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FERC at the Supreme Court: Drawing the Line Between Federal and State Jurisdiction Over Electric Power Markets

March 23, 2016

In its current term, the Supreme Court has taken on two cases (one already decided[1] and the other argued on February 24, 2016[2]) involving the increasingly unclear lines between the jurisdiction of state public utility commissions and the Federal Energy Regulatory Commission (“FERC”) over electric power rates and markets. Once-clear jurisdictional boundaries have become blurred as FERC has taken steps to increase competition in wholesale power markets—moves that have had impacts on the retail rates paid by utility consumers. Actions by states to facilitate additional generating capacity have had impacts on wholesale markets.

Historically, retail rates have been the exclusive province of state commissions, but efforts to create vibrant wholesale power markets have had effects that spill over to impact electric power consumers in direct and indirect ways. Increasingly, regional power markets have been created which are governed by power “auctions” that are intended to take the place of federal price regulation. In any event, what were once clear lines between state and federal jurisdiction have become muddled. 

In FERC v. Electric Power Supply Association, the Court reviewed the effects of two FERC rules. The first, FERC Order 719, requires wholesale market operators to receive demand response bids from aggregators of electricity consumers.[3] The second, Order 745, requires market operators to pay the same price to demand response providers for conserving energy as they pay to traditional generators for producing it, so long as a “net benefits test” is met.[4] In upholding FERC’s demand-response rules, the Court elaborated in important ways on the limits of FERC’s authority.

In the consolidated cases Hughes v. Talen Energy Marketing and CPV Maryland LLC v. Talen Energy Marketing, argued on February 24, 2016, the Court will address the degree to which state regulation of utility generation can impact interstate wholesale markets. At issue there is a Maryland effort to ensure that adequate generating capacity exists to serve its retail loads. In return for state subsidies, the Maryland program requires the generator to bid into interstate markets in a way designed to dampen adverse rate impacts on consumers. Based on oral argument, the Court is expected to find that the state's actions intrude on FERC's jurisdiction to regulate wholesale electric power rates. How broadly the Court’s ruling will sweep—and thus the precise contours of state jurisdiction over electric power markets—remains to be seen

Background

Historically, state public utility commissions[5] regulated all functions of the electric utilities that provided service to consumers in their states. Over time, generating stations became larger and long-distance transmission lines were constructed, permitting interstate sales of electric power that often provided economies of scale. At the same time, utility holding companies formed that held utilities in multiple states. The holding companies (or their utility subsidiaries) made downstream sales to other subsidiaries of the holding company, sometimes at rates that state regulators believed were anti-competitive and collusive. The Supreme Court, though, eventually held that the Commerce Clause prevents state and local regulators from regulating certain interstate electricity transactions, including wholesale sales (i.e., sales for resale) across state lines.[6] This inability of the state commissions to regulate the wholesale sales of power between multi-state utilities or with utility affiliates formed a regulatory gap.[7]

To address this gap, the Congress passed the Federal Power Act (“FPA”)[8] and the Public Utility Holding Company Act[9] in 1935. Under the FPA, FERC has authority to regulate “the transmission of electric energy in interstate commerce” and “the sale of electric energy at wholesale in interstate commerce.”[10] The FPA requires that “[a]ll rates and charges made, demanded, or received by any public utility for or in connection with [interstate transmission or wholesale power sales] and all rules and regulations affecting or pertaining to such rates or charge be just and reasonable.”[11] The Act, though, does not grant FERC authority to regulate all power sales. Specifically, while FERC has jurisdiction over interstate wholesale power sales, its authority does not extend to “any other sale of electric energy.”[12] Thus, the regulation of intrastate wholesale and all retail sales of electricity are left to the states.

In the current era of the interconnected grid, FERC works to ensure lawful wholesale pricing largely by facilitating competition.[13] Specifically, FERC has encouraged the creation of regional entities that manage respective portions of the grid.[14] Importantly for present purposes, these regional operators conduct competitive auctions that set wholesale prices for electricity.[15] These auctions function essentially as follows. Load-serving entities (“LSEs”)—entities such as utilities that purchase power for resale—submit orders to the wholesale market operator.[16] Power suppliers submit bids, detailing the amount, timing, and price of the power they can provide.[17] The operator then accepts bids, from least to most expensive, until the LSE’s demand has been met. Suppliers whose bids have been accepted are then paid the price per unit of electricity of the highest accepted bid, regardless of their actual bid.[18] This is the locational marginal price (“LMP”).

