The Federal Power Act1 splits jurisdiction over the electricity system between the Federal Energy Regulatory Commission (FERC), which regulates the wholesale market and transmission, and state regulators, which have authority over retail markets.2 However, the seeming clarity of this jurisdictional divide has been muddied by the recent advent of “demand response,” in which consumers are paid for reducing their energy consumption.3 Recently, in Electric Power Supply Ass’n v. FERC4 (EPSA), the D.C. Circuit vacated a FERC order that attempted to regulate the wholesale prices paid for demand response, on the basis that the order was beyond FERC’s jurisdiction due to its impermissible effect on retail markets.5 The breadth of the court’s holding risks confusion in the energy markets and unnecessarily limits FERC’s regulatory options.
Demand response offers a partial solution to inefficiencies in the electricity market. The typical organizational model for the electricity market makes a division between wholesale and retail sectors.6 The regional systems relevant to this case are run by “system operators,” independent entities responsible for ensuring that energy supplied in the system’s wholesale market meets the demand in the system’s retail market.7 Because the demand for electricity is not constant, at times of high demand system operators must buy power at high prices from less efficient generators.8 Due to the unresponsive nature of retail prices, consumers have little incentive to reduce consumption during these peak-demand periods.9 Demand response offers a partial solution. At times of peak consumption, system operators can reduce the overall cost of electricity in the system by paying consumers or groups of consumers, dubbed “demand response resources” (DRRs),10 to reduce their energy consumption.11
FERC’s Order 74512 attempted to address perceived problems with the compensation of demand response in the wholesale market.13 Though FERC had previously issued orders governing the structure of this market as a whole,14 Order 745 specifically addressed payments to DRRs.15 FERC found that the rates paid to DRRs by some electric system operators were too low to adequately incentivize the development of demand response.16 The Order mandated that, in certain circumstances, a system operator must pay to DRRs the same price for a forgone megawatt of consumption that the system operator would have paid a generator that had successfully bid that megawatt into the wholesale market.17 After notice and comment, Order 745 was passed by four of FERC’s five board members over the dissent of Commissioner Moeller.18 The Commission received numerous requests for rehearing, which it denied.19 Electric Power Supply Association, a trade group of power suppliers,20 petitioned the D.C. Circuit for review.21
The D.C. Circuit vacated Order No. 745.22 Writing for the court, Judge Brown23 found that FERC had exceeded the bounds of its jurisdiction in issuing Order 745,24 and that Order 745 was “arbitrary and capricious.”25 To analyze FERC’s claim that it had jurisdiction over wholesale demand response, Judge Brown outlined the relevant statutory provisions. The Act contains two sources of agency power, and two prohibitions, relevant to the court’s decision. Section 201(b)(1) grants FERC jurisdiction over “the sale of electric energy at wholesale in interstate commerce,”26 but not over “any other sale,”27 which is the domain of the states. Sections 205 and 206 contain a broad ancillary grant of power over “‘all rules and regulations affecting . . . rates’ in connection with the wholesale sale of electric energy.”28 Finally, section 201(a) states that “FERC’s reach ‘extend[s] only to those matters which are not subject to regulation by the States.’”29 To determine whether FERC had jurisdiction to regulate the wholesale price of demand response, the court recognized that it must apply the Chevron test, determining first “whether the statutory text forecloses the agency’s assertion of authority,”30 and, if instead the statute was “silent or ambiguous,” deferring to “the agency’s reasonable construction.”31
The court began by analyzing the jurisdictional grants. FERC did not have jurisdiction under the “sale . . . at wholesale” language of section 201(b)(1) because demand response is a non-sale.32 Next, the court considered FERC’s argument that it had jurisdiction under the sections 205 and 206 authorization to regulate practices “directly affect[ing] wholesale rates.”33 The court accepted that wholesale demand response directly affects wholesale prices, but found that the Commission’s characterization of its “affecting” jurisdiction “ha[d] no limiting principle,” “could ostensibly authorize FERC to regulate . . . the steel, fuel, and labor markets,”34 and would allow the agency to “‘lure’ non-jurisdictional resources into the wholesale market . . . to create jurisdiction”35 by requiring generous compensation.36
To provide a limiting principle for sections 205 and 206, the court turned to the “overall statutory scheme.”37 Noting that under section 201(a), FERC’s “reach ‘extend[s] only to those matters which are not subject to regulation by the States,’”38 the court reasoned that “[t]he broad ‘affecting’ language of §§ 205 and 206 does not erase the specific limits of § 201.”39 Such limits could not come from section 201(b)(1)’s exclusion from regulation of “any other sale”: demand response is not a sale.40 Instead, the “statutory scheme as a whole” showed that demand response, “while not necessarily a retail sale, is indeed part of the retail market, which . . . is exclusively within the state’s jurisdiction.”41 Finding that the Act unambiguously foreclosed FERC jurisdiction, the D.C. Circuit invalidated Order 745.
