Implications for the Power Sector of Recent Rulings by U.S. Supreme Court and FERC
One of the most important issues currently facing the power industry is the potential conflict between federal and state roles in power supply planning. Two recent developments at the federal level bear directly on this issue.
First, on April 19th, in Hughes v. Talen Energy Marketing LLC et al. (Hughes), the U.S. Supreme Court struck down on federal pre-emption grounds a Maryland program intended to support construction of a new 725 MW natural gas-fired generating plant in Maryland. The Court held, by an 8-0 vote, that the program invaded “FERC’s [exclusive] regulatory turf” over determination of wholesale rates for electricity.1
Then, just eight days later, on April 27th, the Federal Energy Regulatory Commission (FERC) blocked implementation of two Purchase Power Agreements (PPAs) approved by the Ohio Public Utilities Commission (Ohio PUC). The PPAs, involving FirstEnergy Corporation (FirstEnergy) and American Electric Power Company Inc. (AEP) were intended to support continued operation of more than 6,000 MW of existing coal and nuclear generation in Ohio.
From a legal perspective, neither ruling came as a surprise. The two rulings, however, highlight the obstacles to state efforts to support continued operation of existing generating units and construction of new plants. Over the next few years, sparring over this issue could intensify. FERC, state regulators, the U.S. Environmental Protection Agency (EPA) and the courts are all likely to be involved.
The stakes in resolving this issue are high. Power producers, lenders to the power sector, equity investors, and end-use customers will need to monitor the legal wrangling carefully.
In the wake of Hughes and the FERC Orders, generation owners and state regulators will be required to explore new mechanisms to support continued operation of existing coal and nuclear generating units and to achieve long-term resource planning goals without running afoul of FERC.
The success of these efforts could have a major impact on market value of new and existing generating units, decisions regarding whether to retire marginally economic coal and nuclear plants, the attractiveness of building new generation and the frequency and severity of future price spikes.
Issues regarding the respective roles of FERC and the states also go to core of implementation of the Obama Administration’s Clean Power Plan, which seeks to impose state-by-state limits on power plant emissions of CO2.
Tension between Federal and State Jurisdiction over Electric Generation and Power Supply Planning
The Federal Power Act (FPA) establishes a seemingly bright line with respect to federal and state jurisdiction over electric generation: FERC has exclusive jurisdiction over the rates for wholesale sale of electricity; states are responsible for determining whether to authorize construction of new generation and power plant siting. States also set rates for retail sales of electricity. Currently, competitive wholesale markets exist in seven regions of the country, which account for more than 70 percent of total electricity sales in the U.S.
All seven markets have established competitive energy markets. In addition, four of the seven Regional Transmission Organizations (RTOs) have established separate markets for capacity. While the rules for capacity markets vary considerably from region-to-region, they generally require the grid operator to procure the rights to sufficient generating capacity to meet expected peak electricity demand one to three years ahead of time. In most regions, this procurement occurs through a competitive auction process in which successful bidders are paid the market clearing price for the highest-priced resource that clears the market. In PJM Interconnection (PJM), the RTO that encompasses Maryland and Ohio, capacity is generally procured three years ahead of time for a period of one year (e.g., in 2016, for calendar year 2019).
In recent years, capacity markets increasingly have become the primary driver of the economic viability of existing generating units and proposed new plants.
Dispute in the Maryland Case
The dispute in Hughes arose at a time when prices for capacity in PJM had been rising rapidly, with particularly steep increases for electricity purchasers in Maryland, which has only limited interconnections to the rest of the PJM. In response, the state enacted legislation requiring the Maryland Public Service Commission (PSC) to take action to protect end use customers from excessive costs.
The PSC initially responded by requesting a modification of the rules for the PJM capacity auction to allow the capacity payments to extend for ten years for new generation built in the state. The PSC contended that that was the minimum period needed to provide power plant developers sufficient price certainty to finance construction of new generation.
FERC rejected this proposal. In response, the PSC developed an alternative approach, under which power plant developers were given an opportunity to submit bids to build a new natural gas-fired generating unit in the state. Rather than entering into a traditional purchase and sales agreement, however, the successful bidder was asked to:
Make a commitment to build new generation in Maryland and sell the energy and capacity into the PJM market; and
Enter into a contract for differences with the Electric Distribution Companies (EDCs) in the state, under which payments would be made to or received by the generator based upon the difference between the market clearing price in the PJM auction and the contract price.
Under this arrangement, the generator was assured of receiving a pre-determined price for capacity, giving it price certainty. The capacity charges paid by end users for the 725 MW unit covered by the program was capped at the contract price.
Further, by encouraging the construction of new generation in the state, the program was intended to reduce the market clearing price for capacity in the Maryland capacity zone, potentially achieving large savings for electricity customers in state.
In a unanimous decision, the Supreme Court upheld an earlier Fourth Circuit ruling that the Maryland program violated the Supremacy Clause. Citing well-established precedent, Justice Ginsberg, in her opinion for the Court, observed that a state law or action is preempted if, under the particular facts and circumstances of the case, it “stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.”2
In this instance, the Court ruled, the contract for differences “is indistinguishable from a traditional bilateral contract for the sale of capacity.” FERC had “approved the PJM capacity auction as the sole rate-setting mechanism for sales of capacity to PJM, and… deemed the clearing price per se to be just and reasonable.”3 By allowing the successful generator to recover a different amount, the contract for differences interfered with FERC’s “plenary authority over wholesale rates.” Id.
In reaching this conclusion, the Court emphasized that its holding was “limited.”4 Justice Ginsberg noted that in “one significant respect” the contract for differences differed from a typical bilateral contract in that it “did not transfer ownership of the capacity from one party to another.”5 Instead, the generator still owned the capacity, but was entitled to be paid the capacity prices provided for under the contract for differences even when the capacity price established in the PJM auction differed. The Court stated that, if the generator had not been required to bid into the auction, “the state’s program would not suffer from the fatal defect that renders Maryland’s program unacceptable.”6
Significance of the Court’s Ruling
There is no reason not to take at face value the Court’s statement that its holding in Hughes is “limited.” The Court went out of its way to emphasize that “[n]othing in this opinion should be read to foreclose… states from encouraging production of new or clean generation through measures ‘untethered to a generator’s wholesale market participation.’”7