Before deregulation of power markets and the mandated division of integrated electric power utilities into distribution utilities and transmission entities, it was relatively easy to determine what constituted the interstate wholesale sale of electric power and what constituted a retail sale. Integrated utilities operated their own generation and provided the output from company-owned generators to their own customers. When a utility’s supply exceeded demand, it sold power into wholesale power markets to other, similarly integrated utilities (and to public power entities[19]). In such a world, the Supreme Court could write, as it did in 1964, that “Congress meant to draw a bright line easily ascertained, between state and federal jurisdiction … . This was done in the [FPA] by making [FERC] jurisdiction plenary and extending it to all wholesale sales in interstate commerce except those which Congress has made explicitly subject to regulation by the States.”[20]

Today, however, electricity markets are far more complicated. As Justice Breyer—no stranger to complex regulatory schemes—put it recently at oral argument, “truer words were never spoke, than I am not quite on top of how this thing works.” In any event, the line between wholesale and retail—and therefore between federal and state jurisdiction—is by now anything but bright. Both FERC v. EPSA and the Talen Energy Marketing cases highlight the difficulties courts have had in drawing it.

FERC v. EPSA

In FERC v. EPSA, the Supreme Court confronted the question whether FERC had ventured too far into state territory by regulating retail electricity sales. That case involved the practice of demand response, whereby wholesale consumers are paid for not using electricity at certain times. In essence, large individual users (e.g., factories) and aggregators of multiple smaller-scale electricity users submit bids in the auction scheme described above, as would a traditional energy supplier.[21] However, instead of offering to produce a given amount of electricity at a given time for a given price, in a demand-response program electricity users offer not to use a given amount of electricity at a given time for a given price.

FERC’s Order No. 745 requires that wholesale market operators pay successful demand-response bidders the LMP (that is, the price of the highest accepted bid, regardless of the bidder’s actual offer) where two conditions are satisfied.[22] First, the bidder must have “the capability to provide the service offered,” meaning that it must be able to make the electricity curtailment it promises. Second, the payment of LMP for demand-response bids “must be cost-effective” under the “net benefits test.” Because LSEs are in the business of selling electricity to retail consumers and each successful demand-response bid results in less electricity being consumed, demand response can cause some LSEs to drop out of the market.[23] This, in turn, increases costs for remaining LSEs, which share the expense of paying successful bidders.[24] In some situations, demand response could result in a lower LMP, but leave LSEs paying more than they otherwise would have. The net benefits test is designed to prevent this result.[25]

Two other aspects of Order 745 warrant mention. First, the order rejected a proposal whereby a demand response bidder’s payment would be reduced by the amount it saved by not purchasing retail electricity.[26] Second, the order permits state regulators to prohibit retail consumers from taking part in wholesale demand-response programs.[27]

FERC v. EPSA involved a challenge to Order 745. The Supreme Court began its analysis by observing that the while the FPA requires that FERC ensure that “all rules and regulations affecting or pertaining to” wholesale rates are “just and reasonable,” the Act does not grant FERC jurisdiction over everything that affects wholesale rates.[28] Instead, the Court approved what it called a common-sense rule adopted by the D.C. Circuit: “FERC’s ‘affecting’ jurisdiction [is limited to] rules or practices that ‘directly affect the wholesale rate.’”[29] The Court had little difficulty concluding that Order 745 passed this test “with room to spare.”[30] As the Court put it, “[w]holesale demand response … is all about reducing wholesale rates; so too, then, the rules and practices that determine how those programs operate.”[31]

The difficult question before the Court, though, was not whether Order 745 directly affects wholesale rates, but instead whether it does so via regulation of retail sales. The Court began by framing the rule as follows. “[FPA] § 824(b) limit[s] FERC’s sale jurisdiction to that at wholesale, reserving regulatory authority over retail sales (as well as intrastate wholesale sales) to the States. FERC cannot take an action transgressing this limit no matter how direct, or dramatic, its impact on wholesale rates.”[32] At the same time, though, “a FERC regulation does not run afoul of §824(b)’s proscription just because it affects—even substantially—the quantity or terms of retail sales.”[33] This is because “transactions that occur on the wholesale market have natural consequences at the retail level.”[34] Thus, FERC has jurisdiction when its regulation directly affects wholesale sales, no matter its effect on the retail market. However, it lacks jurisdiction to regulate retail sales, no matter the effect on wholesale markets.

