US Supreme Court upholds wholesale demand response

The Supreme Court of the United States has issued an opinion upholding regional electricity grid operators' ability to operate wholesale demand response programs under federal authority.  In that opinion, FERC v. Electric Power Supply Assn., the Supreme Court reversed a lower court's decision invalidating the Federal Energy Regulatory Commission's regulation of electricity demand response.   While further evolution of demand response will continue, the Supreme Court's 6-to-2 ruling puts regional wholesale demand response programs back on surer footing after the uncertainty injected by the lower court's previous ruling.  A grid portfolio including some degree of demand response can provide beneficial environmental, reliability, and economic effects compared to pure generation.  It appears relatively more likely that existing regional wholesale demand response programs may continue to operate under federal authority, and relatively less likely that a new state-driven demand response paradigm will arise.

As described in the Supreme Court opinion, wholesale electricity demand response programs pay consumers for commitments to reduce their consumption of electricity during peak demand periods or other times of scarcity or high prices.  For about 15 years, wholesale market operators have increasingly adopted wholesale demand response programs, with the blessing of both Congress and the FERC.  In 2011, the FERC issued its Order No. 745, establishing a rule requiring market operators to pay the same price to cost-effective demand response providers for conserving energy as to generators for producing it. 

But that order was challenged by an association of generators, among others.  In May 2014, the D.C. Circuit Court of Appeals issued a ruling in Electric Power Supply Association v. Federal Energy Regulatory Commission vacating Order No. 745.  Its chief logic was that FERC lacked authority to issue the order on jurisdictional grounds -- because in the lower court's view, Order No. 745 directly regulates the retail electric market.  Under the Federal Power Act, FERC is authorized to regulate "the sale of electric energy at wholesale in interstate commerce," but cannot regulate "any other sale" (i.e. any retail sale) of electricity.

But today's Supreme Court ruling held that the Federal Power Act does provide FERC with the authority to regulate wholesale market operators' compensation of demand response bids.  The Court divided its analysis of this point in three parts.

First, the Supreme Court held that the practices at issue directly affect wholesale rates.  In the Court's words, "Wholesale demand response is all about reducing wholesale rates; so too the rules and practices that determine how those programs operate."

Second, the Supreme Court noted that FERC has not regulated retail sales.  "Here, every aspect of FERC's regulatory plan happens exclusively on the wholesale market and governs exclusively that market's rules.  The Commission's justifications for regulating demand response are likewise only about improving the wholesale market."  Putting the first and second sets of conclusions together, the Court found that the rule established by Order No. 745 complies with the plain terms of the Federal Power Act.

Third, the Court noted that adopting a contrary view would conflict with the core purposes of the Federal Power Act: "The FPA should not be read, against its clear terms, to halt a practice that so evidently enables FERC to fulfill its statutory duties of holding down prices and enhancing reliability in the wholesale energy market."

The Supreme Court also addressed an alternative holding by the D.C. Circuit Court that the Order No. 745 compensation scheme is arbitrary and capricious under the Administrative Procedure Act.  The Supreme Court noted that its "important but limited role" in reviewing FERC's decision "is to ensure that FERC engaged in reasoned decisionmaking."  Noting FERC's detailed explanation of its choice to compensate demand response providers at LMP, the same price paid to generators, and its lengthy responses to contrary views, the Supreme Court held that "FERC's serious and careful discussion of the issue satisfies the arbitrary and capricious standard."

Justice Kagan delivered the Court's opinion, joined by Chief Justice Roberts and Justices Kennedy, Ginsburg, Breyer, and Sotomayor.   Justice Scalia filed a dissenting opinion, in which Justice Thomas joined, noting his belief that the Federal Power Act prohibits the FERC from regulating the demand response of "retail purchasers of power."  Justice Alito did not participate in the case.

The case now returns to the D.C. Circuit for "further proceedings consistent with this opinion." If Order No. 745 stands and FERC retains jurisdiction over the compensation paid to wholesale demand response market participants, it seems likely that existing regional wholesale demand response programs will continue to operate under federal authority.  As the Supreme Court found, these wholesale demand response programs can provide significant consumer savings when properly implemented.  How will demand response continue to evolve in the wake of FERC v. EPSA?  How does this decision reshape the boundary between wholesale (federal) and retail (state) jurisdictions?  What's next for demand response?

Court overturns FERC Order 745 on demand response

A federal appellate court has overturned the Federal Energy Regulatory Commission's key ruling on demand response -- when electricity customers respond to signals about the scarcity of electricity by temporarily reducing their consumption -- and how it should be compensated.

A smart grid technology, demand response can be a key tool in reducing the cost and environmental impact of society's electricity needs.  In most US markets, as the demand for electricity rises (such as during a summer heat wave), grid operators turn to increasingly expensive generating units for new supply to meet that demand.  Those "peaking" units -- used primarily to supply energy during times of peak demand -- are thus relatively expensive.  In many cases, they also rely on fuels like oil that lead to increased emissions of pollutants and carbon dioxide.

Demand response offers an alternative solution.  Customers participating in demand response programs agree to reduce their consumption of power from the grid when so instructed by the grid operator.  For example, an office building might commit to temporarily reduce its air handling load, or a factory to reduce or pause its manufacturing operations.

This can provide much the same benefits as generation, by balancing electricity supply and demand, for a lower cost than generation solutions and without causing incremental air emissions.  Demand response can also avoid the need to develop new or upgraded transmission lines, because it solves the problem through reduced energy flows.  Demand response programs therefore provide benefits to the entire grid, and have been established by both organized wholesale markets and vertically integrated utilities across the country.

