Supreme Court: FERC Has Authority to Regulate Electricity Market Demand Response Prices to Bolster Grid Reliability

Several energy cases have worked their way to the steps of the U.S. Supreme Court recently. On Monday January 25, 2016, the High Court issued its 6-2 decision in FERC v. Electric Power Supply Assn, et al., 577 U. S. ____ (2016) confirming that the Federal Energy Regulatory Commission (FERC) does have the authority under the Federal Power Act (FPA) to regulate whole­sale electricity market operators’ compensation of demand response bids. Only eight Justices considered the case, as Justice Alito did not participate. Oral arguments last year revealed that not all of the Justices viewed FERC’s regulation of demand response rates as regulating the wholesale electricity rates within its jurisdiction, leaving open the possibility that an even split among the Justices would allow the D.C. Circuit’s ruling to stand, depriving FERC of that authority. Ultimately, Justice Kagan was joined by Chief Justice Roberts and Justices Kennedy, Ginsburg, Breyer, and Sotomayor in reaffirming that FERC indeed has the power to regulate the methodology for determining the compensation paid to demand response participants in the wholesale electricity markets. Coming as no surprise based on arguments, Justice Scalia dissented from the majority opinion and was joined by Justice Thomas. You can read our previous post for details regarding the background of the case (which was consolidated with EnerNOC, Inc., et al. v. Electric Power Supply Association, et al. (14-841)) and major points of contention. We highlight key points of the Supreme Court’s analysis below.

The Value of Demand Response – Grid Reliability

In times of peak electricity demand (e.g. extreme heat or cold), consumers use more electricity which thereby increases the cost of wholesale electricity and the amount of strain on the power grid, leading to escalated prices, service interruptions and potential blackouts. The value of demand response:

Consider what would happen if wholesale market operators could induce consumers to refrain from using (and so LSEs from buying) electricity during peak periods. Whenever doing that costs less than adding more power, an operator could bring electricity supply and demand into balance at a lower price. And simultaneously, the operator could ease pressure on the grid, thus protecting against system failures. That is the idea behind the practice at issue here: Wholesale demand response, as it is called, pays consumers for commitments to curtail their use of power, so as to curb wholesale rates and prevent grid breakdowns.

In the Energy Policy Act of 2005 (EP Act), Congress declared as the nation’s policy that demand response “shall be encouraged.”

Don’t Be Hyperliteral: FERC’s Regulation Directly Affects Wholesale Rates, Does Not Regulate Retail

At issue is FERC’s Order No. 745, which requires wholesale market operators to use the same methodology to determine compensation for demand response participants as they use to compensate power generators that supply electricity to the wholesale market under specified conditions – i.e., locational marginal price (LMP). The FPA grants FERC the authority to regulate “the sale of electric energy at wholesale in interstate commerce,” including wholesale electricity rates and any rule and practice “affecting” those rates. Reserved to the states is the authority to regulate in-state wholesale electricity sales and retail electricity sales. On which side of the line the demand response activity that FERC attempted to regulate falls was central to this case. As the Supreme Court recognized “[t]hat statutory division generates a steady flow of jurisdictional disputes because—in point of fact if not of law—the wholesale and retail markets in electricity are inextricably linked.”

The Supreme Court majority believes FERC’s statutory authority to regulate wholesale market operators’ compensation of demand response bids is clear. Approving the “common-sense construction” of the FPA previously used by the D.C. Circuit, the Supreme Court clarified that FERC’s authority to regulate rules or practices “affecting” wholesale rates is limited to those rules and practices that “directly affect the wholesale rate.” In interpreting that limitation, the Court stressed “[a]s we have explained in addressing similar terms like ‘relating to’ or ‘in connection with,’ a non-hyperliteral reading is needed to prevent the statute from assuming near-infinite breadth.” That is, FERC’s authority certainly does not extend to regulating in “surprising places” like the steel, fuel, and labor markets which affect electricity demand. And in the majority’s view “the rules governing wholesale demand response programs meet that standard with room to spare.” The purpose of wholesale demand response is to reduce wholesale rates.

Nonetheless, the Court clarified further that FERC cannot issue a rule regulating retail sales “no matter how direct, or dramatic, its impact on wholesale rates.” But, that does not mean that FERC has overstepped its bounds “just because [a rule] affects—even substantially—the quantity or terms of retail sales”:

When FERC sets a wholesale rate, when it changes wholesale market rules, when it allocates electricity as between wholesale purchasers—in short, when it takes virtually any action respecting wholesale transactions—it has some effect, in either the short or the long term, on retail rates. That is of no legal consequence. When 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, §824(b) imposes no bar.

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And in setting rules for demand response, that is all FERC has done. The Commission’s Rule addresses—and addresses only—transactions occurring on the wholesale market.

The majority pointed to the fact that FERC’s rule allows States to prohibit consumers from submitting demand response bids in the wholesale market as further support. Giving the States this “veto power…removes any conceivable doubt as to its compliance with §824(b)’s allocation of federal and state authority.” Justice Scalia’s dissent, however, takes issue with the fact that demand response is not the wholesale sale of electricity (even if the rule does not regulate retail rates) because it does not involve the resale of electricity at all and therefore outside of FERC’s jurisdiction.

A Regulatory Void

If the EPSN had its way, how would demand response be regulated in the wholesale market? The Supreme Court majority stressed that the States certainly have no jurisdiction to regulate demand response bids into the wholesale market. If FERC lacked jurisdiction to regulate the demand response bids and demand response programs more broadly, there would be a regulatory void which the FPA sought to eliminate. “Some entity must have jurisdiction to regulate each and every practice that takes place in the electricity markets, demand response no less than any other.”

Without opining on whether it was the right decision, the Supreme Court also held that FERC’s decision to use the LMP methodology to determine compensation rather than the alternative methodologies proposed was not arbitrary and capricious. FERC “met its duty of reasoned judgment” by fully considering alternatives and adequately supporting and explaining its decision. With the FERC rule validated by the Supreme Court, the required methodology for compensating demand response bidders is expected to increase incentives for greater demand response participation by preventing lower compensation to demand response bidders, thereby providing a tool to help alleviate strain on the grid and electricity prices at times of peak demand.