White Paper: Commissioner James Danly on the Requirement that Competitive Markets be Protected from the Exercise of Market Power Applied to RTO Capacity Markets

SECOND SUPPLEMENT (July 15, 2021)

On May 20, 2021, our office issued a White Paper explaining why, under the law, RTO capacity markets cannot produce just and reasonable rates absent mechanisms that protect the market against the exercise of both seller-side and buyer-side market power, including buyer-side market power exercised by the states.  We have received a great deal of feedback from many stakeholders and sincerely appreciate the engagement. 

We issued a supplement to our White Paper on June 17, 2021 to address comments we received asserting that state action to subsidize resources cannot constitute the exercise of buyer-side market power because the states are not acting as buyers of power.  As we explained, however state support of resources is characterized, when such support distorts capacity market prices, it must be mitigated in order for the capacity market price to be just and reasonable.

We issue this second supplement to address a different comment we have received: that the Commission is barred from mitigating the effects of state support for certain resources on RTO capacity markets under Federal Power Act (FPA) section 201(b)(1), which provides that the Commission has no jurisdiction over “facilities used for the generation of electric energy.”[1]  As we explain below, this statutory limit on the Commission’s jurisdiction does not prevent the Commission from acting to mitigate market-distorting state support of generation resources to ensure that the rates produced by FERC-jurisdictional wholesale markets are just and reasonable.

We are interested in hearing reactions to this supplement.  Please contact Matt Estes at matthew.estes@ferc.gov if you would like to discuss this further.

1. FPA SECTION 201(b)(1)

As an initial matter, it is important to consider FPA section 201(b)(1) in its entirety:

The provisions of this subchapter shall apply to the transmission of electric energy in interstate commerce and to the sale of electric energy at wholesale in interstate commerce, but except as provided in paragraph (2) shall not apply to any other sale of electric energy or deprive a State or State commission of its lawful authority now exercised over the exportation of hydroelectric energy which is transmitted across a State line.  The Commission shall have jurisdiction over all facilities for such transmission or sale of electric energy, but shall not have jurisdiction, except as specifically provided in this subchapter and subchapter III of this chapter, over facilities used for the generation of electric energy or over facilities used in local distribution or only for the transmission of electric energy in intrastate commerce, or over facilities for the transmission of electric energy consumed wholly by the transmitter.[2]

Although section 201(b)(1) does not give the Commission jurisdiction over facilities used for the generation of electricity, section 201(b)(1) does give the Commission jurisdiction—held by the courts to be exclusive[3]—over the wholesale sale of electricity generated by such facilities.  And under FPA section 206(a), the Commission is charged with ensuring that “any rate, charge, or classification, demanded, observed, charged, or collected by any public utility for any . . . sale subject to the jurisdiction of the Commission, or . . . any rule, regulation, practice, or contract affecting such rate, charge, or classification” is just and reasonable.[4]  The Commission’s jurisdiction over rates, rules, regulations, and practices affecting wholesale sales of electricity gives the Commission extensive authority over the sales and operations of generation facilities even if it does not have jurisdiction over the facilities themselves. 

In this regard, FPA section 201(a) provides that “Federal regulation of matters relating to generation to the extent provided in this subchapter and subchapter III of this chapter . . . is necessary in the public interest.”[5]  The Conference Report on the FPA explains that this language was “added to remove any doubt as to the Commission’s jurisdiction over facilities used for the generation . . . of electric energy to the extent provided in other sections.”[6]  The statutory language and Conference Report confirm that Congress understood the jurisdiction it granted the Commission over wholesale rates necessarily would affect generation facilities and Congress nevertheless believed that the Commission’s rate regulation affecting generation is in the public interest.

The case law addressing the division of jurisdiction between the Commission and the states likewise confirms that the Commission’s lack of jurisdiction over generation facilities does not prevent the Commission from regulating rates in a way that affects state determinations as to the need for generation capacity and/or state choices regarding the generation capacity used to serve customers.

This is best illustrated by the litigation over the allocation of the costs of the Grand Gulf nuclear plant (Grand Gulf) among the various utilities in the Middle South Utilities (MSU) holding company system (now Entergy).  Grand Gulf was subject to cost overruns that caused it to be the most expensive generation facility on the MSU system and, as Grand Gulf was being constructed, it became clear that MSU’s demand growth was much lower than expected.  Consequently, it was not clear that the Grand Gulf capacity was needed at the time it was placed in service.  The Commission conducted two separate hearings to address how the costs of Grand Gulf should be allocated among the various states in which the MSU utilities are located and, at the conclusion of the hearings, the Commission issued an order allocating more of the costs of Grand Gulf to Arkansas and Mississippi than the utility commissions in those states asserted was warranted.[7]

On appeal, the United States Court of Appeals for the District of Columbia Circuit (D.C. Circuit) upheld the Commission’s rulings against a number of attacks, including the argument that the Commission had no jurisdiction under FPA section 201(b)(1) to allocate the costs of Grand Gulf.[8]  The D.C. Circuit held that “FERC has not exercised jurisdiction over generating facilities in any way that violates the FPA.”[9]  This was because “the Commission is acting pursuant to its exclusive rate authority over wholesale transactions and its remedial authority as set forth in sections 205 and 206.”[10]  As the court explained:

