How the Electricity World has Changed

Demand Response and the Story of this Clean Energy Resource

By: Michael Panfil, Attorney, EDF Clean Energy Program

In the very near future (maybe even as early as even next week), the U.S. Supreme Court will decide whether or not to hear a case known as EPSA v. FERC. Hidden within these dueling acronyms is a vitally important resource known as demand response. Although few people even know this tool exists, it invisibly benefits the life of many Americans.

Simply put, demand response is an innovative tool that rewards people who use less electricity during times of peak, or high, energy demand. Our current system largely balances energy demand and supply with fossil fuel power plants, so greater demand has traditionally been met with more power plants coming online. Demand response instead approaches this balance from the demand side (hence the name): it reduces or delays unessential demand, resulting in cleaner, cheaper electricity.

This may sound simple, but in a world where the arrow has pointed in one direction for over 100 years (from energy provider to user), saying it is a change from business as usual would be an understatement. Moreover, demand response is part of a greater paradigm shift already underway, one in which the energy industry as we know it is transforming, powered by new technology and resulting in lower electricity bills, a smarter electric grid, and reduced carbon emissions.

As a result, demand response and a court case involving the clean energy resource, EPSA v. FERC, have been the subject of much debate over the past year — a story that would be difficult to tell without beginning at the Federal Energy Regulatory Commission (“FERC”), the agency tasked with ensuring our nation’s energy grid stays up and running.

The agency behind the curtain

The Federal Energy Regulatory Commission (FERC) sits in a nondescript building on a nondescript street in the heart of the Washington, D.C. Until recently, the interior could be described as a good match for the exterior — for many years, FERC was seen as a quiet agency, housing technocrats fulfilling a vital but little-known government function.

As the name may suggest, FERC’s job is to regulate wholesale electricity markets. This means regulating electricity in concert with state agencies and in cooperation with utility companies, ‘regional transmission authorities,’ and other entities to ensure light appears at the flick of a switch and the air conditioner turns on at the press of a button.

But the ease at which power flows hides the enormous complexity and challenge of this function. As the Smithsonian and many others have put it, the electric grid remains the “largest machine ever built” and stands as “one of the greatest achievements of the 20th century.” Understandably, regulating such a machine involves an enormous number of moving pieces.

FERC has a mission statement and mandate from Congress, with one rule above all else: to ensure people, at all times, day or night, have power at ‘just and reasonable’ rates. To put it simply, electric reliability at prices people can afford.

But unlike other commodities, the supply of electricity is not so easy to ensure. The reason is embedded in and spurred by two truths of electricity: first, electricity cannot (in any large measure) be stored; and second, electrical supply and demand must be balanced at all times or the grid may go down, leaving people without power. Electricity cannot be stocked on shelves like a typical commodity, and that means supply and demand for electricity are far more real-time than in most markets. With millions of people using energy at all hours, it’s almost unfathomably complicated to ensure they get it.

Which brings us back to FERC.

Perhaps this vital agency was once a quiet one; after all, only if the lights stopped working would there be reason to draw back the curtain and ask who, exactly, is in charge. For FERC’s economists, grid planners, and attorneys, success equaled affordable reliability, and affordable reliability equaled relative anonymity.

Utilities and natural monopolies

In 1881, long before FERC or the electric grid as we know it, Samuel Insull moved to the United States from England, taking the job of Thomas Edison’s personal secretary. He quickly moved on to more ambitious pursuits, co-founding Edison General Electric (now General Electric Company), and becoming president of one of the first electric utilities, Chicago Edison Light Company. Insull charged ahead with steadfast determination, creating a public utility empire built upon a belief that electricity could only be reliable, cheap, profitable, and extensive if done at enormous scale.

He was not wrong — unlike most other commodities, where competition tends to drive down cost, electricity lends itself in many ways to a natural monopoly. For instance, few would ever call for multiple companies installing multiple wires in parallel. Likewise, large centers of power production tended to be more efficient than many smaller power plants.

Insull’s vision largely succeeded — his belief in economies of scale took root in the United States and still prevails in most of the country. Over time, power plants became bigger, more efficient, and less costly to operate, and that was more or less the extent of change in the industry. That is, until recently.

A changing landscape

Reliability has been a critical benchmark for success since the first electric utility sprang to life over 100 years ago. It’s not hard to see why, nor is it the wrong benchmark: life where electricity cannot be counted on would be vastly different than what our country has become accustomed to.

But technological advances are creating new opportunities and pressures for the electricity sector, and customers are demanding it offer more than just reliability. The advent of the internet has enhanced and increased energy’s communication and data capability, expressed most recently through the proliferation of ‘smart grid’ technology like smart meters and home energy management apps. But the smart grid is not defined by its parts or pieces; instead, it is defined by its ability to provide two-way communication and information once thought impossible.

