Energy > AG Speaking Energy > Supreme Court Vindicates FERC’s Demand Response Policy in 6-2 Vote
26 Jan '16

The Supreme Court’s decision in Federal Energy Regulatory Commission v. Electric Power Supply Association (FERC v. EPSA)1 will certainly cheer up Federal Energy Regulatory Commission (FERC) policymakers still digging out after Sunday’s blizzard. Undeterred by the weather, on Monday, the Supreme Court upheld Order No. 7452 in its entirety by a 6 to 2 vote,3 reversing the D.C. Circuit’s order in EPSA v. FERC.4   FERC v. EPSA ends years of uncertainty as to whether demand response will be able to continue to participate in organized wholesale energy markets. Additionally, the Court’s order upholds FERC’s decision that demand response providers should be compensated at the full Locational Marginal Price (LMP) paid to electric generators. FERC v. EPSA will come as a relief to FERC and the demand response industry, but will be a disappointment to generators.

FERC v. EPSA is also likely to have a ripple effect, expanding FERC’s authority at the boundary of state and federal jurisdiction. The Court’s opinion reaffirms FERC’s plenary authority over wholesale rates and practices, even where the agency’s actions may impact retail rates and practices. In particular, the Court concludes that no bright line can be drawn between wholesale and retail transactions: “Transactions that occur on the wholesale market have natural consequences at the retail level. And so too, of necessity, will FERC’s regulation of those wholesale matters.”5 That FERC’s regulation of the wholesale market will have effects¾even substantial effects¾on the quantity or terms of retail sales is of “no legal consequence,”6  unless FERC seeks to directly interfere with state ratemaking by “specify[ing] terms for sale at retail.”7 The Court’s decision leaves open the question of whether the impact of a state’s retail regulation on the wholesale market is similarly of no “legal consequence.”  However, that question could be answered next month when the Court hears arguments in Hughes v. PPL EnergyPlus, LLC, 8 which concerns the effect of state actions on wholesale ratemaking.

Order No. 745, issued on March 15, 2011, directed that demand response resources offering into markets operated by Regional Transmission Organizations and Independent System Operators (RTOs/ISOs) be paid the full LMP, the same compensation offered to electric generators. The decision to pay full LMP to demand response providers (who lack the overhead costs of generators and who benefit from not having to pay for the power they were forgoing) was highly controversial, and numerous parties appealed FERC’s order to the D.C. Circuit.

The D.C. Circuit’s order in EPSA v. FERC shook the wholesale electric industry, because it not only called into question whether demand response could be included in RTO/ISO markets, but whether FERC has jurisdiction to regulate demand response in wholesale markets at all. Not confining itself to the question of whether it was arbitrary and capricious for FERC to order full LMP compensation for wholesale demand response, the D.C. Circuit agreed with the arguments presented by the Electric Power Supply Association (EPSA), the trade association representing competitive power suppliers, that FERC lacked the jurisdiction to regulate demand response in the first instance. The D.C. Circuit reasoned that, because demand response involves retail consumption, it is fundamentally a retail activity. Since FERC’s authority is confined to wholesale sales of electricity, and not to “any other sales,”9 the court held that FERC lacked the authority to regulate demand response. In a rare step for the agency, FERC sought review of the D.C. Circuit’s decision by the Supreme Court, supported by many other members of the industry and a number of states,10 including some that had opposed Order No. 745’s grant of full LMP to demand response.

The Court, in an opinion authored by Justice Kagan, overturned the D.C. Circuit, finding both that FERC has the authority to regulate demand response and that its decision to compensate demand response providers at full LMP is not arbitrary and capricious. The Court explained that the ability to trigger demand response at peak hours prevents the LMP in an RTO/ISO market from spiraling higher as more expensive generators are called online to meet demand, and, therefore, demand response directly affects wholesale prices. 11  Accordingly, the Court concluded that wholesale demand response is a set of “rules or practices” that “directly affect[s] the wholesale rate”12 and is thus squarely within FERC’s authority under Section 205(a) of the Federal Power Act (FPA).13  Likewise, the Court found that FERC’s decision to compensate demand response providers at full LMP also “directly affects” the wholesale rate, because it increases the participation of demand response in the market, which serves to lower wholesale prices.14

