States and Rates: Federal Preemption in the Interstate Energy Marketplace

Posted by on March 13, 2017

By Kyle Smith*

Barrier to entry into the electricity production industry is naturally high due to steep upstart costs and regulatory uncertainty.[1] These barriers are perhaps even higher for electricity production through renewable energy technologies. In addition to requiring significant investment into research and development that put them at a headwind to mature energy technologies, renewable technologies face public opinion that does not always value or understand them, and existing subsidies and tax incentives that favor established energy producers.[2] Despite these barriers, states have an established and growing interest in encouraging and fostering renewable energy production.[3] The benefits are manifold, including reduced local and global pollution, independence from foreign sources of energy, creation of stable jobs that pay a livable wage, and more.

One common sense and relatively unobtrusive method of encouraging renewable energy production is through price-setting on the wholesale marketplaces on which energy producers sell and purchasers buy electricity that is then delivered to and paid for by consumers at retail rates. These marketplaces are regulated by the Federal Energy Regulatory Commission, or FERC, which was created by the Federal Power Act and the Natural Gas Act, passed by Congress in 1935 and 1938 respectively.[4] ERC was given authority to regulate wholesale interstate sales of electricity, specifically by requiring states to implement FERC approved wholesale rates, and preempting states from questioning the reasonableness of those rates.[5] Regulation of retail sales of electricity was left to the states, a ratemaking authority that they most often exercise through a utilities commission.[6] Consequently, states are limited in their capacity to regulate in this area, and the interplay between wholesale rates and retail rates is fodder for conflict between supremacy of the federal authority to regulate in a given field and a state’s desire to use energy regulation to incentivize certain activities.

In April 2016, the Supreme Court decided Hughes v. Talen Energy Mktg., LLC, limiting the ability of states to use contracts that mandate wholesale rates in order to provide subsidies to new entrants to the energy production market[7]. The state of Maryland used such a method to encourage in-state energy production, important to the state because of the complex and congested interstate electric grid that provides electricity to Maryland and several other states in that region. [8] Maryland solicited proposals for the construction of a natural gas power plant and in exchange, promised a state-mandated fixed price contract for differences that would ensure that the new entrant would be paid a set rate by utility companies for a 20-year period[9]. The load servicing entities regulated by the state of Maryland would be required to buy from the new producer at the fixed rate.[10] This differs from the FERC approved marketplace, in which the price is set through an auction where energy producers offer to sell at varying rates and the highest rate accepted – the “clearing price” – is then applied to all sales at that auction.[11] The clearing price is accepted by FERC to be reasonable per se, constraining the ability of producers to sell at any other price.[12] In promising the new producer a state-mandated rate that differs from the FERC approved clearing price, the state of Maryland was in essence offering that producer a unique subsidy, in which electricity consumers in Maryland would pay higher or lower retail rates depending on whether the fluctuating auction rate fell above or below the fixed rate.[13]

On its face, it appears evident why the Supreme Court would shut down such a scheme, both for legal and policy concerns. The Court reasserts through the Hughes decision that FERC’s regulation of the wholesale electricity marketplace preempts state efforts to intrude into that field.[14] This preemption addresses legitimate concerns, namely the protection of a utility marketplace in which buyers and sellers rely on fair and predictable prices. Guaranteeing a single seller a fixed rate has rippling effects that effect other players in the market by distorting rates in non-price guaranteed exchanges. However, the state may have an equally legitimate interest – albeit one that would require an overhaul of federal regulations in this area – in intentionally distorting portions of the marketplace to subsidize desired players and penalize undesirables. It has been shown that some consumers in the United States are willing to pay more for green and renewable energy[15], suggesting that a subsidy scheme like that employed by Maryland may be a socially desirable and regulatorily simple method of allowing them to do so. The court recognizes the state’s interest here, writing “Our holding is limited: We reject Maryland’s program only because it disregards an interstate wholesale rate required by FERC….States might employ [other measures] to encourage development of new and clean generation, including tax incentives, land grants, direct subsidies, construction of state-owned generation facilities, or re-regulation of the energy sector.”[16]

While it is encouraging that the Court is willing to suggest some policy schemes that may pass regulatory muster in the future, one worries about the political difficulty and regulatory costs in implementing such schemes. It is also important to watch the ways that courts interpret the Hughes decision and apply it to other states, as is already beginning in states like Connecticut and New York.[17] While the Court’s holding in Hughes is narrow and does not expressly limit states efforts to promote renewable energy through slightly different regulatory schemes, it also does not preclude courts from stretching it to regulate similar efforts by states that have an interest in encouraging energy production by private players.[18]

 


*Kyle Smith is a Junior Editor on MJEAL. He can be reached at kydsmith@umich.edu.

[1] John Kwoka, Barriers to New Competition in Electricity Generation, Report to the American Public Power Association 18-20 (2008).

[2] Barriers to Renewable Energy Technologies, http://www.ucsusa.org/clean_energy/smart-energy-solutions/increase-renewables/barriers-to-renewable-energy.html#.WCaMTvkrKIs (last visited Nov. 17, 2016).

[3] E.g. California Renewable Energy Overview and Programs, http://www.energy.ca.gov/renewables/ (last visited November 17, 2016); Office of the Governor of Texas, The Texas Renewable Energy Industry, (2014) http://gov.texas.gov/files/ecodev/Renewable_Energy.pdf; Energy Efficiency and Renewable Energy, http://www.maine.gov/energy/initiatives/efficiency_renewable.html (last visited Nov. 17, 2016).

[4] Federal Power Act of 1935, 16 U.S.C.S. § 792; Natural Gas Act of 1938, 15 U.S.C.S. § 717.

[5]  David J. Muchow and William A. Mogel, Energy Law and Transactions, § 144.03 (LexisNexis Matthew Bender 2016).

[6] David J. Muchow and William A. Mogel, Energy Law and Transactions, § 80.02 (LexisNexis Matthew Bender 2016).

[7] Hughes v. Talen Energy Mktg., LLC, 136 S. Ct. 1288 (2016).

[8] Id. at 1294.

[9] Id. at 1295.

[10] Id. at 1294.

[11] Id. at 1293.

[12] Id. at 1297.

[13] Id. at 1295.

[14] Id. at 1300.

[15] Brian Roe Et Al., US Consumers’ Willingness to Pay for Green Electricity, 29 Energy Policy 917, 924 (2001) (concluding that a wide array of consumers are willing to pay higher prices).

[16] Hughes at 1299.

[17] Allco Fin. Ltd. v. Klee, Civil Action No. 3:15-cv-608 (CSH), 2016 U.S. Dist. LEXIS 109786 (D. Conn. Aug. 18, 2016); 2016 N.Y. PUC LEXIS 425 (N.Y.P.S.C. Aug. 1, 2016).

[18] Supreme Court Decision Striking Down Maryland Program Contains Good News for Clean Power, https://www.nrdc.org/experts/allison-clements/supreme-court-decision-striking-down-maryland-program-contains-good-news (last visited Nov. 17, 2016).

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