November 01, 2016

The Supreme Court’s Platonic Energy Policy

Scott B. Grover

With more than a decade having passed since New York v. FERC, 535 U.S. 1 (2002), the U.S. Supreme Court recently returned to the boundaries of federal and state authority over national energy policy. Across three factually unrelated cases, decisions for which issued during a 12-month span bridging the 2014 and 2015 terms, the Court considered and determined the extent to which state action (in two cases) and federal action (in the other) constituted permissible or impermissible exercise of power under the provisions of the closely related Federal Power Act (FPA) and Natural Gas Act (NGA). And while it might be tempting to conclude that federal authority took the prize, a collective analysis of the three decisions supports the view that the states made out well for themselves. In what is arguably to the states’ benefit, the bright line between federal and state authority that many wanted is not going to be drawn by the Court any time soon.

Of the three governmental actions reviewed, the Court found only one unlawful: a Maryland electric generator subsidy program conditioned on participation in, and the outcome of, a wholesale capacity auction regulated by the Federal Energy Regulatory Commission (FERC). See Hughes v. Talen Energy Mktg., 136 S. Ct. 1288 (April 2016) (Hughes). Hughes, however, was the closest to a bright-line exercise. In an almost unanimous opinion (Justice Thomas joined the opinion only as it relied on the FPA, not implied preemption; also, this case was decided after Justice Scalia’s death), Justice Ginsburg wrote that the Maryland program “invades FERC’s regulatory turf.” Hughes, 136 S. Ct. at 1297. The program in question sought to incentivize the construction of new electric generation in Maryland by ensuring that the new generators would be guaranteed some assurance of cost recovery (through a separate contract between the generator and a load-serving entity (LSE)). Maryland structured the subsidy, however, around the generator’s participation in the FERC-regulated capacity auction process used by its regional transmission organization (RTO) and, importantly, the clearing price awarded to capacity through the auction. If the auction clearing price fell below a certain threshold set forth in the contract, the LSE paid the generator the difference. If the auction clearing price was above the threshold, then the generator paid the LSE the difference. Id. at 1294–95. In short, the Maryland program “adjust[ed] an interstate wholesale rate.” Id. at 1297. Doing so put the situation squarely in line with prior precedent, thus making the Court’s decision to strike the law ostensibly an easy one.

Federal Energy Regulatory Commission v. Electric Power Supply Association, 136 S. Ct. 760 (Jan. 2016) (EPSA), also put a check in the federal column. In that case, the Court revived a rulemaking by FERC that, among other things, allowed certain forms of compensation in demand-response programs conducted in RTO and independent system operator wholesale energy markets. Specifically, the rule allowed entities bidding demand response—i.e., the reduction in the consumption of electric energy by an entity from its expected consumption—into the day-ahead and real-time supply markets to receive compensation equivalent to that awarded to generators bidding in actual supply (known as the locational marginal price). See EPSA, 136 S. Ct. at 771–72. The U.S. Court of Appeals for the District of Columbia Circuit saw this rule as the regulation of retail electricity rates—action unquestionably beyond the agency’s authority under the FPA—as demand-response bidders engaging in economic decision-making would now view the cost of retail electricity consumption to be the actual retail rate charged for use, plus the opportunity to receive locational marginal price by foregoing such use, rather than the state-regulated retail rate. Id. at 772–73.

With Justice Kagan writing for the majority, the EPSA Court found the rule to comport with the limitations of the FPA. First, and notwithstanding a vigorous dissent from Justice Scalia, the Court held that the rule sought to regulate a practice directly affecting wholesale rates. Id. at 774 (approving a “common-sense construction of the FPA’s language” that limits FERC’s “affecting jurisdiction” to rules or practices that “directly affect” the wholesale rate). Second, the Court rejected the idea that the rule’s potential influence on retail activity rendered it infirm, stating that “a FERC regulation does not run afoul of [the FPA] just because it affects—even substantially—the quantity or terms of retail sales.” Id. at 776. Given the rule’s practical occupation of the wholesale sphere, and the fact that no retail rate actually was affected (“the rate is what it is . . . the price paid, not the price paid plus the cost of a forgone economic opportunity”), the Court found the rule to not intrude on the powers of the states to regulate retail sales. Id. at 778–79, 784.

