Billions and Billions Served: FERC v. Electric Power Supply Associaton

I was at the U.S. Supreme Court on October 14 to attend the oral argument in Federal Energy Regulatory Commission v. Electric Power Supply Association.  Here are some impressions:

            When I was the general counsel of a state utility commission, I figured out that a surefire way to get colleagues at the agency to wander into my office to share insight and information was by keeping a big jar of chocolate candy on my desk.  But I wanted the insight and information for free, which meant I needed a mechanism to pay for the candy.

            By and by, I devised such a mechanism.  Any time the word “stakeholder” was uttered in my presence, I assessed a fee of 25 cents.  Proceeds were devoted to supplying the candy jar.

            The reason the word “stakeholder” is so unhelpful, and thus so worthy of expurgation from the world of utility regulation, became apparent yet again at the oral argument before the U.S. Supreme Court on October 14 in Federal Energy Regulatory Commission v. Electric Power Supply Association.

            At the podium was former Solicitor General Paul Clement, now in private practice.  Here, Clement was representing a big coalition of generators and old-fashioned electric utilities who were seeking to thwart efforts by the Federal Energy Regulatory Commission (FERC) to allow so-called “demand response” (DR) to be paid at wholesale for their negawatts just as the generators that produce negawatts are compensated.

            A big question in the case is whether the FERC acted in an arbitrary and capricious fashion, thus warranting appellate reversal, by deciding that the negawatt providers should receive the same price the megawatt providers do – the so-called locational marginal price, or LMP.  Clement told the justices a tale he gleaned from one of the briefs, having to do with MISO – the grid operator that oversees the transmission system and wholesale electric markets for most of the Midwest.

            “At FERC’s direction,” said Clement, “they basically spent two years trying to come up with . . . . [to] get all the stakeholders in a room and come up with a formulation” for how much to compensate DR providers.  The formulation on which they agreed was not LMP but LMP minus the cost of generation and transmission – the so called “LMP minus G” price.  “And after having spent two years with all the stakeholders coming up with LMP minus G,  they were then told by the federal government at a late-breaking hour that there was a one-size-fits all solution and it was LMP.”

            Clement called this a “particularly poignant” illustration of how FERC had gone awry.  Imagine wasting the time of stakeholders by letting them have lots of meetings and conference calls for two years and then not agreeing with them!

            Justice Sotomayor responded, not with the “boo hoo” a more glib commentator might have interjected, but with a hearty “well, wait a minute.”

            “That’s a classic choice that we give agencies,” she said.  “They had expert testimony, Dr. Kahn, who was undisputed to be a leading expert in this field, say the opposite.  I mean, how do we choose to go into the weeds of something as technical as that?”

            References to the economist Alfred Kahn were poignant in their own right, since this particular “expert witness” died in 2010 – but not before a long and legendary career in utility regulation that reached its apex when Kahn oversaw the deregulation of the airline industry as the last chairman of the Civil Aeronautics Board during the Carter Administration.   Four months before his death, Kahn submitted an affidavit to the FERC explaining why LMP, and not LMP minus G (usually abbreviated as LMP-G), was the right measure of payment for DR providers in wholesale markets.  More recently, the Kahn torch is carried in an amicus brief to the same effect submitted by another distinguished economist and former utility regulator, Charles J. Cicchetti.

            The high court, of course, can avoid this thicket entirely by simply holding that the FERC lacks authority under the Federal Power Act to allow DR providers into wholesale electricity markets because DR is a retail phenomenon and under the Federal Power Act retail electricity is strictly reserved to the states for regulation.  The lower court (the U.S. Court of Appeals for the District of Columbia Circuit) embraced precisely that view of where demand response fits into the Federal Power Act, which should have mooted the more arcane question of whether it was arbitrary and capricious to spurn LMP-G in favor of LMP.

            Since the Court of Appeals decided both questions, the Supreme Court agreed to hear both of them as well.  Doctrinally distinct, they are nevertheless entangled -- if only because many people seem to think that if the FERC had been more measured about compensation Mr. Clements' clients might not have appealed.  Hovering over this case is the general notion that the FERC flouted commonsense notions of economics itself.  Or, as Justice Kennedy put it, might the FERC be guilty of the unseemly act of “luring retail customers into the wholesale market?”