While demand response's value to the grid is clear, how to compensate customers for their curtailment remains a key question.  In 2011, the Federal Energy Regulatory Commission issued a landmark order known as Order No. 745.  In Order No. 745 (116 page PDF), the Commission ruled that organized wholesale energy market operators must pay demand response resources the market price for energy, known as the locational marginal price (LMP), when those resources have the capability to balance supply and demand as an alternative to a generation resource and when dispatch of those resources is cost-effective.  Order No. 745 thus represented a major step forward for both demand response providers as well as all customers in markets with demand response program.

But some energy industry associations did not like the rule, and challenged the legality of Order No. 745.  The Electric Power Supply Association appealed the Commission's order to a federal court.  Meanwhile, other groups supported the rule, including industrial energy consumers and environmental advocates.

Today the D.C. Circuit Court of Appeals agreed with the appellants, holding that the Commission overstepped its jurisdictional bounds by encroaching on the states’ exclusive jurisdiction to regulate the retail market.  The court ruling, issued in the case Electric Power Supply Association v. Federal Energy Regulatory Commission (44-page PDF), vacates Order No. 745 and remands it back to the Commission.

If the Commission is to require fair compensation for demand response providers, it will have to find a new way to do so -- and one that would survive renewed judicial challenge.  In the meantime, grid operators are faced with a challenge (and an opportunity): whether and how to revise the way they pay customers for demand response.  As demand response's value remains beyond debate, the economic and environmental pressures that led to Order No. 745 remain strong, so expect this issue to continue to play out over the next year.

Landmark FERC electric orders promote fairness

The Federal Energy Regulatory Commission is the lead federal agency in a variety of energy-related fields.  FERC regulates the transmission and wholesale sales of electricity in interstate commerce, the transmission and sale of natural gas for resale in interstate commerce, and the transportation of oil by pipeline in interstate commerce.  FERC also approves the siting (and abandonment) of interstate natural gas pipelines and storage facilities, as well as siting applications for electric transmission projects under limited circumstances.  FERC also licenses and inspects private, municipal, and state hydroelectric projects.

FERC has issued a number of landmark orders pursuant to its jurisdiction over electric utilities.  These landmark orders focusing on promoting fair and competitive markets include:

• Order No. 888 (Transmission Open Access. Promoting Wholesale Competition Through Open Access Non-discriminatory Transmission Services by Public Utilities; Recovery of Stranded Costs by Public Utilities and Transmitting Utilities).  This landmark rulemaking fostered greater competition in wholesale power markets by reducing barriers to entry in the provision of transmission service.  Historically, vertically integrated utilities dominated the electric power industry.  Despite efforts to empower independent power producers and to promote competition, the Commission noted that “[b]ecause many traditional vertically integrated utilities still did not provide open access to third parties and favored their own generation if and when they provided transmission access to third parties, access to cheaper, more efficient generation sources remained limited.”  In 1996, the Commission adopted Order No. 888 prohibiting public utilities from using their monopoly power over transmission to unduly discriminate against others.  The Commission required interstate transmission utilities to file open access non-discriminatory transmission tariffs – Open Access Transmission Tariff or OATTs – containing minimum terms and conditions of non-discriminatory service. It also obligated such public utilities to “functionally unbundle” their generation and transmission services.
• Order No. 890.  An outgrowth of Docket Nos. RM05-17-000 & RM05-25-000 (Preventing Undue Discrimination and Preference in Transmission Service), Order No. 890 cracked down on opportunities for utilities to unduly discriminate against certain customers under the Commission’s pro forma OATT.  In Order No. 890, the Commission strengthened its pro forma OATT to remedy undue discrimination, facilitate the Commission’s enforcement, and increase transparency of transmission planning and use rules.
• Order No. 1000.  The result of Docket No. RM10-23-000 (Transmission Planning and Cost Allocation by Transmission Owning and Operating Public Utilities), FERC Order No. 1000 reforms how public utilities plan and pay for transmission upgrades.  Previously, grid operators had fairly broad discretion to determine who should pay for an approved transmission line -- all regional consumers, the subset of consumers benefited by the line, generators, or others.  FERC observed that the lack of a uniform framework for cost allocation decisions meant that on the one hand, consumers could be paying more for transmission than they should, while on the other hand renewable power projects might be stifled by a lack of transmission expansion.  To fix this problem, the Commission issued Order No. 1000 to provide a framework for fair and open evaluation of transmission needs and to allocate the costs of transmission solutions fairly to those who receive benefits from them.
• Order No. 719.  The product of Docket Nos. RM07-19-000 and AD07-7-000 (Wholesale Competition in Regions with Organized Electric Markets), Order No. 719 offered a series of reforms to improve the operation of organized wholesale electric power markets.  Based on the premise that improving the competitiveness of organized wholesale markets is integral to the Commission's mission, FERC required regional grid operators to reform their tariffs and practices in the areas of demand response, long-term power contracting, market monitoring, and the responsiveness grid operators to their customers – and through them, to the consumers who benefit from and pay for electricity services.
• Order No. 745.  The product of Docket No. RM10-17-000 (Demand Response Compensation in Organized Wholesale Energy Markets), Order No. 745 requires regional grid operators to compensate customers fairly for reducing their consumption of electric energy in response to the grid operator’s warnings of supply scarcity – demand response – when that reduction in energy use is cost-effective and capable of displacing the need to additional generation online.