Take, for example, a blackout in two scenarios: one in a traditional grid, the other in a smart grid. By and large, when blackouts occur on a traditional grid, utilities have no way to independently discover where and when they occur. A far more rudimentary method is employed: the utility simply waits for its customers to call and report they are without power. On the other hand, a smart grid affords utilities the ability to wirelessly identify the source of an outage and the geographic spread of a blackout.

The same innovation and technology that has driven us toward the ‘smart grid’ has introduced an opportunity to completely redesign and transform our electricity system. Electric reliability is no longer achieved only by building more power plants. Players in the energy sphere are discussing ways to use technology to make the system more efficient, provide cheaper electricity, and reduce the sector’s carbon footprint — all while ensuring reliability. Instead of allowing utilities to operate as natural monopolies with little competition to speak of, the new market will enable innovative entrants and resources to play.

New ideas, new orders

It was 2006 when Jon Wellinghoff first arrived at FERC, elected as one of the agency’s nine Commissioners. He arrived with a wealth of experience: 30 years of work in energy policy, degrees in mathematics and law, and Nevada electricity laws bearing his fingerprints. Three years later, he was named to the agency’s top position, FERC Chairman. However, it wasn’t his experience or background that would distinguish Wellinghoff’s tenure at FERC, but his recognition of and efforts within this changing landscape.

Wellinghoff also led the effort to establish Order 745.

Generally speaking, FERC Orders are clear in purpose: they provide directives to fulfill the agency’s basic mission of providing reliable electricity at ‘just and reasonable’ prices. In many ways, Order 745 was Wellinghoff’s capstone achievement at FERC — an order based on well-established FERC tenets but applied to a novel type of electricity resource: demand response.

The name ‘demand response’ — which would surely raise eyebrows at a PR firm — doesn’t do much to convey meaning or do justice to the importance of the concept it represents. To understand demand response and its importance, recall the two truths of electricity: electricity cannot, in any large measure, be stored, and electrical supply and demand must be balanced at all times. Now, imagine a seesaw: on one end is the electric supply, the other electric demand. The two ends must stay in balance to ensure the grid itself does not go down and leave customers without electricity.

Typically, balance is achieved in the most obvious way conceivable. When demand increases (for example, when many customers turn on air conditioning units on a hot day), grid operators turn on new supply to maintain the balance.

Demand response achieves balance differently. When the demand increases, grid operators turn off demand elsewhere, such as elevators that are going unused but still drawing electric power. The resulting balance is the same, but it’s achieved without the environmental or cost implications of turning on more power plants.

Wellinghoff seized on this low-cost, environmentally-friendly, and efficient way to balance the electric grid. FERC Order 745 requires that demand response receive the same payment as other energy resources in ‘wholesale energy markets’ (one of several types of regional electricity markets that exist) so long as it provides the same benefit, essentially creating a level playing field between conserved electricity and generated electricity. The concept followed long-standing FERC principles that electricity be ‘reliable’ and provided at ‘just and reasonable’ prices. Yet it delivered on these principles in a more efficient, sustainable, and cost-effective way.

If anything, demand response worked too well. In 2013, for example, demand response reduced electricity costs to customers by over $11 billion dollars in only the mid-Atlantic region of the U.S. Although each dollar saved by customers furthered FERC’s mission, it naturally provoked inquiring eyes by longstanding and entrenched interests in the field, interests that had never dealt with competition like this.

The old guard

Insull’s vision helped usher in the era of electricity, but came at a cost: electricity would be provided by monopoly industries. To this day, many utilities slash the United States into fiefdom-like service areas, each of which is serviced by one utility. In some states, new laws have changed to allow more freedom in choosing where electricity comes from, introducing competition in energy but not in the transport of that energy. However, the utility world remains ripe for protectionism.

To balance this inherent vice, states have public utility commissions to ensure utilities operate fairly. To accomplish this, Commissions have access to utility information to the extent that would make auditors blush. Each and every action taken by a utility can be reviewed, from large purchases to customer service satisfaction records.

Utilities are additionally constrained in how they can charge customers, but in many parts of the United States can themselves purchase power in competitive marketplaces. It’s half-monopoly, half-market, with customers receiving monopoly treatment and utilities able to purchase power at competitive prices. To reconcile these two models of business, Commissions limit the profit that a utility can make, but ensure that costs paid by the utility are paid back in full.

The benefit of the model is clear: utility companies cannot create enormous profit margins on the backs of customers that have no alternatives. The downside is likewise crystal: utility companies have little reason to become more competitive — building the same thing for cheaper only results in less revenue. This trade-off between limiting abuse of power at the cost of innovation and efficient behavior has been the economic rule of the road for a century. It was this world, a melting pot of competition and monopoly, that fledging demand response companies entered.