            “Wrong as a matter of history . . . [and] wrong as a matter of law,” responded Solicitor General Donald Verrilli, arguing on behalf of the FERC.  He patiently explained that “wholesale demand response” – the idea of allowing foregone retail consumption to receive compensation in wholesale markets – “grew up organically out of the private actions of market participants once the wholesale markets were deregulated.  It’s exactly the kind of private market conduct that you would hope that deregulation would bring about.  And the private actors, the wholesale market operators, brought this idea to the FERC as early as 1999.”

            Okay, replied Chief Justice Roberts.  But what’s the “limiting principle” – at what point does FERC’s regulation of the wholesale market have such an effect on retail markets that the agency has exceeded the authority reserved to it by the Congress?  When the case was decided against FERC at the U.S. Court of Appeals for the District of Columbia Circuit, the opinion Judge Janice Brown wrote complained that FERC was basically claiming unlimited authority to regulate things that have some effect on wholesale markets.

            General Verrilli said the “limiting principle” is that there must be “direct effects” on wholesale markets, and (obviously) “conduct that occurs in the wholesale auction in the wholesale market” has such a direct effect.”

            Justice Scalia, clearly skeptical that the FERC had acted within its authority, disagreed about the conduct being regulated.  It’s not wholesale market behavior, he said, but “the refusal to buy power during the peak hours.  That occurs in the retail market.”  In the parlance of the economist-amici, what Amory Lovins famously described as “negawatts” is not the equivalent of wholesale energy with a negative number in front of it but is actually “the unexercised call option of a curtailing end-user.”  See footnote 18 at page 29 of the Cicchetti Brief, quoting energy consultant Robert Borlick.  Justice Breyer seemed to be flirting with this notion as well during his colloquy with Clement.

            Chief Justice Roberts didn’t just flirt with it; he bit into it, by drawing an analogy to Quarter Pounders.  “IF FERC is basically standing outside McDonald’s and saying ‘We’ll give you five dollars not to go in,’ and the price of the hamburger is three dollars . . . the price of a hamburger is actually, I think most economists would say, eight dollars, because if they give up the five dollars they’ve still got to pay the three dollars.”  Yes, the Chief Justice conceded, the states could still set the price of hamburgers at two dollars or four dollars, but it can’t be said the FERC is not directly affecting the retail price.

            The problem with this analogy is that the hamburger buyers are not being accosted by the FERC outside McDonald’s.  Rather, they’re foregoing Quarter Pounders and going into a marketplace lawfully regulated by FERC and asking to be compensated for behaving virtuously.  The FERC is simply agreeing with their claim that, beyond virtue, these burger-avoiders are creating economic benefits for other market participants that deserve compensation.

            The big generators and the big utilities represented by Clement argue, in effect, that under the Federal Power act demand response is only okay if retail customers are indirectly represented in the wholesale markets by their friendly neighborhood utilities – the ones that, as General Verrilli pointed out, generally have to forego profits when customers buy less electricity.  In other words, for purposes of big electricity, retail customers are not “stakeholders.”  Can we really be sure that’s what Congress intended when it passed the Federal Power Act in 1935?

Postscript added on October 15

So . . . I see that Lyle Dennison of the Scotus Blog, and I believe others as well, foresee a 4-4 split (Breyer, Ginsburg, Kagan and Sotomayor voting to reverse; Roberts, Kennedy, Scalia and Thomas voting to affirm) -- which would be a loss for the FERC of course.  Perhaps it is wishful thinking on my part, but I predict a more interesting outcome in which Kennedy and possibly even the Chief Justice vote with Breyer et alii that the FERC has the authority under the Federal Power Act to order compensation in wholesale markets for producers of negawatts, with a majority (though perhaps a somewhat different group of justices) rule that FERC acted in an arbitrary and capricious fashion by failing to account adequately for its rejection of LMP minus G.  Justice Kennedy was mighty interested in having the lawyers address the second issue, and the Chief Justice's hamburger analogy could be understood as less an inquiry into wholesale vs. retail and more an exploration of what the right price is.  It should also be said that Justice Breyer seemed mighty attracted to the idea of demand response being considered not "negawatts" that offset wholesale megawatts but rather an unexercised call option -- i.e., a retail product through and through.  As I said in my main post above, the two questions in the case are distinct as a doctrinal matter and yet they are sufficiently intertwined as to make it too facile, I think, to predict a 4-4 draw.

Earnest apologies to those who reasonably expect this blog to be about cooperatives.  Maybe a few electric co-op folks will read this and appreciate it.