FERC has not regulated a facility, but rather the wholesale rates of interstate sales within the MSU system.  It is well-accepted that FERC must allow the recovery of the cost of generating facilities in setting wholesale rates.  Here, FERC has simply exercised its undisputed authority over the wholesale rates of electric generating facilities in interstate commerce, which includes, under the facts presented, the authority to reallocate the costs of Grand Gulf across the system.  As the statute quite plainly states, FERC’s control here is exclusive.  The jurisdictional line drawn by Congress is bright, and FERC stands on the correct side of that line.[11]

Subsequent to this decision, the Supreme Court ruled that the State of Mississippi could not defeat FERC’s allocation by prohibiting the recovery in Mississippi retail rates of Grand Gulf costs allocated by the Commission to Mississippi pursuant to the Commission’s jurisdiction over wholesale rates.[12]  Earlier, the Supreme Court had rejected a similar effort by the state of North Carolina to allocate low-cost hydro power differently in retail rates than the Commission had allocated in a wholesale rate order.[13]  These decisions did not directly rule on the question of the Commission’s jurisdiction under FPA section 201(b)(1), but by holding that the Commission’s wholesale allocations of generation capacity preempts contrary state retail allocations, the Supreme Court implicitly recognized that the Commission’s allocation of generation capacity in a manner contrary to the directives of the states does not exceed the Commission’s jurisdiction under section 201(b)(1).

In a more recent case, the D.C. Circuit rejected a challenge by the Connecticut Department of Public Utility Control (“Connecticut DPUC”) to the Commission’s jurisdiction to approve a requirement imposed by ISO-New England that utilities must obtain specific amounts of capacity and pay a deficiency charge when the amount of capacity obtained by the utilities fell below the required amount by a certain quantity.[14]  The Connecticut DPUC argued that any increase in the capacity requirement mandated by ISO-New England amounted to a requirement that utilities install new capacity, and therefore the Commission’s approval of this requirement violated the limitation on its jurisdiction imposed under FPA section 201(b)(1).[15] 

The court rejected the Connecticut DPUC’s claim that the Commission’s approval of the capacity requirement imposed by ISO-New England amounted to direct regulation of generation facilities.  First, ISO-New England’s tariff did not require the installation of additional capacity at all.  Instead, the tariff set a peak demand estimate, and employed market forces to locate a price at which market incentives were sufficient to meet that demand.[16]  State and local authorities retained control over their power plants without interference from FERC.  The tariff required only that states shoulder the economic consequences of their choices.[17]  Consequently, the court found that the Commission was not attempting to impose a capacity requirement but was instead merely seeking to:

[E]nsure that the capacity charges actually imposed by ISO-NE are fair to suppliers and consumers.  That reasonable concerns about system adequacy might factor into the fairness of those charges is precisely what brings them within the heartland of [FERC’s] . . . jurisdiction.”[18]

These cases illustrate that the limitation on the Commission’s jurisdiction in section 201(b)(1) does not prevent the Commission from regulating wholesale rates in a way that affects generation facilities, including effects on the amount and cost of generation acquired by a utility.  Rather, section 201(b)(1) prohibits only the direct regulation of generation facilities by the Commission unrelated to the regulation of wholesale rates.

2. THE COURTS HAVE HELD THAT THE COMMISSION HAS JURISDICTION TO APPLY MITIGATION TO STATE-SUPPORTED GENERATION FACILITIES

Although the cases generally describing the bounds of the Commission’s jurisdiction under FPA section 201(b)(1) are instructive, there is no need to extrapolate the holdings of those cases to the Commission’s application of mitigation (such as imposition of a minimum offer price rule (MOPR)) to capacity market offers submitted by state-supported resources.  The specific question of whether FPA section 201(b)(1) deprives the Commission of jurisdiction to impose such mitigation has been directly addressed by the courts.  Their decisions unambiguously confirm that section 201(b)(1) does not prohibit the Commission from requiring such mitigation.

In 2014, the United States Court of Appeals for the Third Circuit (Third Circuit) rejected New Jersey’s argument that the Commission was without jurisdiction to approve PJM’s application of its MOPR to state-supported generation resources.[19]  New Jersey argued that “by eliminating the state-mandated exemption, FERC effectively attempts to substitute its own power supply preferences for those of the states and LSEs in violation of § 201 of the FPA, which provides that states retain authority over ‘facilities used for the generation of electric energy.’”[20]  New Jersey further asserted that application of the MOPR to state-supported resources was different from the ISO-New England deficiency charge upheld by the D.C. Circuit in Connecticut DPUC.  According to New Jersey, “in that case, FERC ‘did not seek to dictate which resources LSEs used to fulfill their capacity obligations,’ . . . while here, FERC is preventing New Jersey from using the resources it has chosen to promote.”[21]

The Third Circuit rejected New Jersey’s arguments, relying on FPA section 201(b)(1)’s grant of jurisdiction to the Commission to regulate wholesale rates, and on the cases discussed in Section I above.

