Divided Court of Appeals Panel Vacates FERC Order 745 on Compensation of Demand Response

by McDermott Will & Emery
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FERC’s Order No. 745 requiring independent regional grid operators  (RTOs and ISOs) in limited circumstances to compensate providers of state-authorized demand response services in the same amounts that they compensate electricity generators was vacated in a May 23, 2014 decision by the majority of a three-judge panel of the U.S. Court of Appeals for the D.C. Circuit in Electric Power Supply Association v. FERC.  Siding with challengers — principally electricity generators — Judge Brown writing for the two-judge majority held that FERC exceeded its Federal Power Act (FPA) jurisdiction over electricity wholesales and intruded impermissibly on retail jurisdiction reserved to states by “lur[ing]” retail customers into the wholesale markets of regional grid operators with “rich” incentives to reduce retail purchases and consumption whenever a net benefit accrues to the wholesale market in the form of lower market-clearing prices in the wholesale market.  Even if it had not vacated the rule based on this jurisdictional conclusion, the majority said it would have reversed the rule on an alternative ground urged by challengers.  According to those challengers, the rule also was arbitrary and capricious by requiring that demand response providers under limited circumstances be compensated at the same locational marginal price or LMP paid to electricity generators.

In a forceful dissent (running nearly twice as long as the majority opinion), Senior Circuit Judge Edwards disagreed with both the jurisdictional vacatur and the threatened reversal of the rule prescribing LMP payments in some circumstances on arbitrary and capricious grounds.  Demand response services at least arguably did not fall under the FPA reservation to states of all sales other than wholesales since demand response involves no sale at all, but rather a foregone sale or “negawatt.”  The court therefore, according to the dissent, should have deferred to FERC rather than presume greater expertise in interpreting the agency’s jurisdictional statute.   In addition, the dissent agreed with FERC that direct participation of demand response resources in wholesale markets entrusted to FERC improves the functioning of those markets in three ways:  (1) by reducing peak demand and system imbalances, it lowers clearing prices; (2) it mitigates the market power of generators (particularly pivotal suppliers); and (3) enhances system reliability by lowering demand in response to system emergencies. Incentivizing demand response that offers net benefits to wholesale markets through LMP payments is not unlike the capacity payments that the court found FERC could regulate in Connecticut Dept. of Public Utility Control v. FERC, even though ensuring adequate capacity in wholesale markets could incentivize, among other investments, investments in generation, which is regulated by the states.  Therefore, FERC was acting well within the parameters of its wholesale jurisdiction and the court’s precedents.

The disagreement between the majority and dissent on the LMP payments was even more pronounced.  Long the preferred method of pricing electricity in organized electricity markets, LMP is the marginal value of an increase in supply or a reduction in consumption at each notional location (node) within an organized RTO or ISO market at a given interval of time.  The majority (siding with FERC Commissioner Moeller, who dissented below from Order No. 745) objected to paying a demand response provider the same LMP as an electricity generator since the demand response provider does not incur the cost of generating or purchasing electricity, while a generator or other supplier does.  The dissent, in contrast, sided with the FERC majority in concluding that demand response providers incur other costs that generators and other suppliers do not incur and more importantly FERC, with judicial approval, ceased cost-based ratemaking in favor of market pricing (in the absence of market power) over a decade ago for all organized RTO and ISO markets.  Therefore, respective costs should not be a controlling consideration.

Because of the undisputed value of demand response in both wholesale and retail electricity markets and the sharp division on the court, FERC can be expected to petition for rehearing of the majority’s decision.

 

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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