In wake of DC Circuit decision vacating Order 745, industry players sort through fallout

Platts
6/2/14

By Tom Tiernan and Bobby McMahon

Power industry players last week continued to sort
through the ramifications of the DC Circuit Court of
Appeals’ ruling vacating Order 745, with questions
swirling as to how the commission will respond and
what will be the broader effects of the decision.

The order, which required that
demand response resources receive comparable
compensation to generation in
energy markets, was vacated by the court
May 23. The ruling was met with criticism
by some in the DR and environmental
communities and praise by generation
groups, with legal observers saying that
the ruling raises questions as to how states
will respond and how other FERC actions,
including enforcement proceedings, could
be called into question.

In the 2-1 decision striking down
Order 745 (Electric Power Supply
Association, v. FERC, 11-1486), the court
ruled that DR, because it is based upon
retail customers choosing not to buy
power to use at their facilities, is a retail
transaction beyond FERC’s wholesale
power market authority.

Judges Janice Rogers Brown and
Laurence Silberman also found fault with
the compensation aspects of the FERC
order, ruling that the commission had not
adequately explained that the compensation
results in reasonable rates. “If FERC
thinks its jurisdictional struggles are its
only concern with Order 745, it is mistaken.
We would still vacate the rule if we engaged
the petitioners’substantive arguments.”

DR programs within independent system operators remain in
place while FERC decides what next steps to take, such as whether
to seek rehearing on the decision before the same panel or file
a petition for en banc review before the entire circuit. Because
the issue revolves around jurisdiction over wholesale and retail
power markets, a FERC petition for review at the US Supreme
Court is not out of the question if appeals at the DC Circuit are
not successful, observers have said.

Pending petitions for rehearing or en banc review, the court
has yet to issue a mandate imposing its ruling on FERC.

Commissioners last week offered differing takes on the
court’s decision, while at the same time saying that reviews of
the decision and its impacts remain ongoing.

Commissioner Tony Clark noted his past reservations with
FERC’s implementation of Order 745 as well as the fact that
he was not on the commission when it was approved. He said
that “on its face, FERC’s assertion of jurisdiction over demand
response was always dubious,” saying that the court found
FERC’s view of its jurisdiction in this matter was “too expansive”
and “without any limiting principles.”

On questions of compensation, Clark reiterated his view that
full locational marginal price for DR was unjust and unreasonable,
noting that the court found FERC’s decision-making on
compensation to be arbitrary and capricious.

At the same time, Clark said that “none of this should suggest
I oppose demand response per se. In fact, DR can and
should play a very important role in our electricity delivery
system. The key going forward will be to work with our state colleagues
to find legally sound ways to facilitate the development
of cost-effective demand side management tools.”

Clark said he was still reviewing the order and “assessing its
far-reaching impacts,” and had yet to make decisions on what
FERC should do next.

Commissioner Philip Moeller agreed with the court’s decision
regarding compensation, saying via email that he was “thrilled
with the decision” in that regard and was “glad the arguments
related to my dissent were embraced.” In his dissent to Order
745, Moeller argued that the rule imposed “a standardized and
preferential compensation scheme that conflicts both with the
commission’s efforts to promote competitive markets and with
its statutory mandate to ensure supplies of electric energy at just,
reasonable, and not unduly discriminatory or preferential rates.”

The court in the decision found Moeller’s arguments regarding
compensation to be “reasonable” and “persuasive,” saying
that FERC failed to properly “engage” Moeller’s concerns.

Moeller, though, said he was “surprised about jurisdictional
aspect of the decision,” noting his support for DR. “We will have
to discuss next steps related to rehearing requests,” he said.

Commissioner John Norris via email declined to comment
on the substance of the order, saying that he was still reviewing
the decision and its effects.

Through a spokesman, Acting FERC Chairman Cheryl
LaFleur declined to offer an individual reaction to the order.
“The Commission is reviewing the decision and considering next
steps,” the spokesman said.

