U.S. Supreme Court to Review Decision Vacating FERC Demand Response Regulation

Sandro Sacerdoti
CRES Boulder County Chapter

On May 4, 2015, the U.S. Supreme Court agreed to review a lower court decision overturning a Federal Energy Regulatory Commission (FERC) order that required wholesale electricity market operators to allow Demand Response (DR) providers to receive wholesale electricity market prices for qualifying DR capacity. The U.S. Supreme Court’s decision to review the case suggests that the Court found fault with some aspect of the lower court’s ruling and could be a positive development for DR in U.S. energy markets.

Background

DR is an important tool in the energy efficiency playbook. Demand Response refers to consumers’ reduction of electricity usage at times of peak energy demand when nearly all of the power in the grid is being used and wholesale electricity prices spike. Peak demand typically occurs during hot afternoons in summer months when air conditioners and other appliances are being used at full capacity across a utility’s service area. The most familiar DR applications are smart thermostats like the Nest, which homeowners can use to reduce energy consumption by adjusting their thermostats remotely from their smart phones. However, the largest contributors of DR capacity currently are industrial and commercial electricity customers who agree in advance to reduce their energy consumption at times of peak demand and frequently have other options for obtaining energy at those times, such as backup generators, solar panels or, more recently, batteries.

DR reduces electricity prices by lowering peak demand at times when electricity suppliers charge the most for wholesale electricity and increases grid reliability by reducing load (the amount of power used by all customers on the grid) at peak times that might otherwise lead to blackouts during a heat wave or cold snap.

In 2005, Congress passed the Energy Power Act, which among other things, stated that the U.S. should upgrade its power grid and encourage more DR for the sake of energy efficiency and grid reliability.  In 2008, FERC responded by passing regulations allowing DR aggregators to participate in wholesale electricity markets. Operators of wholesale electricity markets across the country, referred to as Regional Transmission Organizations (RTOs) and Independent System Operators (ISOs), soon adopted a variety of policies and prices for DR in their respective markets. Some RTOs and ISOs allowed DR providers to sell kilowatts of DR capacity at the market price for electricity, the same price a utility would pay for a kilowatt of electricity generated by a power producer, while others required DR providers to receive a lower price, in some cases the difference between the wholesale and the retail price of electricity. Needless to say, DR participation was much higher in wholesale markets where DR providers could sell at market rates and pass the full amount, or a portion of it, to their customers as an incentive for providing the DR capacity.

In 2011, FERC passed Order 745, which aimed to standardize DR treatment across wholesale markets and requires RTOs and ISOs to pay DR providers the prevailing wholesale market price for electricity, known in the industry as the locational marginal price (LMP), when the DR resource is capable of balancing supply and demand in the wholesale market and when purchasing DR is cost effective under a “net benefits test” described by FERC. The “net benefits test” helps RTOs and ISOs determine when purchasing DR resources will reduce the overall price of electricity required by the grid (including the price of purchasing the DR resource), so that remaining electricity purchasers are not left with a higher bill once the DR providers have reduced their consumption.

Disagreement over FERC Order 745

Power generators were predictably upset by the competition from DR resources, which by some estimates reduce the peak price of wholesale electricity by nearly 50% and may have caused retirement of generation assets that are expensive to operate, including coal plants. Seeking to hamper this new competition in wholesale electricity markets, a trade association of power generators, the Electric Power Supply Association, sued FERC to overturn Order 745.

In 2014, one of the more activist judges on the U.S. Court of Appeals for the D.C. Circuit vacated FERC Order 745 on the grounds that FERC’s regulation of DR participation in wholesale markets is actually regulation of retail electricity sales, which are under the jurisdiction of state lawmakers according to federal law. Under the Federal Power Act, FERC is responsible for regulating wholesale electricity markets, which frequently involve interstate commerce, and states are responsible for regulating retail sales to customers within their respective states.

The D.C. Circuit also ruled that requiring DR providers to receive LMP, the clearing price for electricity, which is the standard price paid to all other wholesale market participants, was “arbitrary and capricious.” Power generators had complained that DR providers did not have to pay to generate power, they just had to refrain from consuming it, therefore, allowing DR providers to receive the full market price was unfair.

On the other hand, DR providers and FERC argue that allowing DR resources to receive the market price encourages development of DR assets and technology and makes wholesale energy markets more efficient by facilitating demand side participation in the markets so that demand can decline when prices rise. A judge dissenting from the majority opinion sided with FERC and argued that Order 745 was within FERC’s jurisdiction to regulate wholesale energy markets and that requiring DR providers to receive LMP was reasonable and not “arbitrary or capricious.” Some observers have commented that the dissenting opinion was more well-reasoned than the majority opinion and that the majority made some inappropriate interpretations of existing law.

On May 4, 2015, the U.S. Supreme Court accepted FERC’s appeal from the D.C. Circuit opinion. If the U.S. Supreme Court had not accepted the appeal, the lower court ruling would have been the final word and FERC Order 745 would have been nullified. In fact, following their D.C. Circuit victory, power generators filed a lawsuit seeking to completely exclude DR resources from future participation in wholesale electricity markets. It is expected that the U.S. Supreme Court will hear the case in the Fall of 2015 and issue an opinion in June 2016.

DR in Colorado

In Colorado, which is not covered by an RTO or ISO and has 65 different utilities, including 29 municipal utilities, that generate and purchase power from various sources to sell to retail customers, DR involvement is more limited. Xcel, one of the bigger utilities in Colorado, allows large industrial and commercial customers to contract directly with them to receive credits for service interruptions at peak hours under a program called Interruptible Service Option Credit (ISOC). For 2015, Xcel budgeted $32.7 million for the ISOC program to be paid as credits to customers who had 239 megawatts of power subject to the program.   The amount paid by Xcel for Contract Interruptible Load (CIL) power subject to the ISOC program is determined by a rate calculation approved by the Colorado Public Utilities Commission.

Xcel and other utilities also have DR programs for home owners involving smart thermostats and other appliances that can be programed to reduce energy consumption at peak times. However, most states have fixed retail electricity rates that do not fluctuate as demand (and wholesale prices) fluctuate during the day. California, New York, and Arizona have established optional time-of-use (TOU) pricing for retail customers in an effort to incentivize customers to reduce electricity consumption during peak demand hours when wholesale prices increase and stress on the grid is high. TOU pricing would also incentivize adoption of new technologies, such as home batteries (see: Tesla’s new Powerwall system) for storing power generated during off-peak hours for use during peak hours, as well as other smart home technologies.

As technology and energy consumption advance, opportunities for efficiencies from DR will advance as well, especially if DR is allowed to compete with conventional power generation in wholesale electricity markets.