To the D.C. Circuit, the FERC rule crossed the line into regulation of retail sales: by “luring … retail customers” into wholesale markets and encouraging them to reduce “levels of retail electricity consumption.” Thus, FERC had engaged in “direct regulation of the retail market.”[35]

The Supreme Court disagreed. In the Court’s view, Order 745 “addresses—and addresses only—transactions occurring on the wholesale market.”[36] The Court explained:

Wholesale market operators administer the entire program … . Those operators accept [a demand response] bid when (and only when) the bid provides value to the wholesale market … . The compensation paid for a successful bid (LMP) is whatever the operator’s auction has determined is the marginal price of wholesale electricity … . And those footing the bill are the same wholesale purchasers that have benefitted from the lower wholesale price demand response participation has produced. In sum, whatever the effects at the retail level, every aspect of the regulatory plan happens exclusively on the wholesale market and governs exclusively that market’s rules.[37]

The Court similarly emphasized that FERC’s justifications behind Order 745 “are all about, and only about, improving the wholesale market,”[38] and dismissed claims that FERC created the demand-response program in an attempt to regulate retail sales.[39] It also found significant the fact that the FERC rule permits states to prohibit altogether consumers from making demand response bids.[40]

The Court also found that were it to hold that FERC lacks jurisdiction to regulate demand response, the result would be that nobody could oversee such programs.[41] This sort of gap, the court explained, is anathema to the FPA: “under the Act, no electricity transaction can proceed unless it is regulable by someone.”[42]

Perhaps most significantly, the Court rejected EPSA’s claim that the FERC rule “effectively,” if not “nominally,” regulates retail electricity prices.[43] According to EPSA, because consumers know there is value in submitting demand response bids, the effective price of retail electricity is the ordinary cost of electricity plus whatever the user could make via curtailment.[44] Under this view, if a user can purchase electricity for $10 but earn $5 for not using it, the “effective” retail price is $15. The Court disagreed, finding that “[t]o set a retail electricity rate is … to establish the amount of money a consumer will hand over in exchange for power.”[45]

Hughes v. Talen Energy Marketing and CPV Maryland LLC v. Talen Energy Marketing

Whereas FERC v. EPSA touches upon the limits of FERC’s authority, the consolidated cases Hughes v. Talen Energy Marketing and CPV Maryland LLC v. Talen Energy Marketingaddress the flip side of the coin: at what point does a state impermissibly interfere with wholesale markets?

The Talen Energy cases involve Maryland’s efforts to promote grid reliability by encouraging the construction of a new generating facility.[46] The case can be simplified as follows. Maryland encouraged bidding on its proposed generating facility by offering the winner “a fixed, twenty-year revenue stream.”[47] To accomplish this, the state would require one or more of its electric distribution companies to enter into contracts for differences with the generator. Under these agreements, the successful bidder (ultimately Commercial Power Ventures, Maryland, or “CPV”) was required to (a) build the generating facility and (b) sell its energy and capacity on the federal wholesale market (i.e., the auction described above). If CPV’s bid was accepted but the LMP did not satisfy its contractual revenue requirements, the electric distribution companies would pay CPV the difference. If, on the other hand, CPV’s bid was accepted but the LMP exceeded CPV’s revenue requirements, CPV would pay the electric distribution companies the difference.[48] Thus, CPV was assured a specified revenue.

1. Decisions Below

CVP’s competitors, led by Talen Energy, argued that Maryland’s approach unlawfully suppressed wholesale market prices, and therefore their own revenue. In the competitors’ view, the contracts for differences encouraged CPV to submit bids that did not reflect its actual cost of producing power, thereby artificially driving down the market. They argued that Maryland’s deal with CPV is unlawful as a result of both field preemption (i.e., the principle that where the federal government fully occupies a regulatory field, states cannot introduce even compatible regulations) and conflict preemption (i.e., the principle that states cannot impose regulations that impede federal regulatory schemes). Finding that Maryland’s approach effectively set the price CPV received for interstate wholesale power sales, the district court held that the state impermissibly strayed onto the field occupied exclusively by FERC.[49] In PPL EnergyPlus, LLC v. Nazarian, the Fourth Circuit affirmed, and in addition held that conflict preemption similarly doomed the Maryland plan.

In upholding the district court’s field preemption holding, the Fourth Circuit held that the Maryland program “is field preempted because it functionally sets the rate that CPV receives for its sales in the [wholesale] auction.”[50] Important to the court’s decision was the fact that the contract for differences payments are conditional on CPV submitting winning bids in the federal market. This, the court found, means that the payments “plainly qualify as compensation for interstate sales at wholesale, not simply for CPV's construction of a plant.”[51] Moreover, the state’s actions “ensure[] … that CPV receives a fixed sum for every unit of capability and energy” it sells in the wholesale auction.[52] As a result, the court held that “[t]he scheme thus effectively supplants the rate generated by the auction with an alternative rate preferred by the state.”

