On Tuesday, the Supreme Court issued its decision (8-0) in Hughes v. Talen Energy striking down a Maryland program that encouraged additional in-state generation. Hughes is the second decision of the term, following FERC v. Electric Power Supply Association, in which the Court has struggled to clarify the increasingly blurry boundary between state and federal jurisdiction over energy policy. In this case, the Court focused on the precise mechanism of the Maryland program which required load serving entities (LSEs) in Maryland to enter into a 20-year pricing contract with a new gas-fired generator owned by CPV Maryland, LLC (CPV). To understand the Court’s holding, it is necessary to understand a bit about FERC’s capacity auctions.

FERC Capacity Auctions

To ensure there is a sufficient amount of capacity to meet forecasted demand, grid operators around the country hold capacity auctions in which capacity owners bid their resources. The grid operator accepts bids, starting with the cheapest resources, until it acquires sufficient capacity to meet projected demand. The final accepted bid sets the clearing price of the auction and all of the accepted bidders receive that same price for their capacity, regardless of the price they bid into the auction. The grid operator then requires LSEs to purchase their share of capacity at the auction clearing price. In theory, higher prices in the capacity auctions will encourage the development of new generation thereby ensuring there are sufficient resources to meet future demand at a reasonable price.

Maryland’s Program

Maryland believed the PJM auction, which covers 13 Midwestern and Mid-Atlantic states, was failing to encourage the development of sufficient new in-state generation. To address the perceived generation shortfall, the Maryland Public Service Commission ordered LSEs to enter into 20-year contracts with a chosen generator, CPV. The contract was what is sometimes referred to as a “contract for differences.” Under CPV’s contract, it was required to participate in the PJM capacity auction, but it was guaranteed to receive the contract price if it cleared the auction, regardless of the auction’s clearing price. The LSEs were required to pay the difference between the PJM auction clearing price and the contract price (If the clearing price was higher than the contract rate, CPV would be required to reimburse the LSEs for the difference). For example, if the auction clearing price was $40/unit but the special contract price was $50/unit, CPV would receive the $40/unit through the auction but would also receive the difference of $10/unit from the LSEs.

Under its contract, if CPV failed to clear the PJM auction, it received nothing. CPV’s only incentive in participating in the PJM auction was to bid as low as it could to clear the auction and get paid under its contract. CPV was therefore distorting the capacity auction price because it would not bid based on its own cost of providing capacity, but to clear the auction at any price.

A Narrow Holding

The Court concluded that Maryland’s program intruded on FERC’s exclusive jurisdiction over wholesale power sales under the Federal Power Act because, in effect, Maryland’s scheme set a different wholesale rate than the rate set by the PJM auction. Although states can provide subsidies for in-state generation, the Court explained that they cannot do so in a way that disregards FERC’s wholesale rate. The fatal flaw of Maryland’s program was that it operated within the PJM capacity auction itself. As the Court explained: “So long as a State does not condition payment of funds on capacity clearing the auction, the State’s program would not suffer from the fatal defect that renders Maryland’s program unacceptable.”

It is likely that Maryland and other states will still be able to achieve their generation goals without running afoul of the Court’s holding in Hughes. The Court’s holding is a relief to some renewable energy advocates who were worried that a sweeping decision could prevent states from encouraging renewable energy development within their own borders.