Electricity in the New SCOTUS Season

It’s October and  a new SCOTUS term has started.  Inasmuch as Burt has temporarily withdrawn, I’ll try to take up a little of the slack with a preview of one of the early cases (oral arguments on Oct. 13).  This one is likely to have a significant impact on the shape of electricity supply policy for the US.

The current big-picture regulatory scheme for electrical power in the US breaks things up into generators, who produce power, utilities, who purchase from the generators and distribute to retail customers, and independent system operators (ISOs) who manage the transmission network that connects generators to utilities.  From the 1990s, federal policy has encouraged former vertically-integrated utilities to split off their generating business.  Utilities provide their best estimates of the future hour-by-hour demand from customers; generators bid to supply that electricity (lowest price wins, obviously).  ISOs may make last-minute purchases (or order some generation curtailed) to keep the grid stable.

Regulatory authority is split along similar lines.  The Federal Energy Regulatory Commission (FERC) oversees the wholesale markets where generators and utilities interact.  States oversee retail (mostly monopoly) markets for consumers.  Conflicts happen.  In California in the early 2000s, generators including Enron gamed the system — and in some cases, just broke the law — to produce shortages and very high wholesale prices.  California state regulators, for the most part, held retail prices steady.  The state wound up having to bail out a couple of the largest utilities.  At the other end of experiences, the Pennsylvania-New Jersey-Maryland (PJM) wholesale market has worked out quite well, although the market operators continue to tinker with it.

One of the problems with the overall market strategy as originally defined is that none of the big players have any incentive to conserve electricity.  California’s utilities, under state regulation, used to operate large conservation programs.  The California regulators allowed the utilities to “invest” in conservation (eg, LED traffic light bulbs) rather than in yet another new generating plant.  So-called “negawatts”, at least in modest amounts, turn out to be significantly cheaper than additional generating capacity.  Separation of distribution and generation removed the incentive to invest in efficiency: distributors make money by delivering more electricity, and generators make money by generating more electricity.  No one (other than consumers directly) makes money by using less electricity.

The FERC’s Order 745 formally added the concept of demand response to the wholesale market model.  The basic concept is simple.  During peak load periods, when the ISO is faced with the need to purchase additional power, usually at quite high prices, utilities make a different bid.  “Pay us $X per megawatt, and we will incent our consumers to reduce their demand.”  For example, a utility may offer residential consumers a deal that says, “We’ll pay you $25 if you let us install a remote-control switch so we can shut off your air conditioner for 15 minutes during peak load periods.”  Over hundreds of thousands of customers, the utility can shed large amounts of demand in fairly short order.  The money to pay those $25 offers can be recovered by selling demand reduction to the ISO.

The generators were upset by the amount of potential money they lost.  In the PJM market, for peak periods, demand response is estimated to have reduced the cost to the ISO for last-minute purchases by about $9B per year. The Electric Power Supply Association (EPSA) representing large generators filed a lawsuit alleging that FERC had overstepped its authority.  The federal DC Circuit Court ruled in EPSA v. FERC (EPSA) that the generators were correct because demand response was a retail transaction, and vacated Order 745 (they also stayed their order, pending appeal to the SCOTUS).

Prediction time.  I’m biased, because I believe the US is facing a long-term electricity supply problem that will require maximum flexibility to address.  The SCOTUS will reverse the Appeals Court 5-4, with Chief Justice Roberts siding with the liberal wing.  The opinion will turn on the fact that where wholesale electricity markets have been successful in the US, the markets deal in much more than just simple generation.  The PJM is a case in point.  The original market for electricity had to be expanded to deal in generation-plus-transmission combinations (in California, Enron made large sums by bidding supply that they knew the grid couldn’t deliver).  The PJM operates a market in spinning reserves to deal with unexpected failures.  The PJM operates a market in long-term capacity to deal with growth.  Just as the utilities aggregate demand by their customers, they should be able to aggregate demand reduction by the customers.

Oh, and why will CJ Roberts side with this argument?  Personal opinion: while he’s a supporter of big corporations, he’s also willing to protect them from themselves.  This won’t be the first time that he’s done this to/for the big generators — he did much the same thing in Utility Air Regulatory Group v. EPA last year, signing on to a convoluted opinion that gave the EPA limited ability to regulate CO2 emissions from power plants.  That was the best deal that the generators could reasonably expect then; demand response in the wholesale market is the best deal they can get now.


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Michael is a systems analyst, with a taste for obscure applied math. He's interested in energy supplies, the urban/rural divide, regional political differences in the US, and map-like things. Bicycling, and fencing (with swords, that is) act as stress relief. ...more →

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13 thoughts on “Electricity in the New SCOTUS Season

  1. Hmmm, before I can predict, I need some clarification. I’m confused about what the suit is over. Is it that utilities are allowed to pay their customers to put in a device that’ll save the utility money? (I think that’s right, FERC and all…). So I’m left wondering why doing that would ought to be illegal since it appears to me entirely consistent with normal market activity. (Or am I not getting it?)

