Supreme Court Considers FERC 745: What’s At Stake for Demand Response

Last week the Supreme Court of the United States (SCOTUS) heard oral arguments over whether the Federal Energy Regulatory Commission (FERC) had jurisdiction to issue Order 745, which federally regulates demand response as a tool of the wholesale bulk power market, and whether the order was “capricious and arbitrary.”

Demand response refers to curtailing a participating customer’s electricity use in reaction to broader system conditions such as surging peak demand that threatens grid stability. These events are typically acute, happen only a defined maximum number of times per year, and customers are compensated for participating in such programs. For example, grid operators often call upon demand response during the hottest summer days when air conditioning use spikes grid demand.

Most demand response resources interact directly with the wholesale market (assuming they are in a region of the country with a wholesale market) in that they are dispatchable. This means that the customer is contractually obligated to reduce its electricity demand by some agreed amount if and when the system operator directs it to. In this way, from the perspective of the system operator, a demand response resource can be deployed much as a power plant, keeping electricity demand and supply in balance.

We should care about and support demand response for four reasons:

  1. It can reduce short-term electricity costs, by dispatching less-expensive demand response rather than more-expensive peaking power plant. This is likely the heart of the challenge—generators are losing money because customers are saving money, and demand response makes that possible.
  2. It can avoid the need for more investments in electricity generation, transmission, and distribution, resulting in a savings of perhaps $200 billion over the next 20 years.
  3. It can bring environmental benefits, such as reducing fossil-fuel consumption, avoiding running more-carbon-intensive peaking plants, and aiding the integration of more wind and solar power into the grid.
  4. It is the “tip of the spear” for customer and DER participation in providing grid services. If you believe, as RMI does, that the future of electricity will see customers as active participants at all levels of the electricity system, then the demand response industry—expected to hit $1.3 billion annually by 2024 globally—is one of the best examples of things to come.
Enter the Supreme Court

FERC, which is responsible for regulating wholesale electricity markets, issued Order 745 in 2011. That order contained rules governing how demand response should be compensated in wholesale electricity markets—rules that generally are seen as supporting more demand response resources competing in those markets.

Unsurprisingly, many incumbents in the electricity generation space were perfectly happy not to face new competition in the form of a more-robust demand response market in the U.S. They sued FERC, arguing that demand response was in essence a retail sale and thus not subject to FERC’s jurisdiction (the retail side of the electricity grid is the domain of each state and its respective public utilities commission), and questioning whether Order 745 was capricious and arbitrary.

A court of appeals sided with the incumbents in 2014 on a 2–1 vote, threatening the future of Order 745 and the country’s demand response market. FERC appealed that decision to SCOTUS, and last week saw oral arguments before the Court.

Predicting the Outcome

Trying to predict a SCOTUS ruling based on oral arguments in the case is an inexact science at best. The Court allows only one hour in total—for all sides—and typically the justices interrupt the parties freely to grill them with questions concerning hypothetical scenarios that might or might not be patently relevant. Justices have surprised us in the past and will do so again, so any prediction should be discounted accordingly.

That being said, Court observers generally expect Justices Breyer, Ginsburg, Kagan, and Sotomayor to side with FERC and Justices Roberts, Scalia, and Thomas to side against. That makes the count four to three in favor of FERC, with two justices remaining. Justice Alito has recused himself (the most likely reason would be holding a financial interest in one of the parties) from this case and thus will not participate. That leaves the typical swing vote on this version of the Court, Justice Kennedy.

This setup provides an opportunity to read the tea leaves.

If Justice Kennedy is inclined to side against FERC, then the count would be an even split of four to four. In such a case, the Court fails to reach a decision, the lower court’s ruling stands, and Order 745 is dead. More importantly for our ability to guess at the outcome, the Court typically announces such splits quickly following oral arguments, so we could hear of this outcome as soon as this week.

If we do not hear anything quickly, then we could infer that Justice Kennedy is not ready to side against FERC on the question of jurisdiction over demand response. The longer we hear nothing, the more likely we might think this to be the situation inside the Court.

However, the outcome would still be uncertain, because Justice Kennedy could go in a couple different directions. He could side completely in favor of FERC, making the vote five to three in favor of FERC’s jurisdiction and giving Order 745 full effect. A second possibility, however, is less of a clear victory for FERC. Justice Kennedy could join with the other four justices holding that FERC does have jurisdiction over demand response, but that FERC loses on the subsequent question of whether FERC’s adoption of Order 745 was “arbitrary and capricious.” This outcome would invalidate Order 745, but it also would allow FERC to return to the drawing board and craft a new order supporting demand response that could avoid whatever problem the Court would have described in its ruling.

Regardless of SCOTUS, a Role for Demand Flexibility

As noted above, demand response has important economic and environmental benefits, and a power system that incorporates demand response is preferable to one that does not. Allowing it to compete with generation is exactly the type of market innovation we should support as we build a sustainable electricity system (whether the particular design of Order 745 is optimal is another question and beyond the scope here).

All is not lost, however, if Order 745 dies at SCOTUS. Demand flexibility—distinct from demand response—remains an important grid capability, and if Order 745 goes down, it will represent a major opportunity to continue to harness demand-side solutions to reduce grid peaks. If the Court upholds Order 745, demand flexibility can take its place alongside demand response as an opportunity to shave off $13 billion per year in forecast grid investment.

Described in RMI’s recent report The Economics of Demand Flexibility, it uses retail grid price signals to incent customers to shift eligible flexible electricity loads (AC via smart thermostats, electric hot water, etc.) according to desirable outcomes, such as avoiding peak demand periods, shifting demand from high-cost to low-cost times, or aligning demand with renewables generation to aid their grid integration.

As such, demand response and demand flexibility both represent powerful demand-side grid operation capabilities that achieve similar effects, but they come at those outcomes from opposite ends of the grid. Demand response, as FERC contends, originates in the wholesale power market and ripples out to end-use customers at the distribution edge of the grid. Demand flexibility, on the other hand, begins with retail price signals at the distribution edge of the grid, with effects that flow upstream for the benefit of managing the bulk power system.

Order 745 a Canary in the Coalmine

The debate around FERC Order 745 might be a sign of things to come. As rooftop solar, smart thermostats, electric vehicles, and other behind-the-meter solutions scale their adoption across the U.S., the distinction between federally-regulated wholesale markets and state-regulated retail markets at the distribution edge of the grid will become increasingly muddy. As an integrated grid continues to evolve that more-seamlessly blends centralized and distributed assets and capabilities, Order 745 might prove itself in hindsight the first of many debates about who regulates what and how the electricity grid operates.

Already it’s clear that we’ll need increased coordination across federal, state, and local areas of jurisdiction. But for now, the eyes of the industry remain transfixed on SCOTUS and the outcome that could arrive as soon as this week or as late as next summer.