By Rich Heidorn Jr.

WASHINGTON — The Supreme Court’s liberal wing indicated support Wednesday for FERC’s jurisdiction over demand response, but the commission faced harsh questions from conservatives Antonin Scalia and Chief Justice John Roberts and swing vote Anthony Kennedy.

Kennedy and Scalia challenged Solicitor General Donald Verrilli’s arguments on behalf of FERC, with Kennedy referring to them as “circular” logic and Scalia expressing opposition to the commission’s “fiddling around” with retail rates.

Justices Stephen Breyer, Sonia Sotomayor and Elena Kagan were equally critical of attorney Paul Clement, representing the Electric Power Supply Association. Sotomayor interrupted Clement early in his argument, demanding “where is that written down?” after the attorney categorized FERC’s intent as trying to reduce retail demand.

EPSA filed the lawsuit challenging FERC Order 745, which set rules for compensating DR in RTO energy markets. In May 2014, the D.C. Circuit Court of Appeals vacated the order, saying DR is a retail product and thus subject to state, not federal, jurisdiction.

Conservative Justice Clarence Thomas and liberal Ruth Bader Ginsburg were silent during the one-hour argument, which drew numerous RTO stakeholders as observers.

If the justices side with their normal allies, the court could end up deadlocked 4-4, meaning the D.C. Circuit ruling would stand. Justice Samuel Alito has recused himself in the case.

“If the court does cast a four-to-four vote at its private conference on Friday, and decides that [is] the most that it can do, that result would be announced promptly, perhaps as early as next Monday,” SCOTUS Blog predicted.

Breyer’s Wife Sells Stock

Bloomberg reported that Alito recused himself because he owns stock in Johnson Controls, which owns EnergyConnect, a DR provider that has filed a brief with the court. Bloomberg also reported that Breyer’s wife owned stock in the same company, which it said Breyer was unaware of when he heard the case. She sold her 750 shares for about $33,000 the following day after an inquiry by a Bloomberg reporter.

FERC sought Supreme Court review because of the growing importance of DR. While the D.C. Circuit ruling explicitly addressed only DR participation in wholesale energy markets, FERC said the ruling also threatened its participation in wholesale capacity markets.

That could create upheaval in markets such as PJM, where capacity auctions represent about 95% of total DR revenue. After some uncertainty, PJM decided to include DR in the 2018/19 Base Residual Auction in August.

The Supreme Court agreed in May to reconsider the D.C. Circuit ruling on two questions:

• Whether FERC reasonably concluded that it has authority under the Federal Power Act, 16 U. S. C. 791a et seq., to regulate the rules used by operators of wholesale electricity markets to pay for reductions in electricity consumption and to recoup those payments through adjustments to wholesale rates.
• Whether the Court of Appeals erred in holding that Order 745 — which required RTOs and ISOs to pay DR the same LMPs as generation in energy markets — is “arbitrary and capricious.”

(See Supreme Court Agrees to Hear Demand Response Appeal.)

Most of the arguments focused on jurisdiction, however.

Direct Effect

Verrilli led off the arguments and was interrupted almost immediately by Kennedy, who — after noting the interplay between retail and wholesale markets — asked what “marks the end of federal power and the beginning of local power?”

Verrilli did not answer directly, but contrasted the current dispute with the Mississippi Power case, in which FERC ruled that the utility could recover at wholesale its investment in a nuclear plant. The commission was overruled, with the court ruling that FERC had infringed on the authority of the state regulator to deny cost recovery in retail rates as imprudent. “That was a very direct effect on the exercise of state regulatory jurisdiction, which you do not have here,” Verrilli said.

“I find that a pretty fuzzy line, ‘very direct effect,'” Scalia jumped in. He continued, “Yes, FERC has the power to regulate wholesale rates. But … the argument is, not through the fiddling around with retail rates, which is what is asserted is happening here.”

$8 Hamburgers

After several exchanges between the two, Roberts took his turn with Verrilli, comparing FERC to someone “standing outside McDonald’s” offering diners $5 not to go in and spend $3 on a hamburger.

Because of FERC’s action, Roberts said, “the price of a hamburger is actually … $8, because if they give up the $5, they’ve still got to pay the $3. And your answer is, there’s no impact on what the states can do, because they can still say, no, the price of the hamburger should be $2, or it should be $4. The point is that … FERC is directly affecting the retail price.”

Kennedy returned with another question: “Is it fair to say that FERC is luring retail customers into the wholesale market? And if that … were true, would that not be a serious problem for the government?”

“It’s wrong as a matter of history. It’s wrong as a matter of law,” Verrilli responded. “Wholesale demand response was not FERC’s idea… This is a practice that grew up organically out of the private actions of market participants once the wholesale markets were deregulated. It’s exactly the kind of innovative private market conduct that you would hope that deregulation would bring about. And the private actors, the wholesale market operators, brought that idea to FERC as early as 1999.”

Verrilli went on, saying that the Federal Power Act gives FERC authority “over practices that affect … wholesale rates. And there’s just no doubt … that all of the practices FERC is regulating occur in the wholesale auction.”

Limiting Principle

Roberts acknowledged that was true, but he pressed Verrilli to identify the “limiting principle” on FERC’s authority, saying that without one, “FERC can do whatever it wants.”

Verrilli responded that “the effects have to be direct.”

Repeating hypothetical examples cited by the D.C. Circuit, he said, “regulating steel, regulating inputs into electric generation — we don’t think FERC’s authority goes anywhere near that far.”

Verrilli concluded by citing the Chevron doctrine, which says FERC is entitled to deference in its interpretation of the Federal Power Act. “There is no statutory text that unambiguously denies FERC this authority that it’s exercising here over this wholesale conduct.”

