The Supreme Court Rules on the Scope of Federal Energy Regulation

 

Economists Ink: A Brief Analysis of Policy and Litigation

View John R. Morris’s Profile
View Keith Everhart ‘s Profile
Dr. John R. Morris leads the energy practice at EI.  Among his consulting assignments, he advises clients on the competitive effects of regulations affecting electric power capacity markets.  Keith Everhart, formerly an Economist with the Federal Energy Regulatory Commission’ Office of Enforcement, consults on energy matters at EI.

Does the Federal Power Act (FPA) preempt a state-mandated contract that fixes the payments received by a generation developer for capacity sold in federally regulated auctions? The Supreme Court addressed that question in Hughes v. Talen Energy.

The question was raised because in 2011 Maryland decided that the energy and capacity auctions operated by the PJM Interconnection (PJM) did not provide sufficient incentives to promote new generation within the state. PJM operates the high voltage transmission grid in all or parts of 13 states running from the Mid-Atlantic region westward to northern Illinois. The daily energy auctions operated by PJM do not provide sufficient net revenues to maintain enough generation capacity for reliable operation. Therefore, PJM conducts forward capacity auctions to provide additional revenue.

In those auctions, PJM forecasts demand for capacity three years in the future, and generation companies submit offers to supply that capacity. The auction process produces a clearing price that is received by all generation units that clear the auction within a region. The regional component of the auction structure means that some regions that are relatively short of generation capacity, such as parts of Maryland, may have substantially higher capacity prices than regions with more abundant capacity. Despite these relatively high capacity prices, there were no new major generation additions in Maryland for many years before 2011.

To promote new generation capacity within the state, Maryland devised a plan to provide capacity suppliers a secure return on investment. It solicited offers for new generation capacity and selected an offer from Competitive Power Ventures (CPV). The plan required the three major electric distribution utilities in Maryland to enter into 20-year contracts for differences with CPV. Under these contracts, CPV would receive the guaranteed capacity price specified in its proposal, and the distribution utilities (and in effect, their retail ratepayers) would either receive or pay the difference between the contract price and the ultimate auction clearing price. For example, if the contract price were $130/MW-day and the annual capacity auction price was $150/MW-day, then CPV would pay the distribution utilities $20/MW-day for the year. If the annual capacity auction price were only $100/MW-day, then the distribution utilities would pay CPV $30/MW-day. As a result, CPV would on net receive the contract price, $130/MW-day, regardless of the prices set by the annual capacity auctions. The contracts were purely financial. That is, the distribution utilities never took title to the capacity rights of CPV’s plant. The contracts set the net price received by CPV from selling capacity into the PJM annual capacity auctions.

The contractual arrangement was accepted by PJM and implicitly by the Federal Energy Regulatory Commission (FERC). When Maryland passed the regulations leading to the CPV contract, PJM petitioned FERC to modify the auction’s Minimum Offer Pricing Rule. The revision required CPV and other similar generation companies that obtain financial assistance from states to submit data to PJM’s market monitor to set a minimum offer price for the capacity auctions. FERC accepted the proposed revisions. CPV submitted the required data, and the market monitor then set a minimum offer. The auction clearing price was greater than the minimum offer, so CPV cleared the auction and was set to construct its plant and receive the benefits of the contracts with the distribution companies.

At this point an independent power producer, PPL EnergyPlus (PPL), filed suit in federal district court challenging the contracts. PPL, which was the predecessor of Talen, put forth several arguments, such as states’ assisting new generation expands capacity and thus lowers capacity prices. Hence, the contracts represent an impermissible attempt by the state to influence the auction clearing prices. The argument that had the most traction, however, was the argument that the contracts “fix” the capacity price and that a state cannot fix a price that is under the exclusive jurisdiction of FERC. Accordingly, the district court found for PPL, and the Fourth Circuit affirmed the district court decision.

Maryland and CPV petitioned the Supreme Court to review the appellate decision. They argued that CPV, not Maryland, set the rate. That is, in competition with other companies, CPV offered to provide new generation capacity at a certain capacity price. The contracts at issue are simply bilateral contracts between CPV and the distribution utilities. Because bilateral contracts are allowed in tandem with the PJM capacity auctions, the contracts at issue are perfectly acceptable. Moreover, the FPA pertains to jurisdictional sellers (e.g., CPV) and not to the respective counterparties. Hence, FERC has no jurisdiction over Maryland’s decision to compel the distribution utilities to contract with CPV. The FPA leaves to the states to decide how much generation is necessary for reliability in the state.

The Supreme Court disagreed. Three facts seemed to sway the Court. First, the contracts went into effect only if the CPV capacity cleared the PJM capacity auction. This fact indicated to the Court that the purpose of the contracts was to fix the auction prices, and not create their own, independent, bilateral prices. Second, the contracts effectively fix the capacity payment to CPV. That is, regardless of the prices established in the PJM capacity auction, CPV would receive the same capacity payment. Third, the contracts were purely financial. In a physical bilateral contract, the purchasers (i.e., the distribution utilities) would take title to the capacity rights, and they would be responsible for offering the capacity to the PJM capacity auctions. In this case, however, CPV kept the capacity rights and offered them to PJM. Hence, the nature of the contracts was to fix the payments for capacity that CPV sold to PJM via the capacity auctions. In that sense, the contracts “fixed” the capacity prices. The Court concluded that “[b]y adjusting an interstate wholesale rate, Maryland’s program invades FERC’s regulatory turf.”