Prevailing in two recent US Court of Appeals’ cases, the states of Illinois and New York have successfully navigated the narrow path of protecting critical power generation resources while working within the cooperative federalism structure established by the Federal Power Act (FPA). In Electric Power Supply Association v. Star, 904 F.3d 518 (7th Cir. 2018) (Easterbrook, J.) (Star), the Seventh Circuit affirmed Illinois’ statutory scheme to support its nuclear power generators, holding it was not preempted by the FPA. Two weeks later, the Second Circuit affirmed a similar regulatory regime in New York as likewise not preempted by FPA. See Coalition for Competitive Electricity, Dynergy, Inc. v. Zibelman, 906 F.3d 41 (2d Cir. 2018) (Zibelman).
The US Supreme Court recently interpreted federal preemption claims under the FPA in Hughes v. Talen Energy Marketing, LLC, 136 S. Ct. 1288 (2016) (Hughes). Applying Hughes, the Star and Zibelman decisions provide a clear road map for state energy programs, as they navigate to avoid federal preemption. Specifically, the Star and Zibelman decisions reveal the boundaries that state programs must comply with in order to be “untethered” to the federal wholesale energy markets.
The Nuclear Electric Power Generation Crisis and Illinois’ and New York’s Responses
Nuclear electric power generators serve the baseload for electricity usage. Baseload power plants typically are slow to turn on, slow to turn off, and run continuously at full output, regardless of the market price. Baseload plants, such as nuclear power plants, offer stability and certainty to the electric energy supply. Nuclear power plants have the added benefit of not emitting air pollution, and thus generate electricity with zero emissions.
The existing in-state nuclear power generators in Illinois and New York provided credible evidence that they were no longer economically viable unless they received state subsidies to stay financially afloat. The Illinois General Assembly created a zero emission credit program in its Future Energy Jobs Act, amending the Illinois Power Agency Act. See 20 ILCS 3855/1-1. The state statute created a new commodity, the zero emission credit, or ZEC, representing the environmental attributes of one megawatt hour of energy produced from a zero emission facility. 20 ILCS 3855/1-10. Electric retail suppliers were required to purchase ZECs in relation to their sales. The ZEC price was set at the “social cost of carbon” with the possibility to be reduced by a market price index. Within Illinois, two nuclear power plants were authorized to issue ZECs, essentially providing the selected nuclear power plants with a subsidy for each megawatt hour of electricity produced.
Using existing statutory authority, the New York Public Service Commission (NY PSC) created a comparable ZEC program to further the goal of New York’s broad statutory mission to reduce greenhouse gas emissions statewide, through its Clean Energy Standard (CES) Order. The NY PSC then determined that three in-state nuclear power plants qualified for the program. Similar to the Illinois statutory scheme, the NY ZEC program compensated nuclear electric power generators for the environmental attributes of their electric production. The NY ZEC program also based its ZEC price on the “social cost of carbon” but locked in the price for two-year periods, and adjustments to the ZEC price were based on complicated energy demand and future price forecasts.
Preemption Challenge, Hughes v. Talen Energy and the Law of “Tethering”
Competing electric power generators and consumer groups challenged the state ZEC programs as preempted by the FPA. The FPA charges the Federal Energy Regulatory Commission (FERC) with the obligation to ensure that all rates and charges for the transmission or sale of electric energy in interstate commerce are just and reasonable. 16 U.S.C. § 824d(a). In most of the country, FERC uses regional energy auctions to ensure just and reasonable rates. Under the FPA, the states “regulate retail electricity sales, local distribution plus facilities used to generate power.” Star, 904 F.3d at 522-23, citing 16 U.S.C. § 824(b). “This allocation leads to conflict, because what states do in the exercise of their powers affects interstate sales, just as what the FERC does in the exercise of its powers affects the need for and economic feasibility of plants over which the states possess authority.” Star, 904 F.3d at 523.
The US Supreme Court has repeatedly served as umpire in these conflicts, with the most recent calls being made in Hughes. In Hughes, Maryland and New Jersey created programs designed to encourage the development of new electric power generation plants to meet specific shortfalls of electric generators’ capability in their respective states. As long as the new power generator participated in the federal regional energy markets, the Maryland and New Jersey programs guaranteed a set contract rate, offset by whatever the new power generator obtained in the federal energy market. The supply of energy would increase, prices would be reduced, and the new power generator would be indifferent to the market price because of the guaranteed contract price.
The Hughes Court held that the state programs were preempted because they directly interfered with the federal energy markets. Specifically, the Hughes Court determined that the programs effectively established the market rate for the federal regional energy market, and thus interfered with FERC’s statutory obligation to ensure just and reasonable rates. However, the Hughes Court wrapped up its decision with a significant recognition of state authority:
Our holding is limited: . . . 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.” . . . So long as a State does not condition payment of funds on capacity clearing the auction, the State’s program would not suffer from the fatal defect that renders Maryland’s program unacceptable.
136 S. Ct. at 1299. The open question remained as to what measures were deemed “untethered” for purposes of federal preemption challenges to state energy programs.
Untethered: Direct Connection versus Indirect Effect
The Star and Zibelman courts interpret Hughes by taking the holding at face value, namely as long as the program does not require direct participation in the federal energy markets, or require “payment of funds” at a federal energy auction, a state program is not preempted. The Seventh Circuit concisely sums up Hughes as drawing “a line between state laws whose effect depends on a utility’s participation in an interstate auction (forbidden) and state laws that do not so depend but that may affect auctions (allowed).” Star, 904 F.3d at 523.
The Seventh Circuit noted that the energy producer was not required to sell its energy in the federal energy markets, and the value of the Illinois ZEC did not vary with a power producer’s bid into the federal energy markets. Star, 904 F.3d at 523. Reassured that FERC had submitted an amicus brief indicating that the ZEC program did not interfere with FERC markets, the Seventh Circuit deferred to FERC and future judicial review to address any adverse impacts on FERC markets. Star, 904 F.3d at 524.
Because the NY ZEC program did not require participation in the federal auctions, and purchased environmental attributes, rather than the energy or capacity, the Second Circuit held that “New York has kept the line in sight, and gone as near as can be without crossing it.” Zibelman, 906 F.3d at 54. The NY ZEC sales were separate from wholesale energy sales. The Zibelman court also narrowed the “tether” requirement to only participation in the wholesale energy markets, and not linkage to wholesale prices. Id., 906 F.3d at 51.
The Star and Zibelman courts both rejected plaintiffs’ arguments that by “increasing” the amount of supply, the ZEC programs depressed the federal energy market prices, and thus were preempted. As the Third Circuit held, “the law of supply-and-demand is not the law of preemption.” PPL Energyplus, LLC v. Solomon, 766 F.3d 241 (3d Cir. 2014), cert. denied, 136 S. Ct. 1728 (2016). So for both courts, the “incidental effect” on energy prices of maintaining existing resources was insufficient to support a preemption finding.
Successfully Threading the Needle
How Illinois and New York designed their ZEC programs provides guidance for future state programs. First, the programs did not require any participation with the regional markets. There was no linkage with the federal markets, and the programs were not tethered in any fashion to the federal market. Next, the ZEC programs were not buying energy or capacity, but rather were purchasing one of the sticks in the bundle of property rights, the environmental attributes. Further, the ZEC prices are constant and did not vary depending upon sales by a particular electric generator. Periodic price adjustments were based upon forecasts of future prices, rather than current prices. Finally, FERC weighed in and said that the programs did not violate the parameters of the FPA. By carefully tailoring state programs, New York and Illinois saved their nuclear plants and helped establish judicial guideposts for similar programs in the future.