Analysis

At least since Adam Smith was writing economic tracts in the late 1700s, it has been widely accepted that when consumers demand more of a product, either someone will produce more or prices will go up.  That’s one of the theories of the “law” of supply and demand.  But is there a way to balance out a market, so that supply and demand flow more evenly and prices are held in check?

How about paying some consumers to back off as buyers just when overall demand is expected to peak — say, turning off the air conditioner for a few hours when all of America is trying to cool itself during a heat wave?  The Supreme Court this week will ponder the legality of a federal program using that kind of economic incentive to smooth out the nation’s electricity market.

The role of the Federal Energy Regulatory Commission in a pay-to-abstain arrangement is at issue in two cases, combined for a one-hour hearing at 11 a.m. Wednesday, that will come to be known by the first case of the two: FERC v. Energy Power Supply Association.   The cases  will be heard by a Court of eight; Justice Samuel A. Alito, Jr., is recused, presumably because of some of his investments.

It used to be that when a consumer flipped a light switch, or a factory worker turned on a machine, the power that flowed in response came from a local utility that got it from transmission wires that were linked to a generator at a power plant.

Because electricity is a vital commodity, it has been regulated by government from the beginning as a public resource.  Back in a simpler age, it was quite easy to divide up the task of monitoring the price to be paid at each step from the power plant to the ultimate user.

The federal government was in charge of the first two steps — generation and transmission — because both generally involved the movement of electricity across state lines.  State governments were the monitors inside their borders, overseeing the ultimate sale to users in homes, offices and factories, for example.  That was the division between wholesale (the regulatory realm of a federal agency, FERC), and retail (the assignment for each state’s utility or public service commission).

Countless legal battles have been fought, however, over what is wholesale and what is retail.  Since the 1970s, the chances of conflict have expanded greatly. as the electricity market has become national in scope, and competition is the new norm.  Giant electric grids using new technology have been set up to pool electricity to keep it moving across the entire country, with new forms of business companies emerging to run the system.

The market is, in short, almost completely interdependent — as thirty million Americans in the northeastern states and a part of Canada discovered in a massive blackout in 1965 that began with a human error by an engineer at a power plant in Ontario.

Within that vast market, keeping the electricity flowing thus is a top priority.  And that has given rise to business experiments in how to cope with times of peak demand.  These days, predicting those peak periods can be done fairly efficiently.

Anticipating a peak period, the wholesale companies could simply let demand go on rising, and call on the generating firms to put out more electricity.  But that can be quite expensive.  Another way is to simply raise wholesale prices at those peaks, but that has not worked well before because users generally keep on using even if they have to pay more.

The alternative that the big companies in the wholesale markets began turning to in the early years of the new century was an idea they called “demand response.”  If users were willing to commit themselves to cut back during peaks, demand will, of course, go down.  Payments might induce them to do just that.

The theory is that, if the wholesalers pay them to cut back at a dollar level less than what it would cost to add more power to the system, supply and demand are managed with less increase in the price when the companies sell at wholesale.  And there is the added benefit that the grid may be less likely to fail in response to heavy demand.

To be sure, some retail suppliers have been experimenting with this approach, too, enticing users with rebates on their monthly bills in return for scaling back their demand at the peaks.   But it is the wholesale use of that approach that led to the controversy that the Supreme Court is now confronting.

Besides focusing on what the federal regulatory agency has done, the Justices will also be exploring Congress’s role in the controversy.  That, too, may have blurred the lines between what is wholesale and what is retail in the electricity business, even though Congress long ago mandated that regulation of each must be kept separate.

In a law passed in 2005, Congress urged the expansion of a pay-to-abstain approach as a national policy, and decreed that barriers to its expansion be removed.  Further, in 2007, it told the federal regulatory agency explicitly to come up with a nationwide plan.

Ultimately, FERC did so in 2011, adopting its “Order No. 745.”  That made “demand response” a nationwide phenomenon.  And, to the dismay of local electric companies and state utility commissions, the order includes retail customers among those who get payments for cutting back.

Electricity companies that sell at the retail level, and the state commissions that regulate those firms, saw in that order a move by FERC into regulating the retail demand and the retail sale of electricity.  The system of payment, they complained in a challenge in federal court, does not actually involve the sale of electricity at wholesale; it is an auction market among users — including local utilities and big companies — that has the actual effect of governing retail supplies and thus retail prices.

The more aggressive of the challengers argued that the demand side of the electricity business is on the retail side, where users purchase the power they need and FERC has no authority there; its sole focus is wholesale supply.

FERC, they argued, had grown impatient with the pace at which state regulators of retail markets had been adopting demand-reducing payments, and decided to bootstrap its power over the wholesale market to reach into into the retail realm.  Order No. 745, they argued, interferes with state policies of maintaining more stable rate structures so that customers know what they are going to have to pay for service.

The challengers also contended that FERC had no power to entice the retail energy community into becoming participants in the wholesale markets.  That is a backdoor way of expanding its reach, but it still exceeds FERC’s mandate, they asserted.

FERC responded by arguing that it had clear authority to regulate the wholesale operators, and to authorize them to set up the auction system that includes “demand-response” payments.  The money they pay out to anyone accepting the payments, the agency contended, is recouped by those companies in adjustments to their wholesale rates — clearly within FERC’s authority, it says.

The agency also has relied on the fact that the Federal Power Act, under which it operates, gives it authority not only over the interstate sale of electricity across state lines, but also over “any practice” that affects wholesale rates.

The U.S. Court of Appeals for the District of Columbia Circuit agreed with the challengers.  FERC, it said, had extended its regulatory reach beyond the wholesale, and it does not have the authority to do that under federal law.   It also declared that FERC had acted arbitrarily in issuing the order, because it had failed to answer the arguments in opposition by one of its own members. The court of appeals split two to one in the ruling.

FERC took the case on to the Supreme Court, as did a group of private energy companies (led by EnerNOC, Inc.), urging the Justices to revive Order No. 745.  If the order needs any adjusting, FERC argued, that could be done when the case returned to it after the order had been upheld.

Although the details of each side’s argument is intensely complex, and the Court may have to dig deeply into the details of the regime set up by FERC as well as how the modern markets actually works, the basic outline of the controversy is quite simple: can the wholesale and retail markets be defined with sufficient specificity that FERC and the state commissions, and the companies they separately regulate, know which realm is which?

FERC and its private industry supporters have drawn amicus support from energy law scholars, environmental protection groups, energy companies, consumer groups, electricity grid operators, and grid engineers.  The trade groups representing local companies and state utility commissions are supported by twelve states, energy consultants, utility consumer organizations, economists, and representatives of energy supply companies.

At Wednesday’s hearing, FERC’s arguments will be made by U.S. Solicitor General Donald B. Verrilli, Jr., with twenty minutes of time.  In support of FERC, for the private firms, will be Washington, D.C., attorney Carter G. Phillips, with ten minutes.  The challengers –local companies, state commissions, and their trade groups — will be represented by Washington attorney Paul D. Clement, with thirty minutes.

Posted in Federal Energy Regulatory Commission v. Electric Power Supply Association, EnerNOC v. Electric Power Supply Association, Analysis, Featured, Merits Cases

Recommended Citation: Lyle Denniston, Argument preview: Evening out supply and demand, SCOTUSblog (Oct. 12, 2015, 12:25 AM), http://www.scotusblog.com/2015/10/argument-preview-evening-out-supply-and-demand/