The first federal appellate court to address whether the FERC has the authority to order compensation for demand response has concluded that it does not. This follows more than ten years of FERC orders that have allowed demand response to participate and be compensated in FERC-regulated wholesale markets throughout the nation for energy, capacity and ancillary services.

On May 23, 2014, in Electric Power Supply Ass’n v. FERC, a split three-judge panel of the United States Court of Appeals for the District of Columbia Circuit held that the Federal Power Act (“FPA”) does not grant the Federal Energy Regulatory Commission (“FERC”) jurisdiction over demand response.  This historic decision stemmed from the appellate court’s review of FERC’s Order No. 745, which directed Regional Transmission Organizations and Independent System Operators to update their organized wholesale market rules to compensate demand response resources at the locational marginal price (“LMP”) at times when it would be cost effective to displace generation resources with demand response resources.  Based on the holding that the FERC acted ultra vires in issuing Order No. 745, the court vacated the rule in its entirety.

Majority Opinion

Reviewing the text of the Federal Power Act, the majority found that Congress clearly delineated the FERC’s authority in FPA section 201(a) and that the states retain “exclusive” jurisdiction over the electric retail market.  The majority further found that “demand response, while not necessarily a retail sale, is indeed part of the retail market, which . . . is exclusively within the state’s jurisdiction.”  Slip Op. at 8 n.1.  The majority rejected the notion that because the FERC is only “luring” demand response to participate in the wholesale market, the FERC has not crossed any jurisdictional threshold, because demand response “involves retail customers, their decisions whether to purchase at retail, and the levels of retail electricity consumption.”  Slip Op. at 11.  Accordingly, the majority held that the FPA “unambiguously restricts the FERC from regulating the retail market.” Slip Op. at 14.

While agreeing that “demand response compensation affects the wholesale market,” the majority held that, under the FPA, the FERC can regulate “practices affecting” the wholesale market provided that it is not “directly regulating” matters under state control, like retail markets.  Slip Op. at 10.  Additionally, the majority faulted the FERC for not providing a “limiting principle” to its “practices affecting” rationale, finding that “[w]ithout boundaries” a slippery slope could emerge under which the FERC could regulate other areas, including steel, fuel, and labor markets.  Slip Op. at 7.

The majority also disposed of the FERC’s insistence that Order No. 745 is consistent with Congress’s policy statement in section 1252(f) of the Energy Policy Act of 2005 to emove “barriers to demand response participation in energy, capacity and ancillary service markets.”  Noting that statements of Congressional policy do not provide an independent grant of authority, the majority also concluded that, in the Energy Policy Act of 2005, Congress recognized the “significant impact” demand response can have on the wholesale market, but still decided to leave regulation to the states.  Slip Op. at 13-14.

In addition to holding that the FERC exceeded its jurisdiction, the majority also examined the merits of Order No. 745 and found the compensation rule to be arbitrary and capricious, because it overcompensates demand resources, which, in effect, receive not just LMP but also avoided generation costs.

Dissenting Opinion

In a lengthy dissenting opinion, Senior Judge Edwards reached different conclusions.  He found:  (1) the Federal Power Act is ambiguous as to whether the FERC has jurisdiction over demand response; (2) the FERC’s interpretation of its statutory authority was reasonable; and (3) paying LMP to demand response under the conditions articulated in Order No. 745 was reasoned decision-making.  The dissent argued that it is ambiguous “whether forgone consumption constitutes a [retail] ‘sale’ under” the FPA barring the FERC’s assertion of jurisdiction, and would find the FERC has the authority under the FPA’s “practices affecting” jurisdiction to set a level of compensation for demand resources that will ensure just and reasonable rates for sales of electricity for resale.  Dissent at 4.

The dissent rebuked petitioner’s (and, by implication, the majority’s) reliance on FPA section 201(a) by noting that the U.S. Supreme Court has “made clear” that the reservation of powers to the states under FPA section 201(a) “is a mere policy declaration.”  Dissent at 16.  The dissent further concluded that, even assuming the FPA considers demand response to be the sole province of the states, Order No. 745 does not “directly regulate” the retail market because the FERC’s compensation scheme only applies to demand resources that are eligible under state law and voluntarily elect to participate, and then only get paid when cost effective to the market.

Contrary to the majority, the dissent discerned two limits on the FERC’s “practices affecting” jurisdiction, which preclude concerns about a slippery slope leading to the FERC’s regulation of steel, fuel, and labor markets.  One, section 201 prohibits any “direct regulation” of retail sales.  Two, as set forth in Cal. Indep. Sys. Operator Corp. v. FERC, 372 F.3d 395, 403 (D.C. Cir. 2004), the FERC’s “affecting” jurisdiction is limited to things that “directly affect” the rate or are closely related to the rate’” and does not extend to “remote things” that might “indirectly or ultimately” affect the rate.  Dissent at 20.

Finally, the dissent examined the merits of Order No. 745’s LMP compensation scheme and found it to be grounded in reasoned decision-making.  Dissent at 27.

Next Steps

Given the strong dissent, it can be expected that parties that sided with the FERC, and possibly the FERC itself, will seek rehearing by the appeals panel and/or rehearing by the full D.C. Circuit.  Rehearing petitions must be filed within 45 days of the court’s decision (i.e., by July 7, 2014).  Pending disposition of any rehearing requests, the court has withheld the formal “mandate” that transmits the decision to the FERC.  If the court does not rehear the case, parties may seek review by the U.S. Supreme Court.

Implications

Given the degree to which demand response has become integrated into the organized wholesale energy and capacity markets, the implications of the court’s holding that the FERC lacks jurisdiction over demand response are wide-ranging.  The court’s holding, if not upset on rehearing or by the Supreme Court, could eliminate demand response’s participation as a supply-side resource compensated under FERC-regulated wholesale energy market tariffs.  The decision similarly has substantial implications for demand response participation as a supply-side resource compensated in FERC-regulated capacity and ancillary service markets.  The opinion also will likely raise significant transitional questions, and it will affect many pending and future FERC proceedings relating to demand response.

Wright &Talisman, P.C. represented market operators and others in the Order No. 745 proceedings and regularly advises clients on issues concerning demand response.

Please contact us via email or call 202-393-1200 if you have any questions or would like to discuss the implications of the court’s opinion.