Once again, the Court of Appeals for the DC Circuit has ruled that the Federal Energy Regulatory Commission (“FERC”) has overstepped its jurisdictional bounds. Last year, the DC Circuit rejected FERC’s presumption of authority to fine energy trader Brian Hunter for manipulating the natural gas futures market.   This time, the DC Circuit struck down Order 745 –  which sets forth FERC’s mandate to compensate end-use customers for not using electricity under a demand response market schematic.  In a ruling issued today (May 23), the DC Circuit found that FERC went too far, “encroaching on the state’s exclusive jurisdiction to regulate the retail market.”

FERC required that RTOs/ISOs establish markets to compensate demand response resources under Order 745 back in 2011.  Participants in  demand response markets are retail electricity consumers that offer to reduce their energy consumption, and are compensated in the wholesale market as though they had generated the amount of energy they saved. Thus, participants receive compensation for the “NegaWatt” (as opposed to the MegaWatt). 

Under Order 745, RTO/ISOs must compensate all demand response providers that serve as an alternative to generation in wholesale energy markets (known as the day-ahead and real-time markets). These demand response providers must be compensated for balancing supply and demand in wholesale markets at full market price, which is known as the Locational Marginal Price (“LMP”).  LMP is the market price for compensating generators, though the calculation is different among RTO/ISOs and varies with nodes or zones within each ISO/RTO footprint. Further, this compensation must pass a net benefits test. The net benefits test requires that the benefits of demand response to the grid is greater than the cost of deploying demand response and paying demand response providers at the same rate as generators. As the dissenting opinion explained, “Order 745 requires compensation of demand response resources only when their participation in a wholesale electricity market actually lowers the market-clearing price for wholesale electricity.”

FERC argued that “when retail consumers voluntarily participate in the wholesale market, they fall within [FERC’s] exclusive jurisdiction . . .” Petitioners (lead by the Electric Power Supply Association) retorted that “retail sales of electricity are within the traditional and exclusive jurisdiction of the States and regulating consumption by retail electricity customers is a regulation of retail, not wholesale, activity. . . [FERC] has no authority to draw retail customers into the wholesale markets by paying them not to make retail purchases.”

When customers have an incentive to reduce consumption during peak usage of energy, this is demand response. FERC made the distinction between “retail demand response,” which is a response to high retail rates, and “wholesale demand response,” which is a response to incentive payments.

Under the Federal Power Act, it is undisputed that FERC has jurisdiction over the wholesale energy markets.  The question is, how far does FERC’s authority extend?  Not to demand response says the DC Circuit, observing that “Demand response resources do not actually sell into the market. Demand response does not involve a sale, and the resources ‘participate’ only by declining to act.” FERC conceded this point and its argument was that “§§ 205 and 206 grant the agency authority over demand response resources in the wholesale market. These provisions task FERC with ensuring all rules and regulations affecting . . . rates in connection with the wholesale sale of electric energy are just and reasonable. . . Thus, the Commission argues it has jurisdiction over demand response because it directly affects wholesale rates.”

The DC Circuit came down hard on this argument, warning that “FERC’s rationale . . . has no limiting principle. Without boundaries, §§ 205 and 206 could ostensibly authorize FERC to regulate any number of areas, including the steel, fuel, and labor markets.” The DC Circuit focused on preserving the distinction between wholesale and retail markets, careful to ensure that it did not set any precedent where anything in the retail market that affected wholesale sales could come under FERC’s jurisdiction. The DC Circuit ruled that “FERC can regulate practices affecting the wholesale market under §§ 205 and 206, provided the Commission is not directly regulating a matter subject to state control, such as the retail market.”

The DC Circuit went on to state, “The fact that the Commission is only ‘luring’ the resource to enter the market instead of requiring entry does not undercut the force of [Petitioner’s] challenge. The lure is change of the retail rate. Demand response – simply put – is part of the retail market. It involves retail customers, their decision whether to purchase at retail, and the levels of retail electricity consumption.”

Finally, (fulfilling the second step of the Chevron-two step for our lawyer friends), the DC Circuit mused that even under the assumption that FERC had jurisdiction to issue Order 745, it abused its discretion by not fully considering counter arguments that demand response should not be compensated like generation, and that Order 745 could “result in unjust and discriminatory rates.” The DC Circuit, in its final verbal lashing, concluded its opinion by stating that “if FERC thinks its jurisdictional struggles are its only concern with Order 745, it is mistaken. We would still vacate the Rule if we engaged the Petitioner’s substantive arguments.”

See the full ruling here [pdf]: Opinion, EPSA v. FERC, No. 11-1486