After reviewing the FERC Orders at issue here and the relevant case law, we conclude that FERC did not exceed its jurisdiction in eliminating the state-mandated provision.  Under the FPA, FERC has jurisdiction over rules affecting the rates of the transmission or sale of energy in interstate commerce.  See 16 U.S.C. § 824d.  Here, it is undisputed that New Jersey and Maryland’s plans to introduce thousands of megawatts of new capacity into the Base Residual Auction would have had an effect on the prices of wholesale electric capacity in interstate commerce.  See Mississippi Power & Light Co. v. Mississippi, 487 U.S. 354, 374, 108 S. Ct. 2428, 101 L.Ed.2d 322 (1988) (holding, among other things, that FERC had jurisdiction over power allocations that affect wholesale rates, and stating that “[s]tates may not regulate in areas where FERC has properly exercised its jurisdiction to determine just and reasonable wholesale rates or to insure that agreements affecting wholesale rates are reasonable.”) (emphasis added); Municipalities of Groton v. FERC, 587 F.2d 1296, 1302 (D.C. Cir. 1978) (rejecting jurisdictional challenge to FERC’s authority to levy deficiency charges on utilities that failed to procure generating capacity sufficient to meet its load requirements, and stating that, “[i]t is sufficient for jurisdictional purposes that the deficiency charge affects the fee that a participant pays for power and reserve service, irrespective of the objective underlying that charge.”).[22] 

With respect to New Jersey’s assertion that the Commission “is preventing New Jersey from using the resources it has chosen to promote,” the Third Circuit held that “FERC is doing no such thing.”[23]  As the court explained:

The states may use any resource they wish to secure the capacity they need.  The elimination of the state-mandated exemption means only that if the states wish to use a new generation resource to satisfy their capacity obligations required under the Reliability Pricing Model, the resource must clear the Base Residual Auction at or near its net cost of new entry.  Such a requirement ensures that the new resource is economical—i.e., that it is needed by the market—and ensures that its sponsor cannot exercise market power by introducing a new resource into the auction at a price that does not reflect its costs and that has the effect of lowering the auction clearing price.  Furthermore, even if the states’ preferred generation resources fail to clear the auction, the states are free to use them anyway; the only caveat is that the states cannot use the resources to offset their capacity obligations in the RPM, as such obligations can only be satisfied by resources that are demanded by the capacity market at a price reflecting their cost.  Thus, as in Connecticut Department of Utility Control, New Jersey and Maryland are free to make their own decisions regarding how to satisfy their capacity needs, but they “will appropriately bear the costs of [those] decision[s],” . . . including possibly having to pay twice for capacity.[24]

The D.C. Circuit reached the same conclusion later that same year in an appeal of ISO-New England’s buyer-side mitigation provisions.  The petitioners in that case similarly argued that “the orders serve to dictate which resources a utility must use to satisfy its capacity obligations, in violation of the FPA,” and that “FERC’s orders impermissibly determine the makeup of a state’s resource portfolio.”[25]  In response, the court held:

Out-of-market resources—whether self-supplied, state-sponsored, or otherwise—directly impact the price at which the Forward Capacity Market auction clears.  As the price of capacity is indisputably a matter within the Commission’s exclusive jurisdiction, FERC likewise has jurisdiction to mitigate buyer-side market power as to out-of-market entrants.  We agree with the Commission’s finding that it has jurisdiction over mitigation matters “affecting or relating to wholesale rates” under FPA § 201 and 206. Third Order ¶ 220 (emphasis omitted) (citing Conn. Dep’t of Pub. Util. Control, 569 F.3d at 478, 481).  We stress that FERC’s mitigation measures here do not entail direct regulation of facilities, a matter within the exclusive control of the states.  See 16 U.S.C. § 824(b)(1).  The Commission also found that uneconomic entry, regardless of resource and regardless of intent, “can produce unjust and unreasonable prices by artificially depressing capacity prices.”  Id. ¶ 170.  As it is FERC’s statutory obligation to ensure that rates are appropriate, we must respect its decision to maintain just and reasonable rates through curbing or mitigating buyer-side market power.[26]

The D.C. Circuit also rejected the arguments that, in approving the MOPR, the Commission was impermissibly dictating the states’ choice of generation resources on essentially the same grounds as the Third Circuit.  The court explained that “states remain free to subsidize the construction of new generators, and load serving entities to build or contract for any self-supply they believe is necessary.”[27]  Further, “this Court has already rejected in Connecticut Department of Public Utility Control the argument that the type of regulation at issue here constitutes ‘direct regulation of generation facilities.’”[28]

3. CONCLUSION

Under FPA section 201(b)(1), the Commission has no jurisdiction to directly regulate generation facilities.  However, the Commission does have jurisdiction, indeed it has the duty, to regulate wholesale rates in a manner that can affect generation facilities.[29]  And, as the courts have held, the Commission has jurisdiction to implement a MOPR or other mitigation to address the price distortive effects of state subsidies for certain types of generation resources.