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    • The generators’ argument — and this is the way the Appeals Court went — is that payments for demand reduction is a retail transaction, so FERC has no authority over it and Order 745 that explicitly blesses demand reduction as a commodity in the wholesale markets is improper. Not addressed, as I read it, is whether the PJM ISO can create a demand reduction market on its own. That’s presumably a matter for another day — with the argument that if FERC can’t regulate it, then there can’t be a wholesale market in it.

      My reasoning for CJ Roberts is that the generators are being stupid. They will eventually lose this issue and look really bad doing it, so better in his mind to smack them now.

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      • Yeahbut based on what argument? It seems pretty clear that the purpose of the Order is to incentivize reductions in retail consumption, and that the Order only applies to the retail end.

        Hmmm. This is a subtle one. Without anything more to go on, I would have to go with a ruling in favor of EPSA, but since the court even decided to hear the appeal the type of shenanigans you’re talking about might be very much in play. (Good ole Roberts…) So given that, I’m with ya: 5-4 FERC!

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      • So is Order 745 limited to wholesale transactions on its own terms, or did Congress not grant FERC the ability to regulate retail transactions, or is this an inverse commerce clause argument (Congress lacks authority to regulate and thus delegate at this atomic of a level)?

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        • See, that’s where things get weird. I take it that FERC’s scope of authority is limited to the wholesale side of the delivery system and because of that Order 745 is illegitimate. Or so EPSA is arguing. But that just begs the question I asked earlier and Lyle mentions as well: unless there’s some already existing restriction on retailers incentivizing reducing energy consumption by end users, the whole suit amounts to a technicality.

          But I assume that all that was discussed in the prior case and so cannot be easily dismissed on *those* grounds.

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        • This amicus brief from a batch of grid reliability engineers was accepted by the Court in the “in support of neither party” category. It provides a very good, concise explanation of the role of demand management in maintaining reliability in the grid from an engineering — rather than legal — perspective. When I read it with my legislative analyst hat on, though, it seems to me to have a pronounced “demand management is a critical resource for the grid operators, who function in the wholesale side of things, and it would be a good idea if you didn’t take the tool away from them” flavor.

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  2. The Federal Energy Regulatory Commission (FERC) oversees the wholesale markets where generators and utilities interact.

    That is, overlooks any issues with those markets. (See California getting completely screwed by Enron, Duke Power, etc, and no regulatory relief at all.)

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    • It took practically forever, but the FERC did eventually find in California’s interest. Unfortunately, by that time most of the bad guys had declared bankruptcy and so California got nothing. A moderately interesting theoretical outcome is that post California, and the constant tweaking that PJM has to do, Cato has actually published papers arguing that the overhead costs of ensuring that the wholesale market works properly are at least as large as the inefficiencies of vertically-integrated utilities.

      I am blessed by living in an electricity “market” that is so geographically isolated that one company is the market on the utility side, so they have an exemption from many of the rules. As a consequence, my utility can make deals to buy all of the (highly variable) output from a wind farm at a fixed price for 20 years, and under that condition the wind farm can price its electricity below the cost of new natural gas-fired generation. But it’s an unusual situation that doesn’t occur in very many places.

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  3. Actually in the dis-integrated model the retailers are the folks who would deal with the customers. (they also bid for the power needed). There is no “utility” as you suggest a retailer just needs a bank line of credit to go into the business. Since the FERC deals with generators and distributors, it seems that if the folks running the ISO’s wanted to they could allow this type of pricing with help from the various state PUCs, in making the rules. The main change would be to allow the negative energy bid. So at most the FERC would have to make its rules silent on the issue i.e. do not forbid it and let the states allow it. Then some retailers could participate and some not and the price of energy to their customers would vary.

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    • I don’t disagree with you, and PJM has had a demand response program for quite some time in states that allow it. That arrangement is generally limited to large individual customers who can lower or raise* their demand on a day-ahead or hour-ahead basis, rather than aggregations of small customers. There are inefficiencies to that arrangement: the PJM ISO may be paying more than they need to for load shedding (since the incentives are fixed well in advance), and sometimes the best place to shed load for reliability purposes is in a state that doesn’t have a program. Order 745’s purpose was to address those.

      I found out today that since the Appeals Court ruling, EPSA has filed suit challenging the entire concept of an ISO using demand management. PJM’s initial analysis — done because it may be important to shareholders of various sorts — says that that’s a possibly plausible interpretation of the ruling.

      * The amicus brief I mentioned in a comment above points out that sometimes a large customer can increase demand more quickly than a generator can decrease supply, which may be important in grid reliability.

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