Montana Supreme Court Rejects Public Service Commission’s Reduction of Avoided Cost Rates and Contract Terms for PURPA Contracts

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On August 24, 2020, the Montana Supreme Court ruled that the Montana Public Service Commission (PSC) failed to properly justify changes it approved for the standard-offer rates and contracts for small renewable energy facilities classified as “Qualifying Facilities” (QFs) under the Public Utility Regulatory Policies Act of 1978 (PURPA). Specifically, the Court rejected the PSC’s conclusions to substantially reduce avoided-cost rates for small QFs, to eliminate a “cost of carbon” adder that had previously been included in QF rates, its method for calculating the capacity value of solar resources, and to shorten standard contract terms to 15 years. The Montana Court’s decision is the latest salvo in a long-running conflict over the implementation of PURPA by the states, and is particularly important for renewable energy producers because Montana is endowed with excellent wind and solar resources.

Background

As we have previously discussed in greater detail, PURPA aimed to increase the production of power by small renewable generation and cogeneration projects (termed “Qualifying Facilities” or “QFs”) as one solution to the recurring energy crises of the 1970s. To overcome the reluctance of traditional utility monopolies to permit their competitors to access electricity markets, Section 210 of PURPA imposes a mandatory purchase obligation on regulated utilities, requiring them to purchase power from QFs at “avoided cost” rates. Under PURPA’s “cooperative federalism” model, the primary responsibility for implementing PURPA falls on the state utility commissions and on the elected boards and commissions that govern the nation’s publicly-owned utilities. However, those boards and commissions must comply with implementation rules issued by the Federal Energy Regulatory Commission (FERC).

Implementation of PURPA in Montana has proved particularly controversial. Under Montana’s “Mini-PURPA” statute, MCA 69-3-601 to 604, QFs with a nameplate capacity of 3 MW or less are eligible for standard-offer contracts, where rates are established by the PSC. The dispute giving rise to the new Montana Supreme Court decision began in 2016, when Northwestern Energy, the largest regulated utility in the state, sought approval of new avoided-cost rates that were far lower than the rates in effect at that time. The 2016 filing gave rise to more than a year of contentious proceedings. Ultimately, the PSC approved substantially reduced standard-offer rates which rejected a carbon adder that had previously been included in QF rates, substantially revised the method for estimating utility avoided costs, and reduced standard contract terms from 25 to 15 years.

The Court’s Decision

Five of Montana’s seven justices agreed that the PSC committed reversible error in approving these revised QF rates. Specifically, the Court concluded, the PSC erred in rejecting the carbon adder previously included in avoided cost rates because it did not adequately justify its departure from decisions dating back to 2012 including the carbon adder in avoided cost rates. The PSC originally included the carbon adder in avoided cost rates to represent the costs of compliance with greenhouse gas reduction mandates that would be avoided if Montana utilities purchased output from carbon-free renewable resources rather than relying on fossil-fueled generation. The PSC reversed course on this element of its avoided cost calculations on the ground that the Trump Administration’s antipathy to carbon regulation made increasing costs for regulation related to carbon reduction less likely. The Court disagreed, concluding that setting avoided cost rates “despite market volatility and uncertain” is inherent in PURPA’s purpose, which requires encouragement of QF development despite the uncertainties. Especially in light of the fact that the PSC had previously identified carbon adders as “key” element of avoided cost rates that, despite uncertainty, could not be zero, the Court concluded that additional uncertainty did not justify departure from those earlier precedents.

The Montana Court also concluded that the PSC erred in its use of the projected costs of electricity from a combined cycle combustion turbine (CCCT) as the proxy for avoided capacity costs. Specifically, the PSC assumed that Northwestern could defer capacity additions until 2025, even though its integrated resource plan calls for new capacity resources in 2019. This mismatch in timing, the Court concluded, violates PURPA because the avoided cost rates set by the PSC do not compensate QFs for the capacity costs avoided by QF purchases in the period between 2019 and 2025. In addition, these utility capacity purchases carry with them avoided costs related to the production of energy from those resources, at least in peak demand periods, which the PSC’s avoided cost calculation failed to reflect.

The Court also rejected the PSC’s estimate that solar resources have a 6.1% capacity value – that is, that they contribute 6.1% of their nameplate generation to the utility’s need for capacity resources. This capacity value receives compensation at the utility’s avoided cost for new capacity, while the QF’s remaining compensation is entirely for energy. The Court concluded that the PSC had erred by unduly discounting the utility’s need for summertime capacity, for which solar resources can provide substantial support. In addition, the Court concluded, the PSC improperly disregarded regional peak demand data.

Finally, the Court rejected the PSC’s conclusion that 15-year contract lengths are sufficient to encourage QFs. While the Court recognized that 15-year terms are not per se unreasonable, it rejected the PSC’s reasoning because the PSC failed to consider whether a 15-year term, combined with the drastically reduced avoided cost rates approved by the PSC, would be sufficient to encourage QF development as required by both the federal PURPA and Montana’s Mini-PURPA.

Importance of the Decision

The Montana Supreme Court’s decision is important for a number of reasons. To start with, both state and federal policymakers have struggled with the social cost of carbon – that is, how to quantify the economic impact of carbon emissions and integrate that cost into government decision-making – and the Court’s rejection of this aspect of the PSC’s decision is therefore likely to reverberate far beyond Montana’s borders.

The remaining issues addressed in the opinion – appropriate methods to determine utility avoided cost, how to assign capacity value to renewable resources, and the length of contracts necessary to encourage QF development – were all major issues in the administrative process leading up to FERC’s recent overhaul of PURPA implementation rules. The Montana Court’s ruling both underscores the importance of these issues under PURPA and suggests how a federal court might view FERC’s justification of its PURPA overhaul. In particular, it is interesting to note that the primary justification for FERC’s rulemaking, the impact of PURPA on electric consumers, was rejected out of hand by the Montana Court, which found that “the frequently-uttered trope that the requirements of PURPA and thus approval solar sources of energy will wildly increase the rates charged to consumers finds little basis in this record.”

Finally, the decision underscores the fact that FERC’s new PURPA implementation rule is but the first step in changing how PURPA rates are set. If the FERC rule survives a likely judicial challenge, it will increase the flexibility of states to set flexible energy rates but require fixed avoided-cost capacity rates. If states elect to take advantage of this flexibility, litigation like that in Montana is likely to ensue. Further, the method for determining the capacity value of PURPA resources will become even more critical, and the Montana Court’s decision on this aspect of the case is therefore could become an important precedent.

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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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