The young guns

Most industries do allow for and encourage competition. For example, a grocer will aim to make the biggest profit possible by charging whatever the market will pay and concurrently reducing his own production costs. When sales slide or a second grocer opens across the street, he is pressured to lower prices.

However, competition is a relatively novel ideology in the electric industry, and one that many were unaccustomed to until relatively recently. And it was in this changing landscape that Order 745 allowed new companies selling demand response to compete with fossil fuels in the electricity marketplace by receiving comparable compensation. Given that demand response, by and large, is cheaper to produce than generating power, this gave demand response companies a competitive edge. And like any competitive company, demand response companies acted accordingly. They cut their prices.

As one of the largest utility companies in the U.S. put it, demand response was taking revenue that was rightfully theirs. It’s a view that makes little sense in a traditional market — no company has a ‘right’ to customer’s money. But in the electric industry, ‘if I build it, they must buy it’ is a relative norm. In the minds of many established electric industry players, demand response was a threat that must be stopped.

Demand response litigation

The Electric Power Supply Association (EPSA) brands itself as a trade association representing over 480 power plants in over 40 states and the District of Columbia. It is not a small number. EPSA’s website notes, front and center, that “competition will continue to be one of the dominant issues facing the electric power industry.” It goes on to note that EPSA “represents companies that understand what it means to compete.” It’s a reference to the earlier mentioned fact that particular types of competition are allowed in some instances, most notably when energy is sold from a generator to a utility, whose job is to distribute that electricity to customers. However, this view confines competition to only particular interests and instances — and sees anything outside well-established entities as unwarranted intruders, not competition.

In 2012, EPSA filed suit against FERC, alleging that Order 745 should be invalidated and demand response not be allowed to compete in the electric sector.

Demand response in the market

Wellinghoff’s work had paid off. Demand response had become emblematic of the very changes that allowed for its growth. It was innovative, using the latest technology, with companies like Google and Walmart taking part. It was also cheaper, so much so that the most expensive sources of electricity were no longer needed. And it was environmentally sound — especially compared to the most expensive sources of electricity, which tend to come from the very dirtiest power plants in the United States.

EPSA had little chance of winning a court battle on the grounds demand response wasn’t competitive. Cries from companies that the lower cost was inhibiting their ability to charge their customers higher amounts for their goods rang hollow.

FERC, Wellinghoff, and Order 745 were not only disrupting the industry, they were helping transform it into something better. But they weren’t alone. Many old guard utilities and companies were changing too, becoming more nimble and offering demand response and other cost-saving innovations. Soon, EPSA began to look more like a trade association representing only those in the industry unwilling or unable to change.

And so, EPSA needed to chart a different course. Instead of arguing demand response wasn’t working as intended, it instead insisted FERC and Wellinghoff didn’t have the authority to enact the order in the first place. And on this basis the D.C. Circuit Court of the United States — the second highest court in the nation when agency actions are concerned — agreed to hear EPSA’s arguments.

Demand response litigation redux

In many ways, EPSA’s legal strategy was equally ingenious and indefensible. It argued, in essence, that FERC was mandated only to ensure electric reliability at just and reasonable prices. Like any federal agency, FERC’s mandate only applies to interstate actions, which includes electricity — a regional product that will not stop flowing simply because of boundaries drawn on a map. EPSA argued, however, that electricity was about providing supply to the system to meet demand. In other words, FERC can only regulate actions that related to meeting demand, not reducing it. That, EPSA claimed, is a state issue and off limits to federal agencies.

Of course, their argument minimized a few important aspects of the Order. Little was said of its express grant to states, which gave them the right to decide against allowing in-state companies to take part in demand response. Little was said of the Order’s recognition that it would only apply at the interstate level to electricity bought and sold regionally in one particular market — an area where the federal, not state, government has authority. And little was said of the many states that welcomed the Order with open arms. It was reducing electricity bills for their residents, after all.

For these reasons, many believed EPSA’s argument would fail. Although demand response was new and different than traditional generation, it could be (and was being) governed by well-established law. Yet that reasoning did not win the day on May 23, 2014, when the D.C. Circuit Court of the United States ruled against FERC, invalidating Order 745 in a 2–1 decision. EPSA won. Demand response lost.

As energy law professor Sharon Jacobs put it, the judge voting against the majority “offered a well-reasoned and ultimately more persuasive dissent.” Others, such as attorney and Foley Hoag partner, Seth Jaffe, were more blunt: “Frankly, I don’t buy it.”

The dissenting judge perhaps summed up the general sentiment best:

“[t]he unfortunate consequence is that a promising rule of national significance — promulgated by the agency that has been authorized by Congress to address the matters in issue — is laid aside on grounds that I think are inconsistent with the statute, at odds with applicable precedent, and impossible to square with our limited scope of review.”

