The Supreme Court Gives FERC's Demand Response Rule a Green Light

By Tyler Johnson, GEI Policy Extern

On January 25^th, the United States Supreme Court upheld the Federal Energy Regulatory Commission’s (FERC’s) demand response rule, established in FERC Order 745. For reasons shown below, The Supreme Court correctly applied the law and did a great service for energy conservation advocates and grid managers struggling to maintain the reliability of the 21^st century grid.

How Demand Response Fits Into the Wholesale Electricity Market

Since the late 1970s and the federal enactment of the Public Utilities Regulatory Policies Act (PURPA) of 1978, federal electricity policy has shifted from a monopoly model in favor of a competitive wholesale electricity market. Competitive wholesale markets have subsequently taken shape in the last few years with the development of various regional networks such as the Midcontinent Independent System Operator (MISO), the California Independent Service Operator (CAISO), and the PJM Interconnection. These approved regional transmission organizations (RTOs) are independently administered to ensure that monopolistic utilities—owning most of the nation’s transmission lines—provide non-discriminatory access to the various renewable energy producers and a competitive wholesale market. The operators do not generate electricity nor provide retail electricity to consumers; they simply manage the grid to ensure efficient regional management and renewable energy producers non-discriminatory access to it.

In the wholesale electricity market, electric utilities purchase wholesale power from independent power producers through an auction-based system. Under the auction system, generators bid power at a certain price to meet the projected demand of the utility. To encourage renewable energy development and ensure a competitive market, these bids to supply power are stacked from lowest to highest. The highest bid, known as the locational marginal price (LMP), is eventually what all the "bidding" power producers are paid.

Under wholesale demand response, independent operators of wholesale markets actually pay electricity consumers to NOT use power at certain times. Demand response developed because reducing demand is oftentimes cheaper and more reliable when electricity consumption is high, like during a Super Bowl, than it is to pay generators for more expensive electricity.

To streamline how this works under the wholesale market, FERC’s Order 745 allows consumers to bid “negawatts” into the  auction market, just as power producers would bid megawatts. Negawatts represent the assurance not to consume electricity over a given period of time. These consumers can receive money for the LMP, just as power producers would receive for their megawatt bids. The whole idea is that demand response lowers the overall price of electricity during peak times, reduces green house gas emissions by promoting conservation, and ensures grid reliability. For more information on how demand response works generally, see here.

FERC v. Electric Power Supply Association

Justice Kagan delivered the opinion of the Court, ruling in favor of FERC’s demand response rule by a 6-2 margin. The dispute in the case generally dealt with FERC’s authority to regulate the rates that demand response “negawatts” receive on the wholesale electricity market. Under the Federal Power Act, FERC is granted the exclusive authority to regulate “the sale of electric energy at wholesale in Interstate Commerce.” However, the Act leaves the states with exclusive jurisdiction over retail sales. The Electric Power Supply Association (EPSA) had argued that FERC exceeded its authority under the Federal Power Act by issuing Order 745. EPSA argued, and the federal Court of Appeals for the DC Circuit held, that FERC’s rule allowing demand response bids into the wholesale market, lured retail customers into the wholesale market, decreasing their retail energy consumption, and thus intruding state regulatory authority of the retail market.

The Supreme Court disagreed with EPSA’s arguments and overturned the D.C. Circuit’s decision. To dispel of EPSA’s argument, Justice Kagan correctly pointed out that wholesale market electricity rates necessarily affect retail market rates and vice versa. In other words, according to justice Kagan’s opinion, the fact that direct regulation of wholesale rates may affect retail rates doesn’t mean that FERC is directly regulating retail rates, which is reserved for the States. Allowing demand response bids into the market, Kagan explained, is nothing more than regulating wholesale rates.

Furthermore, the Federal Power Act demands that FERC ensure that wholesale electricity rates are “just and reasonable.” Kagan correctly explained that one of the primary goals of demand response is to lower the electricity rates paid by consumers. By reducing electricity demand during peak periods (the time when electricity demand and electricity rates are highest), demand response lowers wholesale electricity rates. This simple phenomenon fulfills FERC’s mandate to ensure that rates are “just and reasonable.” Thus, despite arguments from EPSA that FERC acted beyond its statuary mandate to ensure just and reasonable rates, FERC did exactly as the Federal Power Act commands of it.

Why The Court Got it Right

The Court’s opinion is legally valid and has important implications for future renewable energy development in the context of the 21^st century grid. First, the Court was correct that FERC’s demand response program only regulates wholesale electricity rates. While the electricity market is unique indeed, wholesale prices in all markets affect retail prices, but that doesn’t mean that they directly set retail prices.

Second, demand response is extremely important, if not essential, for grid reliability in the modern energy economy. As electricity generation has become more dispersed, grid managers have an increasingly difficult time matching demand and supply, which is necessary to maintain reliability and prevent blackouts. Demand response has proven to be very effective at supporting grid reliability by reducing demand at peak times.

Finally, transitioning to a more sustainable economy in an attempt to mitigate climate change will require a variety of creative efforts. Efficient technology can only go so far. Reducing human energy consumption should be encouraged wherever possible, and arguably could have the biggest impact on reducing the negative effects of climate change. Demand response thus provides a cost-effective means to reduce energy consumption and electricity prices, benefitting all.