While FERC and the intervenors on the commission’s side
in the case can file for rehearing or en banc review, federal rules
place a high threshold on those cases the court will review en
banc, saying that doing so is “not favored” unless “the proceeding
involves a question of exceptional importance” or “en banc
consideration is necessary to secure or maintain uniformity of
the court’s decisions.”

Carolyn Elefant, a DC-based energy lawyer, said in her newsletter
last week that petitioners stand a “better chance” of showing
that the decision involves a matter of “exceptional importance”
than a question of maintaining uniformity. She said that
the court’s ruling could call into question commission authority
over DR programs in capacity and ancillary services markets as
well as DR facilitated by behind-the-meter generation.

“Like the economic demand response programs covered by Order
745, capacity and ancillary demand response programs may
consist of payments to retail customers to commit to or actually
reduce consumption and therefore, would run up against
the same ‘jurisdictional struggles’ that sank Order 745. The
potentially far-reaching scope of the court’s decision to all variants
of demand response programs could possibly justify en banc
review,” Elefant said.

A review of FERC’s recent legal history shows that commission
petitions for en banc review are exceedingly rare. According
to the commission’s website, FERC has sought en banc review
only once since 2009, seeking review of the Fourth US Circuit
Court of Appeals’ rejection of commission rules implementing
transmission backstop siting authority under the Energy Policy
Act of 2005 (Piedmont Environmental Council v. FERC, 07-1651).

In an April 2009 petition, FERC argued in part that its decision
should have been entitled to deference and that the court’s
interpretation “is not compelled by the statute.” But the court
rejected that request for en banc review, and the Supreme Court
subsequently denied a petition for a writ of certiorari from Edison
Electric Institute and others.

DR supporters and environmental groups last week criticized
the decision while at the same time acknowledging its uncertain
effects.

“The decision opens up so many cans of worms that everyone
is simply trying to understand what this could mean,” said
Dan Delurey, executive director of the Association for Demand
Response and Smart Grid. Delurey also called the majority’s
opinion “one of the most weakly supported and illogical decisions
I’ve read in a long time.”

In contrast, Delurey called Judge Harry Edwards’ dissenting
opinion “firmly supported and logically explained.” In doing so,
Delurey noted that Edwards in the dissent highlighted how the
DC Circuit had previously reached the conclusion that FERC had
jurisdiction over a generation capacity market despite challenges
based on a perceived encroachment into the retail realm.

Specifically, Edwards in his dissent found that Order 745
was similar to the DC Circuit’s ruling upholding actions related
to the installed capacity requirement in ISO New England
(Connecticut Department of Public Utility Control v. FERC, 07-1375).

In Connecticut, Edwards noted that “even though increasing
the capacity requirement incentivized the procurement of additional
resources, including new generation facilities, to meet the
higher requirement, we recognized that States retained their ultimate
authority over the construction of new generation facilities.”

“The lesson of Connecticut is that FERC can indirectly incentivize
action that it cannot directly require so long as it is otherwise
acting within its jurisdiction – and that doing so does not constitute
impermissible direct regulation of an area reserved to
the States. So too here: Order 745 may encourage more demand
response, but States retain the ultimate authority to approve the
practice,” Edwards said.

A relatively new DR trade group, the Advanced Energy
Management Alliance, said the decision is likely to be appealed,
and if it were to stand, “would significantly increase costs to
households, businesses and other energy consumers throughout
much of the country.

“Not only would this decision lead to increased electricity
costs for consumers by putting more money in the pockets of
power generators, it would also stifle innovation on our nation’s
electric grid,” Jon Wellinghoff, former FERC chairman and now
strategic counsel for AEMA, said in a statement.

In a blog post, Natural Resources Defense Council staffers
John Moore and Allison Clements said FERC probably will ask
the court to reconsider its decision, “and if that is not successful
it could appeal to the US Supreme Court. If its appeals are
unsuccessful, FERC probably will have to unwind the Order 745
requirements.”

