On Monday, the U.S. Supreme Court issued a decision ruling that the Federal Energy Regulatory Commission (FERC) has the authority to establish uniform rules for how electricity customers are compensated for temporarily reducing their electricity demand when the wholesale price of electricity peaks, an action often called “demand response.”
The court also upheld the compensation scheme established by FERC Order 745, which pays customers the actual wholesale electricity price at the time they reduce their demand. This payment comes on top of any benefit the customer reaps from not purchasing electricity they would have otherwise used, as long as the overall electricity cost is reduced by the customer’s action of reducing their demand. In practical terms, this means that consumers would really only be paid to reduce their demand when the wholesale price is much much higher than usual, as shown in the figure below.
The Supreme Court first heard arguments in the case back in October. The case was brought by a group of independent power producers — companies that own conventional power plants and often rely on periods of peak demand and the very high wholesale electricity prices they bring to pay off their generators. The plaintiffs argued that FERC’s authority does not extend into retail electricity markets, so the agency does not have the authority to regulate demand response.
In her opinion for the 6-2 majority, Justice Elena Kagan ruled against the independent power producers, and argued that demand response falls under federal jurisdiction because it directly affects wholesale prices. Kagan wrote: “Compensation for demand response . . . directly affects wholesale prices. Indeed, it is hard to think of a practice that does so more.” Kagan also ruled that FERC’s authority extends to demand response even if it does indeed affect retail electricity markets, writing:
It is a fact of economic life that the wholesale and retail markets in electricity, as in every other known product, are not hermetically sealed from each other. To the contrary, transactions that occur on the wholesale market have natural consequences at the retail level. And so too, of necessity, will FERC’s regulation of those wholesale matters.
Furthermore, Kagan ruled that FERC’s actions to enable demand response fall directly under the purview of the Federal Power Act’s mandate that FERC ensure “just and reasonable” wholesale electricity rates by improving market competition. Kagan wrote:
We will not read the [Federal Power Act], against its clear terms, to halt a practice that so evidently enables the Commission to fulfill its statutory duties of holding down prices and enhancing reliability in the wholesale energy market.
Finally, the majority opinion concluded that FERC — and FERC alone — has the authority to establish the specific compensation scheme that will be used for demand response, and that FERC established the rules of Order 745 with sufficiently reasoned decisionmaking that it would be wrong for the court to dispute FERC’s final rule.
The Commission, not this or any other court, regulates electricity rates. The disputed question here involves both technical understanding and policy judgment. The Commission addressed that issue seriously and carefully, providing reasons in support of its position and responding to the principal alternative advanced. . . . Our important but limited role is to ensure that the Commission engaged in reasoned decisionmaking—that it weighed competing views, selected a compensation formula with adequate support in the record, and intelligibly explained the reasons for making that choice. FERC satisfied that standard.
The Supreme Court’s decision is a victory for both demand response providers and market purists that would prefer to see more competition on the part of both supply and demand in electricity markets. The decision is a loss for independent power producers that might depend on periods of very high wholesale electricity prices to pay for their power plants.
In my opinion, it’s a good thing that we are moving toward a more competitive electricity market regardless of the impact it might have on the owners of conventional generation. If we “need” their power, then a competitive market should ensure they get the compensation they need to pay off their power plants. If the market can produce lower-cost alternatives to their power, then it’s a good thing that consumers in competitive electricity markets are no longer beholden to pay off the sunk capital costs of electricity generation that cannot compete.
Read the full U.S. Supreme Court decision here.