May the Federal Energy Regulatory Commission (“FERC”) pay retail customers to consume less electricity in order to balance supply and demand in the wholesale-market electricity grid?
The Federal Power Act (“FPA”) empowers the Federal Energy Regulatory Commission (“FERC”) to regulate the transmission and sale of electric power in interstate commerce. FERC issued Order 745 to incentivize retail customers to reduce electricity consumption when economically efficient. Under the new order, the cost of incentive payments to retail customers to encourage reduced energy consumption is subsidized by entities participating in the wholesale electricity market. The Electric Power Supply Association (“EPSA”), along with four energy industry associations, brought suit under the Administrative Procedure Act alleging that the FERC’s Order 745 violates the FPA, because it invades the states’ exclusive jurisdiction to regulate the retail market. The Supreme Court will consider whether (1) the FPA extends authority to the FERC to create a methodology that wholesale-market operators must use to calculate the compensation payments in the demand response scheme, and (2) whether the court of appeals erred in holding that Order 745 is arbitrary and capricious. . The Court’s resolution of this case will impact the regulatory balance in the energy sector between federal and state governments.
Questions as Framed for the Court by the Parties
- Did the Federal Energy Regulatory Commission reasonably conclude that it has authority under the Federal Power Act, 16 U.S.C. 791a et seq., to regulate the rules used by operators of wholesale electricity markets to pay for reductions in electricity consumption and to recoup those payments through adjustments to wholesale rates?
- Did the Court of Appeals err in holding that the rule issued by the Federal Energy Regulatory Commission is arbitrary and capricious?
Under the The Federal Power Act (“FPA”), the Federal Energy Regulatory Commission (“FERC”) is charged with regulating the transmission and sale of electric power in interstate commerce. The FPA confines the FERC’s jurisdiction over the sale of electricity to the wholesale market. On March 15, 2011, the FERC issued Order 745, entitled “Demand Response Compensation in Organized Wholesale Energy Markets.” The order seeks to incentivize retail customers to reduce electricity consumption when economically efficient. Under the order, the cost of incentive payments to retail customers to encourage reduced energy consumption would have to be subsidized by entities participating in the wholesale electricity market.
Wholesale market operators, regulated by the FERC, run the wholesale-electricity market. These operators match supply and demand in order to set the rates for wholesale electricity sales. Typically, this means adjusting the amount of power supplied to the grid as the demand for electricity changes. Wholesale-market operators, however, can also balance supply and demand by paying some consumers to reduce their electricity consumption at particular times. This practice is called “demand response” and occurs when customers reduce their expected electric energy consumption in response to electric energy price increases or upon receipt of incentive payments to induce lower electricity consumption. The demand response payments that the wholesale-market operators pay to consumers are then recouped by adjusting wholesale rates. In Order 745, the FERC created a methodology that wholesale-market operators must use to calculate compensation payments included in a demand response scheme. The formula requires equal compensation for commitments by electricity customers to reduce demand and commitments by electricity generators to increase supply.
The Administrative Procedure Act (“APA”) directs courts to “hold unlawful and set aside agency action . . . in excess of statutory jurisdiction, authority, or limitations.” The FERC has the authority to regulate “only . . . those matters which are not subject to regulation by the States.” The Electric Power Supply Association (“EPSA”), along with four other energy industry associations (“Petitioners”), brought suit alleging that FERC’s Order 745 violates the FPA, because it violates the states’ exclusive jurisdiction to regulate the retail market. The FERC denied a rehearing of Order 745 on February 29, 2012. The Petitioners appealed to the Court of Appeals for the District of Columbia, which vacated Order 745. The FERC filed a petition for a writ of certiorari on January 15, 2015.
This case presents the Supreme Court with the opportunity to decide whether the FERC has authority under the FPA to regulate the rules used by operators of wholesale electricity markets to pay for reductions in retail electricity consumption, and to recover those payments through adjustments to wholesale rates. The FERC argues that it has the authority under the FPA to impose rules on wholesale-market operators, which includes the rule requiring wholesale-market operators to use the locational marginal price (“LMP”) when offering demand-response payments, because: (1) the plain text of the FPA confers this power, (2) the FPA does not forbid the FERC from regulating wholesale demand-response payments, and(3) the FPA does not bar the FERC from regulating practices that indirectly affect the retail market. The FERC further asserts that, even if the FPA is ambiguous on these points, the FERC is entitled to Chevron deference, because it came to a reasonable decision on a highly technical matter. However, the EPSA argues that the FERC does not have the necessary authority under the FPA, because Order 745 is an improper attempt to regulate retail sales (as opposed to the permitted wholesale sales). Furthermore, the EPSA argues that even if the FERC has authority, the rate for compensating demand response is “arbitrary and capricious” under the APA, because it is does not align with the FERC’s stated policy goal and the FERC cannot properly explain its position.
