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Electricity Regulation Is Back at the Supreme Court, Again

Ari Peskoe's picture
Harvard Law School Environmental Policy Initiative
  • Member since 2018
  • 16 items added with 4,669 views
  • Feb 18, 2016

court and electricity

On February 24th, the Supreme Court will hear oral argument in a case involving, once again, the roles of state and federal regulators in electricity markets.  The argument will come less than one month after the Court upheld federal (FERC) authority to set compensation for demand response in wholesale electricity markets.  Taken together, the Court’s two decisions this term about electricity regulation could set the ground rules for how advanced energy technologies such as solar and storage participate in electricity markets for decades to come.

It is highly unusual for the Supreme Court to decide two cases about electricity regulation in a single term.  Since 1990, the Court has heard only six cases about electricity regulation (although the Court has heard additional cases about regulation of power plant pollution).  The dearth of Supreme Court cases is not due to a lack of controversies; lower courts routinely decide these issues.  The rarity of a Supreme Court case on electricity regulation serves to amplify the importance of these two decisions.  The cases will set precedent for lower courts and regulators, and it is unlikely that the Supreme Court will revisit these issues for years to come. 

Both cases challenge the division of authority between state and federal regulators that was established in federal law 80 years ago.  When the Federal Power Act (FPA) was written in 1935, power flowed primarily from plants owned by vertically integrated utilities to their local consumers.  The FPA provided federal regulators with authority to regulate wholesale sales between utilities, which at the time represented only a small portion of total energy consumption, while preserving state authority over the retail rates that consumers pay to their local utility.  That reservation of authority also left states in control of how utilities earned money from power plant construction because the costs of those investments were included in customers’ retail rates.

The industry has since evolved.  Vertically integrated utilities now generate about half of the nation’s power, while so-called “independent power producers” that are not owned directly by a utility serving retail customers are also major suppliers.  In much of the country, generators and utilities trade power through regional auction markets.  Pursuant to the FPA, these wholesale auction markets are under FERC’s jurisdiction.  FERC approves market rules and must ensure that rates are just and reasonable.  States continue to set retail rates, but in many states those rates are paid to utilities that do not generate their own power.  To serve their customers, these utilities purchase power at wholesale through transactions regulated by FERC, and then resell that power at retail.

The demand response case illustrates how intertwined wholesale and retail transactions can be.   The Supreme Court was asked whether federal regulators can set the compensation paid by wholesale market operators to consumers who reduce their retail purchases.  FERC argued that it has authority to do so because even though demand response providers are retail customers they help to balance supply and demand in wholesale markets.  The lower court, however, had held that FERC had no authority to invite retail customers, who fall under state jurisdiction, into wholesale markets where they would be subject to federal regulation.  The Supreme Court overturned that ruling, finding that FERC’s broad jurisdiction over wholesale markets allows it to regulate demand response, even though doing so will have effects at the retail level.  

The case the Supreme Court will hear later this month is about state-mandated contracts between Maryland utilities and a yet-to-be-constructed natural gas fired power plant.  In 1999, Maryland ordered its utilities to sell their power plants and then meet their customers’ demand with wholesale power purchases.  This restructuring meant that new power plants in the state would earn revenue through FERC-regulated wholesale sales, and not directly from retail customers, as was the case when utilities were vertically integrated.  

A decade later, Maryland regulators determined that the state needed additional power supplies.  They requested proposals from developers, and ultimately selected a winning project.  Regulators then required the state’s utilities to sign 20-year contracts with the developer.  The contract rates were pegged to the price generated by a FERC-regulated auction.  If the auction price was below a specified rate, the utilities would pay the difference between the specified rate and the auction price.       

Competing generators in the PJM wholesale auction market filed complaints in federal court, arguing that the state-mandated contracts violated the wholesale-retail divide established by the FPA.  By guaranteeing the developer revenue over and above the auction price, the competitors claimed Maryland was essentially setting a wholesale rate, which it may not do.  They also argued that the state-mandated contracts conflict with FERC’s policy of using markets to set just and reasonable prices.  Two lower courts agreed, finding that the contracts ordered by Maryland are preempted by federal law (a very similar scheme in New Jersey was invalidated by two different federal courts).

Regardless of how the Supreme Court rules on Maryland’s contracts, the Court has an opportunity to clarify that federal and state regulation can co-exist.  When all utilities were vertically integrated, the Court said that the FPA established a “bright line” between federally regulated wholesale and state regulated retail sales.  But these two cases illustrate that whatever line Congress intended to draw in 1935 does not neatly divide the industry today.

Demand response is just one energy technology that has a foot on either side of the jurisdictional line.  Rooftop solar is typically compensated through state programs, such as net metering.  But one federally regulated wholesale market operator has developed a plan to let these resources participate. Energy storage, including batteries in electric vehicles, would also qualify for the program.   

FERC must approve the plan before it can go into effect.  The Supreme Court’s demand response decision appears to sanction this approach, but legal challenges are likely.  The Court’s second decision this term may tip the balance.  The Court could endorse a flexible answer to the jurisdictional question, as it did with demand response.  Or, the Court could retreat to the “bright line” approach that it applied to a very different electric industry.  If that happens, proponents of advanced energy technologies may find themselves asking Congress to amend the 80-year old FPA to ensure that development of the twenty-first century electric grid is not hamstrung by a twentieth century law.

Ari Peskoe's picture
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Bob Meinetz's picture
Bob Meinetz on Feb 20, 2016

Ari, there are fewer differences between twentieth-century electricity markets and contemporary ones than you think.

The entities collectively labeled “vertical integration” in 2016 were known as “holding companies” in the 1920s. They provided fertile soil for a garden of abuses and conflicts of interest before the Wheeler/Rayburn Act, also known as the Public Utility Holding Company Act of 1935 (PUHCA), put a stop to them. Among other important restrictions, it mandated strict SEC oversight to ensure the business relationships of utilities served “the public interest”. For seventy years, regulated utilities in America worked well enough to become a model for the world.

After decades of attempts to do so, energy interests allied with the Bush administration successfully repealed PUHCA in 2005. Since then, electricity rates have risen by 40% and influence peddling is rampant. With utilities still holding a natural monopoly on transmission, it’s once again easy to design a multi-layered, derivative corporate structure where they sell themselves fuel to generate electricity, then send the bill to ratepayers. The same scam it was 90 years ago in bright new “renewables” packaging. Singlehandedly, it’s the repeal of PUHCA – not “cheap natural gas” – which is providing the financial incentive for utilities to close nuclear plants.

In prepared testimony to the SEC in 2004, former FERC administrator Lynn Hargis warned of the consequences of repealing PUHCA:

“In my thirty-odd years of electric utility regulatory practice, I have come to believe that PUHCA is the most important piece of federal legislation relating to electric and natural gas utilities…if PUHCA is repealed the consequences to electric and natural gas utility customers and to our national economy may be catastrophic.”

It’s a shame we didn’t listen.

Edward Kee's picture
Edward Kee on Feb 22, 2016

Ari: great article – thanks.  All eyes on 8-justice SCOTUS

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