State energy initiatives designed to support new generation and existing resources through price guarantees are increasingly subject to challenge at the Federal Energy Regulatory Commission (FERC) and in state and federal courts, including at the U.S. Supreme Court. Incumbent generators have alleged that these types of state programs are impermissible because they allow participating generators to distort price signals in wholesale capacity and energy markets subject to FERC’s jurisdiction. The outcome of, and reactions to, the legal proceedings could have significant market implications because, in the absence of these state initiatives, new generation resources may have difficulty entering the market and existing resources may no longer be competitive enough to remain in the market.

The most high-profile challenge to a state energy program, which was decided by the Supreme Court on April 19, 2016 in Hughes v. Talen Energy Marketing, involved an effort by the State of Maryland to incentivize the construction of new generation within the state. The Maryland Public Service Commission (Maryland PSC) required three electric distribution companies to enter into long-term agreements with a new generator that would effectively guarantee the price the generator received for both capacity and energy sold in the wholesale markets operated by PJM Interconnection, LLC (“PJM”). The agreements were structured as “contracts-for-differences” which ensured that the generator received payments to make up any shortfall between the contract price and the PJM market price. Each utility would then pass on the costs associated with the long-term agreement to its ratepayers. The Court determined in Hughes that the Maryland program violated FERC’s authority over wholesale rates under the Federal Power Act because the contract guaranteed the generator a rate for capacity which was 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 clarified, however, that states remain free to encourage new generation through 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.

Market participants also have begun to challenge proposals designed to support existing generation resources. In particular, a recent decision by the Ohio Public Utilities Commission (Ohio PUC) to allow subsidiaries of American Electric Power (AEP) and First Energy to enter into Power Purchase Agreements (PPAs) with affiliated generators has generated controversy because the costs of the PPAs (net of capacity and energy sales in the PJM market) are recovered through non-bypassable charges assigned to retail rate customers. In addition to challenging the Ohio PUC’s decision in state proceedings, a coalition of existing generators has filed a complaint at FERC alleging that the PPAs, as backed by the non-bypassable retail rate charges, will distort prices in PJM by permitting allegedly out-of-market generators to participate in the market without regard to recovering their costs. This coalition of generators has requested that FERC subject the AEP and First Energy generation affiliates to offer price mitigation to “prevent the artificial suppression of prices in the [PJM Capacity Market] by below-cost offers for existing resources whose continued operation is being subsidized by State-approved out-of-market programs.”

The fate of state-supported generation initiatives could have significant impacts on organized wholesale markets as these programs can determine, in part, which resources participate and clear in the market. While Hughes provided additional guidance to states developing new programs by drawing a line at whether the state subsidies are tied to the generator clearing its capacity and energy in the market, 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 existing generation resources.