FERC Opens the Door to Carbon Pricing in Wholesale Electricity Markets

Davis Wright Tremaine LLP

Davis Wright Tremaine LLP

The Federal Energy Regulatory Commission (FERC) recently took steps to encourage regions to incorporate state carbon pricing policies into wholesale electricity markets. FERC's proposed policy statement comes at a time when some states are calling for regional transmission organizations (RTOs) and independent system operators (ISOs) to do more to further state clean energy policies.

Earlier this month, five New England governors issued a strongly-worded statement declaring that ISO New England Inc. must become a partner in New England's decarbonization efforts and develop market-based mechanisms that, in concert with state policymakers, facilitate growth in clean energy resources.

Carbon pricing has emerged as an important tool in state efforts to reduce greenhouse gas (GHG) emissions from the electricity sector in order to address climate change. Eleven states currently require some version of carbon pricing, which includes both state-established prices on GHG emissions and indirect approaches such as cap-and-trade systems. Other states are considering adopting a carbon pricing regime.

FERC Clarifies Jurisdiction Over Market Rules With Carbon Pricing

FERC's October 15, 2020, notice of proposed policy statement is intended to clarify its jurisdiction over market rules for incorporating state-determined carbon prices into organized wholesale electricity markets and encourage filings to implement such market rules.

Well prior to FERC's proposed policy statement, some RTOs and ISOs have been examining approaches to incorporating a state-determined carbon price into the wholesale electricity markets they oversee. FERC has long permitted generators to recover the costs of environmental compliance and also approved filings establishing wholesale market rules addressing the impact of California's carbon pricing regime on the California ISO's Energy Imbalance Market.

In its proposed policy statement, FERC clarified that although it is not an environmental regulator, wholesale market rules that incorporate a state-determined carbon price into RTO/ISO markets can fall within FERC's jurisdiction as a practice affecting wholesale rates under section 205 of the Federal Power Act (FPA). FERC explained that under a two-part test established by the Supreme Court of the United States for evaluating whether a FERC action is within its jurisdiction, such market rules can both (1) directly affect wholesale rates and (2) be regulated by FERC because they are not exclusively within state jurisdiction.

In a partial dissent, however, Commissioner Danly cautioned that specific RTO/ISO carbon pricing proposals that may be presented to FERC could violate the FPA by impermissibly invading the authorities reserved to the states.

FERC Seeks Comments Regarding Evaluation of Carbon Pricing Market Rules

FERC found that one of its recent technical conferences identified numerous potential benefits from incorporating a carbon price set by one or more states into RTO/ISO markets. Based on the record at the technical conference, FERC listed a set of questions that may be germane to its evaluation of any FPA section 205 filing.

These include questions such as how the proposal would ensure price transparency and enhance price formation, how the carbon price would be reflected in locational marginal prices, and how incorporation of the carbon price into the RTO/ISO market would affect dispatch and co-optimization of energy and ancillary services. FERC requested public comment on whether its questions are the appropriate ones to ask or whether different or additional considerations may or must be taken into account.

The proposed policy statement was supported by both Republican and Democratic FERC Commissioners. Chairman Chatterjee stated that he views carbon pricing in wholesale markets as a fuel-neutral design feature in contrast to other state policies which he has characterized as subsidies that that degrade wholesale market efficiency.

Comments on the proposed policy statement are due November 16, 2020, and reply comments are due December 1, 2020.

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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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