demand response resource is cost-effective.

Order No. 745 garnered the opposition of electricity generating entities, who sought to overturn it. After the Commission denied requests for rehearing, arguments were heard by the U.S. Court of Appeals for the District of Columbia Circuit. The Court of Appeals vacated the Order, holding that the action taken was outside the Commission’s jurisdiction and thus encroached on the states’ regulatory authority. In addition, the Court of Appeals found that the Order was arbitrary and capricious because the Commission did not address certain arguments against the rulemaking, notably, that the Order results in overcompensation of demand response resources.

The Supreme Court reversed the lower court’s findings, holding that the practice of demand response compensation directly affects wholesale rates and is not a retail-level regulation. The Court explained that while the Commission has jurisdiction over the rules, regulations and practices that affect the rates within its statutory authority, its jurisdiction is limited to the rules, regulations and practices that directly affect such rates. The Court found that the use of demand response resources in wholesale energy markets to balance supply and demand (i.e., load) affect the setting of wholesale electricity prices. Accordingly, the rules promulgated by the Commission for wholesale demand response programs directly affect wholesale rates.

In rejecting the respondents’ contention that the rulemaking usurps state regulatory authority, the Court explained that most any rate or rule established by the Commission has some effect on retail rates. That, the Court found, does not represent an encroachment on a state’s authority but is an example of the natural consequences of wholesale and retail markets. The Court further held that the Commission had considered and rejected competing arguments and compensation schemes through the rulemaking process, and thus, it rejected the respondents’ argument that the Order was not adequately justified. 

Looking forward, the outcome of this case is essential to the Commission’s continued regulation of demand response activities in the wholesale market. The case, however, may have broader implications in areas where wholesale market rules are likely to create natural consequences in retail markets. Examples of such areas could include rules and regulations affecting capacity requirements, resource adequacy, environmental controls, transmission planning, reliability planning, non-traditional market participants, etc.

One case currently pending before the Supreme Court and listed for argument on February 24, 2016, is Hughes v. Talen Energy Marketing,[2]which addresses whether the State of Maryland may incentivize the construction of new power plants, or whether such action by a state is preempted by the Federal Power Act (“FPA”). A similar case, CPV Power Holdings, LP v. PPL EnergyPlus, LLC, addressing whether New Jersey’s Long-Term Capacity Agreement Power Program (“LCAPP”) statute is preempted by the FPA, is pending decision on a petition for certiorari.[3] The Court of Appeals in both cases held that state action was preempted.

One takeaway from EPSA is, as the electricity industry continues to evolve, the Court is allowing the Commission to move with it. Whether theEPSA holding will be extended to other areas in the wholesale sector may be known shortly.