On June 12, 2018, the U.S. Court of Appeals for the District of Columbia Circuit (“D.C. Circuit”) rejected challenges to FERC orders modifying PJM’s financial transmission right (“FTR”) and auction revenue right (“ARR”) designs. FERC had ordered changes to PJM’s FTR/ARR designs to address PJM’s inability to make all of the payments owed to FTR owners.

In PJM, market participants can purchase FTRs at auction to hedge against transmission congestion costs. FTRs entitle their holders to receive a payment from PJM if a “source” node in PJM specified in the FTR is more congested, and thus higher priced, than a “sink” node, based on day-ahead pricing. Alternatively, if the “sink” node is more congested than the “source” node, the FTR holder must pay PJM. In addition, PJM allocates ARRs to load-serving entities (“LSEs”), which allow the LSEs to receive a portion of FTR auction revenue. Between 2010 and 2014, PJM could only pay between 69 and 85 percent of the amounts entitled to FTR holders. As a result, ARRs were less valuable because FTRs did not receive full payments from PJM and, therefore, were less valuable at auction.

To address these issues, on October 19, 2015, PJM filed proposed revisions to its FTR and ARR provisions seeking to minimize or eliminate cross-subsidies between holders of FTRs and ARRs. On September 15, 2016, following a technical conference, FERC found that PJM had demonstrated that its market designs were unjust and unreasonable (“September 15 Order”). In addition, FERC required PJM to revise its FTR/ARR designs to, among other things, remove the costs of “balancing congestion” – costs arising from imbalances between transmission capacity in the real-time market and the day-ahead market that are unrelated to the day-ahead market – from the FTR funding mechanism and exclude unused transmission paths from the ARR-allocation methodology, but ordered PJM to retain the practice of netting amounts owed to FTR holders against amounts owed by FTR holders to PJM. The petitioners sought review by the D.C. Circuit of FERC’s September 15 Order and the associated order denying rehearing. In particular, the petitioners argued that FERC should have required PJM to (1) retain “balancing congestion” in the definition and funding source of FTRs; (2) stop netting amounts owed under FTRs; and (3) retain unused transmission paths in PJM’s ARR-allocation methodology.

In denying the petitions for review, the D.C. Circuit held that the petitioners could not overcome the deference reviewing courts give FERC for issues related to rate design. With respect to the exclusion of “balancing congestion,” the D.C. Circuit held that FERC reasonably determined that including “balancing congestion” in FTRs “reduces the efficacy of FTRs as a hedge” and that FERC adequately explained that it is reasonable to require the entire market to bear the costs of “balancing congestion,” because FTR holders are not the sole beneficiaries. Moreover, the D.C. Circuit held that FERC reasonably concluded that eliminating PJM’s netting practice would not address the fundamental issues with PJM’s FTR and ARR designs. Lastly, the D.C. Circuit held that FERC’s elimination of outdated transmission paths from the formula used to allocate ARRs was reasonable, particularly because artificially increasing growth forecasts did not address the root issue of the FTR/ARR designs and because doing so would have distorted the transmission planning process.

A copy of the D.C. Circuit’s opinion is available here.