Supreme Court To Decide Future of Demand Response in Wholesale Markets

On May 4, the Supreme Court decided to hear Federal Energy Regulatory Commission v. Electric Power Supply Association, a case with significant implications for the participation of demand response resources in the nation’s organized wholesale electricity markets. The Sierra Club, along with other environmental and consumer advocacy groups, had filed an amicus brief urging the Supreme Court to take up this case and set the law straight after an appellate court, the D.C. Circuit, vacated a key rule governing wholesale demand response compensation.

Demand response, a form of energy efficiency, is a mechanism by which customers agree to reduce their energy consumption for finite periods of time, such as when the grid is stressed by high demand or unexpected generator outages. Demand response gives grid operators a valuable tool for managing the grid during these periods and, by avoiding the need to fire up the least-efficient and most-polluting power plants, reduces air pollution and all consumers’ electricity bills. The Supreme Court’s decision to take this case bodes well for the future growth of demand response, and for a grid that meets our nation’s energy needs at lower costs and with less pollution. 

Background

In 2011, the Federal Energy Regulatory Commission (FERC) adopted Order 745, which required operators of wholesale energy markets, such as MISO, PJM and ISO-New England, to allow demand response resources to participate in those markets. Order 745 also requires that demand response resources be compensated for curtailing usage at the same level that power plants would receive for generating electricity. Under this framework, demand response has been highly competitive in energy markets, frequently offering better prices than peaking power plants. Demand response has been especially critical at keeping prices stable during periods of unusually high demand: when load during the 100 highest-use hours of the year is reduced by only 3 percent, wholesale energy prices are reduced by up to 12 percent. Demand response has been estimated to save consumers hundreds of millions, likely billions, of dollars.  

While consumers, the broader economy, and the environment all benefit when demand response participates in wholesale markets, not everyone loves demand response. The reduction in wholesale prices, an undeniable benefit to consumers, cuts into the profits of power plant operators, especially the oldest, least-efficient plants that depend on high prices in a few hours of the year. Therefore, in 2012, a trade association for large power plants, the Electric Power Supply Association (EPSA), challenged Order 745, contending that FERC had exceeded its authority under the Federal Power Act. 

A split panel of the D.C. Circuit Court sided with EPSA and vacated Order 745, finding that the order impermissibly regulated retail (as opposed to wholesale) electric sales—a matter within the states’ jurisdiction. The appellate court acknowledged that demand response participation in wholesale energy markets has a beneficial, downward impact on wholesale energy rates, and that the Federal Power Act gives FERC authority to regulate “any . . . practice . . . affecting” wholesale rates. 16 U.S.C. § 824e(a). However, the court strayed from the law when it concluded that even the indirect impact of these wholesale-market rules on retail electric markets violated the state-federal boundaries erected by the Federal Power Act. Among other errors, the appellate court’s decision gives unwarranted significance to the statute’s reserved state powers provision, which the Supreme Court has deemed a “mere policy declaration that cannot nullify a clear and specific grant of jurisdiction” to FERC.  New York v. FERC, 535 U.S. 1, 22 (2002).

Legal uncertainty creates market uncertainty

The D.C. Circuit’s erroneous decision has created uncertainty about how grid operators will continue to rely upon and compensate demand response resources going forward. A key question is whether demand response resources will be able to continue participating in the capacity markets operated by regional transmission organizations. Through these markets, grid operators seek to ensure that the system will have sufficient generating resources to meet demand, plus a reserve margin, in the coming years. Demand response has successfully participated in capacity auctions, offering bids to reduce consumption in future years that are often less expensive than generators’ bids to produce more power during that time period. This has yielded tremendous benefit for ratepayers and allows the retirement of uneconomic coal-fired power plants that would otherwise be kept on life support by capacity market payments. 

The Sierra Club and many others dispute that the D.C. Circuit’s decision undermines the legality of demand response participation in the capacity markets (as the decision directly affected energy markets only), but EPSA and other generators have asked FERC to exclude demand response from capacity markets. This uncertainty is having an immediate impact on major decisions facing state utility regulators. In Ohio, for example, FirstEnergy is seeking a massive subsidy for three coal-fired plants—each of which began operation in the 1950s and has been struggling economically in recent years. FirstEnergy asserts that capacity prices will increase in the future due to the industry’s attacks on demand response and, therefore, that these aging plants will eventually be profitable again if the state would just subsidize them in the near-term. 

From our position on the front lines of coal retirement battles in many states, the Sierra Club sees firsthand the adverse consequences of the D.C. Circuit’s decision. While no one can say how the Supreme Court will ultimately rule in this matter, the Court’s decision to take the case is a welcome development. We believe that after careful consideration, the Court will conclude that FERC was well within bounds in adopting Order 745 because demand response has a substantial and direct impact on wholesale energy rates, an area within FERC’s exclusive authority. Along with our allies, the Sierra Club will file an amicus brief on the merits of this appeal, urging the Supreme Court to reverse the D.C. Circuit’s erroneous decision. Oral argument on the case is expected in late 2015, with a decision likely by June 2016.