On January 25, 2016, in a 6-2 decision delivered by Justice Kagan, the U.S. Supreme Court upheld the authority of the Federal Energy Regulatory Commission (FERC) under the Federal Power Act to require wholesale market operators to compensate demand response resources at the same market rate paid to electricity generators.  Justices Roberts, Kennedy, Ginsburg, Breyer and Sotomayor joined in the majority opinion, while Justices Scalia and Thomas filed a dissenting opinion.  Justice Alito was recused.

Demand response refers to voluntary programs available in many states and regional electricity markets—specifically FERC-regulated regional transmission organizations and independent transmission system operators (RTOs and ISOs)—by which retail electricity customers can reduce or shift their electricity usage when demand for electricity is highest.  Load reductions can lower electricity prices and reduce the likelihood of utility blackouts or energy shortages.  Typical demand response participants include large industrial and commercial customers—for example, a factory might shift its production to the evening when electricity demand is lower, or a large retail chain might agree to set its cooling system higher to reduce its load on an August afternoon—but several markets have created opportunities for aggregated small retail customers as well.  In fact, demand response providers have long participated in wholesale electricity markets, submitting bids for demand response resources to offset the need for additional energy generation, but the compensation for such providers has varied among regional energy markets. 

In 2011, FERC issued Order No. 745, which was intended to encourage greater demand response participation in FERC-regulated wholesale electricity markets.  Order No. 745 amended FERC's regulations to require compensation for demand response resources participating in FERC-regulated markets at the locational marginal price (LMP), which represents the payment to a generator, in dollars/MWh, for providing an additional MWh of power at a specified location on the transmission system.  By receiving payments based on the LMP, a demand response participant is paid the same amount not to use electricity at peak times that an electricity generator would get paid for providing electricity to the wholesale energy market at that time.

The Electric Power Supply Association (EPSA), a trade group representing wholesale electricity generators, as well as several other parties, sought rehearing of Order No. 745—which was denied by FERC—and ultimately petitioned for review before the U.S. Court of Appeals for the District of Columbia Circuit (D.C. Circuit).  EPSA argued that under the Federal Power Act, regulation of retail market participants is reserved to the states, and that demand reduction involves power usage by retail customers—namely, end-users such as factories and commercial businesses.  FERC's jurisdiction, EPSA urged, is restricted to power sales to "wholesale" customers, such as utilities and power marketers, which re-sell, rather than consume, power.  Accordingly, EPSA contended, state utility commissions, and not FERC, have jurisdiction to regulate payments to demand response providers.

In March 2014, over a dissent by Judge Edwards, the D.C. Circuit agreed with EPSA and struck down Order No. 745, holding that FERC lacked jurisdiction under the Federal Power Act to regulate demand response in the wholesale electricity market.  The D.C. Circuit agreed with EPSA that the provision of the Federal Power Act prohibiting FERC from regulating retail sales (and reserving such regulation to the States) barred the reforms adopted in Order No. 745 because demand response providers are retail market participants.  The D.C. Circuit also concluded that the decision to set compensation for demand response providers at the LMP was arbitrary and capricious.  In a petition for certiorari, FERC asked the U.S. Supreme Court to review the D.C. Circuit's opinion, and the Court granted certiorari.

On review, the U.S. Supreme Court reversed the D.C. Circuit, ruling that Order No. 745 is a lawful exercise of FERC's authority under the Federal Power Act.  The Court reasoned that payments to demand response providers directly affect wholesale rates, and therefore regulating such payments is within the authority granted to FERC by the Federal Power Act.  Accordingly, the Court rejected the D.C. Circuit's conclusion that Order No. 745 improperly encroached upon state regulation of retail rates.  As Justice Kagan stated, a "FERC regulation does not run afoul of the [Federal Power Act] just because it affects—even substantially—the quantity or terms of retail sales."  Rather, the Court determined that regulating wholesale compensation for demand response resources is within FERC's authority because it "is all about reducing wholesale rates," regardless of its effects in retail markets.  In addition, the Court determined that excluding demand response from FERC's jurisdiction would "prevent[] all use of a tool that no one … disputes will curb prices and enhance reliability in the wholesale electricity market."  Finally, the Court held that FERC's decision to compensate demand response providers at LMP is not arbitrary and capricious.

In his dissenting opinion, Justices Scalia, joined by Justice Thomas, argued that FERC's rule exceeds the limitation in the Federal Power Act that prohibits FERC from regulating retail electricity sales.

The Court's decision means that FERC's Order No. 745 will move forward and FERC-regulated wholesale electricity market operators must pay demand response resources the same price paid to generators in the wholesale market—namely the LMP.  The result is likely increased participation of demand response resources in FERC-regulated wholesale electricity markets, which could result in lower wholesale electricity prices.