The court also held that the agency had acted arbitrarily and capriciously in issuing Order 745.42 FERC had failed, in light of Commissioner Moeller’s “persuasive”43 argument that “overcompensation cannot be just and reasonable,”44 to “adequately explain[] how [Order 745] results in just compensation.”45
Judge Edwards dissented. He agreed that Order 745 appeared to fall under FERC’s “affecting” jurisdiction,46 but thought that the limit the D.C. Circuit had previously read into sections 205 and 206 — that FERC could regulate only conduct with “direct” effects on wholesale prices — was sufficient.47 Because wholesale demand response directly affects wholesale prices,48 Order 745 was a valid exercise of FERC’s “affecting” jurisdiction unless barred by section 201(b)(1)’s preclusion of FERC regulation of “any other sale of electric energy.”49 As demand response could be reasonably construed not to be a sale, section 201(b)(1) did not unambiguously preclude regulation.50 Moreover, section 201(a) could not control because the Supreme Court had previously interpreted it to be a “mere policy declaration.”51 As the Act did not speak unambiguously to the precise question of whether demand response was a retail sale,52 Chevron deference to FERC’s interpretation of the jurisdictional grant was required.53
Although the majority established new limits on sections 205 and 206, the preexisting limits of the Act and case law adequately cabined FERC’s jurisdiction.54 The existence of these limits, the paucity of statutory grounding for a limiting principle, and the availability of an alternative holding all should have counseled the court either to have avoided announcing a limiting principle at all or to have delineated the limits of sections 205 and 206 more narrowly. Even assuming that FERC had overstepped in this instance, the potential breadth of the court’s holding has caused uncertainty in the industry and has unduly foreclosed the possibilities of beneficial regulation.
The statutory grounding for the court’s limiting principle was shaky; by looking to the “statutory scheme,”55 the court derived a limiting principle from two provisions, neither of which would have provided that restriction alone. Although section 201(a) appears an appealing candidate to supply limits to FERC’s jurisdiction, Supreme Court precedent forecloses this possibility. Section 201(a) “declare[s] that . . . Federal regulation . . . [is] to extend only to those matters which are not subject to regulation by the States.”56 However, it begins a section entitled “[d]eclaration of policy; application of subchapter,”57 and the Supreme Court has determined section 201(a) to be a “mere ‘policy declaration.’”58 Had the court sought a jurisdictional limit in section 201(a) alone, the decision to deny Chevron deference to FERC would have been difficult to support: while (as the court recognized) a specific limit should trump a general grant of jurisdiction,59 it is not clear that section 201(a), a statement “of great generality,”60 would unambiguously trump the general language of sections 205 and 206, even in light of a separate “retail sale” limit in section 201(b)(1). The court’s reading of section 201(a) as part of a statutory scheme setting internal, implicit limits on sections 205 and 206 ignored the section’s status as a general policy declaration.
Likewise, the court could not have relied solely upon section 201(b)(1)’s denial of FERC jurisdiction over “any other sale[s]” than those “at wholesale.”61 The problem in using section 201(b)(1) to limit the grant of “affecting jurisdiction” in sections 205 and 206 is that the plain meaning will not easily support it — section 201(b)(1) speaks of retail and wholesale “sales,” not markets.62 A reliance on section 201(b)(1) to supply limits would also have been in tension with the court’s own earlier reading of an identical term. The term “sale” is used both to grant and to limit FERC jurisdiction within the same sentence of section 201(b)(1): “[The Commission’s jurisdiction] shall apply to . . . the sale of electric energy at wholesale in interstate commerce, but . . . shall not apply to any other sale of electric energy . . . .”63 In dismissing FERC’s claim of section 201(b)(1) authority, the court relied on the plain meaning of “sale”: “[D]emand response is not a wholesale sale of electricity; in fact, it is not a sale at all.”64 If section 201(b)(1) were construed to limit FERC’s jurisdiction over the retail market, it should logically also be construed to grant authority over the wholesale market. Because demand response falls somewhere between the two,65 section 201(b)(1) would not unambiguously preclude FERC regulation of wholesale demand response.
The court’s search for limits led to a principle derived from the statutory scheme that nonetheless is in tension with the rest of the statute. As the court acknowledged, the plain text of sections 205 and 206 supports jurisdiction.66 Further, it is difficult to find in the statutory scheme a clear intent against demand response, which did not exist at the time of the Act’s passage. In New York v. FERC,67 the Supreme Court made the same point about another emergent phenomenon, “unbundled transmissions.”68 The Court reasoned that because unbundled transmissions “ha[d] been a recent development”69 and “ha[d] never been ‘subject to regulation by the States,’”70 section 201(a) did not preclude FERC jurisdiction. The same argument applies to demand response — an emergent phenomenon not previously subject to state regulation.
The court had several options besides broadly holding that FERC lacks jurisdiction over demand response, even if it did not want to follow Judge Edwards in deferring to the agency. The fact that the court arrived at the alternative holding that Order 745 was arbitrary and capricious meant that the court did not need to reach the jurisdictional question at all.71 An alternative would have been to rule the present regulation ultra vires on very narrow grounds. In particular, the court recognized that FERC’s “lur[ing]”72 of customers from the retail to the wholesale market through preferential rates was “the heart of the Petitioners’ challenge.”73 The court could have found that this way of attracting customers made the regulation an impermissible intrusion on the retail markets. Such a finding would have enabled the court to address the conduct that most troubled the petitioners, while still leaving room for wholesale demand response that did not distort retail customers’ incentives.
The capaciousness of the court’s decision to locate demand response unambiguously within the retail “market” has the potential to lead to jurisdictional confusion. As the case itself demonstrates, regulation that occurs at the first instance in the wholesale market can now be ruled ultra vires if it has an impermissibly direct effect on the retail market (unless it directly regulates a wholesale sale of electric energy). This result is problematic, given the court’s recognition that “a change in one market will inevitably beget a change in the other.”74 The development of both new technologies and FERC’s regulatory program means that questions that do not neatly fall in one or the other of section 201(b)(1)’s categories are likely to arise more often.75 Already, FERC’s entire system of wholesale demand response, widely agreed to be beneficial,76 is being challenged in a FERC hearing.77
In EPSA, the court turned to the statutory scheme to infer a limiting principle that the provisions of the Federal Power Act taken individually did not provide. Given the statute’s limitations for supplying such a principle, the court should have moved more carefully to limit the upheaval caused by its holding and to allow FERC greater room to maneuver in the face of technological change in the energy sector.