In a major victory for consumers and the environment, on January 25 the Supreme Court reversed the D.C. Circuit Court of Appeals and held that demand response resources may continue to participate in wholesale energy markets on a level playing field with generators. Because the issues at stake in this case are fundamental to Sierra Club’s work to move our country toward clean energy, the Sierra Club teamed up with other environmental groups and consumer advocates to encourage the Supreme Court to review and reverse the D.C. Circuit’s decision. See my earlier blog on this case, as well as amicus briefs we submitted here and here.
How Demand Response Benefits Consumers and the Environment
In Federal Energy Regulatory Commission v. Electric Power Supply Association (14-840), the Supreme Court held that the Federal Energy Regulatory Commission (“FERC”) properly exercised its authority to oversee wholesale energy prices when it issued an order regulating how much regional grid operators should pay for demand response bids that clear wholesale energy markets. Demand response, a form of energy efficiency, is a mechanism by which customers agree to reduce their energy consumption for finite periods of time, such as when the grid is stressed by high demand or unexpected generator outages.
When demand response participates in wholesale energy markets it reduces the need for grid operators to turn on the least-efficient power plants to supply electricity at peak times. This not only brings down the costs that customers see on their electric bills, but also avoids harmful air and water pollution. Demand response also promotes electric reliability, since it helps prevent the grid from becoming overloaded. And by providing grid operators with more tools to help achieve the fine balance of supply and demand needed on the grid, demand response helps integrate low-cost, variable energy sources like wind and solar.
As detailed in an earlier blog I wrote with my colleague Tony Mendoza, some electricity generators objected to demand response being allowed to participate in wholesale energy markets because the lower prices that consumers enjoy mean reduced profits for generators. A coalition of these generators—the Electric Power Supply Association—challenged FERC’s order and persuaded two judges on the D.C. Circuit Court of Appeals to find that FERC’s order unlawfully treaded on state authority to regulate the retail sale of electricity.
The Supreme Court’s Decision
Fortunately for consumers and the environment, the Supreme Court resoundingly rejected the generators’ arguments. In a 6-2 decision written by Justice Elena Kagan, the Court held that FERC acted well within its authority to ensure “just and reasonable” rates in the wholesale energy market when it regulated the compensation for demand response for bids clear the market. The Court reasoned that under the Federal Power Act, FERC could regulate any practice that “directly affects wholesale rates,” and held that “the rules governing wholesale demand response programs meet that standard with room to spare.” (p. 16) To make the point perfectly clear, Justice Kagan wrote: “Compensation for demand response thus directly affects wholesale prices. Indeed, it is hard to think of a practice that does so more.” (id. p. 17). The Court also rejected the generators’ arguments that because incentivizing customers to curtail energy usage, FERC was effectively regulating retail rates, a matter that the Federal Power Act expressly reserves for the states.
Finally, the Court upheld FERC’s decision about the amount that demand response should be paid it clears the market. FERC’s judgment, made after an extensive stakeholder comment process, was that demand response should be compensated at exactly the same rate that a generator would be—at the market clearing price—because both resources provide the same value to the wholesale market. FERC also found that compensating demand response at the market clearing price would incentivize more demand response to enter the market, thereby enhancing competition and driving down wholesale rates. Noting FERC’s expertise in rate-setting and the thoroughly considered approach the Commission had taken on the issue, the Court left FERC’s compensation decision in place.
Implications for Clean Energy
The Supreme Court’s decision preserves an essential component of the clean-energy economy. Although some states and utilities offer incentives for demand response, none of these come close to matching the scale of benefits realized by demand response participation in wholesale energy markets. Had the Supreme Court gone the other way, FERC, states, and grid operators would have worked together to find a workable alternative to the current system. However, there would have been a period of adjustment and a set-back for consumers and clean energy. Fortunately, the Supreme Court’s decision allows demand response to continue to grow as a critical clean energy resource.
This decision also lifts a cloud that had hung over capacity markets. (See this blog for an explanation of capacity markets). Demand response participation in capacity markets reduces the prices that consumers must pay to ensure future resource adequacy and helps avoids the need to keep around old, inefficient fossil-fuel plants just so that they can be run during a few peak hours each year.
Emboldened by the D.C. Circuit’s now-reversed decision regarding demand response in energy markets, two groups of generators had petitioned FERC to exclude demand response from these capacity markets. With the Supreme Court’s opinion, those petitions have less merit than ever, and will almost certainly be dismissed by FERC in the coming months. Thus, this decision eliminates any doubt that demand response will continue to contribute to resource adequacy, allowing utilities and state regulators to more effectively plan for resource needs in the coming years. Moreover, a significant element of uncertainty in the forecasts of prices in energy and capacity markets has now been removed, enabling utilities, investors and regulators to make better-informed decisions about whether new generation should be built and whether inefficient fossil generating plants nearing the end of their life cycle can retire on schedule.
In sum, the Supreme Court’s decision will enable demand response to continue to compete on equal terms with generation, to the benefit of consumers, public health, and the climate.
Photo by Kelapstick, courtesy of Wikimedia Commons.