Reliability Benefit

Representing DR provider EnerNOC, attorney Carter G. Phillips backed Verrilli, saying that FERC did not create DR but rather responded to a market created by his clients and others who were trying to create a demand-side component to the wholesale market and a way to avoid brownouts. “And so tariffs were filed in order to provide a basis for putting in the demand side. And the reason why this is a direct effect on the … wholesale rates is because it’s an absolute one-to-one relationship. If I put in a unit of — or reduce a unit of — demand, I don’t need as much supply, and that affects the price directly. And that’s the direct relationship that derives from the economic principles.”

Phillips also sparred with Kennedy and Scalia. “FERC’s argument is essentially circular,” Kennedy said. “It says, well, the market forces will work this out — but we define the market.”

Scalia asked Phillips why “all the companies” aren’t in agreement with FERC and EnerNOC. DR provider EnergyConnect, the Coalition of MISO Transmission Customers and the PJM Industrial Customer Coalition joined EnerNOC’s brief.

“Most of the private companies on the other side generate electricity” and see DR as competition, Phillips responded.

Clement, the final attorney to speak, made a point to note that he represented not only the generators that make up EPSA but also load-serving entities that could provide DR under state-sanctioned retail programs.

Signing on to EPSA’s brief were the National Rural Electric Cooperative Association, the American Public Power Association, PPL and Old Dominion Electric Cooperative.

FERC Reducing Retail Demand?

“What FERC was trying to do here was to reduce retail demand by providing payments to retail customers on an otherwise wholesale market in an effort to change the effective price for retail sales,” Clement said. “Now, that sure sounds like something that belongs to the states.”

“Where is that … written anywhere that that was their goal?” interrupted Sotomayor. “What I’ve heard them say is, we’re trying to lower the price of wholesale [power] to a more just amount. That’s what’s in anything I’ve seen written.  You’ve recharacterized it.”

Clement persisted: “These retail customers don’t belong on the wholesale market. Whether you think they were lured in or you think they walked in the door, it doesn’t matter. They are in a market where they don’t belong.”

“What’s the horror here of concurrent jurisdiction … if, in fact, it’s lowering prices?” Sotomayor asked.

“You actually have the … federal regulators and the state regulators bidding against each other for the same customers to reduce their same retail demand,” Clement responded.

LMP Too High?

That led Clement to move from the jurisdictional dispute to the second question, saying that while no states raised a jurisdictional objection before FERC itself, Ohio, Illinois and all of the MISO states said FERC should not require compensation at LMP “because that’s too high.”

“And by setting it so high, what you are going to do is you’re going to crowd out our own efforts at dealing with demand response,” Clement said for the states. “Because we love demand response. We want demand response. But we don’t want to pay twice as much as the market really should pay for demand response. And if you’re out there offering our same retail customers the ability to get demand response paid at huge LMP levels, then [states are] going to be crowded out.”

Breyer said Clement’s logic would prevent FERC from allowing large consumers to buy electricity at wholesale, “because that would take the retail customers away from the jurisdiction of the state.”

He continued: “I have found no case … that would say that they cannot do this for the reason you suggest.”

Kagan said Clement’s argument seemed to be that FERC “can’t do anything with respect to demand response.”

Clement disagreed, saying FERC was allowed to have a role in “true wholesale demand response,” which he said meant working through load-serving entities.

He said FERC’s premise “that the sky will fall if you don’t have this precise type of retail customer on wholesale market demand response” was belied by the experience of Southern Co., which does not participate in an RTO or an ISO, yet it has “a greater level of demand response than other parts of the country” subject to Order 745.

Congressional Intent

Kagan said Clement’s argument was at odds with the 2005 Energy Policy Act, “which made it so clear that Congress liked demand response — that it wanted FERC to lower barriers to demand response — to then say, well, FERC has no jurisdiction to do exactly what the policy that Congress articulated is.”

Clement cited Commissioner Philip Moeller’s dissent on Order 745 and comments by the Federal Trade Commission, which he said told FERC “you are picking the wrong compensation level.”

Having saved five of his 20 minutes for closing remarks, Verrilli got the last word, saying Clements’ view of “hermetically sealed-off retail and wholesale spheres” was unrealistic.

“In the real world today, large customers can buy directly. They can do it through contract, and they can also go into the wholesale market auctions and buy, if their states permit it… And this is really no different because demand response entities that want to come in and participate can only do so if their state law allows them to do so. So it’s no different than what’s been going on in the real world for quite a long time.”

Verrilli also responded to Clements’ arguments about the role of load-serving entities in providing DR. FERC “found that load-serving entities don’t have sufficient incentives to engage in demand response. And it’s obvious why they don’t, because they cannibalize their own profits. The higher cost they have, the higher their rate-of-return profits are going to be generated. They will do it under commands from state regulatory agencies to do it, but they’ll do it grudgingly. And what FERC said is you want people to come in who have a real profit motive to do it and that’ll incent the LSEs to get in there and try to get a piece of the action rather than letting it go to somebody else.”

Fears Unwarranted

Verrilli said fears that state and federal DR can’t coexist were unwarranted, saying “we have 24 states in which this is going on. And if this were a problem, you’d expect to see in this administrative proceeding some evidence that it was a problem, and there is zero evidence. You look at all these briefs; there isn’t a citation to anything in the administrative record that suggests that the federal and state programs can’t work in harmony.”

“You’ve got a practice … that has saved billions of dollars in wholesale costs and will save billions of dollars, and it’s an effective tool against blackouts and brownouts, and that nobody has shown in the real world does any harm.”

More: Transcript of Argument; Briefs