Supreme Court Rules in Favor of Demand Response

Jesse Remillard for Zondits, February 4, 2016. Image credit: Mark Fischer

On January 25, 2016, The Supreme Court ruled in favor of an appeal by the Federal Energy Regulatory Commission (FERC) to uphold FERC Order 745, which requires wholesale market operators to pay the same price for demand reduction as for electricity supply during periods of peak demands. The order gives FERC the authority to establish demand response rules and rates in wholesale electricity markets, leaving retail markets within state jurisdiction. FERC has jurisdiction in wholesale markets per the Federal Power Act, but it cannot make rules that direct affect retail markets. Although it is recognized that demand response has impacts on retail prices, Justice Elena Kagen, who delivered the ruling, wrote: “It is a fact of economic life that the wholesale and retail markets in electricity, as in every other known product, are not hermetically sealed from each other. To the contrary, transactions that occur on the wholesale market have natural consequences at the retail level. And so too, of necessity, will FERC’s regulation of those wholesale matters.”

Order 745 states that demand response providers will be able to garner the locational marginal price (LMP), as long as the Net Benefits Test is met. The Net Benefits Test was developed by FERC as part of Order 745 to ensure that demand response bids save rate payers money. The test requires that demand response only be implemented when it costs less to pay consumers to reduce demand than it does to generate it. The LMP is determined by stacking bids to supply electricity from lowest to highest, where bids are required to be accepted until all requests for power from local utilities have been met. The highest accepted bid is known as the LMP. When electrical demand becomes very high, prices spike and the least efficient generators have their bids accepted into the markets.

The order was originally introduced in March 2011, but was vacated in a case brought by the Electric Power Supply Association (EPSA) in May of 2014. The decision was appealed and oral arguments took place at the Supreme Court in October of 2015.

The EPSA’s arguments against FERC order 745 covered several major points:

  • Because demand response affects retail prices, FERC is overstepping its jurisdiction by regulating demand response programs across state lines.
  • Demand response should be regulated in retail markets because reduction of electricity demand does not have the same value of electricity generation and should be paid the difference between wholesale and retail rates. This alternative compensation scheme was rejected by the Supreme Court as part of the ruling.

In response, FERC leaders argued the following points:

  • Order 745 is narrowly tailored so that it only affects wholesale markets and rates.
  • By paying demand response resources the difference between wholesale and retail rates, electricity suppliers would essentially give a credit for power that electricity suppliers won’t need to generate.

Some additional arguments for the order include these:

  • Demand response is required to have a net benefit for retail customers.
  • Demand response helps improve the reliability of the nation’s electricity supply and saves rate payers money.
  • States can already opt out of providing wholesale demand response to regional markets and none have done so.

Here is an excerpt from page 14 of the Supreme Court ruling summarizing the rational for their decision:

“Our analysis of FERC’s regulatory authority proceeds in three parts. First, the practices at issue in the Rule— market operators’ payments for demand response commitments—directly affect wholesale rates. Second, in addressing those practices, the Commission has not regulated retail sales. Taken together, those conclusions establish that the Rule complies with the FPA’s plain terms. And third, the contrary view would conflict with the Act’s core purposes by preventing all use of a tool that no one (not even EPSA) disputes will curb prices and enhance reliability in the wholesale electricity market.”

Demand response is a proven resource that has been used by wholesale market operators for the last 15 years (page 2). By requiring wholesale market operators to pay demand response on the LMP during peak demand periods, FERC Order 745 ensures that demand response resources will be able to bid in wholesale markets during peak demand events on equal terms with generation sources. This will save rate payers money and promote a diverse range of technologies from simple plant scheduling to thermal storage, electrical storage, and advanced controls. Certainly, demand response would have existed without Order 745 but might not have been implemented universally or at its full value. With increasingly advanced control systems available and a growing number of mature technologies to pull from, demand response is positioned to be a key player in future electricity market structures.