The Court also concluded that FERC’s regulation of demand response does not run afoul of the FPA’s grant to the states of authority over the terms of retail sales. The fact that FERC’s regulation of demand response affects retail demand and retail conduct is not dispositive, the Court said, because “[i]t is a fact of economic life that the wholesale and retail markets in electricity, as in every other known product, are not hermetically sealed from each other.”15 FERC’s regulation of wholesale matters will inevitably have “natural consequences at the retail level.”16 Thus, the Court reached the sweeping conclusion 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 . . . [the FPA] imposes no bar.”17

The Court also dismissed arguments made by EPSA that FERC was “effectively” setting retail rates, because the presence of demand response changes consumers’ economic considerations regarding whether to buy power. To set a retail electricity rate, the Court explained, is to “establish the amount of money a consumer will hand over in exchange for power,” and “[n]othing in . . . the FPA suggests a more expansive notion.”18  FERC, therefore, does not set a rate for retail electricity “merely by altering consumers’ incentives to purchase [the] product.”19

In addition to upholding FERC’s jurisdiction to regulate wholesale demand response, the Court found that FERC did not act arbitrarily or capriciously in setting the compensation for demand response providers at full LMP. This issue, the actual focus of Order No. 745, was almost lost in the furor that followed the D.C. Circuit’s order concluding that FERC lacked the jurisdiction to regulate demand response. The Court found that FERC had engaged in reasoned decision making when it ordered that demand response be paid full LMP, although it was careful to note that it was not suggesting that FERC made “the better call.”  Instead, the Court noted that “it is not our job to render that judgment, on which reasonable minds can differ.”20 In any event, FERC satisfied the relevant standard, which was that “it weighed competing views,” its decision had “adequate support in the record,” and it “intelligibly explained” the reasons for its choice.21

Justices Scalia and Thomas dissented from the Court’s opinion. In the dissent, authored by Justice Scalia, the two justices argued that FERC’s authority is confined to sales “at wholesale,” and whatever demand response may be, it is not a wholesale sale. They reasoned that, since the “purchaser” in demand response is not an entity that engages in “sales for resale,” demand response involves a retail sale (or the lack thereof). The dissent also contends that demand response payments do change the “effective” price for retail energy. The justices explain that, when a customer is offered a credit for not consuming and that customer chooses not to dial down its demand, it forgoes the credit and functionally suffers an increase in its retail price.  

1 FERC v. EPSA, Nos. 14-840, 14-481 (U.S. Jan. 25, 2016).

2 Demand Response Compensation in Organized Wholesale Energy Markets, Order No. 745, FERC Stats. & Regs. ¶ 31,322 (2011), order on reh’g and clarification, Order No. 745-A, 137 FERC ¶ 61,215 (2011), reh’g denied, Order No. 745-B, 138 FERC ¶ 61,148 (2012).

3 Justice Alito recused himself from the case.

4 EPSA v. FERC, 753 F.3d 216 (D.C. Cir. 2014).

5 FERC v. EPSA at 18.

6 Id. at 18-19.

7 Id. at 17-18.

8 PPL EnergyPlus, LLC v. Nazarian, 753 F.3d 467 (4d Cir. 2014), cert. granted sub nom. Hughes v. PPL EnergyPlus, L.L.C. (Oct. 19, 2015) (No. 14-614).

9 16 U.S.C. 824(b)(1) («The provisions of this subchapter shall apply to the transmission of electric energy in interstate commerce and to the sale of electric energy at wholesale in interstate commerce, but . . . shall not apply to any other sale of electric energy . . . . «).

10 Other states, however, filed briefs in support of EPSA and the D.C. Circuit decision.

11 FERC v. EPSA at 7-8. The Court consciously disregards the effect of congestion on LMP.

12 Id. at 15.

13 Id.; 16 U.S.C. § 824d(a).

14 Interestingly, Justice Kagan describes compensation for demand response as a rule or practice that affects wholesale prices, not as a wholesale price in its own right. See FERC v. EPSA at 17.

15 Id. at 18.

16 Id.

17 Id. at 19.

18 Id. at 21.

19 Id. at 22.

20 Id. at 33.

21 Id.