Supreme Court To Hear Major Energy Law Federalism Case

by Joel Eisen

As many scholars have noted (see here and here, for example), the Federal Power Act’s bright line jurisdictional split between “retail” sales of electricity (regulated by states) and “wholesale” sales (regulated by the Federal Energy Regulatory Commission) is untenable in the modern era. The interconnected nature of the electric grid – electricity flows freely throughout the nation - means that many activities at one level affect the other, and vice versa. The precise allocation of state and federal jurisdiction to regulate this modern network, however, remains unclear.

On Monday, the Supreme Court took a step toward providing that clarity, granting the petition for certiorari in FERC v. Electric Power Supply Association. This case squarely tests the split of authority between FERC and the states, as it is an appeal of a decision by a divided D.C. Circuit panel that held that, although “demand response” can impact the wholesale markets, it is exclusively a retail level matter beyond FERC’s jurisdiction. Demand response involves reductions in electricity demand in response to price signals or emergency conditions on the grid. In the wholesale energy markets, aggregated blocks of demand reductions can substitute for electricity generation.

The Court will hear argument this fall on two issues, the first of which is discussed here: (1) whether FERC reasonably concluded that it had authority under the Federal Power Act to issue “Order 745,” its demand response rule; and (2) whether it was arbitrary and capricious for FERC to price demand response at the prevailing energy market rate, the “locational marginal price” or “LMP.” (For more background on demand response and Order 745, see here.)

Demand response has many benefits for the wholesale markets: it decreases the amount of power necessary to meet peak demand, improves system reliability, and counters generators’ ability to demand a premium for their power. These benefits can have substantial value. The independent monitors that analyze regional wholesale electricity markets’ performance have estimated that demand response saved customers in Northeastern and Mid-Atlantic markets as much as $50 billion between 2008 and 2013. Recognizing these benefits, FERC issued Order 745 in 2011, setting the compensation level for aggregated demand reductions offered into the wholesale markets at LMP. A coalition led by generators of electricity, which would be adversely affected by lower peak power prices, challenged Order 745, and the D.C. Circuit invalidated the rule over a strong dissent. The result has been enormous uncertainty in the wholesale markets.

The resolution of this case will have multi-billion-dollar impacts on the markets, but must also be viewed in the context of the Court’s recent preemption decisions. In an important energy law preemption case this April (ONEOK, Inc. v. Learjet, Inc.), the Court held the Federal Power Act did not preempt state antitrust laws for addressing manipulation of the natural gas market during the California electricity crisis of 2000-2001. Writing for the majority, Justice Breyer construed the same statutory provision as FERC used to justify Order 745 (the Federal Power Act and Natural Gas Act are read in pari materia), and rejected a field preemption argument. The majority concluded that state antitrust laws were not “aimed directly at the wholesale markets,” but instead regulate business conduct more broadly. (See a detailed analysis of ONEOK here.) As Justice Scalia noted in dissent in ONEOK, this test has serious shortcomings. What does it mean for a state law to be “aimed directly at the wholesale markets,” if it has multiple goals?

Nevertheless, the Court could apply the ONEOK test, possibly distinguishing demand response from antitrust law on the theory that any state law governing demand response would “aim directly” at the markets. Or, the Court could apply a conflict preemption approach, discerning congressional intent by looking to the cases interpreting statutory language that empowers FERC to regulate a “practice . . . affecting such rate.” Under this logic, the Court might find that FERC has authority to regulate wholesale rates and activities that have a direct impact on rates, such as demand response. Still, some boundaries must be drawn, and it will be up to the Court to articulate a test with clearer standards for managing the concurrent jurisdiction between the states and federal government and preserving room for each to craft policies for reducing greenhouse gas emissions and achieving other goals.

As such, this case may resolve the most vexing legal question involving the modern electric grid: what relevance do the Federal Power Act and other New Deal-era statutes designed to rein in monopolists have in allocating jurisdiction between states and federal agencies in a modern market-based context?


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