The decision “has potentially sweeping implications for
consumers and policy makers because it could sharply limit the
ability of FERC to develop important grid reforms. Equally worrisome,
it could slow the pace of emerging markets and technologies
that reduce pollution, increase grid reliability and lower consumer
costs because people won’t find demand response such an
attractive option,” Moore and Clements said.

Enernoc, one of the biggest DR firms, in comments last week noted
the possibility that FERC may be forced to order refunds by DR
firms for the compensation they received from ISOs. But the firm
said that most of its revenue is received from capacity payments
for having customers available to reduce demand, and that revenue
would not be affected by the court ruling.

Actual demand reductions in ISO energy markets that are
the subject of Order 745 “have not been a material component
of Enernoc’s revenues. Of Enernoc’s approximately $1 billion
of revenue over the last three years, these payments have represented
approximately 2% of those revenues.”

The company said its “preliminary estimate of the impact of
[the May 23] decision suggests that Enernoc and its customers
could be required to refund in a future period as little as $0 and
as much as $20 million” if the decision is ultimately upheld.

A key question moving ahead, observers said last week, is
how states will respond if the ruling remains in place.

If the jurisdictional aspect of the decision is upheld, Enernoc
said it would expect state regulators to take a much more active
role in facilitating DR activity.

“If the decision is broadened to include capacity and ancillary
services markets, the company would expect state programs
to expand significantly to preserve the nearly $12 billion of consumer
savings that demand response delivered last year” in PJM
Interconnection alone, Enernoc said.

The law firm Akin Gump Strauss Hauer and Feld issued a
May 23 statement saying it is unclear not only what impact the
opinion will have on wholesale capacity markets but also “what
steps, if any, state regulators will take to fill the space that was
vacated.”

“It is widely agreed that some level of demand response is appropriate
in a well-functioning market, and Order 745 describes evidence
that energy savings alone may not be sufficient to prompt
demand response participation,” Julia Elizabeth Sullivan, Carrie
Hill Allen and J. Porter Wiseman said. “Now it may fall to the
states to provide whatever additional incentives are thought to be
needed to achieve the desired level of demand response.”

The attorneys continued, saying that “going forward,
demand response could be addressed entirely at the retail level,
with load-serving entities reporting reduced requirements to
their ISO/RTOs to account for demand response resources under
contract at the retail level.”

Delurey also questioned the state regulation of DR resources.

“I don’t know who will be for the delegation of all wholesale
demand response to the states. Who would be for that
other than the generators? I don’t think the states will want it,”
Delurey said.

Delurey at the time also said that it was yet to be seen how
the National Association of Regulatory Utility Commissioners
will come down on the issue. In a statement late last week, Holly
Rachel Smith, NARUC assistant general counsel, said that while
the organization was still reviewing the decision, the court “at
a glance . . . appropriately recognized the clear jurisdictional
boundary” in the Federal Power Act ensuring state authority over
retail matters.

“NARUC’s members have been diligently working for years to
ensure robust demand response offerings. Indeed, this decision
underscores the leading state role in adopting innovative
demand-response programs,” Smith said. “We anticipate that our
members will embrace this opportunity to assist with any transition
necessitated by the court’s decision to ensure that demand
response remains an integral component of the resource mix in
order to capture economic efficiency, resource diversity and system
reliability benefits.”

In the financial sector, both Barclays Capital and UBS
Securities called the decision a boon to the generation sector, with
Barclays issuing a statement saying “we believe this is positive for
 
UBS went into more detail, saying the ruling interjects significant
risk for companies participating in DR markets nationally
without FERC’s jurisdiction and compensation at full LMP prices.

“While we don’t mean to appear too alarmist (as this could
have significant impacts on power markets), there remains a
likely appeal to clarify how demand response can participate
in Base Residual Auctions” such as the recently completed auction
in PJM, said Julien Dumoulin-Smith, executive director of
equity research for utilities and independent power producers
at UBS.

“It appears that IPPs will have to further petition FERC and
the ISOs to revise their tariffs given the latest decision to gain
clarity on precisely how the regions will each interpret the
change to state jurisdiction,” he said.

