FERC Reversed on Demand Response Programs – Who Can and Should Incent Non-Sales of Electricity?

In an appeal decided on May 23, 2014 at Docket No. 11-1486, the District of Columbia U.S. Court of Appeals vacated in its entirety the Federal Energy Regulatory Commission’s (“FERC”) Order No. 745 due to FERC’s lack of jurisdiction over the retail electricity market regulated by the states.  Order No. 745 set compensation levels for suppliers of demand response resources that participated in Regional Transmission Organizations’ day-ahead and real-time electric energy markets.  Demand response, as defined by FERC, is the reduction in consumption of electric energy by customers from their expected consumption in response to an increase in the price of electricity or a reduction in response to incentive payments designed to induce lower consumption of electricity.

FERC claimed that Order No. 745 narrowly focused on “wholesale demand response” which it defined as a customer reduction in energy consumption in response to incentive payments.  FERC contrasted this wholesale focus with “retail-level demand response” where consumption is reduced by customers in response to high prices.  FERC argued that regulation of wholesale demand response was squarely within its jurisdiction under sections 204 and 205 of the Federal Power Act, which task FERC with ensuring that all rules and regulations affecting rates in connection with the wholesale sale of electricity are just and reasonable.  In FERC’s view, the nexus between wholesale rates and demand response is that as electric demand is reduced, wholesale electric prices fall.

The District of Columbia Circuit found FERC’s linkage between the demand response program and its authority over matters “affecting” wholesale prices to be too tenuous given the Federal Power Act’s Section 201 limitation of federal regulation to matters” which are not subject to regulation by the states”.  Because incentive payments were made under Order No. 745 when retail customers decided to reduce retail electricity purchases and therefore reduce retail demand, the Court held that this demand response initiative constituted unlawful direct federal regulation of the retail electricity market.  If FERC could assert jurisdiction whenever the retail market “affected” the wholesale market, the Court reasoned that the Federal Power Act Section 201 prohibition of federal regulation over the retail market would be rendered useless.

FERC’s reliance on a statement of policy in the Energy Policy Act of 2005 that encouraged and facilitated demand response was not sufficient to avoid reversal of Order No. 745.  The Court viewed Order No.745 as going far beyond removing barriers to demand response, and construed it as attempting to draw demand response resources into the wholesale electric market and dictating the compensation providers of demand response resources must receive.  The Court was also skeptical that the demand response payment of full locational marginal pricing (“LMP”) was just and reasonable.  It cited with favor FERC Commissioner Moeller’s separate opinion in Order No. 745, and observed that under Order No. 745 customers received both (i) payments equivalent to compensation paid to generators and (ii) the “saved” expense of avoided generation costs.  The Court did not consider FERC to have adequately explained what appeared to be overly generous compensation for demand response.  The Court vacated Order No. 745 in its entirety as ultra vires agency action.

In his extensive dissent, Judge Edwards found that the Federal Power Act was ambiguous on whether foregone electric consumption was a sale of electricity.  This dissenting Judge seemed impressed with FERC’s finding that demand response improved the functioning of wholesale markets.  Judge Edwards concluded that FERC can indirectly incentivize action that it cannot directly require so long as it is otherwise acting within its jurisdiction and not directly regulating an area reserved to the States.  According to the dissent, given the ambiguity of jurisdiction over non-sales of electricity and the impact of demand response on wholesale prices, deference should have been paid to FERC’s statutory construction of its jurisdictional authority, and Order No. 745 upheld.

FERC’s demand response rules guided what was generally regarded as a valuable restraint on wholesale electricity prices.  The next few months will determine whether there is a consensus that this decision has created a problem that needs a legislative or regulatory fix.  FERC will now have to consider whether it can effectively encourage and adequately compensate demand response in some new approach that has more of a “wholesale” flavor than was conveyed by Order No. 745.  The fact that state level demand response programs are possible complicates the issue and moves demand response to the forefront of discussion issues between and among federal and state regulators. We think the upcoming NARUC Summer meetings in Dallas just got a new hot topic.

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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