The Energy Policy Act of 2005 ("EPAct 2005") established a national policy to encourage reliable and affordable demand response services. Demand response refers to the ability of retail electric customers to reduce or shift their load when demand for electricity is highest in order to lower electricity prices and avert 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 one degree higher to reduce its load on an August afternoon), but several markets have created opportunities for aggregated small retail customers as well.
Demand response providers have long participated in the wholesale market, bidding in demand response resources to offset the need for additional energy generation, but the compensation for such providers has varied from one regional energy market to the next. To encourage greater demand response participation in wholesale markets, the Federal Energy Regulatory Commission ("FERC") issued Order No. 745 in 2011, amending its regulations to require compensation for demand response resources participating in FERC-regulated wholesale power markets at the locational marginal price ("LMP"). LMP is the benchmark of compensation used for wholesale generation resources. In other words, a demand response participant would get paid the same amount not to use electricity at peak times that an electric 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, challenged Order No. 745 in the U.S. Court of Appeals for the District of Columbia ("D.C. Circuit"). In March 2014, the D.C. Circuit struck down Order No. 745, holding that FERC lacked jurisdiction under the Federal Power Act to regulate demand response. That court reasoned that because demand response providers are retail market participants, the Federal Power Act bars the federal government from regulating them, and instead reserves such regulation to the States. The D.C. Circuit also concluded that the decision to set compensation at the LMP was arbitrary and capricious.
The U.S. Supreme Court granted certiorari and sought to resolve two issues: (1) does FERC have authority under the Federal Power Act to regulate payment for demand response in wholesale electricity markets (the jurisdictional question), and (2) did the Court of Appeals err in determining that it was arbitrary and capricious for FERC to require wholesale energy markets to provide direct compensation to demand response resources at the LMP (the merits question)?
On October 14, 2015, the U.S. Supreme Court heard arguments in Federal Energy Regulatory Commission v. Electric Power Supply Association, et al. Eight Justices heard the case (Justice Alito recused himself), and there seems to be a real chance of a four-four split. From the questioning at the oral argument, it appeared that Justices Scalia and Roberts sided with EPSA and that Justices Breyer and Sotomayor sided with FERC. While they were much quieter at the oral argument, based on their voting records, it is a fair guess that Justice Thomas will join his conservative-leaning colleagues and side with EPSA and that Justices Ginsburg and Kagan will side with FERC. The conservative Justices will probably see this as a federalism case and resolve it based solely on the jurisdictional provision of the Federal Power Act, reserving regulation of the "sale of electric energy" in the retail market to the States. The liberal-leaning Justices, by contrast, are far less likely to see this case as one about federalism and will likely apply Chevron deference to FERC on both the jurisdictional and the merits questions.
As is not uncommon, Justice Kennedy may be the swing vote. The nature of his questions suggested that Justice Kennedy was leaning toward EPSA's side, but he appeared to be genuinely searching for responses and not pre-set in his views. Justice Kennedy's questions indicated that he viewed the case as presenting an issue of federalism, and that he thinks it is important to understand where the line between federal and state power lies. He also appeared to think that FERC's motives for adopting the rule changes set forth in Order No. 745 (namely, to bring down wholesale energy prices and avert blackouts) did not matter if the effect of the rule was to drive electricity rates in the retail market. In addition, Justice Kennedy expressed concern that FERC had not adequately explained the rule. He seemed particularly concerned that FERC was relying on a circular argument: that market forces will work everything out when FERC itself was creating the market (he made this point twice). Justice Kennedy was the only Justice who took interest in this second question (the merits question), suggesting that he was not decided on the first issue (the jurisdictional question).
If the case results in a four-four split, the D.C. Circuit's opinion will be upheld without an opinion. Some commentators have suggested that if that were the outcome, we would already know because if the Justices split four-four at conference, they would quickly issue a one-sentence order upholding the D.C. Circuit. But this is an important case, and even if the initial vote at conference were an even split there may well be jockeying for a fifth vote on both sides. The Supreme Court is unlikely to release an order disposing of the case while any Justice is still working to convince others. For example, it is possible that Justice Kennedy will cobble together a compromise with the liberal Justices to say that FERC has jurisdiction to regulate demand response in the wholesale markets, but that FERC did not adequately explain its decision to adopt LMP as the benchmark for compensation. Such a result likely would be more appealing to the liberal Justices than a split upholding the D.C. Circuit's decisions. It also might quell Justice Kennedy's concerns about how FERC developed and supported its demand response rule. But the most likely outcome remains a four-four split upholding the D.C. Circuit's decision without an opinion.
A copy of Order No. 745 can be found here.