On January 25, 2016, the Supreme Court of the United States issued its decision in Federal Energy Regulatory Commission v. Electric Power Supply Association et al (EPSA), restoring Order 745 after the DC Circuit vacated the Order on May 23, 2015.

For the past 15 years, the Federal Energy Regulatory Commission (FERC) has created regulations to encourage demand response. Demand response is an offering policy that pays consumers who commit to diminish their use of power when requested, notably at peak times. The goal of encouraging demand response is to decrease demand, lower wholesale electric rates, and maintain reliability when user demand strains the electric grid. FERC’s Order 745 requires RTOs and ISOs to “appropriately compensate demand response providers.” RTOs and ISOs must pay the applicable locational marginal price (LMP) for any accepted demand response bid, similar to the prices paid for electricity in the auction systems utilized for electric supply. Order 745 puts compensation for conserving electricity on equal footing with compensation for producing electricity. Additionally, under the Order, the RTO/ISO only pays LMP if the demand response bid passes the “net benefits test.” This test ensures that the acceptance of a demand response bid in lieu of a bid for extra production actually benefits load-serving entities (LSEs) by lowering the wholesale rate.

In EPSA, the Supreme Court reversed the DC Circuit’s conclusions that FERC lacked the authority under the Federal Power Act (FPA) to issue Order 745 and that FERC provided insufficient explanation for adopting the LMP methodology to compensate demand response providers.

The Supreme Court’s opinion, delivered by Justice Kagan, held that FERC did not overreach its authority in enacting Order 745 because the Order directly affects wholesale rates and only incidentally affects retail rates. In addition, the Supreme Court found that eliminating FERC’s authority over setting wholesale demand response compensation would contravene the intent of the FPA.

The FPA grants FERC authority to regulate “any rule or practice affecting wholesale electricity rates.” The Supreme Court noted that FERC’s jurisdiction is limited to policies “directly affecting” wholesale rates, and found that Order 745’s compensation scheme brought more actors into the demand response market, creating a downward pressure on generators to lower wholesale rates. This price shift directly affects wholesale rates.

Further, the Supreme Court took the view that any action in the wholesale electricity market produces downwind effects on retail rates, but that these incidental effects do not mean that FERC has exceeded its limited authority. Analyzing Order 745, the Supreme Court found that FERC’s rationale relates only to the wholesale market, the justifications for the Order involve only the wholesale market, and that Order 745 does not encroach on a state’s authority to set retail rates.

In addition, the Supreme Court found that the DC Circuit’s decision vacating Order 745 undermines the FPA. Legislative history indicates that Congress created the FPA to eliminate “vacuums of authority over the electric market.” The Supreme Court concluded that EPSA’s interpretation of wholesale demand response programs creates a vacuum by preventing any party, whether federal or state, from regulating demand response bids.

Turning to the question of whether FERC adequately justified its decision to use LMP to compensate for demand response, the Supreme Court held that FERC adequately explained the benefits of its compensation scheme of paying LMP for accepted demand response bids. The Supreme Court noted that in technical areas such as electric rate design, courts provide FERC “great deference” in decision-making. FERC easily met the bar of explaining why it chose LMP pricing over other compensation schemes.

Justice Scalia, joined by Justice Thomas, dissented, arguing that the majority framed the question incorrectly. Justice Scalia argued that the FPA provides FERC the authority to regulate “the sale of electric energy at wholesale.” The FPA defines a sale at wholesale as a sale to any person for resale. The dissent used this definition to argue that FERC’s wholesale rate authority depends on the identity of the purchaser and not the effect on wholesale rates. Since demand response bidders do not resell energy, the dissent concluded that demand response falls outside the purview of FERC’s regulatory authority.

EPSA recognizes that there is no bright line distinction between FERC’s role and the states’ role in regulating electric utilities and other electricity market participants. While jurisdictional uncertainty may spawn additional litigation, demand response at the wholesale level provides many benefits to the electric grid. The Supreme Court’s decision allows those benefits to flow to users of the grid, without being limited by state boundaries.