The Supreme Court Upholds FERC Order 745

January 2016

Case UpPost-EPSA Blog Post Title Pagedate: The Supreme Court Upholds FERC Order 745

Author: Matthew R. Christiansen

On Monday, the Supreme Court held that the Federal Energy Regulatory Commission (“FERC”) has jurisdiction under the Federal Power Act (“FPA”) to regulate demand response in wholesale electricity markets.[1]  Although the decision is, first and foremost, a significant victory for the FERC and its efforts to support demand response, it also goes a long way toward clarifying the legal regime governing the FERC’s exercise of its jurisdiction more generally.

In Federal Energy Regulatory Commission v. Electric Power Supply Association (“EPSA”), the Court upheld a FERC rule, known as “Order 745,” that required electricity market operators to compensate a reduction in electricity demand at the same level as an increase in electricity supply.  A lower court had invalidated Order 745 on the grounds that it (1) exceeded the FERC’s jurisdiction and (2) did not adequately respond to criticisms of FERC’s chosen pricing formula.  On the jurisdictional issue, the lower court concluded that the FERC could not require electricity market operators to compensate end users for reductions in demand because to do so regulated retail sales, a matter that the FPA reserves to the states.  Monday’s Supreme Court decision rejected that interpretation, holding that this form of wholesale-market demand response is squarely within the FERC’s jurisdiction.  The Court also handed the FERC a win on the second question, concluding that the Commission had adequately explained its decision to price reductions in demand at the same level as increases in supply.

On its face, the EPSA decision is a significant victory for the FERC and supporters of demand response.  It protects one of the Commission’s most important recent rulemakings and vacates a decision whose logic could have imposed limits on the FERC’s authority far beyond the facts of this case.[2]  By removing that uncertainty, the holding in EPSA paves the way for demand response to become an increasingly important tool for balancing supply and demand in wholesale electricity markets.

Nevertheless, the decision is an even more sweeping victory for demand response than it might initially appear.  That is because the Court held that the regulation of wholesale demand response falls unambiguously within the FERC’s jurisdiction under the FPA.  As a result, the Court did not consider the argument, adopted by the dissenting judge in the lower-court decision, that the FPA’s grant of jurisdiction was ambiguous and that the Court should defer to the FERC’s reasonable interpretation of that jurisdiction.[3]  Without getting too deep into the legal weeds, the upshot of the Court’s conclusion that the FERC’s jurisdiction is unambiguous is that it is extremely unlikely that the FERC—perhaps under a different presidential administration—would be able to reverse course and conclude that demand response has no place in wholesale markets.  If the Court had merely deferred to the FERC’s interpretation of its jurisdiction, the FERC would have remained free to change that interpretation and conclude that it lacks jurisdiction over wholesale demand response.  Such a reinterpretation would have precluded demand response from participating in wholesale markets.

The Court’s holding that wholesale demand response is unambiguously within the FERC’s jurisdiction means that such a reinterpretation is no longer possible.  Instead, it appears that the FERC could prohibit demand response from participating in wholesale markets only upon concluding that its participation is not just and reasonable.  Given the overwhelming evidence that wholesale demand response reduces prices and improves reliability, justifying that conclusion would prove a tall, if not possible, task.[4]  In short, wholesale demand response is not only here, it’s here to stay.

But EPSA’s significance is not limited to demand response and Order 745.  The majority opinion also resolved a number of long-standing questions regarding the FERC’s jurisdiction more generally.  As a result, the decision goes a long way toward providing a clear framework for evaluating the Commission’s authority.

First, the Court clarified the standard for evaluating the FERC’s jurisdiction under Sections 205 and 206 of the Federal Power Act.  Section 205 vests the FERC with jurisdiction to ensure that, among other things, all wholesale rates as well as all rules and practices “affecting or pertaining” to those rates are “just and reasonable.”  Section 206 authorizes the FERC to promulgate new rules or practices upon determining that the existing ones are not just and reasonable.  Because a literal reading of this “affecting jurisdiction” could extend the FERC’s authority to almost any economic activity that consumes electricity (and therefore affects the price of electricity), the D.C. Circuit had previously limited the FERC’s affecting jurisdiction to practices that “directly affect” wholesale rates.[5]  The EPSA decision marks the first time that the Supreme Court has formally adopted this test, thereby resolving any lingering uncertainty about the appropriate standard for evaluating the FERC’s affecting jurisdiction.[6]