THE TEXT OF THE FPA
The FERC contends that the plain text of the FPA gives the FERC the authority to promulgate rules governing demand-response participation in organized wholesale energy markets. The FERC explains that it has a responsibility under the FPA to strike down any rule affecting wholesale energy markets that is “not just and reasonable,” and therefore, it contends that it has a similar responsibility to create just rules that result in reasonable wholesale rates. The FERC concedes that its authority is not boundless; for example it cannot be construed to reach any economic activity that affects wholesale rates indirectly. But FERC contends that Order 745 is well within that limitation. And FERC argues that its reading comports with Congress’ intent to fill a regulatory gap between federal and state law, but if the FERC could not regulate the compensation of demand-response commitments in wholesale markets, regulation would cease. The FERC asserts that the FPA does not bar the FERC from creating regulations that affect the retail market: The FERC has the responsibility to certify that rules affecting wholesale rates are “just and reasonable” even if those practices also indirectly affect retail rates. Further, EnerNOC argues that prior Supreme Court holdings support the position that the FERC can properly exercise jurisdiction even where it appears to indirectly infringe on the states’ exclusive jurisdiction.
But EPSA argues that FERC’s attempt to regulate demand response is not authorized by the FPA, because the FPA does not give FERC the power to regulate electricity retail sales, which are subject to regulation by the states, and the demand-response rule is an attempt to regulate these retail sales. The EPSA contends that FERC is attempting to do indirectly what it cannot do directly, by luring retail customers into the wholesale market, circumventing the FPA’s express intent. Therefore, the EPSA argues, the fact that wholesale-market operators are paying the demand-response payments is irrelevant: The FERC is using the wholesale-market operators to achieve its improper goal of regulating the retail market to reduce the amount of electricity customers consume. EPSA further argues that the FERC’s reading of the FPA is unreasonable because it is too broad: Just because the FPA gives the FERC authority to regulate “practices affecting wholesale rates” does not mean that the FPA takes away any of the states’ reserved police power to regulate the retail market. The California Public Utilities Commission additionally argues that the FERC’s reading of the FPA undermines the principles of cooperative federalism underlying the act: The FERC is supposed to work in concert with the states to increase opportunities for demand response in energy markets, but the FERC is coopting the states’ role.
FERC asserts that even if the FPA’s text were ambiguous regarding its power to regulate the demand-response rules, the FERC is entitled to Chevron deference, according to the Court’s decision in Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). According to Chevron, courts must defer to agency interpretations of ambiguous statutes, so long as the agency’s interpretation is reasonable. Here, the FERC argues, the FPA, at minimum, does not unambiguously bar the FERC’s interpretation: A major purpose of the FPA is to provide a broad grant of jurisdiction to the FERC over “practices affecting wholesale rates,” and the practices here substantially affect wholesale rates. The FERC maintains that the primary inquiry is whether its interpretation is reasonable, and the FERC asserts that it is reasonable in light of the FPA’s language as well as the national policy expressed in the Energy Policy Act of 2005 (“EPAct”).
EPSA counters that Chevron is irrelevant to this case, because no ambiguity exists about the customers whom the FERC’s demand-response program affects: The FERC is attempting to regulate retail demand, which the FPA expressly forbids. The EPSA argues that the FERC improperly relies on the EPAct for support, because the act neither grants any jurisdiction to the FERC to regulate demand response nor suggests that the FERC has this jurisdiction.
“ARBITRARY AND CAPRICIOUS”
The FERC argues that its decision to require wholesale-market operators to use the LMP formula when offering demand-response payments was not an “arbitrary and capricious” abuse of discretion, because the FERC carefully evaluated its options: The FERC relied on expert advice and deliberated between several options to “maximize social welfare.” Further, the FERC asserts that due to the highly technical nature of the rule, the FERC is owed “informed discretion.”
However, EPSA contends that the FERC’s rule is “arbitrary and capricious,” because it would lead to overpayments that would hinder economically efficient energy consumption, a deviation from the FERC’s stated policy goal. The EPSA further argues that the FERC did not properly explain its decision-making process, calling the FERC’s rationale “circular.” EPSA contends that the FERC cannot adequately explain its decision, because the FERC’s demand-response scheme simply results in inefficient consumption—the same sort of inefficient consumption that prompted the rule change in the first place.
The Supreme Court will determine whether (1) the FPA extends authority to the FERC to regulate the rules used by operators of wholesale electricity markets to pay for reductions in electricity consumption, and to recoup those payments through adjustments to wholesale rates; and, (2) whether the D.C. Circuit erred in holding that Order 745 is arbitrary and capricious. The FERC contends that (1) the FPA authorizes it to regulate compensation levels that wholesale-market operators pay customers for commitments to reduce consumption, and (2) the FERC adequately addressed the points made by FERC Commissioner Moeller and other commenters but simply reached a different conclusion. But the EPSA maintains that Order 745 is an attempt by the FERC to regulate retail demand and prices, which plainly exceeds its jurisdiction under the FPA. The Court’s ruling could change the regulatory balance in the energy sector between federal and state governments.