UBS expects states to implement their own regulations “to soften
the blow of any reduction” in DR participation, “given the very
significant and disruptive impact on prices in energy markets,
but more importantly on capacity prices,” Dumoulin-Smith said
in a statement.

“We see states taking over DR regulations as cutting both
ways. We see the potential for more generous compensation in
jurisdictions encouraging participation, while those that have
been opposed, implementing tighter rules,” he said.

Beyond FERC’s pending decision on seeking rehearing or en
banc review, observers say that effects of the decision could be
felt outside of the commission’s efforts on DR, including in its
enforcement regime and in its work to implement the landmark
transmission planning and cost allocation rule, Order 1000.

The commission, for one, is asking the US District Court for
the District of Massachusetts to affirm its finding that Lincoln
Paper and Tissue (1:13-cv-13056), Competitive Energy Services
and CES managing member Richard Silkman (1:13-cv-13054)
manipulated an ISO New England DR market. FERC is also asking
the court to uphold the millions in penalties the commission
has levied.

In a March brief (IF, 24 March, 5), FERC sought to rebut
Lincoln’s argument that the court should dismiss the suit in
part because the commission does not have jurisdiction over DR
under the Federal Power Act. The company argued that DR falls
under the umbrella of retail activities and is thus under the jurisdiction
of state regulators, similar to what the DC Circuit found
in the decision on Order 745.

But FERC argued that the statute gives it the authority to impose
penalties on companies that engage in fraud “ ‘in connection
with’ a jurisdictional transaction,” a criterion met by the commission’s
case against Lincoln. “As long as there is a ‘nexus’
between the fraudulent conduct of an entity and a jurisdictional
transaction, the commission can penalize an entity that commits
fraud,” FERC said.

Elefant as well said that even penalties imposed as part of a
settlement, including those against Enerwise Global Technologies
in 2013 (IN12-15), could be “potentially vulnerable.”

Elefant also predicted that critics of Order 1000 could file socalled
28j letters with the DC Circuit in the suit over the transmission transmission
order, if nothing else “to call the court’s attention to a
recent example of FERC overstepping its statutory authority.”
Following oral arguments in March (South Carolina Public Service
Authority, et al. v FERC, et al.,12-1232), the court has yet to rule
on numerous challenges to Order 1000.

And even though the court has withheld its mandate on its Order
745 ruling, at least one market participant has wasted no time in
pressing FERC to act on the vacatur.

FirstEnergy Service on May 23 filed a fast-track complaint
(EL14-55) asking FERC to order PJM Interconnection to remove
tariff language “allowing or requiring PJM to include demand
response as suppliers to PJM’s capacity markets.” FirstEnergy
argued that the results of PJM’s most recent capacity auction
“must be considered void and legally invalid because the inclusion
of demand response in the auction parameters was unlawful
and those parameters are void ab initio,” or from the beginning.

While noting that Order 745 pertained specifically to DR in
energy markets, FirstEnergy argued that the DC Circuit’s “rationale
necessarily extends to include capacity markets as well,”
given that PJM’s capacity auction includes DR in its parameters
and that DR resources qualify for participation in the market.

“FirstEnergy therefore requests that the commission direct
PJM to remove all portions of its tariff allowing or requiring the
inclusion of demand response as suppliers in PJM’s capacity market.
They should be removed effective today,” the company said
May 23.

RTO officials last week noted the lack of a mandate in
responding to the court’s order.

The ISO/RTO Council, a collection of the seven ISOs in the
US, said in a statement last week that once the court issues its
mandate, “this will allow ISOs and RTOs time to determine how
best to comply within the confines of their tariffs,” according to
Kacey George, spokeswoman for the ISO/RTO Council.

PJM following the court’s ruling on May 23 said that it would
continue to abide by the terms of its tariff related to demand
response. “In other words, PJM will continue to operate business
as usual” until the next step is clear, the grid operator said.


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