In the decorum-filled world of the judiciary, these words were about as biting as they come.

The immediate aftermath of the court’s decision

The market reacted immediately to the court’s decision, as did interested parties. Stock prices of some demand response companies plummeted 50 percent. FERC asked the D.C. Circuit Court for en banc review — a rehearing of the case by all eleven judges rather than only three.

FERC additionally requested and received grant from the court that the decision would not take hold until it was final. It’s an important distinction — with this, Order 745 would remain in effect until the case was completely closed. To reach that point, the case would need to reach the Supreme Court where it would either be heard or denied.

The following months were not kind to Order 745. By September 2014, the D.C. Circuit Court denied en banc review. Although the decision to conduct this review is rare, it represented the next best hope for the Order’s survival. With that possibility dead, it left only a review by the Supreme Court.

Electric markets were also beginning to feel the impact. The largest energy market in the world, PJM, published an October report outlining the variety of issues created in light of the decision. It noted the uncertainty created in a world where certainty is necessary to determine how much electricity will be needed one, two, and even ten years in the future. In later documents, PJM expanded its analysis, stating that without Order 745 (or a mechanism to allow for demand response), consumers would face “over-procurement and substantially higher prices.” In response, PJM created a stop-gap proposal, but was quick to note it “does not contend that the ‘stop-gap’ rules it proposes…are superior to the current” rules under Order 745. And for good reason — roughly 70 percent of demand response comes from private companies that would be barred direct access to the regional marketplace without Order 745.

Some members of the old guard, on the other hand, rejoiced. FirstEnergy, one of the largest utility owners in the country, went on the offensive, insisting demand response immediately be removed from energy markets and previous payments refunded. It suggested that the court decision should be expanded to other regional markets, something never suggested in Order 745 or the court decision. The company’s incentive was clear. If demand response suddenly disappeared, energy demand would be far greater. In turn, the need for carbon-emitting power plants would seem far more pressing, and traditional generators would be more than happy to provide it.

As PJM put it, accepting the “relief FirstEnergy seeks is not just and reasonable, and would be extremely damaging to the market certainty that is critical to sustaining investment in electricity infrastructure.”

Dust settles, at least a bit

FERC knew it had to act. Order 745 helped fairly compensate demand response and showcase its value. Legal threats to FERC’s authority was damaging not only to the Order, but to FERC’s very ability to carry out its function and purpose. Demand response is too valuable to ever disappear or stop growing — with or without Order 745 — but FERC’s authority to act, even in this narrow instance, was being compromised. In the late months of 2014, the agency coalesced around the prospect of asking the Supreme Court to hear the case.

This step, known as seeking certiorari, is not taken lightly by a federal agency. Not only must it believe the D.C. Circuit decided incorrectly, but that the incorrect decision has immense and significant national implications. A federal agency must also gain approval from the Office of the Solicitor General, which argues all cases before the Supreme Court on behalf of the federal government and must be convinced the Court would likely grant a review.

Despite the uphill battle, there were reasons to hope the Solicitor General would bring the case. The issue is certainly one of national significance — a federal agency’s power had been tested and a resource saving Americans money was under attack. And in December 2014, White House Counselor John Podesta said “[w]e think this is a very significant and mistaken decision and we’re hopeful that in time we can see it reversed.”

On January 15, 2015, the Solicitor General granted FERC’s request and officially filed for cert., formally asking the Supreme Court to hear and reverse the D.C. Circuit Court’s decision and restore Order 745.

Over the following months, support for FERC poured in. A coalition of 12 environmental and consumer groups jointly filed in support of Order 745. A number of demand response companies followed suit, as did a coalition of states, including Pennsylvania, California, and Maryland. In a telling move about EPSA’s stature within its own industry, the utility NRG — the largest member of EPSA by megawatts — likewise filed in support of FERC.

Not a single brief in support of EPSA was filed.

The road ahead

Predicting what cases the Supreme Court may take is a fool’s errand. Analysts can point to how rarely a FERC case brought by the Solicitor General has been heard by the Court — the last was 25 years ago. Others may point to the increased likelihood of cases being heard when brought by the Solicitor General.

What is known, however, is that demand response will continue to grow, regardless of the decision, due to its vital role in reducing costs, mitigating air pollutants from fossil fuel power plants, and supporting grid efficiency. And, it’s certain that if the Supreme Court decides to take the case, many advocates will again support FERC and Order 745. It is an issue that supporters of the free market, environment, and low electricity bills can rally behind and one of those rare points on which most states and federal entities agree.

And as for Wellinghoff’s take on the road ahead? Ever the optimist, he sees a bright future for demand response if the case is heard.

“If the Supreme Court takes this case, we’re going to win. We will win this hands down.”

Image source: John Rae

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