Recent Complaints Highlight Continued Friction between State Policy Goals and Federally Regulated Wholesale Power Markets

by Akin Gump Strauss Hauer & Feld LLP
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On June 24, 2016, two complaints were filed with the Federal Energy Regulatory Commission (“Commission or FERC”) that highlight the continued tension between state policy initiatives and the mandatory centralized capacity markets operated by Regional Transmission Organizations and Independent System Operators (RTOs/ISOs). The complaints are just the latest in a series of FERC proceedings that raise the question of whether buyer-side market power mitigation measures in those markets (such as minimum offer price rules) are necessary to maintain accurate price signals in the face of state policies or whether such measures unduly interfere with legitimate state policy goals. More broadly, they also will likely add to the debate over the appropriate division between federal and state regulatory authority under the Federal Power Act in the context of the still-evolving RTO/ISO markets.

Capacity Markets and Minimum Offer Price Rules

The three eastern RTOs/ISOs—ISO New England (ISO-NE), the New York Independent System Operator (NYISO) and PJM Interconnection—all operate mandatory centralized electric capacity markets as a tool to maintain sufficient resources (including generation and demand response) to reliably serve customers. These markets are intended to provide price signals to incent the construction of new resources and to provide a critical source of revenue to existing resources. Using an auction mechanism, each RTO/ISO purchases electric capacity from generators and other resources to meet the region’s expected load obligations, plus a reserve margin, for a period in the future. The RTO/ISO then recovers the costs of those purchases from utilities (who pass those costs on to consumers). Resources submit sell offers into the auction, and those with a sell offer equal to or less than the auction “clearing price” will “clear” the auction and receive payments for capacity equal to the clearing price (regardless of what they actually bid). Resources that fail to “clear the auction” (i.e., submit sell offers in excess of the final clearing price) do not receive capacity payments. Thus, while resources are generally expected to submit offers reflecting their “net going-forward costs” to operate (less expected income from energy and ancillary services markets), in some cases, they may offer well below that amount to ensure that they clear the auction.

In recent years, concerns have been raised that buyers of capacity (load-serving entities and their customers) may have incentives to take actions in the capacity market that artificially suppress capacity prices below competitive levels and lower their total capacity bill. This is a form of “buyer-side market power.”  For example, a load-serving entity could, under certain circumstances, construct or procure a new generation resource and offer it into the capacity market at well below its costs, lowering the market clearing price and the overall capacity costs passed to it from the RTO/ISO. In some circumstances—such as the recent Maryland and New Jersey state-sponsored capacity programs that the Supreme Court recently concluded were pre-empted by federal law—state regulators may direct a load-serving entity to take such an action and allow it to recover the full costs it incurs to construct or procure the new resource from retail customers. This “subsidy,” as some have labeled it, allows the new resource to bid below its costs in the capacity market without risk that it will fail to recover those costs if the market clears at a lower price.  

FERC has found that this kind of artificial price suppression in the capacity markets may interfere with the price signals that such markets are intended to provide, discouraging new entry and potentially leading existing generators to retire too early because of insufficient payments. To address this concern, the RTOs/ISOs (often at FERC’s insistence) have instituted buyer-side market power mitigation rules, such as minimum offer price rules. These rules prevent certain resources—generally new resources—from submitting low offers and require them to offer at a price that more closely mirrors their costs, rather than allowing them to bid below their costs. Because these resources are required to submit higher offers, they face a greater risk that they will not clear the market and receive capacity payments.

June 24, 2016, Complaints

In the first of the June 24 complaints, two generation owners in the ISO-NE market allege that additional buyer-side market power mitigation measures are needed to address the alleged potential for suppression of wholesale prices by proposed state efforts to support the construction of new natural gas pipeline capacity to deliver gas to electric generators in the region.1 Under those proposals, which are pending before utility commissions in Massachusetts, New Hampshire, Connecticut and Rhode Island, electric distribution companies (EDCs) would enter into contracts for new pipeline capacity, with the contract costs recovered from their retail customers. The EDCs would then release that pipeline capacity for purchase and use by gas-fired electric generators in the region. Complainants—who state that they own generation that is either not natural gas-fired or not located near the contemplated pipeline—assert that these proposals, if approved, will result in a “subsidy” benefiting only those generators using the released capacity, and will “suppress wholesale market clearing prices by artificially flooding the market with supply and by artificially decreasing transportation costs.”2 The complainants ask the Commission to find that this alleged “price suppressive effect” will result in unjust and unreasonable wholesale prices, and to direct ISO-NE to develop and file tariff revisions to mitigate this effect.

Rather than seeking additional buyer-side mitigation measures, the other June 24 complaint, jointly filed by the New York Public Service Commission, several other New York governmental agencies and two nonprofit organizations, seeks to exempt certain demand response resources from the buyer-side market power mitigation measures that apply to resources participating in the NYISO capacity market.3 Under these measures, all new resources in New York City and the Lower Hudson Valley regions must offer into the capacity market at a predetermined minimum offer price (or “floor”). Among other things, the NYISO tariff includes in the calculation of a demand resource’s minimum offer price any payments received from state-approved retail demand response programs (e.g., distribution-level load relief programs). The complainants assert that applying these mitigation measures to demand response resources participating in state programs limits their full participation in the capacity market (since they are excluded if the market clears below their minimum offer price) and may force them to choose to forgo participating in state programs to avoid mitigation. These outcomes, they contend, directly interfere with New York’s policy objectives to promote and maximize the use of demand response resources, and interfere with the state’s authority over distribution rates, and reliability and distribution planning matters, which are all left to the states under the Federal Power Act. For these reasons, the complainants ask FERC to adopt a blanket exemption from buyer-side mitigation for these demand response resources or, in the alternative, exclude the revenues they receive from certain specific state programs from the calculation of their minimum offer price.

Implications

These complaints are just the latest in a string of FERC proceedings addressing buyer-side market power issues in the eastern RTO/ISO centralized capacity markets and, in particular, how state policy initiatives can (or cannot) be accommodated in those markets. In all three markets, FERC has issued numerous orders in the past five years that revised the types of resources to which minimum offer price rules apply and that granted or rejected exemptions for capacity resources developed pursuant to state public policies (e.g., renewable portfolio standards). The June 24 complaints once again ask FERC to draw lines regarding the extent to which state policy objectives may, or may not, impermissibly affect wholesale prices.  

The complaints also come on the heels of increased litigation and debate regarding the division of authority between the federal and state governments under the Federal Power Act. The Supreme Court issued two opinions this term (in FERC v. EPSA and Hughes v. Talen Energy) that addressed jurisdictional disputes in the RTO/ISO markets. Those decisions both ruled in favor of federal jurisdiction on relatively narrow grounds and explicitly declined to rule more broadly on the scope of federal and state authority. In a recent letter to FERC seeking additional information on RTO/ISO market performance, congressional leaders raised concerns that these decisions may spur additional jurisdictional uncertainty and litigation going forward. FERC may be forced to again wade into this increasingly uncertain area of the law in addressing the complaints.


1 NextEra Energy Resources, LLC and PSEG Companies v. ISO New England Inc., Complaint, Docket No. EL16-93-000 (filed June 24, 2016).
2 Id. at 29-30.
3 New York State Public Service Commission, et al. v. New York Independent System Operator, Inc., Complaint, Docket No. EL16-92-000 (filed June 24, 2016).

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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