A new power industry landscape

On April 19, in Hughes v. Talen Energy Marketing, 2016 DJDAR 3693, the U.S. Supreme Court unanimously held that Maryland and New Jersey overstepped the authority of states to encourage development of clean power generation. Under the Federal Power Act (FPA), the Federal Energy Regulatory Commission (FERC) has the plenary authority over interstate wholesale market pricing. The court's opinion, written by Justice Ruth Bader Ginsburg, states that "Maryland's program invades FERC's regulatory turf." That leads to a key question: How will California stay within its turf as it promotes clean distributed generation and a regional power grid?

In Hughes, Maryland and New Jersey regulators tried to incentivize wholesale power generating plant construction in their states with long-term contracts. Under the FPA, states have the authority over in-state development of power plants and the promotion of state policies reducing greenhouse gas emissions with clean power generation. The Maryland and New Jersey programs required that the power plants bid their wholesale capacity into the regional power markets run by PJM Interconnection LLC, a regional transmission organization authorized to run wholesale power markets in certain mid-Atlantic and Midwest states. If the plants' bids cleared the FERC-regulated PJM Interconnection LLC capacity auction, the Maryland load-serving entities were obligated to pay the difference between the PJM capacity auction clearing price and the specified capacity price on differences in the state-imposed contracts.

Other generators in these markets sued the states, arguing that states were improperly subsidizing competitors and interfering in the markets regulated by FERC pursuant to the FPA. The court agreed with the generators and the lower courts that ruled in their favor. The court stated that "States may not seek to achieve ends, however legitimate, through regulatory means that intrude on FERC's authority over interstate wholesale rates, as Maryland [and New Jersey] has done here."

Notably, the court limited its holding to instances where a state program "disregards an interstate wholesale rate required by FERC." The court stated, "Nothing in this opinion should be read to foreclose Maryland and other States from encouraging production of new or clean generation through measures 'untethered to a generator's wholesale market participation.'" The court provides examples of state programs that may survive preemption, such as tax incentives, land grants, construction of state-owned generation facilities, direct subsidies, or re-regulation of the energy sector.

But the boundaries aren't so clear. California regulators aim to promote the development of a power grid that integrates evolving distributed generation technologies, or clean power that is produced at the consumer end of the power distribution system. As the grid evolves to integrate energy storage and demand-response resources, the link between power transmission and power distribution systems will grow closer. For instance, energy storage has evolved to serve electrical demand at the wholesale power grid level as part of an electrical transmission system, and at the retail level as part of an electrical distribution system.

Demand-response technology has similar capabilities, which became apparent in the court's earlier energy decision on Jan. 25, Federal Energy Regulatory Commission v. Electric Power Supply Association, 2016 DJDAR 801. In that case, the court held that the FERC has the authority to require power grid operators to compensate demand-response providers at the same rate as other power generators participating in the wholesale power market, even though such a regulation may affect retail rates. The court rejected EPSA's argument that setting the price consumers will pay for demand-response resources invades the states' turf. It remains unclear how states may craft a regulatory incentive for in-state storage or demand-response resources that participate in wholesale and retail markets.

The growth of a regional grid in the West could also blur the line between wholesale and retail markets. If a California electricity consumer's energy storage units behind its electrical meter makes excess power available, the power could be dispatched to a regional power grid outside the state. The consumer of electricity would also function as a power generator at times. Such a system would likely involve coordination between a distribution system operator and a grid operator. Under current precedent, it remains unclear how far a state regulator could go to provide incentives for producers of such power without directly impacting the wholesale market. As the regional power market in the West is still evolving, no one knows for certain.

It is no wonder the court noted in FERC v. EPSA that the FPA's statutory divide between wholesale market and retail market regulations "generates a steady flow of jurisdictional disputes because - in point of fact if not of law - the wholesale and retail markets in electricity are inextricably linked." There's no doubt that federalism issues will play a key role in the court's decisions as the power grid undergoes landmark changes. These cases mark the beginning of a transforming regulatory landscape for the power industry.

Tara S. Kaushik is a partner practicing energy regulatory and utility law in San Francisco at Holland & Knight LLP.