Updates

On January 25, 2016, the Supreme Court of the United States issued a decision upholding a rule issued by the Federal Energy Regulatory Commission (“FERC”) requiring operators of organized wholesale markets to pay electricity consumers the same price for conserving energy during high-demand periods as generators are paid for producing the energy. The decision, Federal Energy Regulatory Commission v. Electric Power Supply Association, overturns a Court of Appeals for the District of Columbia Circuit (“D.C. Circuit”) ruling issued in 2014 finding that FERC’s rule impermissibly intruded upon the states’ authority over retail electricity markets. The Court’s decision clarifies that FERC has authority under the Federal Power Act (“FPA”) to regulate any practice that “affects” wholesale power markets, so long as the effect is sufficiently “direct” and does not regulate retail rates. The Court’s decision also removes uncertainty regarding the participation of demand response resources in wholesale markets.

Background

The FPA attempts to establish a clear boundary between federal and state authority over the nation’s electric power industry. Under the FPA, FERC has jurisdiction over the “sale of electric energy at wholesale in interstate commerce,” including both wholesale electricity rates and any rule or practice “affecting” such rates.1 The states retain exclusive jurisdiction over “any other sale” of electricity (i.e., retail sales).2 However, the wholesale and retail markets are interdependent, with regulation in one sphere inevitably affecting the other. Thus, the line between the regulatory provinces of FERC and the states can be challenging to discern. 

In recent years, FERC has sought to regulate price fluctuations in wholesale markets and improve reliability by encouraging consumers to reduce their consumption of electricity during periods of peak demand. In 2011, FERC issued Order No. 745, which required wholesale market operators to compensate demand response providers in the same way they compensate generators who sell power in wholesale markets as long as the demand response resource provided “net benefits” (i.e., the resource would actually reduce costs for wholesale purchasers). Order No. 745 also required wholesale purchasers, who benefit from the lower prices demand response creates, to share proportionately the cost of demand response payments.

Electric Power Supply Association and other industry representatives challenged Order No. 745, arguing that FERC lacked the statutory authority to regulate what they considered retail market activity. They also asserted that FERC failed to adequately consider reasonable objections to the practice of compensating demand response resources at the same rate as wholesale providers. The D.C. Circuit agreed with the challengers and struck down Order No. 745, concluding that demand response is “part of the retail market” because it “involves retailcustomers, their decision whether to purchase at retail, and the levels of retail electricity consumption.”3   Accordingly, the D.C. Circuit held that demand response is beyond FERC’s regulatory reach. The D.C. Circuit held, alternatively, that Order No. 745 was arbitrary and capricious because it failed to address “reasonable (and persuasive) arguments” that Order No. 745 would result in unjust and discriminatory rates by overcompensating demand response resources.4 

FERC petitioned the Supreme Court to review the case. In May 2015, the Court granted FERC’s petition, and an eight-justice panel heard oral arguments on October 14, 2015.

Decision

In a 6-2 opinion delivered by Justice Kagan, the Court disagreed with both holdings of the D.C. Circuit. In so deciding, it first turned to the question of whether FERC has the authority to regulate wholesale market operators’ compensation of demand response bids. The Court began by considering whether the practices at issue in Order No. 745—market operators’ payments for demand response commitments—affect wholesale rates. Adopting a “common-sense construction” of the FPA, the Court determined that “FERC’s ‘affecting’ jurisdiction” is limited to “rules or practices that directly affect the [wholesale] rate.”5  The Court then determined that the practices at issue in Order No. 745 directly affect wholesale rates and therefore fall squarely within FERC’s jurisdiction under the FPA because “every aspect of [Order No. 745] happens exclusively on the wholesale market and governs exclusively that market’s rules.”6 

The Court clarified, however, that FERC cannot act in a way that would regulate retail sales, “no matter how direct, or dramatic, its impact on wholesale rates.”7  Accordingly, the Court next considered whether FERC regulated retail electricity sales through Order No. 745, and determined that, even though the order affected retail customers and retail markets, Order No. 745 did not regulate retail sales. Specifically, the Court affirmed that “FERC regulation does not run afoul of [the FPA] just because it affects—even substantially—the quantity or terms of retail sales.”8  On the contrary “[w]hen FERC regulates what takes place on the wholesale market, as part of carrying out its charge to improve how that market runs, then no matter the effect on retail rates, [the FPA] imposes no bar.”9   

Finally, the Court concluded that a contrary determination would limit FERC’s ability to protect against excessive wholesale prices and maintain reliability during periods of peak demand. Given the record evidence demonstrating how demand response programs assist FERC in achieving its statutory obligation, the Court concluded that such an outcome would flout the FPA’s core objectives. 

The Court also rejected the D.C. Circuit’s finding that FERC’s decision to compensate demand response providers at the same price paid to generators was arbitrary and capricious. The Court held that its sole task is to determine whether FERC weighed competing views, selected a compensation formula with adequate support in the record, and intelligibly explained the reasons for making that decision. Because FERC provided a detailed explanation of its choice and responded at length to contrary views, the Court found that FERC satisfied that standard.

A copy of the decision can be found here.