Still, the Fourth Circuit stopped short of holding that all state subsidization of generating facilities is impermissible under the FPA. It specified, for example, that it did “not express an opinion on other state efforts to encourage new generation, such as direct subsidies or tax rebates, that may or may not differ in important ways from the Maryland initiative. It goes without saying that not every state statute that has some indirect effect on wholesale rates is preempted.”[53] But the Maryland program’s effect “on matters within FERC's exclusive jurisdiction is neither indirect nor incidental. Rather, [it] strikes at the heart of the agency's statutory power to establish rates for the sale of electric energy in interstate commerce by adopting terms and prices set by Maryland, not those sanctioned by FERC.”[54]

The Fourth Circuit also held the Maryland program conflict preempted. The Court focused on two aspects of the program. First, the program effectively sets the wholesale price CPV is paid. Second, while the FERC-approved new entry price adjustment program “guarantees certain new producers a fixed price for three years,” the Maryland program guarantees CPV’s price for 20 years.[55] While the court again noted that “not every state regulation that incidentally affects federal markets is preempted,” it found the Maryland program “a bridge too far. It presents a direct and transparent impediment to the functioning of the PJM markets, and is therefore preempted.”[56]

2. Argument Before the Supreme Court

On February 24, 2016 the Supreme Court heard oral argument in the consolidated Talen Energy Marketing cases. If oral argument is any indication,[57] the Supreme Court will not revive the Maryland program held unlawful by the lower courts. The only question appears to be how broadly the Court’s ruling will sweep.

At oral argument, no justice appeared inclined to find in favor of the petitioners. Justice Kagan repeatedly indicated that regardless of whether Maryland employed a competitive bidding process leading up to the contract with CPV, the state was in effect setting the price the generator would receive for wholesale power sold at the federal auction. Justice Sotomayor pointed to the program’s 20-year price lock, drawing a contrast with the shorter periods deemed acceptable by FERC, and suggesting that issue might be dispositive. Justices Alito and Breyer observed that the Maryland program encourages CPV to submit as low a bid as allowed in the federal auction, regardless of its actual costs. Justice Kennedy similarly indicated that the Maryland program “altered the consequences of that auction in a way that was inconsistent with FERC's policy.”

At the same time, the Court does not appear inclined entirely to rule out states’ abilities to subsidize new generating facilities, even though subsidization inevitably impacts the wholesale market. Justice Roberts on several occasions suggested that merely subsidizing the construction of a power plant might not always be preempted by the FPA. Justice Kagan made a similar point. FERC’s attorney agreed, stating that a state paying for the construction of a power plant would be permissible under the FPA (despite the fact that this additional capacity would of course impact the wholesale market) so long as the state did not condition its subsidy on the recipient taking certain actions in the federal wholesale market.

If oral argument is any indication, then, the Court will issue a relatively narrow ruling. Presumably the Court will emphasize that the Maryland program is preempted because it expressly conditions its subsidies on CPV submitting successful bids to the federal wholesale auction, and directly ties the amount of those subsidies to the LMP paid at that auction.

Such a ruling would be in keeping with the Court’s decision in FERC v. EPSA, which acknowledged the interconnected nature of the interstate wholesale markets under federal jurisdiction and the retail and intrastate wholesale markets left to the states. In FERC v. EPSA, the Court walked this line byfinding that while the FERC rule at issue affected the retail market, the rule (a) was oriented with respect to the wholesale market and (b) did not set retail rates, effectively or actually. The Court could well take a similar approach here, finding that while Maryland is ordinarily free to subsidize power plant construction, it cannot do so by directing parties to enter the federal wholesale market or effectively setting the rates they are paid in those markets.

Implications

While the Court’s decision in FERC v. EPSA does not describe FERC’s jurisdiction using the sort of bright-line test contemplated byprevious Courts, it makes several important points:

  • To invoke “affecting” jurisdiction, FERC regulations must directly affect interstate wholesale markets.
  • FERC cannot regulate retail sales, even if doing so would directly and even dramatically impact wholesale rates.
  • However, FERC’s wholesale-market regulations may affect retail sales, “even substantially.”
  • The FPA does not permit regulatory gaps: “no electricity transaction can proceed unless it is regulable by someone.”

