EPSA Decision: Great for Demand Response and Nothing for States to Fear

There were many cheers over last week's Supreme Court decision in Federal Energy Regulatory Commission v. Electric Power Supply Association (EPSA) (including our own, as amici in the case) because of its positive effect on energy prices, reliability and the fight against climate change. But some worry that the decision could undermine laudable state-driven grid modernization efforts to empower electricity customers and build a cleaner, more resilient electric grid. It won't.

As is often the case in relation to groundbreaking efforts that involve the intersection of state and federal law, the legal parameters of these initiatives are not yet neatly defined. Last week's decision in EPSA, however, will not prevent these grid modernization efforts.

Defining key terms.

Before we delve into the legal issues, it's worth explaining some important terms. "Wholesale sales" of electricity are sales of electricity for resale (e.g. sales from power plants to utilities or competitive energy suppliers), and "retail sales" are the sales from those utilities or other suppliers to customers for use in our homes and businesses. "Rates" are the per unit price at which these sales are made. For purposes of this blog, "practices affecting wholesale electricity rates" are other things that influence those rates. "Demand response" is a reduction in energy consumption in return for payment. As the Court explains in EPSA, demand response can help lower electricity rates and prevent blackouts (more on the benefits of demand response here).

Now, on to the analysis.

EPSA lets FERC take action to lower electricity prices.

In EPSA, the Supreme Court confirmed that FERC has jurisdiction over practices directly affecting wholesale rates, including participation and compensation of demand response in wholesale markets. The Court held that FERC's regulation of demand response in wholesale markets is okay even if it has an impact on retail rates, so long as FERC stops short of regulating the actual retail rate itself.

As the Court explains it in the context of airline tickets: if states had authority to set prices for a particular flight, FERC would be prohibited from changing the price customers actually paid for those state-priced tickets, but it could do things like offer deals if they didn't take the flight that would increase the "effective" price of tickets. This might impact customer choices, but it wouldn't actually change the price of tickets. Similarly, FERC can regulate demand response in a way that lowers retail rates, but it can't regulate the rates themselves.

This holding respects the understood division of authority between FERC and states. The Court's opinion then emphasizes that the Federal Power Act (FPA), the statute that governs all of this stuff, should be read to avoid absurd results - here, that neither FERC nor the states could regulate demand response's participation in the wholesale markets, an established activity and robust industry that provides valuable services to the electric grid. The opinion determines that the FPA "prevents the creation of any regulatory 'no man's land'" that is not able to be regulated by either FERC or the states. Because the FPA doesn't let states set the rules for wholesale electricity markets (and demand response participation in those markets), FERC must be able to do it.

There's room in the sandbox for FERC and the states.

So what does EPSA mean for states engaging in reforms to encourage customers to provide demand response at the retail level, intelligent or automated efficiency, or even distributed resources like rooftop solar and electric vehicles?

We think that although EPSA is relevant to these efforts because it will shape related wholesale markets, it should not, by itself, do anything to limit state authority over these resources. If anything, the Court's pronouncement that no regulatory gaps may be created should ensure that states retain authority over retail sales practices beyond FERC's reach. States can continue to encourage development of these customer-powered resources by governing transactions between utilities and customers or distribution system operators and customers. The Court signaled no distress over states maintaining their traditional authority, which extends over these retail sales of electricity and other services even where that results in efficiencies that impact wholesale energy prices, so long as (and this is oversimplified legally) the states do not try to take on FERC's role directly or prevent FERC from doing its job.

Although some people may worry that EPSA's holding means, at least in some circumstances, that states can't regulate demand response because it is a practice directly affecting wholesale rates (and therefore under FERC's exclusive control), we think these worries are misplaced. The Court's decision in EPSA precludes states from regulating payments to demand response in the wholesale markets regulated by FERC, but this much was clear well before EPSA. By contrast, efforts to promote efficiency and demand response resources in retail markets, specifically the sorts of broader reform taking place in California and New York, do not usurp or frustrate FERC's role in regulating compensation in the wholesale markets. Nothing in the EPSA decision prevents these traditional state activities.

Aggregators don't change the analysis.

That states like New York and California are regulating the procurement of demand response and energy efficiency by aggregators who then are reselling them does not change the analysis under the FPA. Even though the resale of demand response by aggregators to utilities in the retail market may be viewed as a "wholesale" transaction in the traditional sense, it is not a wholesale sale of electricity. Instead, it falls into the category of "practices affecting retail rates." The FPA gives states authority over these practices. While the Supreme Court is about to hear arguments in another case--Hughes v. Talen Energy Marketing--that will to some extent address what states can and cannot do with regard to wholesale electricity sales (a topic that EPSA did not address), we think that states' ability to regulate demand response and energy efficiency resources in the retail markets should be safe regardless of the outcome of Hughes.

Last year in a case called Oneok v. Learjet, the Supreme Court confirmed that states have the authority to regulate practices affecting retail rates, even where the matter being regulated has the ability to affect both wholesale and retail sales. Accordingly, states should be able to safely regulate practices like demand response so long as they aim at the retail rather than wholesale markets (i.e. so long as they do not attempt to set rules that determine participation or compensation in FERC's wholesale markets or frustrate FERC's ability to regulate the wholesale markets).

Although the law will continue to try and catch up with the rapid technological changes taking place in the electric sector, EPSA serves to clarify FERC's role without blocking states' efforts to move forward towards grid modernization.