Relatedly, the majority firmly rejected the lower court’s expansive understanding of states’ exclusive jurisdiction over retail sales.  As noted, the FPA prohibits the FERC from regulating aspects of the electricity sector that are subject to exclusive state jurisdiction, even if those aspects directly affect the wholesale rate.  The lower court held that Order 745 did just that because, by setting the opportunity cost of consumption for a retail customer, it was effectively regulating the retail rate.  Monday’s decision rejected that characterization of states exclusive jurisdiction over the retail rate.  Without disputing the economic reality facing retail ratepayers, the Court held that it is the actual retail rate—i.e., the price consumers pay for electricity—that matters for the FPA’s jurisdictional divide, not the economic decision facing ratepayers.  When combined with the Court’s adoption of the “directly affects” test discussed above, the EPSA decision provides a clear framework for evaluating the FERC’s authority under Sections 205 and 206, although the debate about what exactly constitutes a “direct effect” will no doubt continue.

Finally, the Court firmly rejected the idea that there can be a regulatory gap between state and federal jurisdiction over the electricity sector.  Throughout the EPSA litigation, various parties and commenters had raised the possibility that wholesale demand response fell outside the jurisdiction of both the FERC and state public utility commissions.  The Court, however, interpreted the FPA to preclude any such regulatory gaps.  The FPA, the Court explained, “prevents the creation of a regulatory no man’s land.”[7]  EPSA thus establishes that if an aspect of the electricity sector is beyond state regulation, it is necessarily one of the powers vested in the FERC by the FPA.[8]

With EPSA decided, energy lawyers will now turn their attention to February 24, 2016, when the Court will hear oral argument in another significant case involving the FERC.  That case, Hughes v. Talen Energy Marketing, will require the Court to decide when the FPA preempts state regulation of the electricity sector, the mirror image of the facts in EPSAEPSA’s importance for Hughes is difficult to gauge.  Although both cases deal with the limits of electricity regulators’ authority, the question resolved in EPSA—i.e., the FERC’s authority to enact a particular regulation—does not necessarily shed any light on the question in Hughes—i.e., when a FERC regulation preempts state regulation of the electricity sector.  As I have noted elsewhere, Talen was an unusual case for the Court to take, but the decision to do so would make more sense if the Court was going to adopt a broad conception of the FERC’s jurisdiction in EPSA—as it ultimately did.  Next month’s oral argument may provide the first real indication of what relationship, if any, the Justices see between the two cases.

[1] FERC v. Elec. Power Supply Ass’n, Docket No. 14-840, slip op. at 14 (Jan. 25, 2016) (“EPSA”).

[2] See, e.g., Amended Complaint of FirstEnergy Service Company, Docket No. EL14-55-000 (Sept. 22, 2014) (arguing that the lower-court decision required the FERC to remove demand response from wholesale capacity markets); Shelley Welton, Non-Transmission Alternatives, 39 Harv. Envtl. L. Rev. 457, 504-05 (2015) (suggesting that the lower court’s decision vacating Order 745 cast doubt on the FERC’s authority to require the consideration of alternatives to traditional transmission infrastructure).

[3] EPSA, slip op. at 14 n.5; Elec. Power Supply Ass’n v. FERC, 753 F.3d 216, 233 (D.C. Cir. 2014) (Edwards, J., dissenting).  On this question, Justice Antonin Scalia’s dissent agreed with the majority.  EPSA, slip op. at 2 (Scalia, J., dissenting).

[4] On this point, the Court quoted then-Commissioner Philip Moeller’s dissent from Order 745 in which, while objecting to the FERC’s choice of compensation level for demand response, he observed that “nowhere did I review any comment or hear any testimony that questioned the benefit of having demand response resources participate in the organized wholesale energy markets. On this point, there is no debate.”  EPSA, Slip Op. at 28 (quoting Demand Response Competition in Organized Wholesale Energy Markets, Order No. 745, 76 Fed. Reg. 16658, 16679).

[5] California Indep. Sys. Operator Corp. v. FERC, 372 F. 3d 395, 403 (2004).

[6] EPSA, slip op. at 15.  On this point, the Dissent appeared to agree that the “direct effect” test provide an appropriate limit on the FERC’s jurisdiction.  Id. at 2 (Scalia, J., dissenting).

[7]  Id. at 27.

[8] As the Supreme Court has explained previously, the FPA also vested the FERC with authority that had previously been exercised by the states.  New York v. FERC, 535 U.S. 1, 6 (2002).

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