States have long been tempted to implement laws and regulations that have the effect of protecting in-state resources at the expense of interstate competition. In cases going back to the founding days of the republic, the U.S. Supreme Court has read the Constitution's Commerce Clause to outlaw protectionist state legislation.

But the boundaries between what is and is not permissible state regulation are frequently the subject of court disputes. Setting the stage for a possible Supreme Court tussle over one such dispute, a split Ninth Circuit last week denied rehearing en banc to the Rocky Mountain Farmers Union – ethanol suppliers who had unsuccessfully challenged the constitutionality of a California regulation they claim discriminates against out-of-state fuel producers. Rocky Mountain Farmers Union, et al. v. Corey, No. 12-15131 (9th Cir. January 22, 2014).

The fuel suppliers had been joined in seeking rehearing by a coalition of state attorneys general from eight ethanol producing Midwestern states – Nebraska, Iowa, Kansas, Missouri, Michigan, North Dakota, Ohio and South Dakota. California's regulations, they said, “close[] the California border to ethanol produced in Amici States in favor of chemically-identical ethanol produced within California . . . .” Last September, the Ninth Circuit had overturned a 2011 district court ruling that the regulations were unconstitutional under the "dormant Commerce Clause.” Rocky Mountain Farmers Union v. Corey, 730 F.3d 1070 (2013).

The strongly diverging sentiments of the Ninth Circuit judges spilled over into their opinions on whether to grant rehearing. The "dissent," said Judge Gould in explaining opposition to rehearing the case, was "riddled with overstatements." Stating his expectation that petitions for certiorari would be "likely forthcoming," the judge maintained that the seven dissenting judges were trying to put a thumb on the scales. The dissent's "tone and substance," he said, appeared "aimed at encouraging Supreme Court review." The dissenting judges didn't mince words either, criticizing the majority for upholding a decision that "finds at least facially constitutional a protectionist regulatory scheme that threatens to Balkanize our national economy." This case is likely to be a battleground over whether various state laws and rules to reduce carbon emissions are permissible state environmental regulation or protectionist legislation barred by the Commerce Clause as means to impede out-of-state competitors.

BACKGROUND

The low carbon fuel standard, or LCFS, is a regulation adopted by the California Air Resources Board (CARB) to implement California’s Global Warming Solutions Act of 2006. To comply with the fuel standard, fuel suppliers must keep the average "carbon intensity" of their total volume of fuel below the fuel standard's annual limit. Carbon intensity measures the extent to which carbon is consumed in the production, transportation and use of the fuel. Fuels generate credits or deficits, depending on whether their carbon intensity is higher or lower than the annual cap.

There was no dispute in the case that "the LCFS does attribute different carbon intensity values to fuels from different geographic areas" or that out-of-state ethanol producers had higher carbon intensity values than their California counterparts. The main controversy centered around whether this amounted to "facial discrimination" against out of state fuel sources. The lower court had earlier upheld Rocky Mountain's claim that it did. Rocky Mountain Farmers Union v. Goldstene, 843 F.Supp.2d 1071, 1090, 1093 (E.D.Cal.2011). And because there is a "virtually per se" rule against protectionist legislation,Minnesota v. Clover Leaf Creamery Co., 449 U.S. 456, 471(1981), California had appealed the lower court ruling to the Ninth Circuit, which reversed the district court's opinion last September. Rocky Mountain Farmers Union v. Corey, 730 F.3d 1070 (2013).

At the heart of the disagreement on the Court was their differing views on what constituted facial discrimination. (A secondary issue was whether California's fuel regulations amounted to unconstitutional extraterritorial regulation of fuel standards in other states.) Judge Smith, writing for six of the seven dissenting judges, maintains that the test for determining “whether a regulation facially discriminates against interstate commerce begins and ends with the regulation’s plain language” and that the regulations, on their face, treat in and out of state ethanol manufacturers differently. In his concurrence to the January 22, 2014 order denying rehearing en banc, Judge Gould maintained that the state regulation was not facially discriminatory. While the regulations contained geographic-based default classifications, he said, they also allowed for out-of-state suppliers to make "individualized" demonstrations that their own fuels had a lower carbon impact. And, he added, the ethanol producer with the lowest carbon intensity was, in fact, from the Midwest not California.

Judge Smith’s response to this argument was that the statutory burden to make the showing, by itself, evidenced facially disparate treatment. The majority, she argued, had confused the determination whether facial discrimination exists with the distinct Commerce Clause inquiry into whether a facially discriminatory statute or regulation might nonetheless be constitutional: “[W]hether California has good reasons for penalizing Midwestern ethanol simply has nothing to do with whether the state’s regulations are facially discriminatory.”

OBSERVATIONS

We are likely to hear more about this case, whether or not the Supreme Court grants review. As Judge Gould noted in his opinion concurring in denial of rehearing, the Ninth Circuit has not ruled the LCFS to be constitutional. Rather, it has only ruled that the regulations are not facially discriminatory and has remanded the case back to the district court. That court will still have to make a determination whether CARB’s regulations “discriminate in purpose or in practical effect.” Rocky Mtn. Farmers Union v. Corey, 730 F.3d 1070, 1078 (9th Cir. 2013). If it finds either to be the case, it must apply “strict scrutiny” to the provisions. Id. This means that California would be required to demonstrate both that the regulations served a compelling state interest and did so in the least competitively burdensome fashion. Maine v. Taylor, 477 U.S. 131, 140 (1986).

This promises to be an interesting inquiry. “I believe,” says Judge Gould, “that California made its geographic distinctions based on the carbon impact and intensity of various fuels, not on their state-of-origin.” But the dissent points to ammunition for those who would argue that the CARB regulations were as much about in-state job protection as environmental protection: “CARB acknowledges that the Fuel Standard will “reduc[e] the volume of transportation fuels that are imported from other states . . . . As such, CARB expects that the regulations will “keep[] more money in the State,” and that they “will provide needed employment, [and] an increased tax base for the State . . . .”

Even if the regulations do not discriminate in intent or effect, the lower court will still have to apply the balancing test established in Pike v. Bruce Church, Inc., 397 U.S. 137 (1970) to determine whether the burden the regulation imposes on interstate commerce is reasonable in light of the benefits.

The Rocky Mountain litigation has broad implications beyond legislation regulating the sale of fuel. Electric utility renewable portfolio standards that might be construed to favor in-state resources would be subject to potentially similar claims. Although it did not act to preempt state law, several years ago FERC voiced criticism of California law SB2, which establishes renewable portfolio standards for the electric utility industry. SB2 requires that ¾ of the renewable resources California utilities procure to satisfy California's renewable portfolio target "must come from resources located in, directly connected to, or delivering in real-time to California." Citing the uncertainty created by this requirement, FERC approved Pacific Gas and Electric's filing for recovery of the costs of abandoning its participation in a renewable energy project located in the Pacific Northwest. Pacific Gas & Electric Co., 137 FERC ¶ 61,192 at P22 (2011). California and other states might face challenges that their own renewable portfolio standards are aimed, not at promoting use of renewable resources, but at protecting local industry from competition.