January 25, 2016

Supreme Court Decides Federal Energy Regulatory Commission v. Electric Power Supply Association and EnerNOC, Inc. v. Electric Power Supply Association

On January 25, 2016, the United States Supreme Court decided Federal Energy Regulatory Commission v. Electric Power Supply Association, No. 14-840, together with EnerNOC, Inc. v. Electric Power Supply Association, No. 14-841, holding that the Federal Power Act (FPA) authorizes the Federal Energy Regulatory Commission (FERC) to regulate wholesale market operators’ compensation of demand-response bids, and that FERC’s decision to compensate demand-response providers at the same price paid to generators was not arbitrary or capricious.

The FPA, 16 U.S.C. § 791a et seq. authorizes FERC to regulate “the sale of electric energy at wholesale in interstate commerce,” including both wholesale electricity rates and any rule or practice “affecting” those rates. But the law gives the states (and withholds from FERC) the right to regulate “any other sale” of electricity—most importantly, any retail sale. In short, FERC gets to regulate the wholesale market, while the states regulate the retail market.

The problem with that seemingly tidy division is that the wholesale and retail markets affect one another; regulation of one can affect the other.

Wholesale markets in most of the country are managed by seven nonprofit market operators. Those operators conduct auctions to balance supply and demand on a continuous basis. The operators receive orders from utilities and other wholesale buyers of power for electricity that they need at various times, and bids from generators of electricity specifying how much they will produce and at what price at those times. The operators would accept bids from suppliers in ascending order of their bids (i.e., accepting lower bids first). But during high-demand periods, this fairly simple auction process can result in both high wholesale prices and increased power usage that might overtax the nation’s power grid. Thus, approximately 15 years ago, market operators began using a practice called “demand response” in managing the wholesale market. They began accepting from wholesale buyers not only orders for electricity, but also bids for a price that they would accept to not use electricity at given times. Allowing such bids would both reduce the wholesale price of electricity, and also decrease the risk of overtaxing the power grid during high-demand times.

Demand response was such a hit that both FERC and Congress developed rules and policies that actively encouraged it. And in 2011, FERC issued the order that is at issue in these cases. It determined that in two specified conditions, demand-response bidders must receive as much for conserving electricity as the generators receive for producing it—in more technical terms, to pay demand-response bidders the same “locational marginal price” that generators of electricity are paid to supply electricity at a given time.

The Electric Power Supply Association challenged FERC’s rule on this point, arguing that it effectively regulated the retail market by encouraging users of electricity to decrease their levels of retail electricity consumption. A divided panel of the D.C. Circuit agreed and vacated the rule, holding that FERC lacked authority to promulgate the rule. The court ruled alternatively that FERC acted arbitrarily and capriciously by failing to adequately explain why paying the locational marginal price to demand-response bidders did not overcompensate those bidders by giving them the full value of locational marginal price plus the savings associated with reduced compensation.

The Supreme Court reversed. The Court started by adopting a previous D.C. Circuit holding that FERC’s jurisdiction over wholesale markets is limited to rules or practices that directly affect the wholesale rate, as a contrary rule would result in FERC having jurisdiction over nearly any transaction, as nearly all transactions have at least an indirect effect on both wholesale and retail markets. The Court then concluded that standard was easily met here, because wholesale demand response is all about reducing wholesale rates, as are the rules and practices that determine how those programs operate. The Court concluded that the rule did not regulate retail electricity sales in violation of section 824(b) of the FPA because its rule addressed only transactions occurring on the wholesale market. The fact that its rule ultimately affects retail rates does not matter, as that effect is indirect, and not the product of direct regulation of the retail market. The Court determined that every aspect of FERC’s plan happened exclusively on the wholesale market, and that FERC’s justifications are all about, and only about, improving the wholesale market. The Court concluded that the contrary view would conflict with the core purposes of the FPA, as Electric Power Supply Association conceded that states could not regulate wholesale demand response, so the result of its argument would be that nobody could regulate the practice. That would contradict FPA’s central purpose of protecting against excessive prices and ensuring effective transmission of electric power.

Lastly, the Court held that FERC’s decision to compensate demand-response providers at the same price paid to generators was not arbitrary or capricious because FERC gave a detailed explanation of its decision and considered and responded at length to contrary views.

Justice Kagan delivered the opinion of the Court, in which Chief Justice Roberts and Justices Kennedy, Ginsburg, Breyer and Sotomayor joined. Justice Scalia wrote a dissenting opinion, in which Justice Thomas joined. Justice Alito took no part in the consideration or decision of the cases.

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