Court Rejects Preemption and Dormant Commerce Clause Arguments and Upholds Connecticut’s Renewable Program

by Stoel Rives LLP
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On June 28, 2017, the U.S. Court of Appeals for the Second Circuit rejected challenges to Connecticut’s renewable energy procurement process and renewable energy credit program (Allco Fin. Ltd. v. Robert J. Klee (Docket Nos. 16-2946, 16-2949)). In doing so, the Second Circuit preserved the flexibility of states to enact programs to support renewable energy and became the first federal court to apply the Supreme Court’s ruling in Hughes v. Talen Energy (136 S. Ct. 1288 (2016)). While the Second Circuit’s decision raises some questions about the boundaries of state renewable energy programs, its narrow reading of Hughes v. Talen Energy supports a wide range of state renewable energy programs.

Allco (a renewable energy developer that participated, but was not selected, in Connecticut’s renewable energy procurement process) petitioned the court to overturn Connecticut’s renewable program on preemption grounds. Under Connecticut’s renewable energy procurement process, Connecticut solicits proposals for renewable energy through a competitive solicitation, and then Connecticut’s utilities are directed to enter into power purchase agreements for energy, capacity and environmental attributes with the solicitation winners. In its complaint, Allco argued that, since the Federal Power Act (FPA) grants the Federal Energy Regulatory Commission (FERC) exclusive jurisdiction over wholesale sales of electricity, the FPA preempts any action taken by states dealing with wholesale electricity sales (outside of the Public Utility Regulatory Policies Act (PURPA) and the regulations that apply to qualifying facilities (QFs)). According to Allco, Connecticut’s renewable energy procurement process compelled a wholesale power transaction, similar to what the Supreme Court struck down in Hughes v. Talen Energy (in which Maryland guaranteed selected generators a fixed capacity price for participating in a FERC-approved capacity auction).

The Second Circuit rejected Allco’s arguments. The court held that Connecticut’s renewable energy solicitation process is a permissible exercise of state power that the FPA (apart from PURPA) grants to states to regulate utilities. The court found that even if Connecticut’s actions had an “incidental effect on wholesale prices,” such an effect does not constitute a regulation of the interstate wholesale electricity market infringing on FERC’s jurisdiction, and therefore is not preempted by the FPA.

The Second Circuit found that, unlike the Maryland program at issue in Hughes v. Talen Energy, the Connecticut renewable energy procurement process did not “compel” utilities to enter into contracts in violation of the FPA. According to the court, although the statutory language authorizing the program “direct[s]” the Connecticut utilities to enter into power purchase agreements with the competitive solicitation winners, the Connecticut utilities are not “compelled” to enter into contracts with the solicitation winners since the solicitation winner and the utility may be unable to reach an agreement, and the agreement may terminate if a party is unable to fulfill the terms.

Other important difference between the Maryland program in Hughes v. Talen Energy and Connecticut’s renewable energy solicitation process challenged in Allco focus on the role of the capacity auction. Maryland sought to override the terms established by the FERC-approved capacity auction and to require transfer of ownership of the generator’s capacity through the auction process; Connecticut transfers ownership of electricity through a bilateral contract, independent of any FERC-regulated auction. According to the Second Circuit, the Connecticut renewable energy solicitation process produces traditional bilateral contracts between utilities and generators that are subject to FERC review for justness and reasonableness, “precisely what the Hughes court placed outside its limited holding.”

The Second Circuit emphasized that, “significantly,” the Connecticut renewable energy solicitation process requires that any bilateral contract from the solicitation will be subject to review by FERC for justness and reasonableness (“Any FERC-jurisdictional Rate Schedule or Tariff and Service Agreement agreed upon by an eligible bidder and the applicable [Connecticut utility] will be filed with FERC under Section 205 of the Federal Power Act [codified at 16 U.S.C. § 824(a)]. The FERC must accept the filing before the Rate Schedule or Tariff and Service Agreement can become effective.”). Therefore, since FERC has the ability to review the resulting bilateral contracts and Connecticut utilities are not compelled to enter into any agreement, the Second Circuit found that Connecticut’s renewable energy solicitation process was not preempted by the FPA.

In addition to its preemption holding, the Second Circuit rejected a dormant commerce clause challenge to Connecticut’s renewable energy credit (REC) program, which requires RECs to be sourced from generators located in ISO New England and the adjacent control areas (thereby excluding RECs from other areas of the country). RECs are a creation of state property law. In upholding Connecticut’s geographically restrictive definition of RECs, the court found that regional RECs can be treated differently than out-of-region RECs since Connecticut had a legitimate interest in a diversified and renewable energy supply accessible through the regional grid or adjacent control area. The court emphasized that Connecticut, in determining the geographic qualifications for RECs, relied on the organized electric market lines already approved by FERC. The court found that any burden imposed on competition in the REC market (by excluding out-of-region RECs) is not excessive in regards to the local benefits derived from Connecticut’s REC program. Therefore, the court ruled that Connecticut’s REC program is permissible.

In Hughes v Talen Energy, the Supreme Court “reject[ed] Maryland’s program only because it disregards an interstate wholesale rate required by FERC.” In Allco, the Second Circuit ruled that Connecticut’s renewable energy program did not cross that line and interfere with FERC’s jurisdiction. This ruling is significant for two reasons. First, a contrary ruling by the Second Circuit could have threatened renewable portfolio standard programs across the country. Second, the Second Circuit’s Allco decision is the first time a federal court has interpreted the Supreme Court’s holding in Hughes v. Talen Energy. The Second Circuit sought to confine the holding in Hughes v. Talen Energy to state interferences in the FERC-regulated capacity market that was directly at issue in that proceeding. The Second Circuit rejected a broad reading of Hugh v. Talen Energy that could be used to restrict state initiatives to promote renewable energy. As Illinois and New York federal courts are currently considering challenges to state nuclear subsidiaries based in part on the precedent in Hughes v. Talen Energy, the Second Circuit’s reasoning in Allco may be influential in those cases.

But, the Second Circuit’s decision in Allco was not clear about when state action would cross the line to “compelling” a utility to sign a power purchase agreement. Does the utility always need to have the option to refuse to sign a contract? What if the utility had the option to refuse to sign a contract with an individual generator, but was required to sign a contract with at least one of the competitive solicitation winners? Furthermore, the court noted that it was not ruling on whether FERC review would be sufficient to defeat a preemption claim if Connecticut had actually “compelled” the utilities to enter into bilateral contracts. Thus, the Second Circuit decision leaves open questions regarding how much FERC oversight is needed over these types of state renewable energy solicitation programs and the range of permissible state actions to require a utility to enter into a wholesale power contract.

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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