Looking at results alone, the 2015–2016 term marked a turn from the 2014–2015 term’s end. In Oneok, Inc. v. Learjet, Inc., 135 S. Ct. 1591 (April 2015) (Oneok), the Court concluded that state antitrust laws (the basis for lawsuits challenging allegedly unlawful price reporting activities by interstate natural gas pipelines affecting both jurisdictional and nonjurisdictional natural gas sales) were not field preempted by the NGA or certain associated regulatory actions undertaken by FERC. Writing for the Court, Justice Breyer (again over a withering dissent from Justice Scalia) stated that “where (as here) a state law can be applied to nonjurisdictional as well as jurisdictional sales, we must proceed cautiously, finding pre-emption only where detailed examination convinces us that a matter falls within the pre-empted field as defined by our precedents.” Oneok, 135 S. Ct. at 1599. In the Court’s view, the primary factors counseling against field preemption included the target of the state laws at issue—generalized antitrust activity, as opposed to NGA jurisdictional activity or the FERC-regulated rates under which such actors transact. Id. at 1600–02. That the state laws might affect FERC regulation in the area did not preclude an ongoing coexistence. Id. at 1600 (“[N]o one could claim that FERC’s regulation of this physical activity for purposes of wholesale rates forecloses every other form of state regulation that affects those rates.”).

Some might say this accounting distorts an accurate interpretation of these cases. Rather than taking events seriatim—state power emboldened in Oneok, only to be undermined by EPSA and Hughes—a reverse look implies a tempering Court, striking state action incompatible with its related federal field, but otherwise seeking an end where federal and state authority coexist, even when doing so means toe-stepping by both. Truth be told, the order does not matter. Oneok, EPSA, and Hughes all carry the same significant, connective tissue for purposes of future energy policy development implicating the FPA and NGA. Hughes punctuates this fact, for its inclusion of the unifying message was wholly inessential to the outcome of the case.

Design matters. This is not a shocking observation, to be sure. By definition, a law, regulation, or program comprises architecture—through language, organization, or both—and it is that very architecture that most often contains the flaws fought over in courts and by agencies and lawmakers. But these three cases underscore a very clear message from the Court: In the FPA and NGA context, the right law or program, be it federal or state, can survive scrutiny even when treading territory seemingly out of bounds.

Oneok advanced this idea (unprecedented, Justice Scalia called it), stressing that more than just the “what” of the state action—namely, the how and the why—requires consideration. Oneok, 135 S. Ct. at 1600. (Similarly instructive, from a technical standpoint, was the Court’s repeated observation that the case before it did not present a conflict preemption challenge. See, e.g., id. at 1595.) The Court in EPSA embraced this concept fully, reiterating how FERC’s demand-response rule “happens exclusively on the wholesale market,” “governs exclusively that market’s rules,” and is “all about, and only about, improving the wholesale market.” EPSA, 136 S. Ct. at 776. In addition, the Court recognized that FERC had, as part of the rule, permitted states to bar participation in the program. Id. at 773, 779. Whether the absence of such a provision (which FERC professed the power to eliminate) would have resulted in a different case went unanswered, but its presence did prompt the following: “Wholesale demand response as implemented in the Rule is a program of cooperative federalism, in which the States retain the last word. That feature of the Rule removes any conceivable doubt as to its compliance with [the FPA’s] allocation of federal and state authority.” Id. at 780.

Hughes did not need this layer of support. Yet at both the outset and finish of the decision, the Court offered commentary clearly signaling that state programs other than the one before it might be upheld. The closing particularly resonated:

We reject Maryland’s program only because it disregards an interstate wholesale rate required by FERC. We therefore need not and do not address the permissibility of various other measures States might employ to encourage development of new or clean generation, including tax incentives, land grants, direct subsidies, construction of state-owned generation facilities, or re-regulation of the energy sector. 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.

Hughes, 136 S. Ct. at 1299 (emphasis added). No doubt, this world is not of bright lines. Conceding the natural desire for more definition, the Oneok Court nonetheless recognized that such a “[p]latonic ideal does not describe the natural gas regulatory world.” Oneok, 135 S. Ct. at 1601. (A fact that holds equally true in the electricity realm. Cf. FPC v. S. Cal. Edison Co., 376 U.S. 205, 211–12 (1964).)

For the optimistic state lawmaker then, the Oneok, EPSA, and Hughes cases represent what could be deemed an ironic wholesale endorsement of creative policymaking. To be sure, FERC has received comparable reassurance—EPSA being the case many thought the Court would affirm as beyond FPA authority. But the playing field has not been skewed federally. The babies of the Attleboro gap, the FPA and the NGA, have been left to grow. And while the Court might once have wished for engineering and science to dictate outcomes (cf. California v. Lo-Vaca Gathering Co., 379 U.S. 366, 369 (1965)), the realization seems to have set in that policy influences on the behavior of molecules and electrons warrant as much deference as their innate properties.

Scott B. Grover

Mr. Grover is a partner in the Birmingham, Alabama, office of Balch & Bingham, LLP, and a member of the editorial board of Natural Resources & Environment. He may be reached at sgrover@balch.com.