Federal Court Limits States' Ability To Legislate Fuel Choices: Case Has Broad Implications For Electric Generation Industry

by Stinson Leonard Street
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In a decision that will have broad impact on the electric generation industry, a federal district court has struck down parts of a Minnesota law that sought to regulate what fuels generators could use in their power plants to generate electricity. In invalidating portions of the law, the court found that Minnesota was not simply limiting the use of coal for electricity in Minnesota, but was effectively regulating power company transactions taking place entirely outside the state. That, the court declared, was unconstitutional.

The case, North Dakota v Heydinger, is the latest in a series of federal court cases in which disputes have arisen about the constitutional limits of a state's role in setting energy policy. Similar to another recent case we have discussed in a previous Insight involving California's Low Carbon Fuel Standard (LCFS), this is a case likely to affect both buyers and sellers of energy products and services throughout the country and is a case they should be following. Read our February 3, 2014 Insight discussing the Rocky Mountain Farmers' Union case.

The Heydinger Decision

Minnesota's Next Generation Energy Act, passed in 2007, aimed to reduce carbon dioxide emissions in three ways. It bars (1) the construction of new large power plants that emit C02, (2) the import of power from out-of-state new large power plants that emit C02 and (3) the purchase of power supplies under long term contracts that would "increase statewide power sector carbon dioxide emissions."

The plaintiffs in the Heydinger case are the State of North Dakota and several rural electric utility cooperatives with operations in Minnesota and neighboring states. The rural cooperatives were concerned that the way the transmission grid operates and the way electricity flows, when one of their non-Minnesota generating units injects electricity into the grid to satisfy its obligations to a non-Minnesota member, it cannot ensure that none of the electricity generated would be consumed in Minnesota. North Dakota was similarly concerned that utilities within its borders could not ensure that power generated from new North Dakota power plants would not be consumed in Minnesota in violation of Minnesota's new law.

That law, the plaintiffs complained, is unconstitutional in two respects. First, while they could seek exemptions from the Minnesota Public Utility Commission, that amounted to giving Minnesota the right to regulate transactions between parties located outside the state. Second, they argued that absent a "compelling state interest" it was also unconstitutional for a state to favor in-state businesses over others, and because of the way the Minnesota statute worked, Minnesota utilities were, in fact, getting favorable treatment.

The court agreed with the plaintiffs on the first point. Because there was no way to trace the actual flow of electrons between seller and buyer, it said, sellers in the region could not risk entering into sales arrangements with non-Minnesota buyers without obtaining permission from Minnesota. It reasoned that if any or every state were to adopt similar legislation (e.g. prohibiting the use of electricity generated by different fuels or requiring compliance with unique statutorily mandated exemption programs subject to state approval), the current marketplace for electricity would come to a "grinding halt." Subjecting market participants to multiple state laws of this nature, it said, is "just the kind of competing and interlocking local economic regulation that the Commerce Clause was meant to preclude."

Because the requirement for prior approval from Minnesota was unconstitutional, the court found there was no reason to reach the plaintiff's second complaint about Minnesota power sellers receiving preferential treatment.

Analysis

The district court in Heydinger reached only the question whether Minnesota's law applied "extraterritorially," that is, beyond the state's borders. In supporting the plaintiffs' claim, the court distinguished the Minnesota statute from California's LCFS at issue in Rocky Mountain Farmers' Union. The Ninth Circuit Court of Appeals, the district court noted, had ruled that the LCFS did not apply extraterritorially, but only applied to those out-of-state ethanol suppliers seeking to sell their product in California.

The extraterritoriality issue, we should point out, is not dead in the California case either. The dissenting judges in the Ninth Circuit case took the position that the LCFS did operate extraterritorially – not because the law literally applied to ethanol sales made outside California (it did not), but because California's ethanol market is so large that ethanol producers in other states were effectively compelled to comply. That argument has been presented to the Supreme Court by the losing parties in the Rocky Mountain Farmers' Union case and, as of this writing, the Supreme Court has yet to decide whether to hear the case.

The district court did not reach the other issue the plaintiffs raised in Heydinger – that Minnesota was discriminating against out-of-state energy suppliers. That issue, however, has also come up in other parts of the country. In fact, as we noted in our earlier Insight, the Rocky Mountain Farmers' Union case poses that precise question. There, a number of Midwestern states and Midwestern ethanol producers have argued that the LCFS – which measures the "carbon intensity" of ethanol by taking into account the carbon consumed to produce and ship the ethanol – puts a thumb on the scales against out-of-state ethanol producers. States and energy producers in the LCFS controversy and elsewhere have been, and are likely to continue to be, at odds over whether state laws are legitimately aimed at protecting the state's environment or are simply local job protectionism masquerading as environmental legislation.

Many participants in the energy industry should closely follow individual state climate change and renewable energy legislation and regulations, and the treatment of these measures by courts. The implications will vary for different participants and from measure to measure. Investors in electric generation facilities, for example, may need to consider not just the regulatory regime in the states where they intend to build and operate plants, but also the existence of regulatory requirements in neighboring states that may limit their ability to sell the output of those plants. California's LCFS is not unique. So, fuel producers may want to take into account the existence of similar legislation when deciding where to site their operations. Energy market participants will also want to consider what affirmative actions they might take to protect their interests. Should they lobby state legislators? Should they pursue exemptions from regulators? Should they bring Commerce Clause challenges or seek other relief through the court system?

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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