Supreme Court Affirms FERC’s Authority Over Demand Response Prices in Wholesale Markets

On January 25, 2016, the U.S. Supreme Court, in a 6-2 decision authored by Justice Kagan and supported by the Chief Justice, reversed the D.C. Circuit’s holding that the Federal Energy Regulatory Commission (FERC) intruded on the retail electric market over which it lacks jurisdiction when it issued Order No. 745, which requires that aggregators of demand response service be paid the market-clearing price (LMP) in electric energy auctions administered by regional transmission operators (RTOs) and independent system operators (ISOs). The Court held that the Federal Power Act (FPA) provides FERC with authority to regulate the compensation paid by RTOs and ISOs for demand response bids in the energy auctions because such practices directly affect wholesale rates. The Court found that wholesale demand response and the rules and practices that determine how wholesale demand response programs operate are “all about reducing wholesale rates.”

The decision found that FERC Order No. 745 does not regulate retail sales of energy in violation of the FPA’s division of jurisdiction between FERC and states. The Court held that when FERC regulates what takes place on the wholesale market, as part of its obligation to oversee the working of that market, the FPA provides no bar regardless of the impact such regulation may have on retail rates. The Court concluded FERC’s regulatory plan is implemented exclusively on the wholesale market, governs wholesale market operations exclusively, and is intended only to improve the wholesale market.

The decision further upheld Order No. 745’s requirement that demand response aggregators be compensated at LMP when a “net benefits test” is met, rather than at LMP minus the savings consumers receive from not buying electricity in the retail market. Reversing the D.C. Circuit’s finding that this pricing scheme is arbitrary and capricious, the Court held that the courts’ limited role is to ensure FERC engaged in reasoned decision-making and that FERC did so by providing a detailed explanation of its choice of LMP and responding at length to opposing arguments.

The decision is a significant victory for demand response aggregators and will likely result in increased reliance on demand response services instead of generation services to improve the efficiency and reliability of the nation’s electricity grid. It also may be expected to help reduce wholesale energy prices, at least for the short-term. For environmentalists, the decision means less energy will need to be generated from fossil-fueled generators on peak days. Whether increased reliance on demand response services will benefit consumers in the long-run, however, remains an open issue. Lower energy prices may be expected to hasten the mothballing or retirement of marginal generation units, as well as discourage investment in efficient new generation resources. This may wash away any short-term price reductions and complicate measures to preserve electric reliability. 

FERC Exempts Certain Facilities from Mandatory Electric Reliability Standards with Issuance of First “Local Distribution” Facility Determination

On December 31, 2015, the Federal Energy Regulatory Commission (“FERC”) issued an order addressing a utility’s request that certain of its 115 kV facilities be classified as “facilities used in local distribution of electric energy” under Section 215 of the Federal Power Act (“FPA”), by which they would be exempt from mandatory electric reliability standards promulgated and enforced by the North American Electric Reliability Corporation (“NERC”).

NERC’s reliability standards apply to facilities within the Bulk Electric System (“BES”). In Order No. 773, FERC established a framework for determining whether facilities are part of the BES, and therefore subject to reliability standards. Order No. 773 adopted a “bright line” test under which facilities operated at or above 100 kV are presumed part of the BES. Although most distribution voltage facilities qualify for exemption under this bright line test, FERC reserved the right to resolve any “factual questions” and “make jurisdictional determinations on a case-by-case basis.”

Southern California Edison Company (“SCE”) submitted an application to FERC on April 15, 2015 requesting a factual determination that certain of its 115 kV facilities are exempt “local distribution” facilities, notwithstanding their failure to qualify as such under Order No. 773’s bright line test. Addressing this request, FERC applied the seven-factor test established in Order No. 888 for distinguishing between transmission and distribution facilities to the specific facts surrounding SCE’s facilities. Under that seven factor test, FERC considers that:

1. local distribution facilities are normally in close proximity to retail customers;
2. local distribution facilities are primarily radial in character;
3. power flows into local distribution systems; it rarely, if ever, flows out;
4. when power enters a local distribution system, it is not reconsigned or transported on to some other market;
5. power entering a local distribution system is consumed in a comparatively restricted geographical area;
6. meters are based at the transmission/local distribution interface to measure flows into the local distribution system; and
7. local distribution systems will be of reduced voltage.

Upon consideration of all seven factors, and taking into account the totality of the circumstances, FERC found that most of SCE’s facilities were “local distribution” despite being over 100 kV. The fact that SCE had generation on its distribution system did not prove dispositive because in most cases power flowed into but not out of the 115 kV system. Certain of SCE’s protection systems and the associated transmission lines were, however, found to be BES facilities because “the failure of the primary protection systems during a single fault… [would] result in the loss of multiple bulk electric system transmission lines.”

The Commission’s decision on SCE’s facilities is noteworthy because it provides a roadmap for responsible entities on whether and how to seek exemption from NERC standards for facilities at or above 100 kV. Many utilities, including rural utilities, may have facilities with voltage levels at or above 100 kV (in order to minimize line losses) but do not operate such facilities as BES transmission facilities. Absent a “local distribution” determination such as the one SCE obtained, such facilities are subject to NERC’s mandatory standards under Order No. 773’s bright-line test.