December PoV

Sponsored and written by Chairman Doug Scott, Illinois Commerce Commission

Chairman Doug Scott Illinois Commerce Commission

On May 23, 2014, in a 2-1 decision, a panel of the United States Court of Appeals for the D.C. Circuit invalidated FERC Order 745. This decision, if it stands, will have tremendous impact on power generators, state regulators, regional transmission markets, environmental policy, and most important, on ratepayers.

So what is Order 745? Previously, in Order 719, FERC established parity between wholesale generator bids and demand response (“DR”) bids from individuals or demand response aggregators. Order 745 built on this to set demand response compensation, using the locational marginal price (LMP). For regional transmission organizations (“RTOs”), this resulted in an increase in the amount of demand response bid into the wholesale energy and capacity markets.

Increasing the amount of demand response that is bid into the markets is a positive result, for a number of reasons. From a cost standpoint, additional demand response means lower wholesale prices, and a better balance of supply and demand. Indeed, Order 745 dictated that DR could not receive compensation unless it demonstrated that both of these important goals were met.

In addition, as we approach a time of carbon constraint, plant retirements and potentially shrinking reserve margins due to environmental regulations and lower gas prices, DR becomes a key resource that can help lessen states’ reliance on traditional generation from power plants. In addition, given that much demand response occurs during times of peak usage, greater demand response may serve to shave peak demand. This has benefits both in terms of lowering costs to consumers, and obviating the need to run peaking generation, which in many areas of the country consist of older, less efficient, less environmentally responsible generation.

The three judge panel of the D.C. Circuit did not see DR in quite the same way. Instead, the panel held that Order 745 should be invalidated, and did so by saying that FERC exceeded its jurisdiction. The panel ruled that by establishing a price for retail customers to bid DR into the energy markets, FERC was in effect regulating the retail markets, a job left to the states under the Federal Power Act. The panel further held that the method used by FERC to set the price (LMP) was not supported by the record. While the dissent pointed out that allowing DR to be bid into the energy markets has an influence on the wholesale markets, which is part of FERC’s jurisdiction, ultimately that interpretation did not win the day.

A motion was made to have the entire D.C. Circuit Court of Appeals hear the case; that motion was denied. By the time this article appears, we may know whether the matter was appealed to the United States Supreme Court. In the meantime, a bill has been introduced in Congress that would allow the practice contemplated by Order 745. While recent history would seem to indicate that it is unlikely to see any energy policy emerge from Congress, at least the introduction of the bill heightens awareness of the potential problems resulting from the Court’s decision.

So what happens next? If we assume that the decision of the D.C. Circuit stands, and Congressional legislation isn’t in the offing, how can we ensure that DR remains a viable part of our energy plan? As set out above, there are very good reasons for retaining DR as an integral part of our individual state and national energy plans. To add to the potential downside, this decision applied only to the energy markets. If the same logic is applied, through a future decision, to the capacity markets, the problems will be exacerbated, and we will be left with even greater questions of reliability, cost, and compliance with environmental matters such as the United States Environmental Protection Agency’s Clean Power Plan.

If the decision holds, and FERC is not allowed to set the rates to bring demand response into the markets, it will likely be left for the states to do so. Since the Court reasoned that it is within the states’ province to set just and reasonable retail rates, and the DR rates are retail, then states, either through establishing DR structures, or rulemakings or orders involving their utilities, may need to occupy this space. While this may be necessary, it is not something that most states have experience in doing and will present a challenge, especially as attention and limited resources are directed to designing states’ compliance plans for EPA’s Clean Power Plan.

States will need to work in concert with their RTOs to establish plans to ensure that any actions taken by the states will not disrupt the regional marketplace. For its part, PJM has issued a white paper on DR in light of the Court decision. In their document, PJM sets out the ways that DR may still play a role in their market, and invites others to make suggestions to them.

It would seem to be incumbent on the states to begin, if they have not already, a discussion on how to respond. Unfortunately, the Court decision that set this process in motion does not provide much guidance to the states in terms of how they should set up DR platforms that will pass court scrutiny, and not exceed their own jurisdiction. But states need to move forward–for reasons of reliability, cost to consumers, evening out of supply and demand in markets, and for environmental compliance. If states wait until all court options have been exhausted or to see what, if anything, Congress may ultimately do, they may miss an opportunity to positively influence the markets and allow for the maximization of DR as a market force.