D.C. Circuit Vacates FERC’s Wholesale Demand Response Compensation Rule Because It 'Goes Too Far'

On May 23, 2014, the U.S. Court of Appeals for the District of Columbia Circuit ("D.C. Circuit"), in a 2-1 decision, vacated in its entirety and remanded Order No. 745 of the Federal Energy Regulatory Commission ("FERC" or the "Commission"). FERC Order No. 745 requires independent system operators and regional transmission organizations ("ISOs/RTOs") to compensate, in certain circumstances, demand response providers at market prices, i.e., locational marginal price ("LMP").1 The D.C. Circuit invalidated FERC Order No. 745 on the grounds that, despite congressional policy in the Energy Policy Act of 2005 ("EPAct 2005") to encourage demand response, FERC acted: (1) beyond its jurisdictional authority because Order No. 745 infringed on the exclusive jurisdiction of the states to regulate the retail electricity market unambiguously set in the Federal Power Act ("FPA"); and, alternatively, (2) arbitrarily and capriciously by implementing Order No. 745 without responding to arguments that such compensation would result in "unjust and discriminatory rates."2

Application of the court's opinion to demand response participation in the capacity and ancillary services markets will prove complex for several reasons. In the near-term, at least, the opinion itself is not yet effective and the court on its own motion has withheld issuance of its mandate until seven days after disposition of any timely petition for rehearing, which is due 45 days from the date of the court's decision. In addition, the vigorous dissent offered by Judge Edwards raises substantive issues that portend a further challenge by FERC - either reconsideration by this panel or rehearing en banc (full court), and perhaps further challenge to the Supreme Court.

In immediate reaction to the opinion, FirstEnergy Service Company filed a "fast track" complaint at FERC to remove demand response requirements from PJM Interconnection, L.L.C.'s ("PJM") tariff, set a refund effective date, and nullify the results of the most recent capacity auction that included demand response resources. We anticipate that if demand response providers do not participate in forthcoming PJM capacity auctions, then prices will clear materially higher. Accordingly, we would not expect FERC to grant the complaint. Instead, we look for the D.C. Circuit to withhold its mandate pending further appeals, which FERC likely will pursue given the scope of the dissent.

Demand Response Programs and FERC Order No. 745

Order No. 745 marked a seminal event for the chairmanship of Jon Wellinghoff. During his tenure, Chairman Wellinghoff described his battle to support demand response as an epic struggle, pitted against entrenched views. Pursuant to ISO/RTO demand response programs, consumers reduce electricity intake in reaction to price signals by serving "as a resource in organized wholesale energy markets to balance supply and demand."3 FERC Order No. 745 requires ISOs/RTOs to compensate demand response resources at LMP, as if the demand response resource had generated that amount of energy. In Order No. 745, FERC explained that it sought

to ensure that when a demand response resource participating in an organized wholesale energy market administered by [an ISO/RTO] has the capability to balance supply and demand as an alternative to a generation resource and when dispatch of that demand response resource is cost-effective as determined by the net benefits test described in th[e] rule, that demand response resource must be compensated for the service it provides to the energy market at the market price for energy.4

The D.C. Circuit's Decision

FERC Lacked Jurisdiction

The D.C. Circuit held that FERC's jurisdiction is limited to regulating the wholesale energy market.5 Meanwhile, the retail energy market is within the exclusive jurisdiction of the states.6 FERC...