On June 28, U.S. Court of Appeals for the Second Circuit issued a decision in Allco Finance Ltd v. Klee in which the court rejected a challenge to Connecticut’s renewable energy program. The court found that the program neither encroached on the Federal Energy Regulatory Commission's (FERC) exclusive jurisdiction over wholesale energy rates nor violated the dormant Commerce Clause. As one of the first federal court decisions to address the legality of state energy programs since the Supreme Court’s holding in Hughes v. Talen Energy Marketing, LLC, 136 S.Ct. 1288 (2016), the Allco decision could influence the outcome in pending cases challenging zero emission credits (ZECs) for nuclear plants in New York and Illinois. The decision also could bolster—or threaten—the viability of several state renewable energy programs.

We have previously discussed the Second Circuit case. In brief, a Connecticut statute authorizes the state Department of Energy to conduct an auction in which qualifying renewable energy sources compete to supply green energy to the state’s two utilities. The Department “directs” the utilities to enter into long-term bilateral contracts with the winning bidders. Connecticut conducted an auction in 2015 as part of a multi-state renewable energy solicitation with Massachusetts and Rhode Island. In September 2016, Connecticut announced that the winning bidders from that auction were ready to be awarded contracts with state utilities. A Second Circuit order put the procurement on hold pending the court’s decision on an appeal taken by Allco, a solar power developer, though it later lifted the injunction following oral argument.

Allco’s Challenge

Allco challenged two parts of Connecticut’s renewable energy program. Allco alleged that the 2015 auction and 2016 award of contracts intruded on FERC’s exclusive jurisdiction under Hughes. Notably, Allco did not assert that the contracts awarded under the Connecticut program have prices tethered to the New England independent system operator (ISO) market or require suppliers to submit bids that clear that market. Indeed, renewable resources are not even required to bid into the New England ISO market under the Connecticut program.

Allco instead argued that any state mandate for the purchase of renewable energy interferes with the FERC-established markets. According to Allco, a state can direct utilities to make wholesale energy purchases only under the limited authority granted by The Public Utility Regulatory Policies Act (PURPA). Under Allco’s theory, Connecticut’s auction is not authorized by PURPA because the state allows participation by renewable resources that are not qualifying facilities under PURPA.

Allco also contested the legality of Connecticut’s renewable portfolio standard (RPS). Connecticut requires utilities that sell to Connecticut consumers to include a certain percentage of renewable energy in their portfolios. Utilities can satisfy that requirement by purchasing clean energy and an associated renewable energy certificate (REC) from a generator, by buying RECs through NEPOOL, or by owning renewable energy resources. Allco argued that the RPS violated the dormant Commerce Clause because only generators that are either in the New England ISO or immediately adjacent to the New England ISO can satisfy the standard, thereby excluding Allco’s solar units in Georgia.

Preemption

The Second Circuit panel rejected each of Allco’s arguments. First, the court found that Allco did not meet its burden of showing that the Connecticut auction process “compelled” or “forced” utilities to enter into contracts with specified generators at specified rates. The court noted that the Connecticut RFP expressly states that it does not obligate any utility to accept any bid and that winning bidders must negotiate the terms of their contracts with utilities.

The Second Circuit also rejected Allco’s claim that Connecticut’s RFP was essentially identical to the Maryland scheme found to be preempted in Hughes. According to the panel, while Maryland sought, in effect, to override the terms set by the FERC-approved PJM auction, Connecticut’s program sets energy prices based on an auction conducted outside an RTO or ISO. The program calls for the winning bidders to enter into bilateral contracts with the utilities independent of the New England ISO market. The court also found it significant that the bilateral contracts are subject to FERC review for reasonableness.

Allco’s assertion that the RFP regulates the wholesale interstate energy market outside the exception contemplated by PURPA also failed. Allco argued that the RFP would increase electricity supply available to Connecticut utilities, placing downward pressure on the “avoided cost” that Allco’s QFs could receive under Section 210 of PURPA, and that this pressure, in turn, will have an effect on wholesale prices, thereby infringing upon FERC’s regulatory authority. Citing Hughes and FERC v. Electric Power Supply Association, 136 S. Ct. 760 (2016), the Second Circuit deemed this “incidental” effect on wholesale prices too attenuated to constitute regulation of the interstate wholesale electricity market.

Dormant Commerce Clause

The Court also dismissed Allco’s dormant Commerce Clause claims. Allco contended that Connecticut discriminates against Allco’s Georgia facility because it does not let that facility’s RECs count towards the Connecticut utilities’ RPS requirements. Allco also argued that Connecticut discriminates against Allco’s New York facility because the RPS program requires producers of RECs in adjacent control areas to pay transmission fees in order to sell their RECs to Connecticut utilities.

The Court began by noting that RECs are inventions of state property law whereby the renewable energy attributes are “unbundled” from the energy itself and sold separately. The Court had no trouble concluding that the RECs produced by Allco’s Georgia facility are a different product from the Connecticut RECs. The Court also noted that RECs produced in Georgia would not satisfy Connecticut consumers’ legitimate need for a more diversified and renewable energy supply, accessible to them directly through their regional grid or indirectly through adjacent control areas.

Allco’s claim that its New York facility has suffered discrimination because it has had to pay transmission fees in order for its RECs to qualify under the RPS program fared no better. The court found that Allco failed to plead that such charges are anything more than use fees, analogous to road tolls, which regularly pass constitutional muster.

Implications for Illinois and New York

Although the Second Circuit’s rationale in Allco generally bolsters proponents of the New York and Illinois ZEC programs, those programs differ in several respects from the Connecticut renewable program at issue in Allco. For example, both the New York and Illinois ZEC programs require nuclear power plants to generate power to be eligible for credits, meaning they must be dispatched by NYISO, PJM, or MISO. The plants can self-schedule, thereby making them price takers, which arguably has less of an impact on auction prices than the Maryland program was perceived in Hughes to have on PJM capacity market prices. Nevertheless, the impact of ZEC programs on wholesale prices in FERC-regulated markets is arguably less incidental than the Connecticut program.

Opponents of ZEC programs, at least in Illinois, may seize on the fact that Connecticut’s RPS program makes geographic distinctions between RECs that piggyback market boundaries drawn by FERC. By contrast, Illinois has drawn geographic lines of its own choosing—namely its state border. That said, the Illinois ZEC program does not specifically limit the program to Illinois facilities, instead focusing on facilities with carbon dioxide emissions and other air pollutants that affect Illinois. And, as noted above, the Court recognized the legitimate state interest in a diversified, clean energy supply.

Illinois’ REC program may be more at risk than the ZEC program, as the former allows participation by out-of-state generators only if an Illinois agency is satisfied that the out-of-state generator promotes the health, safety, and welfare of Illinois residents. Courts may regard such a vague standard skeptically.

At bottom, while the Second Circuit decision in Allco may give ZEC proponents some cause for optimism, the unique features of the Connecticut renewable program may make it easier for federal courts in Illinois and New York to distinguish the decision. Thus, the Second Circuit’s ruling provides no assurance that courts will find the Illinois and New York ZEC programs (or REC programs for that matter) pass constitutional muster.