Courts Back State Flexibility on Choice of Generation

Power regulation in the U.S. is split between the federal and state levels, with the Federal Energy Regulatory Commission (FERC) having jurisdiction over the wholesale sales of electricity and the states retaining jurisdiction over generation.

But as certain states seek to push back against the outcomes of federal regulation, the courts have established guideposts for abiding by this federal-state jurisdictional split. While the Supreme Court recently struck down a state program requiring generator participation in a FERC-regulated market, the Seventh Circuit and the Second Circuit have both since upheld state programs subsidizing nuclear generators based on their production (even if such subsidies would impact wholesale markets).

Jennifer Mersing

The circuit courts are allowing states to achieve indirectly what they are prevented from achieving directly. Under this precedent, as long as states are not mandating participation in FERC-regulated markets, the states maintain their flexibility to encourage generation of their choosing.

Several years ago, Maryland—unhappy with the outcomes of FERC-regulated PJM capacity auctions—sought to jump-start the construction of generation in the state by establishing a subsidy program that guaranteed selected generators a specified price if they cleared the FERC-regulated PJM capacity auction. In Hughes v. Talen Energy Marketing, LLC (Hughes), the Supreme Court struck down the program, finding it was preempted because Maryland was setting an interstate wholesale rate and thereby disregarding the FERC-approved wholesale rate. Though it invalidated the Maryland program, the Supreme Court narrowed the decision’s reach, explicitly noting it was not addressing the permissibility of various other measures states might use to encourage development of generation. According to the Supreme Court, “[s]o 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.”

ZEC Subsidy Programs

Illinois and New York took this guidance to heart and fashioned subsidy programs to support certain existing nuclear generators, selecting facilities to receive zero emissions credits (ZECs) for each megawatt-hour (MWh) of electricity produced. In Illinois, the price of a ZEC will decrease if an Illinois-set market-price index (based on the annual average energy prices in the PJM auction and two of the state’s regional energy markets) exceeds a certain level. In New York, the price of the ZEC is fixed for two-year periods and based on the federally determined social cost of carbon, as may be adjusted for renewable energy penetration and forecasted wholesale prices.

Unlike the Maryland program at issue in Hughes, both state subsidy programs do not require the selected facilities participate in a FERC-regulated capacity auction (although it is widely acknowledged the generators will likely be participating in such auctions).

In both Electric Power Supply Association v. Star and Coalition for Competitive Electricity, et al. v. Zibelman, et al., the Seventh Circuit and the Second Circuit upheld the Illinois and New York programs, respectively, each finding enough of a distinction between the Maryland program (which mandated participating in the PJM capacity auction) and the Illinois and New York programs (which did not mandate participation in a FERC-regulated capacity auction, even though continued participation in a capacity auction was the likely result of the subsidy programs).

According to the Seventh Circuit, the Supreme Court’s decision in Hughes “draws 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),” and the Illinois program came down on the right (that is, allowed) side of this line. As the Second Circuit noted, “New York has kept the line in sight, and gone as near as can be without crossing it.”

‘States Retain Authority’

While the Seventh Circuit acknowledged the Illinois subsidy program can affect the FERC-regulated capacity auction price, it concluded, “because states retain authority over power generation, a state policy that affects price only by increasing the quantity of power available for sale is not preempted by federal law.” According to the Second Circuit, even if the practical effect of the subsidy program is to exert downward pressure on wholesale electricity rates, this “incidental effect” does not justify preemption of a state generation subsidy program.

The courts focused on the means that Illinois and New York employed to implement their subsidy programs—not on the ends the states sought to achieve. With their narrow reading of the holding in Hughes, the court decisions maintain the ability of states to subsidize generation of their choosing (as long as such state subsidy only has indirect impacts on wholesale power markets).

But, even though the nuclear subsidy programs were upheld, nothing in the decisions prevents FERC from taking actions to mitigate the wholesale market impact of state generation subsidy programs. Thus, while states have flexibility to subsidize generation of their choosing, FERC has the corresponding flexibility to modify the wholesale market rules to counteract the pricing effects of such state subsidies. ■

Jennifer Mersing is an attorney in the Energy & Regulatory group at Stoel Rives LLP, where she focuses her practice on electric regulatory issues including FERC and certain state law matters.