Supreme Court Rules that FERC Wholesale Markets Can Compensate Demand Response Providers 

Energy, Environmental & Utilities Alert

February 5, 2016

In late January, the Supreme Court issued a decision in Federal Energy Regulatory Commission v. Electric Power Supply Association, et al., 577 U.S. __, slip. op. (2016) upholding Federal Energy Regulatory Commission (FERC) Order No. 745. Order No. 745 allows demand response providers to participate in wholesale energy markets, and more specifically, requires wholesale electric market operators to pay the same price to demand response providers for conserving energy as to generators for producing energy, as long as a net benefits test is met (i.e., the demand response will result in actual savings to wholesale purchasers).

For those unfamiliar with the basic structure of energy markets, electric utilities, sometimes referred to as load-serving entities (LSEs), purchase electricity from generators in wholesale markets regulated by FERC. The LSEs, in turn, sell electricity in retail markets to end-use consumers, such as residential customers and manufacturing facilities. FERC has exclusive jurisdiction under the Federal Power Act (FPA) to regulate all rates and charges for and in connection with the interstate transmission or the wholesale sale of electricity. Moreover, and key to the Court’s decision in this case, under the FPA, FERC may regulate any “practice” affecting such wholesale rates or charges. However, FERC does not have jurisdiction over retail markets and rates. Retail rates are regulated at the state level by state public utility commissions.

When purchasing energy in wholesale markets, LSEs indicate how much energy they need and energy generators (and now demand response providers) bid into the market until the LSEs' total energy requirements are met. All of the successful bidders, i.e., those bidders whose bids are accepted, are then paid at the highest accepted price, known as locational marginal price (LMP).

Consider this example: A group of public utilities determine that they need 1,000 megawatts (MWs) of electricity to meet their retail customers’ needs. The public utilities then go to the wholesale energy market, where generators and demand response providers bid to supply the LSEs’ needs. Assume Generator A offers to supply 600 MW at $10/MW. Generator B offers to supply 300 MW at $20/MW. Generator C offers to supply 100 MW at $30/MW. At that point, the LSEs’ energy needs would be met, and all of the generators would be paid at the LMP of $30/MW.

Now consider how the market would be affected under Order No. 745. Instead of Generator C offering to supply 100 MW at $30/MW, Demand Response Provider A offers to curtail usage by 100 MW at $25/MW. Demand Response Provider A’s bid into the market would be accepted before Generator C’s bid, and the LMP would be set at $25 instead of $30, assuming that the market operator determined that Demand Response Provider A’s curtailment would result in actual savings to wholesale purchasers under FERC’s net benefit test.

In upholding Order No. 745, the Court determined that paying market participants for demand response commitments was a practice affecting wholesale rates and that demand response was a specific practice that directly affected wholesale rates. The Court also stated that although FERC’s regulation of demand response in the wholesale market may affect the retail market, the Commission had not regulated retail sales through Order No. 745. The Court concluded that "[w]hen 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) [of the FPA] imposes no bar." Federal Energy Regulatory Commission v. Electric Power Supply Association, et al. slip op. at 19.

The Court also determined that the process utilized by FERC to adopt Order No. 745 was not arbitrary and capricious. Deferring to the judgment of the agency, the Court held that FERC had engaged in reasoned decision-making when considering various alternatives to compensate demand response providers, such as a proposal to pay demand response providers the LMP less any retail savings derived from curtailing usage (referred to as LMP-G), and had articulated a satisfactory explanation for its decision, reasonably based upon the facts at issue and evidence presented. In language sure to be paraphrased by the FERC Solicitor in future appellate briefs, the Court concluded:

The Commission, not this or any other court, regulates electricity rates. The disputed question here involves both technical understanding and policy judgment. The Commission addressed that issue seriously and carefully, providing reasons in support of its position and responding to the principal alternative advanced. In upholding that action, we do not discount the cogency of EPSA’s arguments in favor of LMP-G. Nor do we say that in opting for LMP instead, FERC made the better call. It is not our job to render that judgment, on which reasonable minds can differ. Our important but limited role is to ensure that the Commission engaged in reasoned decisionmaking — that it weighed competing views, selected a compensation formula with adequate support in the record, and intelligibly explained the reasons for making that choice. FERC satisfied that standard.

Id. at 33.

In Federal Energy Regulatory Commission v. Electric Power Supply Association, et al., the Court continued to interpret the FPA in a manner consistent with FERC’s initiatives in an ever-evolving wholesale power market. Previously, the Court upheld (i) FERC’s jurisdiction over unbundled retail transmission in New York, et al. v. Federal Energy Regulatory Commission, et al., 531 U.S. 1 (2002); and (ii) FERC’s continued application of a high bar to modify rates contracted for in a market-based rate regime. Morgan Stanley Capital Group Inc. v. Public Utility District No. 1 of Snohomish County, 554 U.S. 527 (2008). Later this month, the Court will address how FERC’s capacity markets can impact a state’s efforts to encourage the development of in-state generation in CPV Power Development, Inc. v. PPL EnergyPlus, LLC. Oral argument in CPV Power Development, Inc. v. PPL EnergyPlus, LLC is scheduled for February 24, 2016.1

1 The Court is also considering similar issues in Fiordaliso v. PPL EnergyPlus, LLC; Hughes v. Talen Energy Marketing; and CPV Maryland, LLC v. Talen Energy Marketing

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