Last Friday, the D.C. Circuit Court of Appeals struck down FERC Order 745, which required that demand response resources be compensated in the same way as traditional generation resources, at the “locational marginal price”, or LMP. Why is this an environmental case? Because use of demand response at times of peak electricity demand substitutes for traditional generation and thus eliminates the emissions that would result from such generation.
The case is Exhibit A for the proposition that law and economics still often don’t play well together. For example, Commissioner Moeller dissented from the issuance of Order 745 as being beyond FERC’s jurisdiction. Nonetheless, as Judge Edwards noted in his dissent, Commissioner Moeller acknowledged that:
nowhere did I review any comment or hear any testimony that questioned the benefit of having demand response resources participate in the organized wholesale energy markets. On this point, there is no debate. The fact is that demand response plays a very important role in these markets by providing significant economic, reliability, and other market-related benefits.
So why was Order 745 struck down? The short version is that FERC has authority over wholesale rates, but demand response means offering incentives to retail consumers to avoid retail consumption. While the majority acknowledged that such foregone retail sales affect wholesale market demand and thus wholesale prices, this argument was not sufficient:
The Commission’s rationale, however, 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. FERC proposes the “affecting” jurisdiction can be appropriately limited to “direct participants” in jurisdictional wholesale energy markets. But, as this case demonstrates, the directness of participation may be a function of the richness of the incentives FERC commands. The commission’s authority must be cabined by something sturdier than creative characterizations.
Frankly, I don’t buy it. To me, Judge Edwards’s dissent seems much more persuasive. Markets are changing. The Federal Power Act did not anticipate these issues. The Act’s language is sufficiently flexible to allow FERC involvement in demand response in the limited circumstances regulated under Order 745. As Judge Edwards stated:
Order 745 does not require anything of retail electricity consumers and leaves it to the States to decide whether to permit demand response. All Order 745 says is that if a State’s laws permit demand response to be bid into electricity markets, and if a demand response resource affirmatively decides to participate in an ISO’s or RTO’s wholesale electricity market, and if that demand response resource would in a particular circumstance allow the ISO or RTO to balance wholesale supply and demand, and if paying that demand resource would be a net benefit to the system, then the ISO or RTO must pay that resource the LMP. That is it. This requirement will no doubt affect how much electricity is consumed by a small subset of retail consumers who elect to participate as demand response resources in wholesale markets. But that fact does not render Order 745 “direct regulation” of the retail market.
Judge Edwards similarly disposed of the principal concern of the majority – that the rationale for Order 745 could not be reasonably limited, leaving FERC with effective authority over retail markets. Case law makes clear that FERC authority does not extend beyond activities that directly and substantially affect wholesale markets. “Order 745 passes [this] test quite comfortably because the demand response resources subject to the rule have a quintessentially ‘direct’ effect on wholesale rates.”
It will be interesting to see whether Judge Edwards’s dissent is of sufficient interest to result in en banc review, assuming FERC requests it.
(The decision also addressed whether, if FERC had authority to encourage demand response, it could require that demand response resources be paid the LMP — the same price paid to other generation resources — or whether demand response resource should be paid the LMP minus the retail price of the forgone electricity. That’s a whole other can of worms and, if I tried to address it here, we’d have an article rather than an already overly long blog post. Thus, I’m going to give that a pass and remain agnostic in this space.)