Where exactly these lines will be drawn remains to be seen. Taken together, though, the principles articulated by FERC v. EPSA suggest that FERC can exert jurisdiction so long as its rules are, by their terms, directed at wholesale markets, and do not plainly set retail prices.

In the Talen Energy Marketing cases, the Court will address the other side of the coin, describing the limits of the states’ ability to impact power markets. At oral argument, the justices suggested a narrow ruling, and one that could mirror the approach described in FERC v. EPSA. We expect the Court will preserve the states’ traditional powers to regulate generation and retail rates (even though these actions inevitably impact the wholesale market), while nevertheless holding that Maryland’s specific approach strayed too far into FERC territory.
 
For more information regarding the limits of state or FERC utility rate or market regulation contact Michael Dotten in the Portland office of Marten Law.

[1] Federal Energy Regulatory Commission v. Electric Power Supply Assn., 136 S.Ct. 760, 577 U.S. ___ (2016).

[2] Hughes v. Talen Energy Marketing, LLC, No. 14-614, consolidated with CPV Maryland, LLC v. Talen Energy Marketing, LLC, No. 14-623.

[3] FERC Order No. 719, 73 Fed. Reg. 64119, ¶154 (codified at 18 CFR §35.28(g)(1) (2015)).

[4] Demand Response Competition in Organized Wholesale Energy Markets, Order No. 745, 76 Fed. Reg. 16658 (codified at 18 CFR §35.28(g)(1)(v)). Order 719 was not directly challenged in the case before the Court, but instead the cumulative impact of FERC Orders 719 and 745 was examined by the Court in reaching its decision.

[5] State utility regulatory commissions are often called public service commissions or railroad commissions based on the historically broad nature of their regulatory activity.

[6] Public Util. Comm’n of R. I. v. Attleboro Steam & Elec. Co., 273 U.S. 83, 89–90 (1927).

[7] This interstate sales regulatory gap became known as the Attleboro gap, after the controlling case.

[8] 41 Stat. 1063, as amended, 16 U.S.C. §791a et seq.

[9] 15 U.S.C §§ 79 to 79z–6, Repealed. Pub. L. 109–58, title XII, § 1263, Aug. 8, 2005, 119 Stat. 974.

[10] 16 U.S.C. §824(b)(1).

[11] Id. § 824d(a).

[12] Id. § 824(b)(1).

[13] FERC. v. Elec. Power Supply Ass'n, 136 S. Ct. 760, 768 (2016).

[14] Id.

[15] Id.

[16] Id.

[17] Id.

[18] Id. at 768-69.

[19] Sales by investor-owned utilities to publicly-owned utilities spawned decades of litigation over the scope of FERC's (and its predecessor, the Federal Power Commission) jurisdiction over certain retail sales of electric power and allegedly anticompetitive practices. Those cases are beyond the scope of this article and will not be addressed here.

[20] Fed. Power Comm'n v. S. Cal. Edison Co., 376 U.S. 205, 216 (1964).

[21] FERC v. EPSA, 136 S.Ct at 769-70.

[22] 18 CFR §35.28(g)(1)(v).

[23] Id. at 771-72.

[24] Id.

[25] Id.

[26] Id. at 772.

[27] Id.

[28] Id. at 773-74

[29] Id. at 774 (quoting California Independent System Operator Corp. v. FERC, 372 F.3d 395, 403 (D.C. Cir. 2004)).

[30] Id.

[31] Id.

[32] Id. at 775 (citations and quotations omitted).

[33] Id. at 776.

[34] Id.

[35] Id. at 772.

[36] Id. at 776. .

[37] Id. (citations omitted).

[38] Id.

[39] Id. at 778-79.

[40] Id. at 779-80.

[41] Id. at 780. That is because states cannot regulate wholesale markets under the FPA.

[42] Id.

[43] Id. at 777-78.

[44] Id. at 777.

[45] Id.

[46] PPL EnergyPlus, LLC v. Nazarian, 753 F.3d 467 (4th Cir. 2014).

[47] Id. at 473.

[48] Id. at 473-74.

[49] Id. at 474.

[50] Id. at 476.

[51] Id.

[52] Id.

[53] Id. at 478 (citations and quotations omitted).

[54] Id. (citations omitted).

[55] Id. at 479.

[56] Id. at 480.

[57] A transcript of the argument can be found here: http://www.supremecourt.gov/oral_arguments/argument_transcripts/14-614_6536.pdf.

 

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