U.S. Supreme Court upholds FERC authority to set demand response compensation

The U.S. Supreme Court on Jan. 25 upheld the authority of the Federal Energy Regulatory Commission (FERC) to set rates for demand response programs in a case brought by the Electric Power Supply Association (EPSA).

The high court returned its decision Jan. 25 after hearing oral arguments on the matter Oct. 14, 2015. The ruling represents a legal setback for EPSA and other parties, who had initially gotten the demand response rule thrown out by the U.S. Court of Appeals for the D.C. Circuit.

The Supreme Court’s decision was on a 6-2 vote, with Justice Samuel Alito not taking part in the decision.

The PJM Interconnection (PJM) was one of the first organizations to comment.

“Although PJM will have to study the court’s decision, the ruling supports the continued participation of demand response in competitive wholesale markets. We’re pleased with that outcome. Certainty and continuity are important in markets. Demand response brings value to competitive wholesale markets and is a vital component of electric system reliability,” PJM said.

FERC Order No. 745 upheld by high court

In an increasingly competitive interstate electricity market, FERC has undertaken to ensure “just and reasonable” wholesale rates by encouraging the creation of nonprofit entities to manage regions of the nationwide electricity grid, the high court noted. These wholesale market operators administer their portions of the grid to ensure that the network conducts electricity reliably, and each holds competitive auctions to set wholesale prices.

These auctions balance supply and demand continuously by matching bids to provide electricity from generators with orders from utilities and other load-serving entities (LSEs) that buy power at wholesale for resale to users. All bids to supply electricity are stacked from lowest to highest, and accepted in that order until all requests for power have been met. Every electricity supplier is paid the price of the highest-accepted bid, known as the locational marginal price (LMP).

In periods of high electricity demand, prices can reach extremely high levels as the least efficient generators have their supply bids accepted in the wholesale market auctions. Not only do rates rise dramatically during these peak periods, but the increased flow of electricity threatens to overload the grid and cause substantial service problems.

Faced with these challenges, wholesale market operators devised wholesale demand response programs, which pay consumers for commitments to reduce their use of power during these peak periods, the court said. Just like bids to supply electricity, offers from aggregators of multiple users of electricity or large individual consumers to reduce consumption can be bid into the wholesale market auctions. Wholesale operators began integrating these programs into their markets about 15 years ago and FERC authorized their use. Congress subsequently encouraged further development of demand response.

Spurred on by Congress, FERC issued Order No. 719, which, among other things, requires wholesale market operators to receive demand response bids from aggregators of electricity consumers, except when the state regulatory authority overseeing those users’ retail purchases bars demand response participation. Concerned that the order had not gone far enough, FERC then issued the rule under review here, Order No. 745. It requires market operators to pay the same price to demand response providers for conserving energy as to generators for producing it, so long as a “net benefits test,” which ensures that accepted bids actually save consumers money, is met.

The rule rejected an alternative compensation scheme that would have subtracted from LMP the savings consumers receive from not buying electricity in the retail market, a formula known as LMP-G. The rule also rejected claims that FERC lacked statutory authority to regulate the compensation operators pay for demand response bids.

Appeals court had ruled against FERC

The U.S. Court of Appeals for the D.C. Circuit vacated the rule, holding that FERC lacked authority to issue the order because it directly regulates the retail electricity market, and holding in the alternative that the rule’s compensation scheme is arbitrary and capricious under the Administrative Procedure Act.

The high court, however, said the Federal Power Act (FPA) provides FERC with the authority to regulate wholesale market operators’ compensation of demand response bids. The court’s analysis is in three parts.

  • First, the practices at issue directly affect wholesale rates.
  • Second, FERC has not regulated retail sales. Taken together, these two conclusions establish that the rule complies with the FPA’s plain terms.
  • Third, the contrary view would conflict with the FPA’s core purposes.

The practices at issue directly affect wholesale rates. The FPA has delegated to FERC the authority—and, indeed, the duty—to ensure that rules or practices “affecting” wholesale rates are just and reasonable. To prevent the statute from assuming near-infinite breadth, the Supreme Court said it adopts the D. C. Circuit’s "common-sense" construction limiting FERC’s “affecting” jurisdiction to rules or practices that “directly affect the [wholesale] rate."

Said the Jan. 25 ruling: "That standard is easily met here. Wholesale demand response is all about reducing wholesale rates; so too the rules and practices that determine how those programs operate. That is particularly true here, as the formula for compensating demand response necessarily lowers wholesale electricity prices by displacing higher-priced generation bids. The Rule also does not regulate retail electricity sales in violation of §824(b). A FERC regulation does not run afoul of §824(b)’s proscription just because it affects the quantity or terms of retail sales. Transactions occurring on the wholesale market have natural consequences at the retail level, and so too, of necessity, will FERC’s regulation of those wholesale matters. That is of no legal consequence. When 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) imposes no bar. Here, every aspect of FERC’s regulatory plan happens exclusively on the wholesale market and governs exclusively that market’s rules. The Commission’s justifications for regulating demand response are likewise only about improving the wholesale market.

"In addition, EPSA’s position would subvert the FPA. EPSA’s arguments suggest that the entire practice of wholesale demand response falls outside what FERC can regulate, and EPSA concedes that States also lack that authority. But under the FPA, wholesale demand response programs could not go forward if no entity had jurisdiction to regulate them. That outcome would flout the FPA’s core purposes of protecting ‘against excessive prices’ and ensuring effective transmission of electric power. The FPA should not be read, against its clear terms, to halt a practice that so evidently enables FERC to fulfill its statutory duties of holding down prices and enhancing reliability in the wholesale energy market.

"FERC’s decision to compensate demand response providers at LMP—the same price paid to generators—instead of at LMP-G, is not arbitrary and capricious. Under the narrow scope of review in [a prior case], this Court’s important but limited role is to ensure that FERC 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 decision. Here, FERC provided a detailed explanation of its choice of LMP and responded at length to contrary views. FERC’s serious and careful discussion of the issue satisfies the arbitrary and capricious standard."

So the high court reversed the appeals court opinion and remanded the case for review in compliance with its decision.

About Barry Cassell 20414 Articles
Barry Cassell is Chief Analyst for GenerationHub covering coal and emission controls issues, projects and policy. He has covered the coal and power generation industry for more than 24 years, beginning in November 2011 at GenerationHub and prior to that as editor of SNL Energy’s Coal Report. He was formerly with Coal Outlook for 15 years as the publication’s editor and contributing writer, and prior to that he was editor of Coal & Synfuels Technology and associate editor of The Energy Report. He has a bachelor’s degree from Central Michigan University.