On April 19, 2016, the Supreme Court of the United States, citing preemption by the Federal Energy Regulatory Commission’s (FERC) exclusive authority over wholesale rates under the Federal Power Act, issued an opinion rejecting state subsidies for new generation which supplement the price a generator receives in the wholesale capacity market with payments that are dependent on a generator clearing in the market. The decision, Hughes v. Talen Energy Marketing, affirms a decision by the U.S. Court of Appeals for the Fourth Circuit that held that state laws are preempted when they deny full effect to the rates set by FERC.

The Supreme Court made clear that not all state initiatives designed to foster new generation resources are impermissible, particularly those "untethered to a generator's wholesale market participation." Today's decision by the Court removes some of the uncertainty regarding the extent to which a state can provide subsidies or other support to new generation resources. Given the scope and breadth of current state energy initiatives, however, existing market resources are likely to continue to pursue challenges to state programs after Hughes.

BACKGROUND: THE STRUCTURE AND HISTORY OF THE STATE PROGRAM

Under the Federal Power Act, FERC alone may regulate “the sale of electric energy at wholesale in interstate commerce,” including "[a]ll rates and charges" for wholesale electricity.1 In organized wholesale power markets, FERC exercises its jurisdiction by regulating the design and operation of the markets. The states exercise authority to regulate electricity sold and distributed at the retail level, as well as the siting of electric generation facilities. The line of demarcation between federal and state regulation is the central question of Hughes.

The state program before the Court in Hughes was Maryland's "contract-for-differences" program which was designed to improve electric reliability by encouraging the construction of new electric generation facilities within the state. In 2011, the Maryland Public Service Commission (Maryland PSC) offered generation developers an incentive to construct new facilities by establishing a program under which local electric distribution companies would enter into a fixed price 20-year contract with a developer for capacity cleared and sold into the PJM Interconnection, LLC (PJM) wholesale market. The developer would be selected by the Maryland PSC following a bidding process.

Under the contract-for-differences program, the developer would be required to construct a new electric generation facility in Maryland and sell all of its capacity and energy into the PJM market. In exchange, the contract would ensure the developer would receive the fixed contract price, and thus a guaranteed revenue stream, by providing for a payment of the difference if the price received in the PJM market for capacity was below the fixed price in the contract. The payment for differences would be made by the electric distribution companies ordered by the Maryland PSC to enter into contracts with the developer, but the electric distribution companies would not have any rights to the capacity sold into the market by the developer. Conversely, if the developer received a higher price in the PJM market than the contract price, the developer would pay the electric distribution companies for the difference, passing on revenues exceeding the contract price. The final structure of the program was formalized in an order issued in 2012 by the Maryland PSC.2

The Maryland PSC awarded CPV Maryland a contract-for-differences for a new 660-MW power plant, and directed Baltimore Gas and Electric Company, Potomac Electric Power Company, and Delmarva Power and Light Company to enter into the contract-for-differences with CPV Maryland.3 A group of existing electric generators who participate in the PJM market filed a lawsuit in the U.S. District Court for the District of Maryland alleging that the contract-for-differences program violates the Supremacy Clause of the U.S. Constitution because it sets rates for capacity and energy sold into the interstate wholesale market administered by PJM, intruding upon FERC’s authority under the Federal Power Act to set and regulate such prices. The District Court ruled in favor of the generators,4 and the Fourth Circuit affirmed.5

DECISION AND IMPLICATIONS

In a unanimous judgment, the Court affirmed the Fourth Circuit's determination that Maryland's payments to CPV Maryland effectively established a wholesale rate, thereby transgressing the division of authority between FERC and the states established by the Federal Power Act. The Court determined that the Maryland program violated FERC's plenary authority over wholesale rates because the contract guaranteed CPV Maryland a rate for capacity separate and distinct from the capacity clearing price that CPV Maryland would receive in the PJM capacity market. The Court's conclusion that the Maryland program was setting wholesale market rates rested on the fact that CPV Maryland was paid only if its offer cleared in the PJM capacity market. The Court distinguished permissible bilateral contracts that are entered into outside of the market from the Maryland contract-for-differences because the latter did not transfer ownership of the capacity from CPV Maryland to the state. The Court held that "[b]y adjusting an interstate wholesale rate, Maryland's program invades FERC's regulatory turf." The Court noted that while states remain free to pursue legitimate public policy objectives, they cannot intrude on FERC's authority over wholesale rates.

Significantly, the Court explained that its “holding is limited” and clarified that its ruling did not address the permissibility of other state programs that encourage the development of new or clean generation. The Court further clarified that “[n]othing in this opinion should be read to foreclose Maryland and other States” from encouraging new generation development through the use of measures such as tax incentives, land grants, and direct subsidies provided those measures do not “condition the payment of funds on capacity clearing an auction” regulated by FERC.

Today's decision clarifies for states, market participants, and developers the limits on mechanisms that states may employ to incentivize new generation. The Court confirmed that states have many permissible options available to promote new generation resources, but cautioned that incentives cannot be tied to a generator's participation in the wholesale markets regulated by FERC. This division of authority still leaves room for argument as to whether a particular state program is permissible. Given the number and diversity of state incentive programs and proposals, market participants are likely to continue to contest state actions that benefit new, and even existing, generation resources.