The Conservation of Law Foundation (the “Foundation”), in support of FERC, contends that Order 745 is a “lawful, appropriate, and important exercise” of the FERC’s responsibility under the FPA to secure just and reasonable wholesale rates. The Foundation asserts that Order 745 continues the FERC’s effort to promote market efficiency and open competition, and reduces “the amount of power that must be transmitted at critical times,” thereby lowering the risk of forced outages and blackouts. Additionally, the Foundation contends that wholesale demand response provides diverse benefits to the environment and public health by avoiding the need to operate dirty and costly plants, by postponing or avoiding the construction of power plants or transmission lines, and by helping the grid to reliably integrate inexpensive and clean renewable energy resources.
But the EPSA and supporting amici contend that the FERC is attempting to “erase the lines of demarcation between federal and state jurisdiction.” CES argues that the federal government has jurisdiction over the wholesale energy market, whereas the states have jurisdiction over the retail energy market. CES suggests that the FERC’s reasoning—that it should also have jurisdiction over practices that directly affect the wholesale energy market even if they concern the retail energy market—is unlimited and could potentially serve to justify the FERC’s entrance into the steel, fuel, and labor markets. And a group of Leading Economists suggests that FERC’s overreaching creates improper incentives in the market. Leading Economists assert FERC married its demand response compensation scheme to locational marginal price (LMP), which represents “all costs of delivering the electricity necessary to meet real-time demand at each location.” Leading Economists argue that in doing so, FERC created perverse incentives that harm society; for example, if a manufacturer can earn more by not using electricity (under the FERC scheme) and receiving a demand-response subsidy, rather than producing goods for society, the subsidy hurts society as a whole.
COST-BENEFIT OF FEDERAL REGULATION
In support of FERC, Illinois and amici contend that the (“EPAct”) specifically contemplates a role for the FERC to regulate demand response in the wholesale energy market. The EPAct provides that various types of demand response schemes “shall be encouraged,” and that “unnecessary barriers to demand response participation in [the] energy . . . market shall be eliminated.” Thus, Illinois argues that the EPAct promulgated a national policy to facilitate demand response schemes. In so doing, amici state that Congress contemplated “an active, not passive, role for [the] FERC” in overseeing the energy market. Amici Charles D. Kolstad, Stanford Economics Professor, maintains that the FERC’s regulation of demand response in the wholesale energy market will achieve a more “economically efficient outcome” than if the FERC is restricted from doing so.
But Southern Company Services (“SCS”) takes issue with the FERC’s claim that Order No. 745 is “inherently superior” to state regulation of the wholesale energy market. Rather, SCS maintains that states are “highly effective” at reducing energy consumption through demand response. SCS presents data to demonstrate that in 2013, working with state regulators, it developed demand response schemes that reduced the amount of energy consumed during the summer—when demand for energy is at its highest—by more than twice the national average. Accordingly, SCS claims that the FERC’s regulation is not necessary to the administration of demand response schemes that reduce energy consumption in the wholesale market.
This case presents the Supreme Court with the opportunity to determine whether (1) the FPA extends authority to the FERC to regulate the rules used by operators of wholesale electricity markets to pay for reductions in electricity consumption and to recover those payments through adjustments to wholesale rates, and (2) whether the court of appeals erred in holding that Order 745 is “arbitrary and capricious.” FERC argues that it had the authority under the FPA to impose rules on wholesale-market operators that affect the retail market because the plain text of the FPA confers this power and, at the very least, FERC is entitled to Chevron deference. Further, the FERC argues that it sufficiently evaluated its rulemaking options and came to a reasonable decision on a highly technical matter. The EPSA counters by arguing that the FERC’s demand-response rule is an attempt to regulate retail energy sales over which it lacks jurisdiction. The EPSA further asserts that the FERC’s rule requiring the use of the LMP formula is “arbitrary and capricious,” because the rule would lead to overpayments that would hinder economically efficient energy consumption, a deviation from the FERC’s stated policy goal. The Court’s resolution of this case will impact federalism, as it relates to the division of jurisdiction in the energy sector between federal and state governments.
- Lawrence Hurley, Supreme Court to Review U.S. Electricity Market Efficiency Rule, Reuters (May 4, 2015).
- Robert Barnes and Chris Mooney, Supreme Court to Rule on Breaks for Cutting Peak-Demand Energy Use, Washington Post (May 4, 2015).